ONDK - On Deck Capital

[KCLarkin]

To pessimists, On Deck Capital is a predatory "payday" lender to small businesses that charges 41% interest rates. With only $300 million in equity, will it survive the next recession?

 

To optimists, On Deck is technology company that has found a way to profitably provide small loans to small businesses. With a net promoter score of 73, it is clearly providing an important service for small businesses.

 

Khrom Capital bull thesis:

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/khrom-capital-new-position-any-ideas/msg260253/#msg260253

 

See also:

https://punchcardblog.wordpress.com/2016/01/19/ondeck-capital-ondk-the-re-engineering-of-small-business-lending/

 

Disclosure: I haven't done much work on this but Khrom's writeup has me intrigued. I will work on it when I get back from vacation.

 

[muscleman]

A few things that you need to dig into:

1. Huge dilution over the years. What did they do with the issued shares?

2. Huge revenue growth. This can hide delinquency problems. What's the true delinquency rate per loan?

3. Secularization. What are the terms? Do they take  the initial 10% losses?

[muscleman]

Dilution seems to be caused by IPO, so this might be OK.

I am still very uncomfortable with the drop of their provision/revenue ratio. Had they reserved the same ratio as 2014, they would have reported an extra 15 million loss in 2015.

[constructive]

Since they originate all of their loans and hold some of them on their balance sheet, ONDK's growth is more balance sheet constrained than a platform company like LC or TREE, which have the ability to grow more explosively. And on the other side, they have a higher cost of capital than banks since they don't take deposits.

 

It seems like it would be more efficient for ONDK to either be a bank, which takes credit risk directly and has a low cost of capital to make up for it, or a platform, which doesn't take credit risk.

[muscleman]

Since they originate all of their loans and hold some of them on their balance sheet, ONDK's growth is more balance sheet constrained than a platform company like LC or TREE, which have the ability to grow more explosively. And on the other side, they have a higher cost of capital than banks since they don't take deposits.

 

It seems like it would be more efficient for ONDK to either be a bank, which takes credit risk directly and has a low cost of capital to make up for it, or a platform, which doesn't take credit risk.

 

Well, they already built an ONDK rating platform for banks to reference to. I think this might build a FICO type of moat, which I really like.

What I don't like is the way they set aside loan loss provisions in 2015. I don't know how to figure out the true delinquency ratio as the loan growth is too high.

[Guest Schwab711]

Since they originate all of their loans and hold some of them on their balance sheet, ONDK's growth is more balance sheet constrained than a platform company like LC or TREE, which have the ability to grow more explosively. And on the other side, they have a higher cost of capital than banks since they don't take deposits.

 

It seems like it would be more efficient for ONDK to either be a bank, which takes credit risk directly and has a low cost of capital to make up for it, or a platform, which doesn't take credit risk.

 

Well, they already built an ONDK rating platform for banks to reference to. I think this might build a FICO type of moat, which I really like.

What I don't like is the way they set aside loan loss provisions in 2015. I don't know how to figure out the true delinquency ratio as the loan growth is too high.

 

FICO added small business scoring services (SBSS) shortly after On Deck. It's not overly popular as small/regional banks tend to think this is their area of expertise (they are in the customer relationship business after all).

 

There's also at least a half dozen private VC-funded companies at various stages that are competing to rate and fund small businesses and consumers that don't have FICO-based credit scores (FICO just launched their own version of this scoring solution in the last few months, which is being distributed by Experian and Equifax). There's probably another hundred or so companies that provide small business lending without attempting to monetize or brand their internal credit score (Kabbage is on the radio all the time).

 

I don't know anything about ONDK but I don't think their scoring solution is ever going to become ubiquitous.

 

http://www.equifax.com/commercialsolutions/nacs/documents/EFX-00119_FICO_SBSS_7-0.pdf

[constructive]

I don't know anything about ONDK but I don't think their scoring solution is ever going to become ubiquitous.

 

I agree.

 

I see the Lending Club model as more likely to be the future of lending. The peer to peer model uses the wisdom of crowds, which will probably meet or exceed any individual company's underwriting abilities. Also, separating the platform from the lending is likely to be most capital efficient.

