Goliath and David: Why Small Loan Books Fail

Loan book debt

Small Loan Books

Everyone loves the story of the young tech start-up, working away in their parents’ garage, taking on the giant corporation with a relentless focus on their customers and delivering them a better experience. Goliath (in this case the bank) is complacent and with a little well-timed flick of his slingshot, David (Fintech start-up, non-bank lender) clocks him right between the eyes. Goliath falls, David is victorious and a wonderful consumer centric lender emerges much to everyone’s celebration.

Unfortunately, this is rarely the case. In the world of money lending, Goliath very regularly sends David packing with his sling shot between his legs. There are some sound reasons for this and emerging lenders need to have mitigation strategies for each of them if they are to survive.

High borrowing costs: As a lender, your cost of goods sold, is your funding costs. You need to be thinking night and day about how you get that funding cost down. If you are running a small loan book your funding options are limited to high net worth’s, who generally need to see a return north of 10%. As your book grows, so do your funding options. If you can get your book above $10m to $15m then institutional investors start to play. Start heading to $50 or $100m and you open up securitisation markets where you can fund a decent portion of your book with banks or super funds. You need to figure out where your funding cost needs to get to in order to be price competitive in your market and get there as quickly as possible. The other obstacle that smaller lenders will face in getting funding costs down is a lack of track record. You are selling a risk exposure to your funders. Until they see a consistency of performance over a number of years they will not lower their price for you.

Fixed overheads: Whether you are writing 100 or 1,000 loans there are a lot of fixed overheads that you will need to have in place. Regulatory, operational, sales etc. If your costs have to scale at the same rate as your loan book then something is broken in your business model and you are growing yourself into a faster oblivion. The smaller lenders that will survive will find a way to minimise their overheads through automation and outsourcing.

Huge working capital drain: Growing a loan book makes any other working capital problem look paltry. You will have to fund the customer acquisition costs, the equity / first loss component of any new loan written and the operational overheads whilst your book remains sub scale and non-profitable. Therefore, you need to figure out how much equity you will require in order to grow your book to profitability and have a war chest to cover it. If you don’t, you could be left high and dry with a loan book that is still sub scale and insufficient equity to continue to fund the growth.

Crowded market: Where are you getting your customers from? Is it digital marketing targeting keywords around debt or is it a broker network that you pay a commission to? If so your cost of acquisition will remain persistently high and assuming that your credit modelling and conversion is in line with similar lenders then inevitably all of your profit margin will migrate to your referral channels etc. as you continue to bid up costs. It also creates an environment where your product becomes commoditised and customers will price compare. If this occurs, the biggest player will win due to their superior funding costs and their ability to disperse their overheads across a larger revenue base. Smaller lenders need to find unique and proprietary channels to market in order to ensure it isn’t a race to the bottom in terms of competition for customers.

If you’ve got your slingshot locked and loaded then good luck to you. If you want to discuss some of your options if you’ve hit one of the above snags or you simply want to assess your options to lower your funding cost then please feel free to reach out.

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