A ‘turtle bank’ plays catch-up in small-business lending

American Banker

By John Reosti

2 July 2019

Provident Financial in Iselin, N.J., has partnered with a fintech to become a stronger small- business lender.

The $9.8 billion-asset company is working with Fundation to offer unsecured small-dollar loans to commercial clients. While available in Provident’s more than 80 branches, applications for loans as big as $250,000 are also being accepted online.

“We wanted to offer something for our customers that was convenient,” said Josephine Moran, Provident’s director of retail banking. The goal is “to offer options to customers. We were searching for solutions for that part of our business.”

The decision to offer unsecured loans might seem odd for a bank known for its conservatism.

“They’re slow and steady,” said Mark Fitzgibbon, director of research at Sandler O’Neill, adding that analysts at his company often refer to Provident as “the turtle bank.”

Provident “just plods along and produces good results in good environments and bad environments,” Fitzgibbon added. “They’re very disciplined on credit and interest rate risk. I think it’s a fabulously well-run bank.” Net income totaled $30.9 million for the quarter that ended March 31 and $116 million in 2018.

That being said, the digital lending push still meshes with Provident’s risk appetite since Fundation holds most of the loans, Fitzgibbon said.

Provident has hit on “a creative way to help small-business customers,” he added.

Indeed, creating new relationships with small businesses should over time help Provident make progress diversifying its loan portfolio. More than half of its loans at March 31 were commercial mortgages or multifamily credits. “It’s important that you’re with the business from start to finish,” Moran said. “If you can capture the startups, earn their trust, gain their relationships, you assist them with their growth, they’re going to be with you for life.”

Similar moves could make sense for other banks that want more contact with small businesses “but do not want to underwrite risk below a certain threshold,” said Walt Levengood, vice president for sales and business development at the business financing firm Nav.

“If you want to fund the loan, by all means put it on your balance sheet,” Levengood said. “But you won’t insult the businesses in the instances where you don’t want to fund loans.”

While it may not immediately lead to meaningful loan growth, the Fundation partnership should give Provident a better shot at capturing the rest of the banking relationship from potential small-business clients, including low-cost deposits.

To that end, Provident is developing a product that combines a checking account with other products from its small-business suite.

“It’s still in the process, but what we’re looking at is a checking account that bundles things such as such as merchant services, payroll and lending,” Moran said. “You want to offer convenience at optimal pricing. You want to make it very easy for them, because small businesses need all these services and it entices them to bring their entire relationship to us.”

Small business “is such an important part of Provident’s funding base,” Fitzgibbon said.

Provident began the Fundation partnership at the end of February. While she declined to discussion the amount of loans processed, Moran said she is satisfied with the early results and bullish on small-business banking prospects generally.

“So far we’re very pleased with our relationship” with Fundation, she said. “It’s opened up another door for us. … There’s a huge opportunity for us, and we’re going for it.”

Citizens CEO: Fintech partnerships will keep bank competitive

Philadelphia Business Journal

By Jeff Blumenthal

22 April 2019

When announcing their $28 billion merger of equals in February, BB&T Corp. and SunTrust Banks said the deal was partly designed to allow the banks to become more competitive with larger rivals in technology.

At more than $220 billion in assets, both are larger than $160 billion-asset Citizens Financial Group, one of the Philadelphia region’s largest banks. But like BB&T and SunTrust, it is significantly smaller than the nation’s Big 4 banks— JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co. and Citigroup, each of which have assets near or exceeding $2 trillion and have invested heavily in developing consumer-facing technology such as artificial intelligence-powered chatbots and digital investing apps.

Citizens Financial CEO Bruce Van Saun acknowledges the challenge but believes his bank has made a significant push to keep pace with its larger competitors by partnering with more than a dozen fintech companies in recent years.

“I think we have sufficient scale to stay competitive,” Van Saun said in an interview after Citizens Financial announced a 13 percent increase in net income during the first quarter. “But it will be worth watching to see which banks will continue competing in five years and which ones won’t be.”

Since taking the reins and spinning the bank off from former owner Royal Bank of Scotland via an IPO five years ago, enhancing technology has been a prime focus for Van Saun.

In the first quarter alone, Citizens entered into partnerships with four different fintechs, adding to the 10 existing relationships it established in recent years: Transactis (payments technology for treasury solutions), mortgage platforms Blend and Vast and corporate liquidity investment platform Cachematrix.

The partnerships stretch across the bank’s business lines, such as SigFig, an investing platform for its wealth management clients and Fundation, which makes it easier for small-business customers to apply for loans.

