Tech Firms Venture Into Lending

Given the extensive relationship between tech and finance it seems inevitable that tech would eventually use the data they are accumulating to try to grab some of the high margin business the banks have earned historically.

Lending, especially to small business, is far from certain, but the returns on all that knowledge as well as the benefits of locking customers even further into their technological ecosystems make the potential profits greater than the financial and reputational risks. JL

Ruth Simon reports in the Wall Street Journal:

The loans provide added profits and a way to build close customer ties. It locks the customer up in a new way. The companies say insights drawn from customer relationships allow them to make smarter loans.
Intuit and Square already know how much money millions of small businesses are bringing in each day. Now these tech firms are stepping up efforts to mine that data to get into the lending business.In the latest move, Intuit Inc., the maker of TurboTax, is expected to announce Thursday that it is teaming up with online lender OnDeck Capital Inc. ONDK 0.76 % to create a $100 million fund to provide loans to users of its QuickBooks accounting software.
“The bottom line is that small businesses need financing,” said Intuit executive vice president Dan Wernikoff. “They are not getting it at the same levels that large businesses are.”
Small business lending remains well below prerecession levels. Banks held $599 billion in small loans to businesses at the end of the second quarter, according to the Federal Deposit Insurance Corp., down nearly 16% from a peak of $711 billion in 2008. By contrast, loans to larger companies increased 35% during that time.
Intuit isn’t the only one seeking to fill the gap. Payments companies PayPal Inc. and Square Inc. are using transaction data to provide financing to their small business customers. United Parcel Service Inc. UPS 0.99 % this summer launched a partnership with online lender Kabbage Inc.

The loans provide added profits and a way to build close customer ties. “It locks the customer up in a new way,” said William Phelan, president of PayNet Inc. a tracker of small business credit.
But small business lending can be risky. Default rates for loans made by captive finance companies, a rough proxy for the new lenders, climbed to as much as 7.65% in the fourth quarter of 2009, compared with 4.5% for small business loans made by banks, Mr. Phelan said.
The companies say insights drawn from customer relationships allow them to make smarter loans. “We are seeing sales patterns week by week, month by month, year by year,” said Darrell Esch, general manager of small business lending at PayPal. A PayPal spokesman says delinquency rates are “in the low single digits and falling.” Loan payments are deducted on a daily basis, further reducing risk, he noted.
Intuit first began experimenting with small business lending in 2013. Over the past two years, QuickBooks customers have taken out roughly 5,000 loans totaling about $200 million, with Intuit receiving a referral or origination fee.
Krika Bradsher, owner of Sophia Sunflower Salon Inc., a Raleigh, N.C., beauty salon and maker of hair-care products, borrowed $10,000 through Intuit in August 2014. “It was very quick; very straightforward,” said Ms. Bradsher, who used the money to buy a new mixer and raw materials for her My Honey Child products. She repaid the loan plus $1,301 in interest and fees over 11 months, with payments deducted daily from her bank account.
But loan demand through Intuit has been modest, in part because many loans carry annual rates of around 30%, well above the 5% to 6% banks typically charge small businesses with good credit. Mr. Wernikoff said Intuit’s new program offers cheaper financing to the company’s strongest customers, with rates of 8% to 19.9% for lines of credit with terms of up to one year and payments deducted on a weekly basis.
Intuit says it will use average cash balances, receivables and other QuickBooks data to identify borrowers with good credit who are likely to need financing in the next three to six months. OnDeck will originate and service the loans. Neither Intuit nor OnDeck would say how much capital each company is contributing to the venture or how profits will be split.
PayPal says it now issues an average of more than $2 million in loans to U.S. small businesses each day, up from an average of $1 million a day in the second quarter. In May, the company boosted its loan limit to $85,000 from a prior limit of $65,000, or as much as 15% of annual PayPal processing volume, up from 8%. The company had extended $500 million in working capital as of May, the most recent period for which data is available.
Gustav Reyes borrowed $6,000 from PayPal in January to redesign the website for Simply Wood Rings, a Chicago-based maker of handcrafted wooden wedding rings, and pay his four employees during the slow winter months. “Within the first month I saw a sales increase,” said Mr. Reyes, who quickly repaid that loan and later borrowed another $8,500 to hire someone to help with marketing.
Square has provided more than $225 million in financing to small businesses since launching its program in May 2014 and is currently advancing more than $1 million a day, a spokeswoman said. In May 2015, Square said it had secured additional funding from investors, including Victory Park Capital and Colchis Capital, to expand the lending program.
At both PayPal and Square, payments are taken as a portion of transaction volume, meaning merchants repay more when sales are high and don’t pay on days without sales. That allows for easier repayments, but makes it difficult to calculate an annual interest rate. A PayPal spokesman said the company is looking for ways to help customers make “apples to apples comparison” with other types of financing.
In June, UPS began referring to small business lender Kabbage small customers that need working capital, but are too small for its traditional vendor financing program. UPS is looking at ways to provide Kabbage with more information about its customers, with their permission, so Kabbage can better tailor its loan offerings.
Rob Frohwein, CEO of Kabbage, calls the transportation giant, “just an absolute treasure trove of information about small business.” “You know how many packages they were shipping,” he added. “You know how many returns, how long they have been in business, have they shifted from place to place.”