 

However, LC seems difficult to value - the current share price assumes a lot of growth.

[dorsiacapital]

I stole this from Glenn Chan, but this article makes me very, very nervous about OnDeck (http://www.bloomberg.com/news/articles/2014-11-13/ondeck-ipo-shady-brokers-add-risk-in-high-interest-loans)

 

No idea if these practices are still going on but I think it says something concerning about a company's DNA that it was ever used to fuel growth. I tend, however, to be far too moralistic in my investing.

 

I would say that I am sure the model both looks and is fancy but it has not been tested in a true credit cycle. Moreover,  I understand small businesses face financing charges, but I am concerned that any small business that is willing to borrow at interest rates well over 50% is either a small business on its very last legs or run by a not particularly astute business owner. For short term, relatively small financing needs, credit cards would generally be a much better source of financing. I understand that careful loss provisioning can make up for this

 

To be honest, I think this is more interesting as a short play on a fintech p2p lending bubble because OnDeck, unlike LC/Tree, keeps some of the loans on the books. Obviously a less appealing play at this low price though.

[roughlyright]

What I see really troublesome with Lending tree model, is the the securitization.

Let us look at a scenario, where they lend $100,000 to a guy, which is funded in chunks of $100 by 1000 people. None of them own this loan. If this borrower defaults, they will send him a couple of automated emails. He will naturally ignore them. Lendingtree is not on the hook to get this $100K because, they got their upfront 5% cut. They are happy and moving on. They don't have enough administrative staff to make sure the loans are paid, like a typical bank. They don't have any credit risk to their balance sheet.

 

The borrower ran away with the money. Collection agency will send a couple of letters and put a negative entry on the credit report. This is a unsecured loan. It is lot worse for the investors than a home loan ponzi scheme that was run by the wall street few years ago. These poor retail investors who are desperate for interest income, because of ZIRP policy are pushing into such risky business which they have no idea. None of the 1000 people who lent this money, have enough skin in the game to go after the borrower, who took on a unsecured loan. What recourse they have if the borrower does not pay? send a negative report, but that automatically goes off a person's credit report in 7 years. What is the big deal to the borrower? He is sitting on a cash of $100,000. He does not need to borrow money. What is also surprising to me is that Lending Tree business model looks risky and too dependent on the whims of the market.  But it carries 3 times the book value, where as OnDeck is future is more secure, but sells at 1.6 time book.

 

I also thought that if we followed Eric Khrom, and correctly identified the stock as OnDeck, we could have lost 50% of the money (on paper) at least because it dropped from almost 60% in one year. Their business model, sounds eerily similar to First Marblehead, where everybody was saying they had a some type of secret sauce in knowing which students will default on their student loans who do not. They also had another entity called, TERI which allowed them to rate and predict the student's ability to pay based on some esoteric algorithm. See what happened to FirstMarblehead stock.

[Picasso]

What I see really troublesome with Lending tree model, is the the securitization.

Let us look at a scenario, where they lend $100,000 to a guy, which is funded in chunks of $100 by 1000 people. None of them own this loan. If this borrower defaults, they will send him a couple of automated emails. He will naturally ignore them. Lendingtree is not on the hook to get this $100K because, they got their upfront 5% cut. They are happy and moving on. They don't have enough administrative staff to make sure the loans are paid, like a typical bank. They don't have any credit risk to their balance sheet.

 

The borrower ran away with the money. Collection agency will send a couple of letters and put a negative entry on the credit report. This is a unsecured loan. It is lot worse for the investors than a home loan ponzi scheme that was run by the wall street few years ago. These poor retail investors who are desperate for interest income, because of ZIRP policy are pushing into such risky business which they have no idea. None of the 1000 people who lent this money, have enough skin in the game to go after the borrower, who took on a unsecured loan. What recourse they have if the borrower does not pay? send a negative report, but that automatically goes off a person's credit report in 7 years. What is the big deal to the borrower? He is sitting on a cash of $100,000. He does not need to borrow money. What is also surprising to me is that Lending Tree business model looks risky and too dependent on the whims of the market.  But it carries 3 times the book value, where as OnDeck is future is more secure, but sells at 1.6 time book.

