1 A Survey of SME Finance and the Emerging Alternatives for Access to Capital Jim Faith Trade and Export Finance Online Global California December 3, TEFO. All Rights Reserved
2 Agenda Section 1: An SME Snapshot View Section 2: Current Bank Lending Environment Section 3: Emerging Alternatives for SME Access to Capital Section 4: Alternative Finance Outlook for 2015
3 Section 1: Snapshot SME Working Definition and Profile Less than 500 employees Represent 99% of all American companies Employ over 50 percent of private sector employees (about 120 million people) Generate 65 percent of net new private sector jobs Represent over half of U.S. non-farm GDP Vast majority are sole proprietorships Represent 98% of all U.S. exporters and 34% of U.S. export revenue
4 Section 1: Snapshot US Small Businesses by Number of Employees Source: US Census Bureau, 2013
5 Section 1: Snapshot Top Five Exporting States by Number and Value All Exporters Rank State Number of Exporters Exports ($Millions) US 302,051 1,365,738 1 TX 40, ,491 2 CA 75, ,045 3 NY 41,028 86,523 4 LA 4,000 63,339 5 FL 61,848 61,344 SME Exporters Number of Exporters Exports ($Millions) 295, ,502 37,921 85,527 71,921 66,693 38,675 51,640 3,378 22,028 58,976 42,051 US Census Bureau 2013 Preliminary Report
6 Section 1: Snapshot Top Five Export Destinations US Exports Rank Country Value ($ Million) 1 Canada Mexico China Country CA Exports Value ($ Million) Mexico 23.9 Canada 18.9 China Japan 65.2 Japan Germany 47.4 South Korea 8.4 US Census Bureau 2013 Preliminary Report
7 Section 1: Snapshot Top SME Exporters by Company Size 140, , ,000 80,000 60,000 40,000 20, K 1-19 Employees Top Exporters by Company Size 33K 17K 14K > 500 4K 7K Source: US Census Bureau, 2013
8 Section 1: Snapshot Exporters are Better Economic Performers Exporters consistently out-perform non-exporters in: Higher Sales Higher Employment Pay higher wages Are more productive in terms of value added per worker Use higher levels of capital per worker Have higher skill intensities Nearly 40% of exporters also import and 80% of importers export. Source: US International Trade Commission Report (2011)
9 Section 2: Environment Current Bank Lending Environment Post-recession Cyclical and Structural Effects Regulatory Oversight: Dodd-Frank and Basel III The Credit Gap and Emergence of Online Alternative Funding
10 Section 2: Environment Greater Perceived Risk Means Tighter Lending SME sales haven t returned to pre-recession levels, which in turn, means less demand for loan capital. Traditional collateral, primarily real estate, lost value during the crisis making some borrowers less creditworthy. Banks have remained more risk averse in the recovery while focused on integrating new regulatory oversight in their day-to-day operations. The resulting tighter lending criteria includes: Greater focus on borrower s personal profile, credit scores, income and assets Higher collateral requirements Increasing equity requirements for new loans Preference for liquid collateral, e.g. personal savings, CD s, or stock.
11 Section 2: Environment Banking Industry Consolidation The Banking industry has been in a state of perpetual consolidation since the mid-1980 s. Community Banks, the second leading source of SME bank loans, are being absorbed by larger banks. There are less than 7,000 today, down from over 14,000 in Smaller banks have traditionally relied on relationship banking which includes social context like the borrower s character and local community history in lending decisions. Relationship banking is expensive and don t translate well to the dataoriented criteria and automation used by larger banks.
12 Section 2: Environment Higher Transactional Costs Lenders face greater risk because SME s are inherently more sensitive to economic volatility, have higher failure rates, and fewer assets to collateralize. Publically available information on SME business and financial performance is fragmented and costly to obtain. The fragmented market makes it difficult to develop general credit standards and to securitize and sell small business loans in the secondary market. This state of operational and information disconnect has yet to be resolved and contributes to the higher transaction costs associated with small business lending. Consequently, transaction costs to process a $100,000 loan are comparable to a $1 million loan, but with less profit for lenders.
