SPOTLIGHT ON LENDING

Dushyant Shahrawat, CFA

Perspectives and Analysis of the Transformation Taking Place in the Lending Market

“Ain’t your Grandpa’s business anymore”

Salient Points About the State of Lending Innovation

1. Startup Activity, VC Funding: The red-hot startup activity and VC funding in Lending seems

to be slowing down, but we have 800 Lending startups with $9.7B capital deployed

2. Disruption of Traditional Lenders: News of the demise of traditional bank lenders is

vastly exaggerated, but cracks are appearing: spreads declining, loan portfolios

deteriorating, risk profiles rising

3. Bank/Startup Competition: Lending startups mistakenly believe they outcompete banks

on all fronts. Instead, the sole advantages are in customer experience and origination

4. Shakeout Among Startups Imminent: Phase 1 of Lending startup growth holds the most

promise for the long-term, with Phase 2 startups bound to struggle, or simply fail

5. Most Powerful Innovation: The use of alternate criterion for assessing credit risk and to

originate loans (aka “Alt Lending”), will transform lending by better matching borrower

requirements with funding risk appetite

6. P2P Marketplaces: This is the biggest transformation in lending as it directly connects

borrowers & lenders, a significant improvement over the traditional bank-intermediated

lender model

Startup Growth, VC Funding and

Market Multiples of Lending Unicorns

Lending Startup Activity Has Been Red Hot Since 2014, With 400 Firms Launched And $6B Of Capital Deployed

$9.5B Cumulative VC funding of alternate

Lending since 2010

$4.95B Amount raised in 2015 alone!

$1B SoftBank’s funding round to SoFi, the

single largest FinTech funding

800+ Number of Lending Startups funded since

2005, with 1/2 funded in 2014/2015

$1.5B Funds raised in LendingClub’s IPO in Dec

2014

7 Number of Lending Unicorns (valuations

of over $1bill)

The 7 Lending Unicorns are: Avant,

Credit Karma, Funding Circle,

Kabbage, Klarna, Prosper, SoFi

Consumer Lending is biggest sector:

• Personal Loans (166 firms, $2B

funding)

• Education (33 firms, $1.7B funding)

Average funding per startup is highest

for B2C models at $54M

VC Funding More Than Doubled in 2015, From 2014

“Funding Circle Raises $65 Million for Peer-to-Peer Small Business Loans”

“Loan Platform Kabbage Raises $135M at a $1B Valuation, Grows Credit Line to $900M”

“Fundbox Secures $50 Million in Funding, With Investment by Jeff Bezos”

“Square Raises More Money To Make Small Business Loans”

Source: Dow Jones VentureSource

Investor Base in Lending Startups is Broadening with Corporates, VCs, Exchanges and Banks Involved in Funding

Its not just Angels and VCs investing in Lending startups; there are Banks,

Corporates, Payment Networks and even Exchanges providing Funding

Source: CBInsights

Lending Startups Dominate the FinTech Unicorn List (5 of 15)

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FIRM TYPE OF BUSINESS INVESTORS

VALUATION

($M)

INVESTED

CAPITAL ($M)

VAL/INV

CAP

Lufax Lending, Specialized Financing

CDH Investments, China International Capital Corporation, BlackPine

Private Equity Partners, Ping An Insurance $10,000 $485 20.6x

Square POS devices, Financing platform First Round Capital, Citi Ventures, GGV Capital $6,000 $717 8.4x

xStripe Payments platform Khosla Ventures, Lowercase Capital, Redpoint Venture $5,000 $190 26.3x

Zenefits HR platform SV Angel, Institutional Venture Partners, Venrock $4,500 $584 7.7x

Social Finance Marketplace lender, Student loan refinancing

Baseline Ventures, Doll Capital Management, Institutional Venture

Partners $4,000 $1,540 2.6x

Credit Karma Consumer credit management service Felicis Ventures, SV Angel, Founders Fund $3,500 $369 9.5x