 

I also thought that if we followed Eric Khrom, and correctly identified the stock as OnDeck, we could have lost 50% of the money (on paper) at least because it dropped from almost 60% in one year. Their business model, sounds eerily similar to First Marblehead, where everybody was saying they had a some type of secret sauce in knowing which students will default on their student loans who do not. They also had another entity called, TERI which allowed them to rate and predict the student's ability to pay based on some esoteric algorithm. See what happened to FirstMarblehead stock.

 

+1

 

I actually find it interesting that he discloses what the stock is now that it lost a lot of value.  I bet he exits the investment in the next year or so at breakeven but the cloners will be holding this all the way down to zero as the thread approaches 1000 pages.

[kab60]

Secret sauce is a nice term. But I have a hard time figuring out its components. I find the Ondeck story compelling but it's full of so many buzzwords I get a bad for feeling. Fintech, disruption and big data all in one doesn't comfort me. What thousand datapoints can they have that is any good when rating a small business? If the borrower pays +35 pct. on their loan the businesses must be shitty and/or new for the most part - thus a lack of data?

[roughlyright]

Thank you dorsiacapital. That article you linked was very good.

 

What type of business in their right frame of mind in this zero interest rate environment, is willing to pay close 80 to 90% interest rate? I would say some one who is very desperate for money and who is not willing to get that money from any source in the whole world. no friends, no banks and no SBA lending no other suckers who see reality of a bad business. A business that is probably in lot of debt already and teetering on the edge of bankruptcy but just running on fumes. Being very efficient in lending money very quickly without a thorough checks and balances ( like the no-doc loans of 2007  :) to such desperate people, sounds like a recipe for disaster.

 

If we run into any type of negative deflationary world that Prem talks, about most of these companies will be toast. Without any kind of Permanent capital base like a bank, who will provide the loans to OnDeck. Is this not exactly what happened to FirstMarblehead? Again, this similarity is making me nervous. how will this avoid the fate of FMD?

[roughlyright]

http://www.wsj.com/articles/bond-offering-tied-to-prosper-marketplace-loans-gets-chilly-reception-1458934559

[racemize]

I spent a little time on this yesterday, and I'm quite skeptical.  Here's my general thoughts:

 

1) Having seen what the CFPB did to short-term money lending in the general marketplace, I think these types of companies have a lot of trouble, potentially.  EZPW and Cash America both basically gave up on short-term lending as soon as CFPB started coming in hard.  If OnDeck is so good at analyzing risk with big data, then the rates shouldn't be so high. 

 

2) I was quite disturbed by the bull thesis in the letter.  It doesn't talk about what OnDeck really does or how it works.  So, I went to the website and read several articles.  Here's my issues with OnDeck's offering:

    A) The business owner has to sign a personal guarantee--the loan is secured by the individual, not the business.  So this is really not that much different from consumer short-term lending, except that the amounts are higher and the person happens to own a business.  See point 1) above.

    B) Rates are very high.

    C) Prepaying the loans does not reduce the effective interest.  This is because the interest is a loan fee, not actually interest.  Reminds me of the rule of 78 loans.  Again, not something I feel comfortable with in the long term, regulation-wise.

 

3) There are a lot of competitors.  One example I am familiar with is Square.  Square is making a big push, and honestly I think Square is better than OnDeck on almost all fronts.

    A) no personal guarantee required by Square;

    B) Square takes payment of the loan through credit card processing, so you don't have required payments per se.  You have 18 months to get enough credit card transactions to cover the loan.  As they advertise, this lets you pay based on how well your business is doing (although the full amount is due by 18 month mark). 

    C) I think Square's big data > OnDeck's big data as you are using Square for every transaction.

    D) From what I read, the interest rates are lower for Square (this is actually hard to figure out, since they are using your transactions to figure out how fast the loan will be paid back, and I bet they are conservative.  So the faster it is paid back, the higher the interest rates.)

    E) Square also charges interest based on a loan fee, but it makes more sense given their model since it doesn't have required payments.  I'm not sure how'd they would change their model to fix that issue if regulation came down.

