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The Key To Alt-Lending’s Survival

As OnDeck and other alternative lenders prepare their second quarter earnings reports for this year, investors and analysts will be keeping an eye on their performance, especially as the latest data suggests bad news for this market. Recent research reveals that alternative lenders have become stagnant and less active in the small business lending space, signaling for some the end of the alt-lending hype.

Analysts have highlighted lackluster performances from OnDeck, Lending Club and other main players following their massive IPOs at the end of last year. “I don’t think people had really dug into some of the underlying risks,” said Compass Point Research & Trading LLC analyst Michael Tarkan in an interview with Bloomberg about the disappointing trend among alt-lenders.

But last week, OnDeck made an announcement that may have caught some by surprise: The company hit record sales of SME loans in the second quarter. What is going on?

The key to OnDeck’s recent success is the institutional investor. As analysts focus on the rise of big bank SME lending and the fall of alternative finance, PYMNTS takes a look at this less-discussed demographic, and how the institutional investor will be key to alternative lenders’ continuing success.

OnDeck’s Record Quarter

OnDeck isn’t due to release its Q2 2015 results until next month, but already, the outlook is good. The firm revealed that it reached a record $143 million in SME loan sales during the period through its Marketplace lending platform, a digital destination for institutional investors to purchase small business loans online.

The definition of an institutional lender is broad. According to Thomson Learning, the segment includes insurance companies, commercial banks and savings banks. Unlike alternative lenders, they are highly regulated, and instead of investing their own funds directly, institutional investors pool funds of clients to invest.

It’s this segment of small business investors that account for OnDeck’s latest announcement. According to the alternative lending platform, its record figures reflect rising demand by this group of lenders as well as the company’s previously announced plans to expand its Marketplace platform — itself a sign that OnDeck is placing confidence in the institutional lending segment.

“We believe institutional investors are increasingly seeking exposure to short-term business loans, as evidenced by the opportunity we had in the second quarter to grow our Marketplace business on very attractive terms,” said OnDeck CFO Howard Katzenberg in a statement.

OnDeck’s announcement raises two key points that industry experts will be focusing on in the coming months.

First, institutional lenders’ interest in SMEs is on the rise. Second, institutional investors may hold the key to ensuring the success of the alternative lending industry. While direct investment in SMEs by alternative lenders is on the decline, alternative lending platforms can also act as a liaison to connect small business borrowers with institutional lenders, meaning that even if an alternative lender isn’t providing financing to a small business directly, it does provide the platform through which an institutional lender finances a small business — whether it’s directly or indirectly.

The Rise In Institutional Lending

OnDeck’s figures correlate with recent data from Biz2Credit, which found that institutional lenders are more interested in small business finance.

The company’s June 2015 data revealed that institutional lenders once again reached new highs in its SME lending practices. With SME financing on the rise overall, Biz2Credit CEO Rohit Arora said that small business loans are once again profitable, especially as the use of digital tools for SME lending — like OnDeck’s online Marketplace — also gains prominence. “That’s why we see institutional lenders getting into marketplace lending,” the executive said in a statement.

The data revealed that institutional lenders approved 61.4 percent of SME loan applications in June, an increase from May’s 61.3 percent figure. May’s results marked the first time in the history of Biz2Credit’s SME lending index that institutional lending approval rates surpassed that of alternative lenders.

“Institutional lenders are establishing themselves as mainstream lenders in the small business marketplace and are continuing to replace cash advance companies, which typically charge interest rates that are simply too high,” Arora said in a statement coinciding with the release of the May 2015 report. Again, the executive highlighted the use of digital platforms as a key reason for this increase in small business lending.

“Institutional lenders are offering more attractive loan packages to businesses on marketplace lending platforms, such as Biz2Credit’s,” Arora said. “As a result, they are making funding deals with more creditworthy borrowers.”

What This Means For Alt-Lending

Meanwhile, both the May and June 2015 SME lending indexes released by Biz2Credit highlighted how stagnant the alternative lending segment has become. In May, the firm revealed a new low in SME loan approval rates after this demographic saw declines every month since January 2014. According to Arora, this decline can be attributed to the generally higher interest rates charged by alt-lenders. In June, figures for SME lending approvals didn’t budge at all.

The figures may spook alternative lending investors. But as OnDeck’s latest figures suggest, a decline in alt-lenders’ direct investment in small businesses doesn’t mean alternative lenders — and their online platforms — aren’t being used.

It’s not just OnDeck that has received attention from institutional investors. A June report by Business Insider found that institutional investors are flocking to alternative lending platforms in troves. Richards Kibbe & Orbe LLP conducted a survey that revealed 85 percent of institutional investors are actively seeking to invest in alternative loans or in alternative lending platforms. Nearly one-third of these respondents said they are looking to target small businesses specifically with their investments.

“The results show that, ultimately, investors are seeking opportunities in lending platforms across the board, but small business might lead the pack because there’s high borrower-side demand in this area,” the publication wrote.

The survey suggests that even as direct alt-lending in small businesses drops, the alternative lending market is far from struggling, many thanks to the institutional lenders that have upped their interest in SME financing and the alternative lending platforms that make that financing possible. As the market waits for Q2 2015 results from alternative lending players, these businesses’ crucial partnerships with institutional investors may be the key to not only surviving, but to thriving.

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