US-based small-business alternative lender OnDeck struggled in Q1 2016, posting near-double losses in its Q1 2016 earnings call on Monday evening.
The firm's loan originations continue to increase, but growth is slowing. OnDeck issued $570 million in loans in Q1 2016, marking a 37% year-over-year (YoY) gain, which was a deceleration from the 51% YoY growth OnDeck enjoyed in the previous quarter. The slowdown in growth could indicate that the firm is maturing, but it could also signify that competition in the alternative-lending industry is increasing, making it harder for OnDeck to maintain constant growth.
And external conditions forced OnDeck to shift its origination strategy.
OnDeck uses a hybrid strategy for its loans. Unlike many peers, OnDeck splits the way it finances its loans. While it sells some to investors in a marketplace-based peer-to-peer (P2P) model, it also holds loans on its own balance sheet. This gives the firm flexibility to shift its strategy in line with market changes, according to CEO Noah Breslow.
The changing alternative-lending landscape forced the firm to change its marketplace-to-balance-sheet ratio. Tumult in global markets has made small-business alternative lending somewhat less attractive to investors, which made it more challenging for OnDeck to sell its loans. As a result, it pushed more of its holdings to its balance sheet. In Q4 2015, OnDeck issued 35% to 45% of its loans through its marketplace, a number that decreased to 26% last quarter. And the firm believes that it could decrease to as low as 15% in the coming quarters if trends continue.
Though that could grow OnDeck moving forward, it's beginning to hit the firm in the near-term. Holding more of its own loans will increase OnDeck's interest income over time. But in the near term, it's leading to a slowdown in revenue growth because OnDeck is gaining less upfront from loan sales, and because the firm has to set aside additional cash in case of defaults.
OnDeck's shortcomings could signal the beginning of a turning tide in the alternative-lending industry. Major US alternative lenders are facing growing pains as the industry expands and competition heightens. And these firms are preparing for government regulation, which could cause considerable consolidation in the industry. As a result, firms are leaning on newer initiatives, like diversified product offerings and bank partnerships, in order to create new streams of revenue and acquisition channels.
Small businesses represent 99% of US companies, 54% of total sales, and 55% of all jobs, according to the US Small Business Administration.
These businesses need capital in order to grow, but small businesses are underfunded — only half of them with $100,000 to $1 million of annual revenue received at least some of the financing they applied for from large banks in late 2015. This is partially because banks have retreated from this segment because issuing loans to small businesses using the traditional underwriting model is expensive. This leaves a massive amount of unfulfilled loans that we estimate reached $96.5 billion in Q4 2015.
Alternative-lending companies have stepped in to capitalize on the opportunity available in helping meet more small business' lending needs. Alternative small-business lending platforms use machine learning and digital tools to extend credit to a wide array of small businesses quickly and efficiently, particularly to those that have been rejected by banks. Alternative small-business lending companies provide digital platforms that connect small-business borrowers to capital using nontraditional means.
We estimate that alternative small-business lenders originated $5 billion and had a 4.3% share of the small-business lending market in the US in 2015. But alternative small business lending platforms will originate $52 billion and gain a 20.7% share of the total market by 2020, driven by the continued growth of new players, increased borrower awareness and interest, and — most importantly — major partnerships with big banks.
Evan Bakker, research analyst for BI Intelligence, Business Insider's premium research service, has compiled a detailed report on small-business alternative lending that analyzes the market opportunity for alternative lenders, forecasts the market share and volume growth of alternative lending platforms, profiles key players, and addresses the main industry risks.
Small Business Alternative Lending Report Cover
(BII)
Here are some key takeaways from the report:
Alternative lending platforms are in a position to capitalize on this underfunding and also take share from banks. These companies use machine learning and digital tools to extend credit to a wide array of small businesses quickly and efficiently. We estimate that alternative lending companies' share of the small-business lending market in the US will reach 20.7% by 2020.
Alternative lenders are now partnering with banks, and this will propel growth going forward. New lenders are finding opportunities to offer white-label services to major banks. We expect banking partnerships, like the one between JPMorgan and OnDeck, to add 7.7 percentage points to the alternative-lending industry's market share by 2020.
A flurry of new lenders have entered the market, but it's still in early innings. A handful of small-business lenders, from FundingCircle to Credibly, have entered the market, and this is creating challenges as customer acquisition costs rise and alternative-lending companies struggle to differentiate themselves.
In full, the report:
Forecasts the market share and volume growth of the small-business alternative-lending sector, and breaks down the main growth drivers.
Explains why small businesses are underfunded, and quantifies the market opportunity for alternative lenders.
Defines the different types of platforms that alternative lenders employ, including their revenue models.
Lists the advantages and disadvantages that alternative lenders have compared to traditional players.
Overviews the key players in the industry and identifies their growth factors as well as the pain points limiting their growth.
Pinpoints the key risks that could undermine the success of alternative platforms.
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