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Consumer Finance Lending: Banking the Underbanked

May 01, 2013, 07:00 AM

According to FDIC estimates, 14% of the U.S. population is considered “underbanked” and does not have access to traditional financial tools such as a checking account or revolving credit (i.e. credit cards). This market of 43 million people has historically been served with unsecured loans from payday lenders with APRs that can often be in excess of 100% (due to the combination of high fees and short tenor).

Borrowers are typically classified as subprime if they have a FICO credit score below 660. This can be due to limited debt history, excessive debt, missed payments, defaults or judgments, etc. However, lenders today are increasingly distinguishing between subprime borrowers with poor credit history from those with little (“thin-file”) to no credit history (“no file”). The former may depend upon on payday lending while the latter thin-file/no-file group is beginning see additional, lower cost options available. Regardless of classification, these consumers need credit solutions to meet day-to-day expenses, make large one-time purchases or to finance unanticipated needs (e.g. medical expenses). In fact, more than one in five Americans, according to a September 2012 poll hosted by the National Foundation for Credit Counseling (NFCC), say they could not make ends meet without access to alternative lenders.

Looking to capitalize on the credit demands of this large, growing and underserved demographic, many entrepreneurs have established new lending platforms solely focused on this underbanked segment. While these entrepreneurs have been able to raise equity capital given the attractive industry growth dynamics, accessing debt capital to finance their companies has been more challenging.  Debt capital for these businesses has been scarce as:  

  • Many lenders provide either unsecured or longer term credit contracts (many with durations in excess of six months) containing only a contractual obligation for repayment but with no specific collateral or security. These long term contracts are by definition difficult for traditional banks to finance.
  • Many subprime lenders operate in an uncertain regulatory environment in which competing regulatory agencies may assert jurisdiction. These lenders may attract more oversight given the higher APR inherent in their business models and the regulated collections practices commensurate to the demographic served (i.e, higher risk of default).  Such regulatory agencies may be either at the federal level (i.e., Consumer Finance Protection Bureau or the U.S. Congress) or at the state level (i.e., Attorney General). Due to the complexity of the regulatory environment and the fear that legislators could impose interest rate caps or penalties on higher subprime lenders, traditional commercial banks generally prefer not to provide credit to these businesses.
  • Many subprime credit providers are in the earlier stages of their life cycle and therefore haven’t yet demonstrated substantial profitability or have significant historical track records, both of which are challenging for more traditional regulated banks to underwrite.

Our firm’s focus is on providing innovative debt capital solutions to companies that may experience difficulties obtaining capital from more traditional venues. One of Crystal’s core strengths is the ability to underwrite deals in industries that are highly regulated and/or operate in complex environments as well as those that operate in international jurisdictions. We have provided loan facilities to many companies in this sector and is intimately familiar with the underwriting and credit challenges faced by these rapidly growing subprime lending organizations.  

Lending to subprime credit providers requires:

  • A detailed knowledge of the complex and evolving regulatory environment
  • The ability to accurately analyze underlying consumer portfolios (i.e., static pool loss statistics, projected long-term collections, etc.)
  • An understanding the viability of the business model (i.e., the underlying cost to acquire new customers relative to portfolio return dynamics)
  • An understanding of the underlying portfolio underwriting, credit extension and collections practices relative to compliance with state and federal oversight and regulation.

Our firm's recent clients in this sector include:

  • A publicly traded merchandise leasing company that offers unsecured amortizing personal loans from $500 to $5,000, as well as other services such as check cashing and prepaid cards. Crystal provided a CAD$20.0 million first lien term loan secured by the company’s consumer loan receivables in order to provide capital required to fund further growth in this division.
  • A leading provider of high APR automotive title loans to consumers in several Western states. This company was outgrowing its existing local bank relationship and required a new lender who could support its rapidly growing consumer loan portfolio. Crystal increased the company’s revolving credit facility with a $45 million facility.
  • A company that offers unsecured loans of $250 to $2,500, usually repaid over a term of 10 to 12 months that primarily targets the “thin filed” Hispanic community. Crystal provided debt capital to facilitate further portfolio growth.

As this underserved segment of the population continues to grow, innovative businesses are likely to continue to expand to meet their needs.

Stephen Krawchuk
Managing Director | Crystal Financial
With 20 years of corporate finance and investing experience, Stephen Krawchuk is a managing director who oversees Crystal’s Los Angeles office.

Prior to joining Crystal, he was a senior vice president at Contrarian Capital Finance. He was the Western Regional Marketing Director for Wachovia Capital Finance, a director with Deutsche Banc Alex Brown, and a Director with Greyrock Capital. He began his finance career with Foothill Capital in Los Angeles, after attaining his CPA with PriceWaterhouse.

He is a graduate of the Eller School of Entrepreneurship and Management and received his BA in accounting and finance from the University of Arizona. Krawchuk currently serves on the Board of Directors for the Los Angeles chapter of the Commercial Finance Association.
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