Direct Lending: Manage the Risks, Reap the Rewards
Direct lenders are well positioned to capitalize on the growing demand for non-bank loans. Consumer and SME borrowers are turning away from big banks because traditional lenders are declining more loans than they approve. Direct lenders who understand the dynamics of non-traditional funding can earn superior returns on their portfolio, without taking on undue risk.
Last summer we reported on direct business loans in SME Borrowers: Perfect Match for Alternative Lenders (July 20, 2018). Today’s article will expand on this topic. We’ll size the overall opportunity, explore the consumer mortgage market, and lay out the obstacles along with the solutions.
Borrower crisis creates direct lender opportunity
We live in a time of great crisis and great opportunity as the marketplace adapts once more to our old friend change. These opposites are really just two sides of the same coin, and direct lending is a clear example of this phenomenon. A borrower crisis is created by big banks and credit unions that decline the majority of new loan applications. But the crisis is converted to an opportunity by direct lenders who are poised to fill the vacuum.
Let’s look at some statistics published by the Biz2Credit Small Business Lending Index. Traditional lenders approved only 26% of small business loan applications in the first half of 2018. Direct lenders – on the other hand – approved 56% of their business loan apps during the same time period. That’s more than double the approval rate. It should come as no surprise that direct lending has grown by 22% YOY in the US and 43% YOY in the UK for the past six years.
Traditional banks have a way of adding insult to injury. Most are still using a slow, paper-based review process that can take up to 90 days to decline a loan. This is good news for those direct lenders who leverage FinTech software systems like TurnKey Lender. They are able to approve far more loans with a faster, easier process that supports better credit decisions.
Consumer mortgage market
Mortgage payments represent the single largest consumer debt category with $10.2 trillion outstanding, or 65% of all consumer debt in the US, according to the US Federal Reserve. This number has remained steady for more than 10 years, even with the recent ups-and-downs of our economy. What has changed is the value of the underlying real estate assets that collateralize these loans. The aggregate valuation has increased from $18.6 to $29.0 trillion over this same time period, substantially reducing the risk associated with mortgage lending.
When we couple these strong fundamentals with the fact that today’s borrowers prefer a digital-only lending process – it’s easy to see why consumers are flocking to direct mortgage lenders.
A recent article in NerdWallet discussed the reasons for this new consumer trend. Direct lenders deliver a painless process. They bypass financial middlemen like mortgage brokers and online lead generation websites. And they approve mortgage applications in as little as 8 minutes. These superfast and precise decisions are due to the fact that they, “…strip away layers of delays built into the old system by using automated loan-decision algorithms, electronic document gathering, and secure online communications.”
Strong borrower risk profile
We’ve talked about strong demand, but as lenders, we are well aware of the inverse relationship between credit demand and credit quality. Today’s environment is unique. These borrowers are creating demand, but they’re not credit hungry. As a group, they have the strongest risk profile we’ve seen in more than a decade.
There’s plenty of negative press touting the fact that consumer debt is on the rise. In fact, some media outlets use the phrase dangerously high level. However, debt tells only half the story. When we balance debt on one side of the scale with income-to-debt ratio on the other side of the scale – then a different, far more positive picture begins to emerge.
Moody’s recently reported that consumer income-to-debt ratio has fallen from 136% to 102% over the past 10 years. And Lawrence Yun, Chief Economist for the National Association of REALTORS, related in a Forbes interview that mortgage debt, “…is performing very well with very low default rates.” He goes on to say that the percentage of seriously delinquent mortgages (3+ months) has fallen from 10.0% to 2.1% during the past decade.
We’re seeing positive indicators from business borrowers as well. 45% of SME borrowers are looking for mobilization funds in order to scale their business. These growing companies are taking on bigger clients and larger production orders. And many are buying, instead of building, new technology. These loan proceeds will be used to finance the acquisition of a smaller, specialized company that can bring new technology to the combined venture.
Direct lending challenges – two obstacles to maneuver
There are two challenges direct lenders must overcome to be successful.
First, a key differentiator for direct and alternative lenders is their speed and accuracy when reviewing applications and pricing new accounts. Direct lenders who deliver a digital-only experience will dominate the competition. Their loan process will include an online application for desktop and mobile devices, as well as quick credit decisions and digital funds transfers.
Specialized lending technology and decision software is an absolute must for lenders who intend to succeed in this fiercely competitive arena. This type of automation delivers an exceptional user experience for the borrower, as well as processing efficiencies and profitable credit decisions for the lender.
Second, this is a young, sexy industry that gets a lot of attention from the media as well as the regulators. Positive publicity is great for building your brand and driving new applications to your website. However, enhanced regulatory scrutiny can create a variety of potential setbacks, including penalties and fines.
The most susceptible lenders tend to be those with a strong entrepreneurial spirit. The ones who focus first and foremost on leading-edge functionality and aggressive marketing campaigns, while they push their compliance strategy to the back burner. This approach can lead to costly mistakes. Financial regulators are publishing as many as 200 notices per day regarding new and revised compliance rules. And they’re launching cyber units that are designed specifically to target lenders that use digital channels.
LaaS platforms automate processes and reduce risk
Direct lending comes with a unique set of challenges, but the rewards outweigh the risks when the discipline is managed correctly. The trick is to approve the right applications, at the right price point, in real time – and then complete a digital funds transfer at the time of approval. It’s easy to see why successful direct lenders rely on specialized technology and software systems to resolve a myriad of origination and account management challenges.
There are a number of good lending-as-a-service (LaaS) platforms that cater to the needs of direct lenders. These platforms automate processes for much-needed speed, accuracy, and efficiency. Regardless of whether the system is reviewing a new application, managing payments, or using predictive bad debt triggers to monitor borrower credit scores. They also provide sophisticated data analytics and advanced credit scoring features that maximize earnings potential within your risk tolerance parameters.
Look for a cloud-based system that’s fully managed, easy to deploy, and easy for your team to master. It should be a rules-based system that can be customized to meet individual requirements, and it should be regulatory compliant right out-of-the-box. Software upgrades, or an all-new release, should be automatic at a platform level with no additional programming on your part; including regulatory compliance updates when new rules are published. The platform should include a proprietary scoring model that uses machine learning and ongoing analysis to constantly fine-tune the scorecard. And it should include alternative scoring models that can evaluate borrowers who have no credit history, or only a thin credit file with traditional credit reporting agencies.
More and more consumer and business borrowers are bypassing traditional banks in order to save time and frustration. Which means there’s no better time to position your direct lending brand as a “go-to” resource for this lucrative target audience.
Successful direct lenders will deliver a streamlined, digital application process along with competitive rates. This can be accomplished both efficiently and cost-effectively with a fully managed loan origination solution that automates the process and controls credit risk. And without the time, expense and expertise required to build a proprietary platform from scratch.
At TurnKey Lender we know exactly the challenges direct lenders face. And we’re proud to provide businesses worldwide with the most intelligent end-to-end lending automation software on the market.
Reach out for a free trial. You will see for yourself just how much TurnKey Lender can improve your direct lending operation.