    F) Square's loans are smaller than OnDeck's I think, so that is one difference.

 

All of the above makes this a pass for me, for what it is worth. 

 

 

Here are some articles, in case people are interested:

http://www.werockyourweb.com/lendingtree-vs-lending-club-vs-kabbage-vs-ondeck/

http://www.smarterfinanceusa.com/blog/ondeck-reviews

http://www.forbes.com/sites/forbestreptalks/2015/11/01/noah-breslow-says-ondeck-is-trying-to-make-alternative-finance-more-mainstream-and-less-expensive/#73516ff47c7d

http://fitsmallbusiness.com/square-capital-reviews-affordable-merchant-cash-advances/

 

 

[muscleman]

I spent a little time on this yesterday, and I'm quite skeptical.  Here's my general thoughts:

 

1) Having seen what the CFPB did to short-term money lending in the general marketplace, I think these types of companies have a lot of trouble, potentially.  EZPW and Cash America both basically gave up on short-term lending as soon as CFPB started coming in hard.  If OnDeck is so good at analyzing risk with big data, then the rates shouldn't be so high. 

 

2) I was quite disturbed by the bull thesis in the letter.  It doesn't talk about what OnDeck really does or how it works.  So, I went to the website and read several articles.  Here's my issues with OnDeck's offering:

    A) The business owner has to sign a personal guarantee--the loan is secured by the individual, not the business.  So this is really not that much different from consumer short-term lending, except that the amounts are higher and the person happens to own a business.  See point 1) above.

    B) Rates are very high.

    C) Prepaying the loans does not reduce the effective interest.  This is because the interest is a loan fee, not actually interest.  Reminds me of the rule of 78 loans.  Again, not something I feel comfortable with in the long term, regulation-wise.

 

3) There are a lot of competitors.  One example I am familiar with is Square.  Square is making a big push, and honestly I think Square is better than OnDeck on almost all fronts.

    A) no personal guarantee required by Square;

    B) Square takes payment of the loan through credit card processing, so you don't have required payments per se.  You have 18 months to get enough credit card transactions to cover the loan.  As they advertise, this lets you pay based on how well your business is doing (although the full amount is due by 18 month mark). 

    C) I think Square's big data > OnDeck's big data as you are using Square for every transaction.

    D) From what I read, the interest rates are lower for Square (this is actually hard to figure out, since they are using your transactions to figure out how fast the loan will be paid back, and I bet they are conservative.  So the faster it is paid back, the higher the interest rates.)

    E) Square also charges interest based on a loan fee, but it makes more sense given their model since it doesn't have required payments.  I'm not sure how'd they would change their model to fix that issue if regulation came down.

    F) Square's loans are smaller than OnDeck's I think, so that is one difference.

 

All of the above makes this a pass for me, for what it is worth. 

 

 

Here are some articles, in case people are interested:

http://www.werockyourweb.com/lendingtree-vs-lending-club-vs-kabbage-vs-ondeck/

http://www.smarterfinanceusa.com/blog/ondeck-reviews

http://www.forbes.com/sites/forbestreptalks/2015/11/01/noah-breslow-says-ondeck-is-trying-to-make-alternative-finance-more-mainstream-and-less-expensive/#73516ff47c7d

http://fitsmallbusiness.com/square-capital-reviews-affordable-merchant-cash-advances/

 

Thanks a lot! Great post!

 

I think the bull thesis writer is desperate to pump up the price so they can sell. If the stock is so good and it dropped, why don't they keep quite and buy more?  :)

[roughlyright]

I realize that this is about OnDeck, but recently there was post about LendingClub as a long at Valueinvestorsclub. Attaching it here. What I found interesting is the response from someone who is bearish on LC.

 

Here are his remarks:

 

I disagree with the thesis.  There is more downside -- still trades at 7x sales and 30x forward earnings.  For what??  This is not a financial technology company, its not even a technology company.  They send out direct mail to acquire their customers.  These guys are just lending originators not an amazing new banking business model.  I see this as highly negatively convex -- if they grow too big they will be regulated no doubt and lending standards will deterriorate.  If they don't grow within expectations then the growth expectations will deflate out of the stock. 

