OnDeck Capital IPO: A Treadmill Lender

[easy_sign_up title=”Sign Up for Free Monthly Newsletter on the hottest FinTech Companies”]

OnDeck Capital (ONDK) has engineered a treadmill lending platform for small businesses resulting in 49.2% of 2014 originations from repeat customers.

This is a risky way to grow the business as ending the refinance of any repeat customer risks default. OnDeck is on the treadmill too and cannot get off.

OnDeck also has substantial balance sheet risk and should not be seen nor valued in the same terms as LendingClub (LC). We recommend not investing in OnDeck.

OnDeck Capital (Pending:ONDK) is an online originator of short-term loans for small businesses.

It has priced its IPO between $16 and $18 a share which places its valuation north of $1B despite being unprofitable.

It will get this valuation when its stock opens for trade on the NYSE on Wednesday, December 17, 2014 because investors view the company as “fintech” and a “marketplace lender” like LendingClub (NYSE:LC) which had a very successful IPO a week earlier.

But, we would avoid investing in OnDeck’s stock as the company’s business is dependent on “treadmill” leading practices that binds borrowers to ongoing refinance.

OnDeck is not LendingClub. It has substantial balance sheet risk as it books most of its originations with offsetting liability.

Furthermore, as a non-bank, it does not have the backstops of a bank in the event of a liquidity crisis caused by requirements to repurchase excessive loan defaults that back its securitization facility.

Unlike LendingClub or alternative student-loan originator SoFi (which uses alma mater as a key risk variable), OnDeck does not tout its ability to offer substantially lower interest rates than banks through curation (a/k/a risk-based pricing).

OnDeck suggests that it creates value for small businesses and distinguishes itself from traditional financial institutions by offering quick-approval, 3 to 24 month term loans. The company suggests that these types of loans are sought by small businesses to fund money-making opportunities with quick paybacks.

For example, a Christmas ornament store with seasonal inventory buildup or a custom yacht dealer that needs some upfront payment from the manufacturer would be ideal candidates for an OnDeck term loan.

But, this is not the case. A near majority of OnDeck’s small business customers have chronic cash flow problems and seem to get stuck on a treadmill of term loan refinance. Furthermore, the churn is growing.

From its S-1,

“We believe the behavior of our repeat customers will be important to our future growth. For the year ended December 31, 2013 and the nine months ended September 30, 2014, total originations from our repeat customers was 43.5% and 49.2%.”

When OnDeck says that its nine month YoY growth in loan originations is 171%, a fair portion of this is repetitive refinance of term loans from existing customers.

OnDeck has “engineered” a treadmill lending platform through the following practices:

(1) originating brief term loans of 3 to 24 months quoted in “cent-on-the dollar” averaging around $1.17, but amortized and paid DAILY via automatic ACH such that the ARP is 60%;

(2) requiring the same origination fee of around 2.5% of principal for refinance from existing customers even though the incremental cost of qualifying repeat customers is substantially less than new customers;

(3) half-heartedly offering a revolving line of credit alternative, which would have spared repeat customers repetitive origination fees, by limiting the revolving line to “a maximum line size of $25,000, repayable within SIX months of the date of the latest funds draw.

The problem is that OnDeck has become as dependent on repeat customers as they have become dependent on it. The consequences of OnDeck turning off treadmill borrowing of a repeat customer could be loan default.

We recommend against investing in OnDeck.

Disclosure: The author is long LC. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.