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Small businesses increasingly turn to online lenders when banks bail

June 22, 2014 at 1:18 PM EST
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STACEY TISDALE: Soon after opening DJ’s Delights, a deli in the New Jersey shore town of Asbury Park, co-owners Ron Wendolowski and DJ Presto realized they needed to upgrade kitchen equipment. And they figured they could easily get a small business loan of about $6,000 dollars to do that.

But when Wendolowski – who manages the books – tried going to a bank in 2010, he quickly found out it was going to be anything but easy.

RON WENDOLOWSKI: It’s aggravating– you don’t have two months to wait to get that loan from the bank, when you– when you need the money now. So you– you know, it’s kind of like getting the door shut in your face.

STACEY TISDALE: So Wendolowski started searching for alternatives online and stumbled across a lender called OnDeck. He did a little research, then applied for a loan. The entire process taking place online.

RON WENDOLOWSKI: I mean, it took literally, like, 10 minutes.  It wasn’t anything, you know, that– that took away a lot of my time from running the business, or having to gather, you know, 50 different documents, or tax statements, or anything like that.  So it was– it was a very easy process. And in three days, we had the money we needed.

STACEY TISDALE: Since the financial crisis, small business lending by banks has declined substantially according to federal data. The value of loans of less than $100 thousand dollars is down by more than 18% since 2008.

But while banks have pulled back, new types of sparsely regulated nonbank lenders have stepped in as alternatives, hoping to disrupt traditional small business lending.

Online companies like Kabbage, CAN Capital, Swift Capital, PayPal, and Wendolowski’s lender, OnDeck, are using technology to make fast decisions about relatively small loans, but with interest rates that can be several times that of a bank loan.

NOAH BRESLOW: Banks have not been natural lenders to this segment of the market.

STACEY TISDALE: Noah Breslow is the CEO of OnDeck and a former software engineer. OnDeck typically lends to small businesses with less than 10 employees – and its average loan is for $40,000 with a term of one year. It’s a type of loan that Breslow says is very difficult for a traditional bank to make profitable.

NOAH BRESLOW: But what our technology lets you do is make that $40,000 loan in– in– in seconds, but using the same kind of analytical breadth that you’d want to bear, speeding up a process that was much less efficient– before.

ONDECK PROMOTIONAL VIDEO: Our platform can yes to more small businesses.

STACEY TISDALE: When a business applies for a loan, OnDeck says it quickly analyzes more than 2,000 data points, both big and small. It crunches traditional metrics like cash flow and the business’s credit profile. But it also looks at social data. Which means if you’re a restaurant like DJ’s Delights, it’ll also be checking what customers are saying on review sites like Yelp.

STACEY TISDALE: What can Yelp tell you about someone’s credit worthiness?

NOAH BRESLOW: It’s– you have to be careful. So what you don’t wanna do is make a decision about a loan because someone didn’t like the chicken– last night in a restaurant.  But what you can start to do is build patterns and models that statistically tell you a restaurant that’s doing $2 million in revenue– might have this number of Yelp reviews or this frequency of Yelp reviews.

STACEY TISDALE: New York-based OnDeck has extended more than $1 billion dollars in credit since launching in 2007 and has raised money from high profile investors.

Unlike banks, OnDeck’s loans are not backed by collateral.  And while OnDeck doesn’t disclose detailed data on defaults, it says the rate is in the quote “single digits” for its loans.

STACEY TISDALE: For Ron Wendolowski, OnDeck has become a consistent source of credit. The business is on its fourth loan and it’s used the money to stock supplies after Superstorm Sandy, and to expand from just a deli to a sit-down restaurant and a small market.

RON WENDOLOWSKI: We definitely would not be what we are today without their help.

STACEY TISDALE: The business’s current loan is for just over $40,000 over 12 months, but the money isn’t cheap. The annual interest rate on its loan is about 30% – almost six times what a small business loan from a bank could be.

STACEY TISDALE: Was getting that money at that time, even at that high rate, worth it?

RON WENDOLOWSKI: It was worth it. It’s higher interest, of course.  But when you’re a business owner and you need the money and your business depends on it, you’re gonna, you know, accept that.

STACEY TISDALE: While an alternative loan worked for Wendolowski, there have been reports of small businesses running into serious trouble with high interest loans taken out from other online lenders.

And while Noah Breslow of OnDeck thinks the cost of alternative loans like its will come down, the average annual interest rate is about 50%.

STACEY TISDALE: The rates aren’t cheap.  How do you justify that higher rate to clients?

NOAH BRESLOW: Well, I think you’re paying for speed and convenience. I think merchants would much rather have the choice of taking a loan than not have that option at all. And I– I think for the value we provide, we’re priced fairly.

STACEY TISDALE: But alternative lenders like OnDeck have been criticized for potentially taking advantage of desperate small business owners.

NOAH BRESLOW: You know, I think people sometimes think, “Oh, small business owners are unsophisticated.”  Our business– customer has been un– in business, on average, ten years.  Right?  Multiple economic cycles. It’s not like we’re taking folks, you know, who don’t understand what they’re doing.

STACEY TISDALE: but alternative lenders are still very much alternatives.

While OnDeck and others have been growing rapidly, lending an estimated $3 billion dollars in total last year. That amount is just a tiny fraction of small business loans given by banks: in total, more than $125 billion dollars in 2013.

PAUL MERSKI: Community Banks have been innovating for decades and they do the vast majority of small business lending, they do the vast majority of lower dollar lending to small businesses.

STACEY TISDALE: Paul Merski is the chief economist for the Independent Community Bankers of America. Together, community banks are responsible for 60% of small business loans, despite being just 15% of the total banking market. And industry surveys show that they approve about half of all small business applicants. That’s less than alternatives lenders on the whole. But more than OnDeck. And more than big banks, which approve about 20 percent of applicants.

PAUL MERSKI: Community banks specialize in small business lending. And that’s because it’s a relationship lending, where the community bank knows the local market, knows the customer, knows the small business owner personally many times. And that really helps with the lending decision and makes a better lending decision than a transaction that’s been done online or a thousand miles away.

STACEY TISDALE: And when it comes to cost, banks can offer a much cheaper option for small businesses that can qualify. On average, just under 5% annual interest for a loan under 100,000 dollars.

PAUL MERSKI: Many of these new startups are a simple formula, high rates. And it may be simple and quick to get your loan, but the rates and the terms are not going to serve the small business owner and not going to serve the best interest of that business.

STACEY TISDALE: But Noah Breslow is convinced technology is ushering in huge changes in small business lending.

STACEY TISDALE: Where do you see this alternative lending industry in ten, 20 years?

NOAH BRESLOW: You know, I think it loses the designation of alternative. I think just like today I buy a plane ticket online with Priceline.com.  Maybe 20 years ago I would have talked to a travel agent.  You know– we are going through that entire cycle.  We’re probably in year five of a 20-year journey in terms of lending.

STACEY TISDALE: Since taking out loans with OnDeck, Wendolowski thinks he could probably now get a loan from a traditional bank. Not that he wants one. After paying back their current loan, Wendolowski and partner DJ Presto are hoping to be able to run the restaurant without any loans – traditional or alternative.