 

Couple of other points

 

1. No mention that Santander consumer - who was their largest buyer stopped buyign lending club loans -- at one point they accounted for 25% of volume.

 

http://bankinnovation.net/2015/10/lending-club-gets-dissed/

 

https://www.abalert.com/search.pl?ARTICLE=165546

 

2.  No mention that LC's default rates are higher than what they projected.  In fact I have gone through every single loan since origination -- the trends are to the downside -- lower coupons, higher loss rates -- across the board. 

 

http://www.bloomberg.com/news/articles/2016-02-05/lendingclub-models-misfire-as-loan-write-offs-exceed-forecasts

 

3.  Madden v Midland is a real threat to this space.

 

4.  Lending Club as opposed to Prosper does not give Reps & Warranties on their loans which is very important for end buyers particularly institutions that want to securitize.  Because of this Moodys / S&P will not provide ratings on any lending club securitizations.

 

http://www.bloomberg.com/news/articles/2015-07-22/citigroup-said-to-plan-sale-of-bonds-backed-by-prosper-loans

 

http://ftalphaville.ft.com/2016/01/11/2149760/why-lending-club-has-shunned-securitisations/

 

Laplanche says the Lending Club isn’t “willing to take more risk to do a securitisation than we would through the normal operation of the platform”.

 

Well gee -- if your end buyers are demanding this to make the math work then what are you going to do?

 

Lets see where this ends up but I guarantee you see this at cash value ($1.5/2)  sooner than you see it at $12/share. 

LENDINGCLUB_CORP_LC.pdf

[KCLarkin]

Thanks for all the thoughtful comments and replies. Especially the articles.

 

Here are my random thoughts:

- There is a very significant potential of a donut here. I view this as a publicly traded VC investment. High chance of poor return. Small chance of very big return. Should be sized accordingly.

- High short interest is a warning sign

- I have no interest in LC or any of the consumer lenders. These guys are just giving more credit to people who shouldn't be borrowing. OnDeck is meeting an unmet need for small business lending.

- I am not too worried about under-provisioning. They are pricing in very high rates of default. They are currently running 12% write-offs on an annualized basis. This will spike in a recession but with short term loans, they should be able pull-back quickly.

- I am not too concerned that they are reducing provisions since they are targeting higher quality borrowers (as seen by declining effective interest rate). You should assume that they are under-provisioning, but this is offset by operating leverage and front-loaded expenses elsewhere.

- they are heavily reliant on external funding debt. In a credit crisis, their funding could dry up and they will be unable to originate loans. Game over.

- They seem well capitalized. $330M of equity on $500M of on-balance sheet loans. Even if you double loan loss allowance, you have $280M of equity on $450M net loans.

- "Our debt facilities for our funding debt and our securitization are non-recourse to On Deck Capital, Inc. and are collateralized by loans." If I read that correctly, if ONDK writes off 100% of loans, they would only have a $120M hit to equity. They would still have $210M in equity. Of course, there are potential legal and put back risks that could wipe them out. Plus negative operating leverage.

- Regulatory risk is real but modest since they target small businesses (not consumers)

 

None of this looks too appealing.

 

But there is clearly an unmet need for short term loans for small businesses. As the old joke goes, if you need a loan the bank won't lend to you. ONDK has a Net Promoter Score of 76 when their product is predatory loans! Unless this is outright fraud, there is something very profound happening here. A payday lender for small businesses has the same level of enthusiasm as Apple or Amazon? Clearly this enthusiasm must be relative to other financing options but it is still remarkable.

 

The articles about the unsavoury brokers for small business lending are actually the bull case for ONDK. These are the crooks that ONDK is disrupting (not the banks which wouldn't make these loans anyway). Currently, you need a broker if you want one of these "payday loans". But if ONDK can build a brand as a one-stop shop for small business loans, you can disintermediate the brokers and reduce the cost of acquisition (ONDK is paying thousands of dollars for each customer they acquire). They can then either cut their interest rates or increase profits. They are currently spending almost 40% of net revenue on sales and marketing!