POWA

Technologies Provides payments/infrastructure technology Bright Station Ventures, Wellington Management $2,700 $177 15.3x

Adyen Payment transaction platform Felicis Ventures, Index Ventures, Temasek Holdings $2,300 $266 8.6x

Klarna Helps retailers process payments Institutional Venture Partners, Sequoia Capital, General Atlantic $2,250 $289 7.8x

One97 Comm Mobile wallet, online marketplace Intel Capital, Sapphire Ventures, Alibaba Group $2,000 $585 3.4x

Prosper P2P lending marketplace Accel Partners, DAG Ventures, Draper Fisher Jurvetson $1,900 $355 5.4x

Transferwise Money transfer service IA Ventures, Index Ventures, SV Angel $1,000 $90 11.1x

China Rapid

Finance Online consumer loan marketplace Broadline Capital, UBS $1,000 $35 28.6x

Coupa Software Cloud-based business automation provider Battery Ventures, Iconiq Capital, T. Rowe Price $1,000 $169 5.9x

Funding Circle Lending platform for small-businesses Accel Partners, Index Ventures, Ribbit Capital $1,000 $273 3.7x

$48,150 $6,124 7.9x

Lufax, SoFi, Prosper, China Rapid Finance and Funding Circle are valued at over

$1B• Largest Unicorn is in the Lending space, and is valued 66% higher than the next Unicorn

• Three lending Unicorns are US, two are Chinese

Chinese Lending Startups Have a Much Greater Valuation Than US Lenders, and Much Higher Than Other FinTech Unicorns

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The average Lending startup has a valuation of 12.9x compared to 7.9x for the

average FinTech Unicorn. But the Chinese startups drive up this valuation

Firm Type of Lender Investors

Market

Valuation ($M)

Invested

Capital ($M) Multiple*

LufaxLending, Specialized

Financing

CDH Investments, China Capital

BlackPine Private Equity, Ping An $10,000 $485 20.6x

Social

FinanceMarketplace lender,

Student loan

Baseline Ventures, Doll Capital,

Institutional Venture Partners $4,000 $1,540 2.6x

Prosper P2P lending

Accel Partners, DAG Ventures,

Fisher Jurvetson $1,900 $355 5.4x

China Rapid

FinanceOnline consumer loan

marketplace Broadline Capital, UBS $1,000 $35 28.6x

Funding

CircleLending platform for

small-businesses

Accel Partners, Index Ventures,

Capital $1,000 $273 3.7x

Average FinTech Valuation 7.9x

*Multiple is calculated as [Market Valuation / Invested Capital]; i.e. what premium the market is willing

to pay to acquire a startup over its invested capital

Source: CBInsights, Individual Firm Data, Venture Sources

Categorizing Lending Startups and

Analyzing the Longer-term Market Transformation

There Are Four Models In Alternative Lending, With Marketplaces Being The Most Transformative

• Direct Lender: Firms with a lending license that carry loans on their own books

• B2C: Platforms that partner with a single lender for loan origination

• B2C Marketplace: Platforms that have multiple lenders (Financial Institutions, Accredited

investors) for loan origination

• P2P Marketplace : Platforms with multiple lenders including non-accredited individual investors

Source: Tracxn, Media Sources, WSJ

Lending Startups Play In A Larger Ecosystem That Includes Payment Networks, Aggregators And Invoicers

Source: Oliver Wyman

We Are In the Middle of a 12-15 Year Transformation of the Lending Market

EARLY STAGE GROWTH MATURITY

2008-2011 2012-2016 2017-2020

Stricter capital

requirements force banks

to restrict lending

Some segments of

borrowers go neglected,

and their needs unmet

First sign of

investment interest

emerge

Traditional banks

dominate as lenders

Lending startups begin

emerging in 2012

Investment funding

explodes in Lending sector

during 2014-2015

Startups begin using

alternative methods to assess

risk (Alt Lending emerges)

