Banks and Lending Fintechs

By Deb Stewart

Twenty-five years ago among community banks with $10 billion or less in assets, 90 percent of consumer loans were held by the bank. “Today that number has dropped to around 5 percent,” says Brian Graham, CEO of Alliance Partners.

And, on the small-business lending side, Joe DiNicolantonio, head of business banking for Regions Bank tells us, “Last year we conducted a survey of our small-business customers and found close to 20 percent were using online alternatives.”

So how should banks today react? Some banks are taking these challenges on by establishing relationships with lending Fintech firms.

Small-business loans

 “Our search for an online lending partner started after seeing the results of that survey,” DiNicolantonio continues. “When we asked our primary business checking customers who had borrowed in the past 12 months where they had borrowed, a large percentage of them said online lenders—due to their easy application, quick credit decisions and funding. After extensive due diligence we opted to establish a relationship with Fundation. Allowing us to get into the market quickly, meeting more of our customers’ needs through the online channel.”

The customer experience is clear and simple.

• When you visit the Small Business section of Regions website you see “Introducing our convenient online small business loan application.”
• As you click through to learn more, you’re taken to a screen that describes potential uses for these loans and introduces the relationship with Fundation.
• “Apply now” leads to a prominent “Exit Notice” informing the user that they are leaving Regions and entering an external site.
• The application begins on a Regions-Fundation co-branded screen.
• Preliminary questions are presented on co-branded screens.
• “Which product better suits your needs?” presents both the Fundation Express Loan and the Regions Business Loan and their associated parameters. Based on that information, you can choose to “Apply now for a Fundation express term loan” or “Have a Regions business banker contact you.”
• If you choose to apply now for a Fundation express term loan, you will enter a page that is branded Fundation only. Co-branding ends at that point, and it is clear that you are entering into an application with Fundation, not Regions Bank.
• Some coaching does occur during the process. If Fundation finds during the application process that the customer is looking for the wrong type of loan, it will refer them back to a Regions business banker to work on the right solution.

Fundation provides term loans up to $1 million with terms up to five years for the Regions relationship. Proceeds are used for working capital, equipment, refinancing debt, business expansion or other purposes. Since the loans are underwritten solely based on capacity to repay (collateral is not taken into consideration), they are appropriate for working capital or other short-term purposes. Approved customers generally receive three options of size and term combinations. Fundation retains servicing for the life of the loan.

Regions receives reporting on customers in the pipeline who are approved or declined. In the future, these Fundation loans will be included in customer profiles, better facilitating opportunities to meet other banking needs as appropriate. Fundation is prohibited from selling other products to these customers without Regions’ approval. “So far, we haven’t seen any definitive patterns in business sizes or segments using the product,” says DiNicolantonio. “Average loan size has been around $100,000. We expect clearer patterns to emerge as our experience base grows.”

At this point Regions marketing of the product is limited to its website.

“Banks come to us for a few reasons, to lower their costs, to serve more customers and to digitize their lending capability,” says Sam Graziano, CEO of Fundation. “For some it’s become too expensive to originate smaller commercial loans. Or it’s too expensive or complicated to build an online origination capability. But regardless of the reason, they are providing better service for their customers by making these loans available. Our broader risk management standards meet the needs of a wider range of clients and provide the opportunity for the bank to expand these relationships in other ways.”

Consumer lending

“Community banks are doing virtually no unsecured personal loans. Market share has been going to larger banks with the scale to underwrite and service these loans. Some banks have gone as far as to remove these products from their websites. But they know that their customers are borrowing. We help them provide a solution to those borrowing needs,” says Andrew Deringer, head of financial institutions for Lending Club.

Lending Club was founded in 2006 and facilitated its first loan in 2007. “We started partnering with banks three years ago. Many banks were already buying loans from us since they were finding it very challenging to generate these assets independently without scale. We give them the opportunity to satisfy a basic need of their customers and to keep the assets for loans meeting their credit requirements.”

The customer experience in Lending Club partnerships is simple and can be completed in five steps with an offer delivered within seconds of completing the application.

• Customers can find the application link on their bank’s website, which would redirect them to lendingclub.com/”BankName” where they can apply for an unsecured personal loan. After they click on the application link, they leave the bank’s website and are taken to a co-branded prequalification landing page.
• On the co-branded prequalification landing page, customers fill out three fields—loan amount, loan purpose, and self-selected credit score. They’re then taken to another co-branded page that takes the customer’s personal information such as name, date of birth, address, etc. The information is run through Lending Club propriety credit model to determine offers to present to the customer based on the information they shared in their application.
• From here, they are given loan offers including amount, rate and terms, and they can choose the offer that best serves their needs. Once their offer is selected, they are asked for additional information to confirm their identity.
• Next, the customer receives information including the loan rate and terms agreement. Once they click “Agree,” they are taken to another page to enter in their bank account information.
• Once the online application is complete, the loan goes into Lending Club’s review and underwriting process.
• The loan is then issued and the borrower will receive their funds. Servicing is done by Lending Club for the life of the loan.