13 Section 2: Environment High Search Costs The current environment includes high search costs in which it s difficult for qualified borrowers to find willing lenders, and lenders to find creditworthy borrowers. A Federal Reserve study states SMEs can spend up to 25 hours on paperwork for bank loans, and often apply to multiple banks. Even successful applicants can wait several weeks before the funds are available.
14 Section 2: Environment Regulatory Oversight Bank management has been focused on the implementation of Dodd- Frank reforms and Basel III requirements in their processing and dayto-day operations. This regulatory overhang has been an ongoing issue during the recovery, has contributed to the lack of available funds for lending and a case can be made that there has been a disproportionately negative effect on SME lending in particular.
15 Section 2: Environment Stalemate and the SME Credit Gap In summary, Banks say there s a lack of demand and they re not finding qualified borrowers. Small business owners say that, despite being creditworthy, banks remain unwilling to lend to them Transaction costs to process a $100,000 loan are comparable to a $1 million loan, but with less profit to the lender; and yet these smaller loan amounts are generally needed most by startups and SMEs. The unstoppable force (small business need for capital) has met the immovable object (bank lending) resulting in the creation of an SME credit gap. And that gap is being filled by technology solutions and the emergence of online alternative finance.
16 Section 3: Alternative Finance Types of Alternative Finance Non-bank Direct Lenders Marketplace Lenders P2P Lending and Crowdfunding Supply Chain Finance Accounts Receivable Marketplace Merchant Cash Advance Equipment Leasing Corporate Venture Capital Angel Investment Venture Capital Public and Private Equity
17 Section 3: Alternative Finance Non-bank Balance Sheet Lenders Balance Sheet lenders make loans and keep them on their own balance sheet instead of packaging and selling off as securities. If the borrower defaults, balance sheet lenders take the borrowers' assets to cover the unpaid debt. Typical terms are less than 9 months and the proceeds are used for working capital. Repayment is made by a fixed amount or percent of sales deducted daily from the borrower s bank account over a period of months. Interest rates can range from 30% to 120% on an average loan size of $40,000. Preliminary market data: $5 billion in loans since 2007 Biz2Credit OnDeck Can Capital
18 Section 3: Alternative Finance Marketplace Lending Online marketplace lending allows borrowers to comparison shop for a range of loan products from a variety of lenders. Lenders can include commercial, community and regional banks and the SBA as well as other alternative lenders. Mitigates the high search costs for borrowers (~25 hours). Revenue generated from fees paid by the borrower if they get funded. Or the loan package is sold to a lender. Interest rates and loan terms are independent of the platform and determined by the lender. Boefly Fundera Lendio
19 Section 3: Alternative Finance P2P Lending and Crowdfunding Peer-to-peer/Person-to-Person and Crowdfunding platforms enable individuals, businesses, institutional investors and investment banks to lend to consumers and businesses for specific projects. Platform revenue comes from origination fees deducted from the loans disbursed to borrowers and servicing fees deducted from principal and interest payments paid to the lender. Value proposition: Lower interest rates for borrowers; attractive rates of return for investors; and a simple, web-based platform with lower operating costs than banks. Platform provides investors with the ability to distribute risk among multiple borrowers. Interest rates can range from 8% to 25% for loans up to $250,000 over three years. Preliminary market data: $4 billion in loans to date Lending Club Prosper.com Funding Circle
20 Section 4: Outlook for 2015 Outlook for 2015 Bank lending to SMEs has improved, but has not and likely will not return to pre-crisis levels. In June 2013, bank portfolio loan balances of $1 million or less was $288 billion down $47 billion from June Online alternative finance is currently generating about $10 billion in outstanding loan capital and these alternatives will continue strong growth in The outstanding portfolio balance of online alternative lenders is doubling every year. By contrast, outstanding loan capital held by the banking sector is declining an average of 3% annually.
