🥽Deep Dive #1: Alternative Lending
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🥽Deep Dive #1: Alternative Lending
In this first installation of Deep Dive, we map out the history and key verticals of the Alternative Lending space, introduce the companies making a splash, and share all our lessons learnt.
By Cécile Tang & Ria Panjwani
Introduction
Market maps present an opportunity for us to approach our investment process from a thematic lens, to expand our knowledge base by creating comprehensive content, and to tap into our network of experts. We’re excited to share our first deep dive on alternative lending, which has been an area of interest for the team at VWV for a few key reasons. First, the team has become increasingly interested in opportunities in the broader fintech industry as new technologies continue to disrupt incumbent players in financial services. Second, we stumbled across several companies in the alternative lending space through our diligence processes—Bags, Microwd, and Creci—but did not have the appropriate knowledge base to reach a comprehensive investment decision. This served as a catalyst for our alternative lending market map.
To add a little more color to our process and takeaways, the team at VWV worked hard to create a framework for our deep dive. Our methodology took a top-down approach: starting with the history of the alternative lending space and what caused its inception. We then segmented the market into key verticals, analyzing the market trends, companies building in the space, the market size, and the venture ecosystem surrounding each vertical. Our research consisted of primary research from the startups we have encountered, as well as secondary sources such as experts, professionals, and other research.
As the credit market continues to heat up and new players enter the alternative space with innovative products and services, we are excited to keep an eye on this burgeoning space in the months to come.
What is Alternative Lending?
Alternative lending, broadly speaking, is a form of debt financing that takes place through online platforms, leveraging technology to bring together borrowers underserved by traditional lending institutions with loan investors seeking attractive high-yield investments. The overarching goal of alternative lending is to use tech-enabled models to streamline the traditional lending process by bringing borrowers and loan investors together.
Key Learnings
Throughout our research, we concluded several key findings on alternative lending:
Alternative lenders differ from traditional banks in several key aspects. Alternative lending differs from traditional lending options through more flexible eligibility requirements, more timely funding via underwriting algorithms, a wider range of loan products, and digital streamlined processes unhindered by brick-and-mortar operations.
Alternative lending finds its roots in the 2008-2009 Financial Crisis. The 2008 recession upended the lending industry, driving banks to pull back from consumer and small-business lending. This allowed alternative lenders to tap into a growing market of underserved borrowers who found it increasingly difficult to access traditional sources of capital.
Alternative lending fills the gap for underserved borrowers, especially small- and medium-sized businesses (SMBs). In 2018, there was a funding gap of $5T between the financial needs of SMBs and the institution-based financing available to them. Major players in the alternative lending space, such as Kabbage and Bluevine, offer tailored solutions that target the vast SMB market.
The lending space is increasingly focused on funding underrepresented groups. Leaders in lending services—incumbent banks and alternative lenders alike—are increasingly committing capital to uplifting and funding diverse & underrepresented groups. Some examples of commitments include Bank of America's equity capital investments in 12 Minority Depository Institutions (MDIs) and Community Development Financial Institutions (CDFIs) as well as Union Bank's Business Diversity Lending Program.
Alternative lending offers unique opportunities that investors cannot find in other asset classes. Alternative lending benefits from reduced sensitivity to changes in benchmark interest rates, outsized credit spreads that cushion investors against realized principal loss during volatile market conditions, acts as a diversification tool against other asset classes, and displayed fundamental resilience and flexibility throughout the COVID-19 crisis.
The Future of Alternative Lending: LaaS
Where is alternative lending space headed? While we do not claim to predict the future, we’ve delved into this space for the last few months and can make some predictions based on our key insights and learnings.
Although we see considerable challenges for some players in the space within a new era of normalized high interest rates and macroeconomic uncertainty, we foresee the greatest potential in the verticalization of loan lifecycle management software, or Lending as a Service (LaaS) platforms. In particular, we are watching players such as:
ezbob: An e-lending platform intended to provide access to funding at any hour of the day, from any internet-connected device. ezbob's fully automated smart lending platform cuts through time-consuming traditional underwriting practices by linking directly to businesses' key data sources, such as cloud-based accounting services, tax reports and bank statements, to make up-to-date and rapid lending decisions based on the business' performance.
LendingFront: An integrated cash flow lending platform designed to automate processes and risk management activities. LendingFront’s platform offers a set of integrated or standalone modules covering all aspects of the financing process including application intake and workflow, underwriting, offer presentation, monitoring and servicing, enabling its clients to automate the lending process, while retaining full control and manual oversight where desired.
Blend: A cloud-based software platform that powers the digital interface between financial services firms and consumers. It supports and simplifies applications for mortgages, consumer loans, and deposit accounts.
These LaaS businesses offer a suite of tech-enabled solutions to both lenders (i.e. institutional investors) and borrowers (i.e. SMBs) that automate and streamline every step of the loan lifecycle, from loan origination to underwriting to loan portfolio management. We believe that these credit-focused SaaS players can, if executed successfully, become deeply embedded within lenders and borrowers’ daily workflows and provide the infrastructure to significantly augment the traditional lending process.
Concluding Thoughts
We have compiled a more detailed discussion of our key learnings from one of the most fascinating and complex fintech verticals in the PDF below ⬇️
Ultimately, we are far from experts in the space and are perpetually learning and growing — if you have any thoughts on alternative lending, or if you are building in this space, feel free to reach out to us at vwv@brown.edu to discuss!