Some banks choose to highlight some unique findings on Lending Club borrowers as part of the introduction:

• Seventy-six percent of Lending Club borrowers experience a FICO score increase three months after obtaining their loan, with an average score increase of 21 points. This is based on the average credit score change of all borrowers who took out a loan via Lending Club between January 1, 2013, and June 30, 2015, with a stated loan purpose of debt consolidation of payoff credit cards.
• Borrowers reduce their rates by an average of 7.4 percentage points. This is based on responses from 9,874 borrowers in a survey of 46,885 randomly selected borrowers conducted from October 1, 2014, to October 1, 2015. Borrowers who received a loan to consolidate existing debt or pay off their credit card balance reported that the interest rate on outstanding debt or credit cards was 21.1 percent, while the average interest rate on loans via Lending Club is 14.7 percent.

“There are a couple of ways that banks benefit from these loans,” says Brian Graham, CEO of Alliance Partners, a firm that facilitates partnerships for community banks looking to fill product gaps. “First, they receive a referral fee for every loan originated to their customers, whether or not the bank retains the loan. Second, for high quality loans, they have the option to book loans that Lending Club has closed that meet their credit quality standards. In that case, they realize the revenue from the loan and pay Lending Club a standard servicing fee to handle loan administration. But, most importantly, the banks are able to serve their customers with a product they didn’t used to be able to offer, providing an efficient and high quality customer experience. Lending Club is able to underwrite a wider range of credit quality since they sell loans to different types of investors. So the real benefit to the bank is satisfying the borrowing needs of more of their customers.”

Lending Club offers these loans online, via mobile or by phone. “It’s not straightforward to offer loan products via online or mobile, Deringer continues. “There has been an important shift in consumer preference to interact with their financial institutions through mobile and online devices, and banks have had trouble responding to that shift in the loan market. One concern that banks have is fraud. We invested in fraud detection early by building an industry leading fraud prevention system. In any case of confirmed identity theft on a loan that one of our bank partners has put on their books, we will buy that loan back mitigating the fraud risk for the bank.”

Citibank has entered into a partnership with Lending Club, and alternative management firm Vardero Capital, to deliver loans to low- to moderate-income households in underserved communities around the country.

What does it take?

 “We knew that our small business customers wanted to borrow online. And we estimated that it could take as long as four or five years to build this capability into our loan system. A fintech partnership brought us to market much more quickly at considerably less cost.

“The toughest piece of establishing this partnership was the due diligence,” says Region’s DiNicolantonio. “In our vetting of Fundation we started with 15 or so firms and talked to a lot of people. We heard presentations from 10 of those and did extensive due diligence on two of those, including all functional areas of the bank.”

When a partner is selected and agreements put in place, the process is relatively simple. The bank builds a product page on its website. The partner hosts the application and provides the infrastructure.

What is the role of lending fintech firms moving forward?

 “Personal lending is an area where community banks cannot compete on their own due to scale” thinks Brian Graham, CEO, Alliance Partners. “So why not leverage customer relationships through technology partnerships? We need to find creative ways to offset this lack of scale and free banks up to do what they do well: Help their customers. In these relationships the customer is happy, the bank is happy, and the fintech is happy since loans are being sourced by the bank.”

“Fintech firms generally will have an impact on certain products which will be felt throughout the industry, from community banks to large banks” believes Brian Graham, CEO, Alliance Partners. “As with our current offerings, the focus of this growth will be on products where you can reduce cost/improve price, and/or improve customer experience.”

“There are now over 100 lending fintech firms in the small-business market. But, in order to have long-term sustainability, you need credit risk management discipline, real technology that provides cost efficiency and strong financial backing” says Sam Graziano, CEO of Fundation. “It’s possible that many of the firms in our market will not survive the next downturn. I expect that the market will take one of three roads in the long run: Some firms will develop their own direct lending franchise and serve the underbanked borrowing population; others will become a service providers to banks to serve the bankable population; and others will fight to survive given the intense competition for customers. Innovation and ultimately partnership with banks are a proven path for innovators in financial technology, it’s happened before.”

Are these partnerships right for your bank? Answering these questions and others may lead you to an answer:

• Are your business customers using online alternatives and not borrowing from you?
• What are the costs of originating your business loans? Is that origination cost appropriate to the potential revenue stream?
• Are your consumer customers looking for online lending options?
• What would the costs be to build business and/or consumer lending capabilities for online and mobile?
• Are these types of products critical to your strategy? Do they impact customer retention? Will you continue to grow share of wallet with your customers if you can’t offer these products?

There are no simple answers, but these questions are worth exploring as these markets continue to change.

Deb Stewart of Charlotte, N.C., is an independent consultant working for the financial services industry. Email: debstewart10@gmail.com.

Online training in digital, mobile and social media from ABA.