Prospa shows why small businesses need non-bank SME lenders but challenges still remain

Prospa shows why small businesses need non-bank SME lenders but challenges still remain

The continued impressive growth achieved by Prospa post last year’s aborted IPO coinciding with the fall out from the Banking Royal Commission highlights just how important non-bank lenders have become for the future of Australian small businesses.

Prospa is the dominant player in the online small business lending sector and the first to IPO. The reputation of this sector rests heavily on its fortunes. In some circles Prospa has been described as an SME lender of last resort, a modern day equivalent of a finance company that takes on high risks in return for high returns.

Such descriptions do Prospa and its customers a disservice. I see Prospa as a user friendly, small business lender (mainly for sums less than $50,000) that provides quick and easy access to finance to businesses that would otherwise find it difficult or even impossible to get support from traditional lenders. It doesn’t require property as security and is prepared to lend to businesses that have a short trading history as well as those with blemished track records. And for this they charge accordingly.

Prospa Image

Since its inception in 2013, Prospa has lent over $1b to more than 19,000 small businesses. It has to be doing a lot of things well to have:

– A Net Promoter Score of 77 which compares with the average for the big four banks of -10.
– Over 3,000 Trust Pilot reviews of which 94 per cent were “excellent”.
– Won dozens of awards including fastest growing, best employer, best leaders and a multitude of industry awards &
– 67 per cent of customers already returning to take out another loan.

All this at an average Annualised Percentage Rate (APR) of 36.5 per cent!

The obvious question which flows from this is “how can this be?”

To answer this question, it is first necessary to really understand what APR means. APR is the interest rate, expressed as an annual rate, applied to the reducing balance of the loan. The following example illustrates how borrowers are easily confused:

Georgia applies for a $100,000 loan to expand her online sales business. She is told her monthly repayments would be $10,000 for 12 months based on an interest rate of 20%. This means the total repayment amount would be $120,000 being the sum of the principal of $100,000 plus the interest component of $20,000. She figures she can afford this monthly repayment and that an interest rate of 20 per cent seems not too bad for an unsecured loan so she goes ahead.

What Georgia has overlooked is that a significant part of each $10,000 monthly repayment goes to reducing the principal but each month she still pays interest on the full $100,000 notwithstanding the amount she owes reduces with every payment she makes.

So the rate Georgia pays on the actual amount she owes over the year works out to be 37 per cent per annum. This is the APR.

Returning to the question of “how is it that Prospa is doing so much business when its average APR is 36.5 per cent?” In simple terms, it is doing an outstanding job in delivering on its Value Proposition which is centred on providing:

– Access to finance to small businesses which struggle to get funding from traditional sources
– A seamless process with personalised customer support &
– Speedy decisions, usually within the same day, and access to funds very shortly thereafter.

Many borrowers are just so relieved and pleased to get the money quickly and with the minimum of fuss they don’t bother to look further into what the loan is really costing them. They know what their periodic payment is and that’s the main thing. Besides, they don’t have the time to make their own assessment, they don’t understand how interest rates really work, they are reluctant to seek advice for reasons of cost and also they don’t want to appear to not know what they’re talking about.

It is not surprising that a large number people don’t get APRs. I confess when I first started following online lending some four years ago I made the same mistake and to this day I still receive messages saying my maths is wrong. But its not just the less sophisticated small business owners who are misguided, many accountants, advisors and journalists continue to do the same which only perpetuates the confusion about the real cost of money.

The need for a unified industry approach to quoting of online small business loans was one of the motivators that in 2016 caused me to reach out to some of the major players as well as Kate Carnell, the Australian Small Business and Family Enterprise Ombudsman (ASBFEO). After many months of consultation and collaboration with various parties including the industry association AFIA, the AFIA Online Small Business Lenders Code of Lending Practice (the Code) was developed and in January this year seven lenders Capify, Get Capital, Lumi, Moula, OnDeck, Prospa & Spotcap were admitted as founding members of the Code.

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Members committed to eight promises to customers, one of which is:

“We will provide clear and accessible information about our Loan Products, so you can
make an informed decision about whether to enter into a Loan Product with us. We will
disclose interest rates, and fees and charges, in an accessible and clear format. Our
advertising and promotional material will not be misleading or deceptive, or be likely to
mislead or deceive.”

Central to delivering on this promise is the SmartBox report, a standard pricing comparison tool which sets out key information including the Loan Amount, the Disbursement Amount, the Total Repayment Amount, the Average Repayment Amount, the Term, the Total Cost of Credit, and the Annual Percentage Rate. The SmartBox report is a key component of the formal offer documentation and all Code members comply with the Code’s SmartBox requirements.

Some lenders could be more transparent by disclosing APRs at the enquiry stage via website loan calculators and examples. For instance, when a potential borrower looks at the Prospa website they will find an example of a loan as follows:

“Rates for small business loans range from 9.9% to 26.5% p.a. simple interest rate. For example, a $10,300 12 month loan (comprising a $10,000 disbursement and $300 origination fee) with a simple interest rate of 9.9% p.a. would have total repayment amount of $11,320.”