At the same time as it’s struck fintech deals, Providence, R.I.-based Citizens, the Philadelphia region’s fourth-largest deposit taker, has increased its in-house capabilities, such as building a new digital and online platform based in large part on the work of its own digital technology employees. It also launched Citizens Access, a nationwide online banking service focused on the collection of deposits that has reeled in $4.6 billion in deposits in its first year. Citizens has about 30 analysts and programmers working on its consumer digital platform, and it plans to hire 45 more this year.

Brian Klock, an analyst from Keefee Bruyette & Woods, said tech platforms can most helps banks is on the consumer side.

“Most consumers largely bank online, so technology on scale and having the most up to date technology is impactful with consumer banking,” Klock said. “But no two companies are the same so there is no algorithm that is going to be a solution for every business customer. So you still need personal relationships for business banking.”

Van Saun said the advancement of AI had not led to a reduction in the number of employees. Citizens Financial employs roughly the same number of people it did five years ago — about 18,000 — but has changed about 3,000 positions from old roles that no longer fit to new ones that are largely customer facing.

While the newer, tech-centric employees are largely paid more than those who departed, Van Saun said the math still works in Citizens’ favor because of improvements in productivity.

“AI has an incredible presence but you have to be selective in how you deploy it because sometimes the cost does not equal the benefits,” Van Saun said. “But it can save hours or research.”

OnDeck, the reigning king of small business lending among U.S. financial technology companies, is sharpening its business strategies. Among its new initiatives: the company is launching an equipment-finance product this year, targeting loans of $5,000 to $100,000 with two-to-five year maturities secured by “essential-use equipment.”

In touting the program to Wall Street analysts in February, OnDeck’s chief executive, Noah Breslow, declared that the $35 billion, equipment-finance market is “cumbersome” and he pronounced the sector “ripe for disruption.”

While those performance expectations may prove true – the first results of OnDeck’s product launch won’t be seen until 2020 – Breslow’s message seemed to conflict with OnDeck’s image as a public company. Rather than casting itself as a disruptor these days, OnDeck emphasizes the ways that its business is melding with mainstream commerce and finance.

Consider that the New York-based company, which saw its year-over-year revenues rise 14% to $398.4 million in 2018, is collaborating with Visa and Ingo Money to launch an “Instant Funding” line-of-credit that funnels cash “in seconds” to business customers via their debit cards. With the acquisition of Evolocity Financial Group, it is also expanding its commercial lending business in Canada, a move that follows its foray into Australia where, the company reports, loan-origination grew by 80% in 2018.

Perhaps most significant was the 2018 deal that OnDeck inked with PNC Bank, the sixth-largest financial institution in the U.S. with $370.5 billion in assets. Under the agreement, the Pittsburgh-based bank will utilize OnDeck’s digital platform for its small business lending programs. Coming on top of a similar arrangement with megabank J.P. Morgan Chase, the country’s largest with $2.2 trillion in assets, the PNC deal “suggests a further validation of OnDeck’s underlying technology and innovation,” asserts Wall Street analyst Eric Wasserstrom, who follows specialty finance for investment bank UBS.

“It also reflects the fact that doing a partnership is a better business model for the big banks than building out their own platforms,” he says. “Both banks (PNC and J.P. Morgan) have chosen the middle ground: instead of building out their own technology or buying a fintech company, they’ll rent.

“J.P. Morgan has a loan portfolio of $1 trillion,” Wasserstrom explains. “It can’t earn any money making loans of $15,000 or $20,000. Even if it charged 1,000 percent interest for those loans,” he went on, “do you know how much that will influence their balance sheet? How many dollars do think they are going to earn? A giant zero!”

Similarly, Wasserstrom says, spending the tens of millions of dollars required to develop the state-of-the art technology and expertise that would enable a behemoth like J.P. Morgan or a super-regional like PNC to match a fintech’s capability “would still not be a big needle-mover. You’d never earn that money back. But by partnering with a fintech like OnDeck,” he adds, “banks like J.P Morgan and PNC get incremental dollars they wouldn’t otherwise have.”

The alliance between OnDeck and old-line financial institutions is one more sign, if one more sign were needed, that commercial fintech lenders are increasingly blending into the established financial ecosystem.

Not so long ago companies like OnDeck, Kabbage, PayPal, Square, Fundation, Lending Club, and Credibly were viewed by traditional commercial banks and Wall Street as upstart arrivistes. Some may still bear the reputation as disruptors as they continue using their technological prowess to carve out niche funding areas that banks often neglect or disdain.

Yet many fintechs are forming alliances with the same financial institutions they once challenged, helping revitalize them with new product offerings. Other financial technology companies have bulked up in size and are becoming indistinguishable from any major corporation.

Big Fintechs are securitizing their loans with global investment banks, accessing capital from mainline financial institutions like J.P. Morgan, Goldman Sachs and Wells Fargo, and finding additional ways — including becoming publicly listed on the stock exchanges – to tap into the equity and debt markets.

