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Payment Fintechs Leave Their Mark On Small Business Lending

Power Forecast Briefing Discusses Improved Spark Spreads and Profitability Projections for ERCOT and PJM


Power Forecast Briefing: Fleet Transformation, Under-Powered Markets, and Green Energy in 2018

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Ondeck Now Open To Exploring Deals, CEO Says

Payment Fintechs Leave Their Mark On Small Business Lending

Aug. 28 2018 — Funding day-to-day operations is a persistent challenge for U.S. small businesses. A recent S&P Global Market Intelligence survey found that, over the past two years, small businesses in the U.S. sought lending primarily to finance working capital needs. Fintech companies are stepping up, and using innovative methods, to meet the demand.

Several fintech companies are using data from non-lending relationships to become larger providers of working capital. As these lenders integrate further into their customers' businesses, they will use their position to issue fast approvals and provide non-conventional loan products, chipping away at market share held by longstanding players, including banks.

Evolution of an old industry

Fintech companies in the payment space have become active lenders in recent years, using their access to clients' real-time cash flow data to provide them financing. While their offerings vary, a number of these newer lenders provide merchant cash advances, or MCAs, which establish a fixed total repayment amount and allow borrowers to determine what percentage of their card transaction volume to put toward their balance. The payment company deducts this percentage from every card transaction until the full amount is paid.

This effectively turns debt servicing into a variable cost that fluctuates based on the level of sales activity, though most lenders require some form of minimum payment amount.

PayPal Holdings Inc. and Square Inc., two of the largest companies in this sector, have used customer data to underwrite loans and make a splash in the marketplace, originating more than $5 billion in loans since 2015. In 2015, Bryant Park Capital LLC estimated the total annual origination volume for the MCA industry, which is composed of hundreds of lenders, at $10.7 billion.

This kind of practice is not new. Merchant cash advances blossomed in the early 2000s but the entrance of fintech companies arguably marks an evolution, in terms of company scale and technological sophistication, in an industry previously dominated by private specialty lenders. Incumbents such as Rapid Financial Services LLC and Strategic Funding Source, Inc. are sizeable competitors, but they do not offer the same range of services as payment companies, nor do they integrate into their customers' business processes in the same way.

Merchant cash advances have received negative attention in the past due to the high effective rates charged by lenders, with annual percentage rates often coming in the high double digits. Moreover, a period of better-than-expected revenue could actually increase the annualized yield paid by the borrower since the total payment amount is fixed. Given the onerous terms, most MCA providers targeted borrowers who could not obtain traditional financing or who simply needed cash very quickly.

Fintech companies will try to combat this narrative with the convenience of their service and, possibly, lower pricing. Paypal Working Capital, for instance, bases fees on an annual percentage rate that is significantly lower than many other legacy players in this sector.

Fintechs continue customer integration, but banks retain advantages

Integrations with small business software are not restricted to payment terminals. Several digital lenders link to borrowers' bookkeeping software, like Xero or Freshbooks, to ensconce themselves in the real-time flow of their customers' businesses. And just like in the payments space, some service providers are leveraging their existing relationships and data access to offer financing themselves. Intuit Inc.'s QuickBooks and competitor Zipbooks, two bookkeeping software providers, both offer working capital financing to eligible customers.

A number of national banks have taken notice of fintech companies moving into small-business lending and many have already launched projects to ease the process of funding working capital. Fundation Group LLC, a digital lending platform that offers customers fully automated online lending applications, has partnerships with regional institutions including Citizens Financial Group Inc. and Regions Financial Corp.

Banks still have some fundamental advantages, including access to cheaper funding than digital lenders. Any small business with the ability to qualify for a traditional bank loan would likely benefit from lower rates.

Trust also remains important to borrowers, and banks still seem to have the advantage there. Our survey shows 42.1% of respondents citing an existing relationship with another lender as a reason for not applying for a loan from a digital lender.

However, nearly 50% of borrowers cited unfamiliarity with digital lenders as a cause of their aversion, suggesting that marketing and customer education may be just as large a hurdle as bank loyalty.

As part of their marketing, many fintech lenders extol their ability to service customers through digital channels without using physical bank branches. Using their proximity to customer data, these fintechs have already become large players in niche lending markets. This trend toward integration will likely continue as new players enter the market and current ones look to expand further.


S&P Global Market Intelligence's 2018 Small Business Borrowing Survey was conducted between Feb. 7 and Feb. 18 across a nationwide sample of individuals who make borrowing decisions for a small business. Small businesses were defined as any business with 2017 revenues of $10 million or less. Survey results have a margin of error of +/- 4.7% at the 95% confidence level based on the sample size of 449.

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Watch: Power Forecast Briefing Discusses Improved Spark Spreads and Profitability Projections for ERCOT and PJM

Dec. 13 2018 — In our latest Power Forecast Briefing, Steve Piper discusses recent power market activity and a forecast that points to profitability for merchant generation regions of ERCOT and PJM. Both saw improved spark spreads in 2018, but ERCOT's upside appears more limited than PJM going forward. More data and market tracking tools can be found on the Market Intelligence platform’s Power Forecast subscription.

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Watch: Power Forecast Briefing: Fleet Transformation, Under-Powered Markets, and Green Energy in 2018

Steve Piper shares Power Forecast insights and a recap of recent events in the US power markets in Q4 of 2017. Watch our video for power generation trends and forecasts for utilities in 2018.