Traditional banking lenders

begin paying attention to

lending startups

15 Lending startups

achieve Unicorn status

($1B valuation)

Banks acquire many

startups and bolt-on new

front-ends to their back-

end platforms

Shakeout among startups;

50% shutter, 20% sell-out

Big improvement in customer

satisfaction among savers

and borrowers

Looking Ahead: Six Projections For the Future of

FinTech Lending

1. Of The Three Phases In The Growth Of Lending Startups, Phase 1 Startups Are Best Positioned To Succeed In The Long-term

PHASE 1 (firms started in 2010-2013): Real innovators with a high chance of long-

term success

PHASE 2 (firms started in 2013-2015): “Me Too” startups excited by Phase 1’s

success, but most bound to fail

PHASE 3 (firms started after 2015): Still in early stages of innovation, with high

hopes for another phase of growth

2. By 2017, Lending Startups Will Begin to Exert Real Competitive Pressure on Traditional Lenders

Source: WEF Report: “The Future of

Financial Services”

Alt Lenders have distinct competitive advantages over traditional Lenders that

are becoming evident every day

More Accurate Underwriting

The modern approaches for

underwriting and assessing

credit risk used by startup

lenders will be adopted more

widely by traditional lenders

Increased Access

Alt Lenders are providing more

lending options to a broader

range of borrowers, who are

currently being neglected by

traditional lenders

Control & Transparency

Lenders will gain greater

control over the return on

savings based on their risk

appetite and more visibility into

the flow of their savings

Reduced Costs for Borrowers/

Increased Returns for Savers

Better risk management use by Alt

lenders reduces the costs for

borrowers, and enhances returns for

savers

Significantly Better Customer

Experience

Streamlined and automated

processes expedite loan

processing and improve customer

experience for borrowers

3. Alternative Measures Used by Innovators to Assess Credit Will Go Mainstream, as Banks Rush to Adopt Them

Conventional

Credit Scoring

Limitations of

Traditional

Models

Need for

Alternative

Methods

Forms of

Alternate Credit

Scoring

Uses existing

financial/credit info

to assess credit risk

Ignores people with

limited credit history

(new immigrants,

international

students)

Include ignored

customer segments,

improve risk

assessment and

better matching of

borrowers/lenders

Use of Social media

info, utility bill

payments,

employment

information

Firms driving usage of Alternative measures to assess credit risk in Lending market

Source: Tracxn “Alt Lending Report”, Firm analysis, Public filings

4. Lending Startups Think They Can Compete with Banks On All Fronts. They Are MISTAKEN!

Funding

Costs

Credit

Decisioning

Customer

Acquisition

Servicing/

Customer Experience

BANKS

LENDING

FINTECHS

How Banks Stack Up Versus Startups in Differentiating Their Services

5. Advice to Banks: Change Your Incentive Structure for Lending Sales teams If You Want to Truly Compete With Startups

If a Bank’s Loan Department Grows its Loan

Portfolio by 50% in 3 years…

The Department Head Gets Promoted and

the staff gets a bonus of 10-15%

If a Lending Startup Grows its Loan Portfolio

by 50% in 3 years…

The Valuation of the startup skyrockets,

enough for the Founders and key employees

to hang up their boots and retire!

Incentives at traditional banks are woefully inadequate to drive lending growth,

and definitely trail what Lending startups are doing to drive growth

6. Banks Will be Forced to Partner with Startups to Improve Customer Experience, Adopt Alternative Credit Methods and Boost Returns

Source: Oliver Wyman Report:

“Battle for Supremacy in Lending”

”JP Morgan Chase Bank announces strategic partnership to use OnDeck’s platform for small business loans”

Select Bank/Startup Partnerships in the Lending Market

Dushyant Shahrawat, CFADushyant.shahrawat@sloan.mit.edu

617.905.5500

THANK YOU

Please reach to me with comments, insights or questions.