One example of the maturation process: through mid-2018, Atlanta-based Kabbage has securitized $1.5 billion in two bond issuances, 30% of its $5 billion in small business loan originations since 2008.

In addition, fintechs have been raising their industry’s profile with legislators and regulators in both state and federal government, as well as with customers and the public through such trade associations as the Internet Lending Platform Association and the U.S. Chamber of Commerce. Both individually and through the trade groups, these companies are building goodwill by supporting truth-in-lending laws in California and elsewhere, promoting best practices and codes of conduct, and engaging in corporate philanthropy.

Rather than challenging the established order, S&P Global Market Intelligence recently noted in a 2018 report, this cohort of Big Fintech is increasingly burrowing into it. This can especially be seen in the alliances between fintech commercial lenders and banks.

“Bank channel lenders arguably have the best of both worlds,” Nimayi Dixit, a research analyst at S&P Global Market Intelligence wrote approvingly in a 2018 report. “They can export credit risk to bank partners while avoiding the liquidity risks of most marketplace lending platforms. Instead of disrupting banks, bank channel lenders help (existing banks) compete with other digital lenders by providing a similar customer experience.”

It’s a trend that will only accelerate. “We expect more digital lenders to incorporate this funding model into their businesses via white-label or branded services to banking institutions,” the S&P report adds.

Forming partnerships with banks and diversifying into new product areas is not a luxury but a necessity for Fundation, says Sam Graziano, chief executive at the Reston (Va.)-based platform. “You can’t be a one-trick pony,” he says, promising more product launches this year.

Fundation has been steadily making a name for itself by collaborating with independent and regional banks that utilize its platform to make small business loans under $150,000. In January, the company announced formation of a partnership with Bank of California in which the West Coast bank will use Fundation’s platform to offer a digital line of credit for small businesses on its website.

Fundation lists as many as 20 banks as partners, including most prominently a pair of tech-savvy financial institutions — Citizens Bank in Providence, R.I. and Provident Bank in Iselin, N.J. — which have been featured in the trade press for their enthusiastic embrace of Fundation.

John Kamin, executive vice president at $9.8 billion Provident reports that the bank’s “competency” is making commercial loans in the “millions of dollars” and that it had generally shunned making loans as meager as $150,000, never mind smaller ones. But using Fundation’s platform, which automates and streamlines the loan-approval process, the bank can lend cheaply and quickly to entrepreneurs. “We’re able to do it in a matter of days, not weeks,” he marvels.

Not only can a prospective commercial borrower upload tax returns, bank statements and other paperwork, Kamin says, “but with the advanced technology that’s built in, customers can provide a link to their bank account and we can look at cash flows and do other innovative things so you don’t have to wait around for the mail.”

Provident reserves the right to be selective about which loans it wants to maintain on its books. “We can take the cream of the crop” and leave the remainder with Fundation, the banker explains. “We have the ability to turn that dial.”

The partnership offers additional side benefits. “A lot of folks who have signed up (for loans) are non-customers and now we have the ability to market to them,” he says. “After we get a small business to take out a loan, we hope that we can get deposits and even personal accounts. It gives us someone else to market to.”

As a digital lender, Provident can now contend mano a mano with another well-known competitor: J.P. Morgan Chase. “This is the perfect model for us,” says Kamin, “it gives us scale. You can’t build a program like this from scratch. Now we can compete with the big guys. We can compete with J.P. Morgan.”

For Fundation, which booked a half-billion dollars in small business loans last year, doing business with heavily regulated banks puts its stamp on the company. It means, for example, that Fundation must take pains to conform to the industry’s rigid norms governing compliance and information security. But that also builds trust and can result in client referrals for loans that don’t fit a bank’s profile. “For a bank to outsource operations to us,” Graziano says, “we have to operate like a bank.”

Bankrolled with a $100 million line of credit from Goldman Sachs, Fundation’s interest rate charges are not as steep as many competitors’. “The average cost of our loans is in the mid-to-high teens and that’s one reason why banks are willing to work with us,” Graziano says. “Our loans,” he adds, “are attractively structured with low fees and coupon rates that are not too dramatically different from where banks are. We also don’t take as much risk as many in the (alternative funding) industry.”

Despite its establishment ties, Graziano says, Fundation will not become a public company anytime soon. “Going public is not in our near-term plans,” he told deBanked. Doing business as a public company “provides liquidity to shareholders and the ability to use stock as an acquisition tool and for employees’ compensation,” he concedes. “But you’re subject to the relentlessly short-term focus of the market and you’re in the public eye, which can hurt long-term value creation.”

Graziano reports, however, that Fundation will be securitizing portions of its loan portfolio by yearend 2020.