 

If you believe that ONDK is a modern boiler room, then you assume they will always have high customer acquisition costs. But a high Net Promoter Score means that your customers are highly likely to recommend your services. So over time, your word-of-mouth increases dramatically.

 

The other very interesting part of this story, is the strategic partnerships. Especially with JPM and other banks. These partners have stable funding sources and can acquire customers very cheaply (since they already have relationships with small businesses). As a VC investor, you could easily justify the current valuation based on the potential for these relationships alone. Fortunately for value investors, ONDK will need to make substantial investments to support JPM's security and compliance requirements. But after those investments are made, this platform can be rolled out quickly to other partners.

 

To summarize a bullish thesis:

- Front-loaded expenses (customer acquisition and loan provisions) mask current profitability due to high growth

- Significant operating leverage

- Declining customer acquisition costs

- J-curve due to investment in ondeck-as-a-service

- Opportunity to shift business to a "technology" business rather than sub-prime lender resulting in multiple expansion

 

On balance, I lean bullish on ONDK. But I am very queasy about the morals of lending at an effective interest rate of 40%. This seems predatory. Even if you are better than the other predators. Moral ambiguity + negative price momentum + risk of blowup. I am sitting this one out but will add to my watchlist.

--

Disclosure: This is based on brief due diligence. I haven't went through 10k or past calls in detail.

[intothebreach]

KC: thanks for starting the thread and for your summary as well.

 

I arrive at pretty much the same conclusion: OnDeck addresses a real need and the opportunity is huge, but I'm not sufficiently convinced they can build a moat strong enough to resist 1) new entrants following in their tracks; 2) large financial institutions when/if they decide to take a serious look at smaller business loans (i.e. it is easier to improve the process than it is to reduce the cost of capital), and 3) a good old-fashion recession.

 

And I don't think it is possible to arrive at a margin of safety without understanding their black box, or alternatively having them survive a few years of increased competition + adverse financing market (of course, by then it will probably be too late to invest if they really are good enough to survive or thrive in these conditions).

 

I can perhaps provide a bit of color on their NPS though: in dealing with a Canadian financial institution that shall remain nameless in the past, I learned that customer satisfaction for lenders is primarily a reflection of whether or not the desired loan was approved: approved = satisfied client, denied = unsatisfied client. So their NPS may be much influenced by their approval hurdle.

 

Also I've seen too many data/sample manipulation to be anything other than extremely sceptical of any customer evaluation measures done by a firm that has an incentive in presenting a positive result without seeing how the cooking is done to get these results. OnDeck may very well be pristine here, I'm just very sceptical.

[KCLarkin]

I can perhaps provide a bit of color on their NPS though: in dealing with a Canadian financial institution that shall remain nameless in the past, I learned that customer satisfaction for lenders is primarily a reflection of whether or not the desired loan was approved: approved = satisfied client, denied = unsatisfied client. So their NPS may be much influenced by their approval hurdle.

 

Also I've seen too many data/sample manipulation to be anything other than extremely sceptical of any customer evaluation measures done by a firm that has an incentive in presenting a positive result without seeing how the cooking is done to get these results. OnDeck may very well be pristine here, I'm just very sceptical.

 

I am surprised that a hard-sell, boiler room, predatory lender with 40% interest rates, and an arm's length of added fees does not have deeply negative reviews. A quick glance on Better Business Bureau, Glassdoor, Google seems to suggest that the NPS is at least directionally correct. Of course, I would never fully trust a NPS based solely on internal surveys.

 

At least relative to other predatory small business lenders, ONDK does seems to be providing a valuable service.

 

If the

[gjangal]

There are Lendit 2014 or 2015 videos on YouTube that give a a high level overview of On Deck's scoring methodology. They use credit card statements, quick book statements, transactions, check bankruptcy history etc.  This is going to be a very competitive landscape and there is no platform value really. They all tout building platforms but new platforms keep coming up and borrowers can go to all these platforms to borrow ( On deck, lending club, kabbage, dealstruck, can capital) . Square has also forayed into this space with cash advances to merchants using its devices.