21 Section 4: Outlook for 2015 Some Perspective on Alternative Finance Total SME Debt Capital Outstanding as of 2013 ($ Billions) 700 Bank Loans 175 Business Credit Card 140 Equipment Leasing SBA Factoring MCA Online Alternatives Source: Mills, Karen and Brayden McCarthy. State of Small Business Lending: Credit Access During the Recovery and How Technology May Change the Game. Harvard Business School. July 2014.
22 Section 4: Outlook for 2015 SME Exporters There are reasons for optimism a 2013 NSBA/SBEA survey shows that 60% of non-exporters are interested in exporting and 52% of current exporters report increased export sales since A 2012 Boston Consulting Group report forecasts that by 2020, declining energy costs and increasingly competitive wages will give America as large as a 25 percent export cost advantage over major exporting competitors like Japan and Germany. The BCG report estimates that the US will experience a manufacturing renaissance and re-shoring starting in 2015, and could add 2-3 million jobs and $100 billion in annual GDP.
23 Section 4: Outlook for 2015 Online Marketplaces Strong growth will continue in Currently Online platform providers generally use proprietary technologies to evaluate risk and creditworthiness. There will be increasing efforts in: Partnerships with third party agencies for data validation. Development of securitization and secondary market due to institutional demand. There are credible estimates for a potential market size of $870 Billion. This figure comes from a comparison to banks, credit cards companies and other lending institutions that generate over $870B/year in fees and interest over $3.2T in lending activity. Specialized segments will continue to grow in many areas of business and consumer lending. Segments like real estate, mortgage appraisal, education and healthcare etc. will continue to evolve.
24 Section 4: Outlook for 2015 Marketplace Investors Institutional debt and equity investors will continue to seek the relatively high rates of return. Traditional bank loans yield 5% to 7%, while many platforms are generating yields ranging from 30% to 120% of the loan value. These higher yields are particularly attractive in the current, and historic, environment of the Federal Reserve s Quantitative Easing that has kept yields low.
25 Section 4: Outlook for 2015 SME Banking Bank lending will likely never return to the pre-2008 environment. However banks currently own the asset marketplace lenders want the most - millions of SME customers. The Bank and Credit Card industry response to online alternatives will be interesting to watch. Some are already participating by: Using their capital to fund loans on marketplace platforms Taking a position in the platforms and offering as a value-added service. Assisting in the development of secondary market for trading and liquidity. A 2013 KPMG banking survey reports that banks have generally accounted for the new regulatory oversight and are now placing a renewed emphasis on a customer-centric business model and improvements to customer s technology experience, which in turn, will drive major investments over the next few years.
26 Section 4: Outlook for 2015 Big Data There will continue to be strong growth in the use of Big Data and development of scoring algorithms which integrate social data from, for example, blogs, product and business reviews and tweets. Online platforms generally recognize that integrating new sources of data is their competitive advantage. The key predictive goal is to establish a correlation with repayment. The more predictive the loan pool, the stronger the underwriting. A marketplace lender uses its own data in a feedback loop that increases the accuracy of its model. Loan performance data feeds back into the model, further increasing the accuracy. As the accuracy increases, the lender can offer lower rates to borrowers. As rates decrease, more borrowers come to the platform, driving more data into the model.
27 Section 4: Outlook for 2015 Regulatory Oversight Marketplace lenders fall between the cracks for federal regulators because they re not banking entities. Currently no single federal entity has broad authority to regulate the emerging industry. The majority of oversight happens at the state level, with a patchwork of regulations within state lines. The P2P platforms are a hybrid of lending (the domain of regulators at the state and federal level) and registered securities (the domain of the SEC). A key innovation of P2P lending is that lenders on the platform are not lending money to borrowers in the legal or regulatory sense; rather the lenders are investors in securities issued by the lending platforms linked directly to specific loans originated by an underlying bank. These and other regulatory issues will be developed in 2015.
28 Section 4: Outlook for 2015 Regulatory Oversight Key regulatory and policy issues to resolve: Define the appropriate level of regulation? Transparency and Disclosure between all parties in a transaction. Standardized Oversight and Monitoring by Federal and State regulators. Borrower financial awareness, literacy and education.
29 Thank You Jim Faith Trade and Export Finance Online TEFO. All Rights Reserved