PayPal Working Capital, a division of PayPal Holdings based in San Jose, and Square Inc. of San Francisco, are two Big Fintechs that branched into commercial lending from the payments side of fintech. PayPal began making small business loans in 2013 while Square got into the game in 2014. In just the last half-decade, both companies have leveraged their technological expertise, massive data collections, data-mining skills, and catbird-seat positions in the marketplace to burst on the scene as powerhouse small business lenders.

With somewhat similar business models, the pair have also surfaced as head-to-head competitors, their stock prices and rivalry drawing regular commentary from investors, analysts and journalists. Both have direct access to millions of potential customers. Both have the ability to use “machine learning” to reckon the creditworthiness of business borrowers. Both use algorithms to decide the size and terms of a loan.

Loan approval — or denials — are largely based on a customer’s sales and payments history. Money can appear, sometimes almost magically in minutes, in a borrower’s bank account, debit card or e-wallet. PayPal and Square Capital also deduct repayments directly from a borrower’s credit or debit card sales in “financing structures similar to merchant cash advances,” notes S&P.

At its website, here is how PayPal explains its loan-making process. “The lender reviews your PayPal account history to determine your loan amount. If approved, your maximum loan amount can be up to 35% of the sales your business processed through PayPal in the past 12 months, and no more than $125,000 for your first two loans. After you’ve completed your first two loans, the maximum loan amount increases to $200,000.”

PayPal, which reports having 267 million global accounts, was adroitly positioned when it commenced making small business loans in 2013. But what has really given the Big Fintech a boost, notes Levi King, chief executive and co-founder at Utah-based Nav — an online, credit-data aggregator and financial matchmaker for small businesses – was PayPal’s 2017 acquisition of Swift Financial. The deal not only added 20,000 new business borrowers to its 120,000, reported TechCrunch, but provided PayPal with more sophisticated tools to evaluate borrowers and refine the size and terms of its loans.

“PayPal had already been incredibly successful using transactional data obtained through PayPal accounts,” King told deBanked, “but they were limited by not having a broad view of risk.” It was upon the acquisition of Swift, however, that PayPal gained access to a “bigger financial envelope including personal credit, business credit, and checking account information,” King says, adding: “The additional data makes it way easier for PayPal to assess risk and offer not just bigger loans, but multiple types of loans with various payback terms.”

While PayPal used the Swift acquisition to spur growth and build market share, its rival Square — which is best known for its point-of-sale terminals, its smartphone “Cash App,” and its Square Card — has employed a different strategy.

By selling off loans to third-party institutional investors, who snap them up on what Square calls a “forward-flow basis,” the Big Fintech barged into small business lending with the subtlety of a freight train. In just four years, Square originated 650,000 loans worth $4.0 billion, a stunning rise from the modest base of $13.6 million in 2014.

Square’s third-party funding model, moreover, demonstrates the benefits afforded from being deeply immersed in the financial ecosystem. Off-loading the loans “significantly increases the speed with which we can scale services and allows us to mitigate our balance sheet and liquidity risk,” the company reported in its most recent 10K filing.

Square does not publicly disclose the entire roster of its third-party investors. But Kim Sampson, a media relations manager at Square, told deBanked that the Canada Pension Plan Investment Board — “a global investment manager with more than CA$300 billion in assets under management and a focus on sustained, long term returns” – is one important loan-purchaser.

Square also offers loans on its “partnership platform” to businesses for whom it does not process payments. And late last year the company introduced an updated version of an old-fashioned department store loan. Known as “Square Installments,” the program allows a merchant to offer customers a monthly payment plan for big-ticket purchases costing between $250 and $10,000.

Which model is superior? PayPal’s — which retains small business loans on its balance sheet — or Square’s third-party investor program? “The short answer,” says UBS analyst Wasserstrom, “is that PayPal retains small business loans on its balance sheet, and therefore benefits from the interest income, but takes the associated credit and funding risk.”

Meanwhile, as PayPal and Square stake out territory in the marketplace, their rivalry poses a formidable challenge to other competitors.

Both are well capitalized and risk-averse. PayPal, which reported $4.23 billion in revenues in 2018, a 13% increase over the previous year, reports sitting on $3.8 billion in retained earnings. Square, whose 2018 revenues were up 51 percent to $3.3 billion, reported that — despite losses — it held cash and liquid investments of $1.638 billion at the end of December.

King, the Nav executive, observes that Able, Dealstruck, and Bond Street – three once-promising and innovative fintechs that focused on small business lending – were derailed when they could not overcome the double-whammy of high acquisition costs and pricey capital.

“None of them were able to scale up fast enough in the marketplace,” notes King. “The process of institutionalization is pushing out smaller players.”