Small business wake-up call for banks
FINTECH SNARK TANK OBSERVATIONS
Amazon and Goldman Sachs have announced a partnership to provide lines of credit up to $ 1 million to merchants selling on the Amazon platform. According to CNBC:
“The application process is completely digital and can be completed in minutes, and most clients will get approval results in real time. The lines of credit will carry an annual interest rate of 6.99% to 20.99%. If users don’t make the minimum payments on time, they’ll have to pay late fees and maintenance fees if they don’t use at least 30% of their line of credit. If the sellers agree, Goldman will use the business income and occupation data on Amazon to determine who needs to be approved.
It’s a clear victory for Amazon
To date, Amazon has issued term loans using a corporate credit facility from Bank of America, a deal that is expected to continue. With the Marcus agreement, Amazon merchants will be able to obtain a line of credit.
There are two clear benefits for Amazon from this deal: 1) Amazon adds a new revenue stream with fees for Marcus lines of credit, and 2) Amazon sellers get the capital they need to continue selling on the platform.
It’s a win for Goldman Sachs
Many bankers don’t care about retailer ‘accounts receivable financing’ and wouldn’t hit this kind of business with a 10 foot pole.
But for Goldman Sachs, this may be the kind of business for which a company with the moniker “Vampire Squid” is perfect for. With interest rates as high as 21%, late payment fees, and non-use line of credit fees, Goldman should get away with it.
Bankers will point out the high loss rates expected on this type of business, but Goldman Sachs has a tolerance for it – it is already seeing high loss rates on its consumer loan portfolio.
And with a near-zero acquisition cost (with the fees Amazon charges being the only real cost) and low loan processing costs, Goldman can live with a higher rate of loss than most banks would like.
It’s also important to note how the Amazon / Goldman Sachs approach will be different from the traditional banking approach.
Banks are spreading their shingles, letting the world know they’re available to lend, and waiting to see who asks for a loan. Inevitably, they receive requests that do not meet their risk guidelines and turn down some (or more) potential borrowers.
Amazon’s and Marcus’ approach will be different. Goldman will select which merchants they wish to lend to and send out invitations to apply through Amazon’s Seller Central site. This will reduce processing costs.
Banks won’t mind, but they should
According to a study called The rise of finance companies and FinTech lenders in small business lending:
“In the aftermath of the financial crisis, non-bank lenders increased their annual lending by 70% from 2010 to 2016. By the end of 2016, non-bank lenders provided the majority of new non-real estate secured loans with market share . by 60%.
Banks don’t really have to lose share to non-bank lenders – rather it is as if they are voluntarily giving up market share as they have become increasingly risk averse.
As a result, many banks will look at the Amazon / Goldman Sachs deal regardless, seeing it as a deal they don’t want. It may be fine in the short term, but there are four broader issues that banks will ignore:
1) The need to diversify. Many banks are in desperate need of diversifying their loan portfolios that are too heavily biased towards commercial real estate. It was a problem before the coronavirus crisis and becomes an even bigger problem after the crisis. Banks cannot just talk about diversifying into more C&I activities, they must seize lending opportunities that they have avoided in the past.
2) Subscription changes. A fully digital process that only takes a few minutes and produces a decision in real time is a big deal. But another big issue is that Marcus’ underwriting decisions will be based purely on revenue, cash flow, and (I’m guessing) sales data by category, all of which will come from Amazon. It will be a revealing test of alternative data sources.
3) Integrated Lending. Integrated finance is the integration of financial services into non-financial websites, mobile apps, and business processes. Marcus’ loan through Amazon’s platform is one example. Matt Harris of Bain Capital estimates that by 2030, 20% of all loans will be integrated loans. Banks that ignore this trend will miss lending opportunities and lose market share.
4) Market perspective. Now is not a good time for banks to ignore the borrowing needs of small businesses, even if it is a bad deal for the banks. In a matter of weeks, banks went from being PPP heroes to being accused of 400 years of systemic racism. Activists will scan bank balance sheets – and management teams – for dirt.
The downsides for Amazon and Goldman Sachs
The downside for Amazon is that it won’t have access to line of credit usage and performance data since Goldman Sachs won’t share it with Amazon.
This is a potentially significant drawback, however.
Amazon could launch a loan market later – rumors and screenshots surfaced earlier this year, involving a wider range of lenders. Data on line of credit usage and performance would be useful in attracting lenders to the market.
For Goldman Sachs, the disadvantage is linked to the problem of market optics mentioned above.
If Marcus Cherry only chooses white-owned businesses to offer lines of credit, there is bound to be a backlash.
In addition, Goldman may open to criticism of exploiting small businesses with interest rates at the 20% level.
A LinkedIn user job:
“As Amazon just closed a $ 1 billion line of credit at 0.4% interest, it is offering small business loans at 7-20 times what it borrowed. This is disgusting business behavior. This is the disease we call the economy These funding rules are predatory.
The comment is far from basic because: 1) Amazon doesn’t lend, and 2) the interest rate it receives on a loan or line of credit (its borrowing rate) has nothing to do with its loan rate.
The commentary is evidence, however, that people are taking notice of these transactions and that there will be a careful public scrutiny of the banks’ actions.