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Technology, Media & Telecom
Nexstar Buys WGN For A Song; Divestiture Of WGN, Stakes In Food Channels Likely

Dec. 10 2018 — Walt Disney Co.'s pending acquisition of much of 21st Century Fox Inc. certainly raised the bar for cable network valuations — at 15.4x cash flow — and the divestiture of the regional sports networks may see another double-digit-multiple transaction with Inc. in the mix of buyers. Another deal, Nexstar Media Group Inc.'s pending acquisition of Tribune Media Co., sees stakes in three cable nets going to the buyer for single-digit multiples (6.9x).

The deal follows the collapse of Sinclair Broadcast Group Inc.'s deal to buy the company, which is now being litigated. We think that Nexstar is getting quite a deal on the cable network assets and will likely flip them for a quick profit.

When Discovery Inc. agreed to buy Scripps Networks Interactive Inc. in July 2017, the domestic cable networks were valued at $10.14 billion, or 10.5x cash flow, with Food Network (US) valued at $4.5 billion (Scripps owned 68.7%) and Cooking Channel (US) (also at 68.7%) valued at $525 million.

In the current transaction, the valuations come to $3.47 billion and $323 million, respectively. Thus, if Nexstar can get Discovery Communications to pay at least what it paid in the Scripps transaction, Nexstar may make a quick profit. Granted, minority interests typically trade at a discount. Scripps Networks Interactive, however, has tried for years to cut a deal to buy out the minority stake and it may be willing to strike a deal at a higher price to put this issue behind it.

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Ondeck Now Open To Exploring Deals, CEO Says


OnDeck has never done an acquisition, but M&A is a possibility now that the company is generating cash, Chairman and CEO Noah Breslow said.

Breslow expects there to be consolidation across online lending companies in the near future.

OnDeck plans to launch a new product line, such as a business credit card or an equipment financing product, by year-end.

Nov. 30 2018 — Noah Breslow has been at the helm of On Deck Capital Inc. since June 2012, overseeing the company's initial public offering and several profitable quarters. The online lender has originated more than $10 billion in small-business loans and is one of the largest players in the industry.

In addition to originating its own loans, OnDeck recently launched ODX, a new subsidiary focused on a platform-as-a-service product for banks. OnDeck has operated that sort of white-label partnership with JPMorgan Chase & Co. for several years and will launchoperations with PNC Financial Services Group Inc. in 2019.

Now, the lender is open to doing deals, Breslow said. He sat down with S&P Global Market Intelligence in Las Vegas to talk about his company's future product plans and the broader online lending marketplace.

The following is an edited transcript of that conversation.

OnDeck CEO Noah Breslow
Source: OnDeck

S&P Global Market Intelligence: How do you view the current state of the online lending marketplace?

Noah Breslow: What you're seeing in that market is a bit of survival of the fittest. Many smaller companies are probably going to be sold in the next couple of years.

The advantages in the business go to those with scale: You can raise capital on the best terms, you collect the most data, so you can make the best decisions when you build your models, and you can reach more small-business owners more efficiently.

That being said, do you foresee being an acquirer?

We're open to it. We haven't acquired a company in 11 years of doing business. One of the advantages of now being profitable and generating cash is we can look around the market.

But we're designing our core business model so we don't need to acquire to hit our targets. Anything we do in the M&A sphere will be additive, and it will not be aggressive M&A. It's going to be reasonable bets to have a nice return or nice synergies, if we do it.

Is OnDeck considering starting other products outside of small business lending?

Not at this time. We focus on trying to be the best small-business lender in the world, but that can mean a lot of different products over time.

Today we have a term loan and a line of credit product. We've talked about four other products that our customers use: equipment financing, invoice factoring, Small Business Administration lending and small-business credit cards. Those are all fair game for us over the next couple of years.

We're on track to announce our third major product by the end of the year. One of those four will probably be picked.

Why is OnDeck focusing on small business lending rather than other offerings?

It's where underwriting is not commoditized. Student lending and personal lending are based on FICO. You can go to 10 different websites and get identical products.

In small business lending, the intellectual property around the OnDeck score is unique.

I like being able to differentiate in that way. It creates a sustainable advantage for our business, whereas if we were just using FICO to underwrite, anyone can buy that and get into the market.

OnDeck's white-label product lets banks use its technology to streamline their own lending process. In those partnerships, do you face regulatory restrictions with the use of alternative data in underwriting models?

When we're partnering with banks, it's critical that the bank has a lot of control over the credit model and the data being used for decisioning.

The model we use with JPMorgan Chase was jointly developed between OnDeck and Chase, so obviously Chase was very comfortable data. The model we're using with PNC is more of PNC's design, and we're advising on its creation. In both cases, we're using data that's right down the middle of the fairway — business credit, business cash flow and evaluating the business owner — but nothing too esoteric.

In our own business at OnDeck, we can use more alternate data because we don't have the same modeled governance that a bank might have.

Are you using machine learning to synthesize data sources and create new models based on alternative data?

Some players out there have tried to go purely digital and almost let the computer decide how to make the decision. We don't believe in that.

We have a hybrid model, where people with a lot of commercial underwriting experience are working in concert with advanced modeling techniques to get the result.

OnDeck's charge-off rates have declined year over year in 2018. Is there correlation between these lower rates and your updated models using more alternative data?

Our credit models have improved over the last year, and alternative data definitely contributes.

Many of our improvements in the last year have been structural or operational. I view the modeling improvements as even more upside potential from here.

We noticed after we loaned our first billion dollars that our credit models got a step-function better. Now, with $10 billion under our belts, it's again happening. We can do a lot of data-driven decision-making about who we approve and who we decline on many years of history now.

It starts to become more powerful. That's why you see these scaled-up companies like American Express or Discover Financial or Capital One. They're reaping the benefits of decades of lending, and hopefully we'll be in the same place.

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