 

IMO It's the merchant cash advance industry in an online format. It's possible that if On Deck can lower borrowing costs and have lower net charge offs compared to other platforms , it could be a competitive advantage.

[KCLarkin]

IMO It's the merchant cash advance industry in an online format. It's possible that if On Deck can lower borrowing costs and have lower net charge offs compared to other platforms , it could be a competitive advantage.

 

Take a hated offline industry and make it a little more convenient. You not only take share from the legacy industry but also expand the market size significantly.

 

But if we assume On Deck doesn't really have a moat, they could still earn above average returns on capital due to operating leverage. Assuming they can retain their leadership position.

[Guest roark33]

How long do you think a small business survives that borrows at 40% interest.  Step back and think about that. 

[Junto]

IMO It's the merchant cash advance industry in an online format. It's possible that if On Deck can lower borrowing costs and have lower net charge offs compared to other platforms , it could be a competitive advantage.

 

Take a hated offline industry and make it a little more convenient. You not only take share from the legacy industry but also expand the market size significantly.

 

But if we assume On Deck doesn't really have a moat, they could still earn above average returns on capital due to operating leverage. Assuming they can retain their leadership position.

 

Right now the only small business lending being disrupted is credit cards and merchant card advances. It's a business pay day loan equivalent.  Wait until they can't off load their high interest, high risk business loans at 9% premiums and default rates surge above 6-7%. Has anyone seen how much volume is repeat?

 

Take this for comparison,  weighted average bank C&I loan rate in 4th quarter 2015 was only 2.06%. https://research.stlouisfed.org/fred2/series/EEANQ

 

Also compare this model to sub prime mortgage originators business before crisis and let me know your thoughts on viability.

[KCLarkin]

Wait until they can't off load their high interest, high risk business loans at 9% premiums and default rates surge above 6-7%. Has anyone seen how much volume is repeat?

 

Stock is down 30% YTD and 70% since IPO. Clearly the market agrees with your risk assessment. But what will cause the surge in default rates and what is the worst case scenario?

 

They charge 40% APR. Using dumb math, let's say they need a 6% spread for loans to be profitable. Let's say Funding cost is 6% and acquisition cost is 8%. So they can afford to lose 20% per year and still be profitable. But they turn over loans more than once per year (let's assume 2x). So the loss rate can jump to 10% before things get uncomfortable. Not a big margin of safety.

 

They have a decent balance sheet, so they could potentially sustain a brief period of high default rates. But there is reflexivity here. If defaults rise, the funding cost will also rise (or funding sources could dry up completely).

 

But can ONDK survive long enough to morph into a technology company?

 

Right now the only small business lending being disrupted is credit cards and merchant card advances.

 

Take this for comparison,  weighted average bank C&I loan rate in 4th quarter 2015 was only 2.06%. https://research.stlouisfed.org/fred2/series/EEANQ

 

This is really the bull case. There is a massive funding gap for small businesses. Relatively few qualify for bank loans. There is a need for funding but no way to serve this need profitably. Can ONDK fill this gap? Probably not. But the rewards would be immense.

 

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One random thought: the JPM partnership sound very promising. But many startups die trying to partner with elephants.

 

[Junto]

This is really the bull case. There is a massive funding gap for small businesses. Relatively few qualify for bank loans. There is a need for funding but no way to serve this need profitably. Can ONDK fill this gap? Probably not. But the rewards would be immense.

 

I don't see it as a bull case at all. Banks are looking for ways to make loans. Loans provide better yields than securities and banks are awash in liquidity. If you have a growing and profitable SMB, you will get a proposal from a bank. If you are getting turned down, you may want to rethink your loan request package and get your financial statements in order.

 

The only bull case I can see is that their platform/technology to reach customers is good and they are building traction; however, I don't think the underlying business model is sustainable through market cycles. The need for new loan volume, non-stable funding/liabilities, and churning of the portfolio works in strong economies but fails miserably in weak economies. 

 

I still think this is another manifestation of the sub-prime mortgage originator business model (originate anything that we can sell to 3rd parties in volume for a fee).