This represents an APR of 25 per cent but there is no mention of this. Of course, in the event the borrower was successful with a formal application, the APR would be prominently disclosed but all this detail is only comes after the completion of the loan application process and the making of a formal offer.

Unfortunately precise SmartBox results cannot be provided at the enquiry stage as the lender has yet to do its credit assessment but in their advertising and promotional material including website loan calculators and loan examples, lenders should ensure that APRs are quoted. It could be argued that failure to do so could be seen as being likely to mislead or deceive.

As an aside, what most don’t know is that the more they shop around, the less likely it is they will be able to get a loan and if they do it will cost more. The reason for this is that the algorithms used in assessing loans penalise applicants for the number of times they apply for credit.

I actually think Prospa can use APR as a means to complement and validate its value proposition. In the space of 3 years, its average APR has fallen from 59 per cent to the current 36.5 per cent and with expected lower funding costs arising from improved performance, government initiatives like the Australian Business Securitisation Fund as well as the savings that scale brings, their average APR should continue to decline.

And if the borrower cannot get quick and unsecured money from anywhere else, who is to say 36.5 per cent is expensive? Expensive compared with what? For potential borrowers who might think an APR of 36.5 per cent is excessive, this creates the opportunity to initiate a conversation about how, even at this rate, the loan still represents good value. A further benefit is that it might encourage business owners to think more carefully about whether they are able to generate an acceptable return on the funds borrowed at such rates.

Just after Prospa’s aborted IPO I wrote a newsletter Prospa, ASIC & the conundrum of Unfair Contract Terms law which identified several areas in which Prospa’s standard form contracts could potentially be in breach of UCT. Since that time a great deal of work has been undertaken by the seven lenders each of the Code members including obtaining independent legal advice confirming compliance. This culminated in the Code Compliance Committee (CCC) confirming that the standard form contracts used by these lenders are compliant with UCT. On this basis, any business which borrows from a Code member is entitled to assume that lender is UCT compliant.

However, the same independent assurance cannot be given in relation to the standard form contracts used by other non-bank SME lenders and this should be of concern to all stakeholders.

Whether the IPO valuation of Prospa at $610m is reasonable is for the markets to judge. The prospectus tells a good story of past performance and future prospects. It has a happy, growing and loyal customer base, it is extending its product offerings and expanding into New Zealand. It has a majority independent board and a stable and committed management team.

Prospa’s future value will depend not just on financial performance but also on its conduct. And the standing of other online SME lenders and indeed all non-bank SME lenders will be influenced by its performance and conduct. So for the sake of SMEs hopefully Prospa continues to deliver on its value proposition whilst leading the way in being fully transparent with customers.

The big unknown is how it and other relatively new non-bank SME lenders will fare in the event of a sudden or sustained downturn in economic conditions.

Post the Banking Royal Commission the small business lending market has been ripe for the pickings by non-bank lenders, not just the online lenders. But there are literally dozens of lenders in this largely un-regulated market and not all of them will survive. There is a risk that some will cut corners in order to remain afloat or get ahead.

Industry self-regulation is key to minimising reputational damage that could restrict much needed access to funding for SMEs. The seven members of the AFIA Code deserve credit for developing and implementing their own code. They are role models for the entire non-bank SME lending sector. At the same time, it should also be noted that signing a code is really only one step in the continuous journey of self-regulation.

Code Members image

The CCC must hold members to account and also be transparent in its reporting. Customers need to be aware that they are able to lodge a complaint with the CCC in addition to their right to take a grievance to the lender’s internal dispute resolution department as well as the new Australian Financial Complaints Authority (AFCA).

Other non-bank small business lenders should follow the lead of the Code members in self-regulation. Organisations like AFIA and ASBFEO will support lenders that want to self-regulate. This is a preferred option to the regulators coming in over the top and unilaterally telling them what has to be done.

As the non-bank SME lending sector moves beyond the challenge of increasing awareness to the next challenge of increasing understanding of their offerings, the role of advisors, industry associations, media, bureaucrats and regulators in educating small business owners becomes even more critical.

Introducers must be able to demonstrate that they have acted in the best interests of their SME clients. One outcome from the Banking Royal Commission is that mortgage brokers will be legally obliged to act in the best interests of their clients. Is there any reason why this shouldn’t apply to finance brokers and any other parties who introduce a small business owner to a lender? This would certainly encourage introducers to ensure they have a good understanding of all the available options.

Prospa’s impressive growth story is proof that Australia’s small businesses want and need the funding support non-bank lenders offer. Lenders, advisors, industry associations, media, bureaucrats and regulators all have a role to play making this happen in a fair and transparent manner. At the same time, small business owners cannot simply rely on everyone else to look after their interests, they must prioritise the need to educate themselves. There are many resources available to help them proactively deal with the challenges of financing their business.

theBankDoctor will continue working with all stakeholders to improve access to fair, competitive and transparent funding for small business owners.

Comments and feedback are invited.


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