A startup in public beta known as "Float" may have found a way to make a decent return on a line of credit product at a price that is essentially free to consumers.
Shane Hadden, Float's CEO, says that his product can generate an attractive
internal rate of return. He says he can do it not by charging interest and fees, but solely by monetizing the value of consumer loyalty. The key word - "loyalty" - means finding a way to tap revenues from the purchasing power of a consumer's ongoing spend.
For the consumer, Float is an interest-free and fee-free line of credit which when drawn is paid back in 10 monthly installments. The minimum extension is $200, but can be increased to a sum well into the thousands.
"You might not have a credit file," Hadden says, "or your FICO may be very low. You don’t have credit, but you do have your loyalty which we can lend against. Loyalty is a new asset class."
Such a creative mechanism is itself worth understanding, but it also underscores a larger point that many people want to clear up. That question - 'is there a better way to offer short-term credit to under-served borrowers? - is very topical right now. Today, in fact, the American Banker has published an article entitled "Can the Payday Loan be Re-Invented?" which reviews the proposition.
There are a lot of small-dollar-credit innovations out there, but few alter the basic price. Most new ideas are built on a few contexts: identifying new channels for distribution, extracting efficiencies through a technology, or perhaps by bundling in heretofore unimagined combinations. But regardless, the mechanics are still a high fee/high interest rate advance collateralized against the borrower's next paycheck.
The AB points to ZestCash and Wonga, online payday lenders that tap thousands of indicators (and social media) to make underwriting decisions which they say lead to lower default rates. Rightfully so, it calls them out for what they are: highly wonky ways to capitalize on advances in information technology in order to trim costs for payday lenders. In some ways, these innovations are actually worse than standard payday, because the costs of such savings are wiped out by the need for internet lead generation. As a results, consumers that met get a "low-cost" payday loan in a retail setting for "only" 200 percent are now being offered a highly innovative online loan with an interest rate of 360 percent.
We know the problems that make it possible to extract exorbitant sums from people for a short-term advance: too many Americans are living paycheck to
paycheck. Too many people have very little. Among the findings in a report published this week by CFED are these two whoppers: one-third of Americans have no savings account and 44 percent would fall into poverty within three months if they lost their job. Even worse, many of those with very little also have debt.
Banks don't make it any better when they offer deposit service products that are designed to cost more at exactly the moment when a consumer has the least. If grocery stores ran their pricing the way that banks have designed overdraft, then hungry people would have to pay more for the same loaf of bread.
Moreover, when we accept an approach to underwriting that excludes millions of people from mainstream credit solely because we don't collect the independent variables that could capture their payment records. Unfortunately, that is the way that the big three bureaus do business. Even successful efforts by companies like VantageScore to develop the kinds of algorithms that incorporate alternative payments are still unaccepted by some of the big credit bureaus. The result is that millions of "thin-file" or "no-file" Americans are left out of mainstream credit. Solving that problem does not mean that companies allocate low-cost credit to people that do not pay their bills. It only means that those people that only make a few payments but who do pay on time are given a shot.
Thus, Float's hope is to capture a portion of a very large market space. What most everyone does have is the stream of payments which he or she will make in the future. If bundled into one whole, even the spend from a household in poverty can can amount to $800 per month in expenditures. For middle-class folks, a spend could easily reach $3,000 to $4,000.
Let's walk through the finances for Float:
a) Float extends a line of credit of $1,000 to John Borrower.
b) Borrower spends $1,000 through the Float portal. Borrower buys gift cards from Home Depot ($150), CVS ($150) and Food Lion ($500). Borrower spends another $100 online at both Amazon and Old Navy.
c) In month one, Borrower pays $100 back to Float.
d) In month two, each of those retailers sends their agreed upon rebate for those purchases to Float. Imagine that Float collects $85. The number could be more or less, of course, but for the sake of the example, that is the number.
e) In the remaining period - months 3 through 10 - Borrower makes the remaining $100 payments back to Float.
In this scenario, Float has collected $1,085 on a ten-month advance of $1,000. My calculation is that this generates an IRR of 20.9 percent.
The numbers could differ depending upon the size of the rebate and consumer utilization of the credit line. I think its possible that few rebates will generate $85. If it generated only $25, then the IRR falls to 5.6 percent. However, the
IRR jumps back when the line of credit is utilized serially: in a scenario with four rebate payments of $25 which are received every other month, the IRR is higher again. I'm not going to do that calculation but I think the dynamic is clear.
Here is the formula for those that want to double-check at home:
where A2 through A12represent a span of 10 months (and 1 day) and where b2 through b12 represent the stream of cash flows for Float.
In those cash flows, Float gives up $1,000 in period one, gets an $85 rebate in period three, and receives ten payments of $100 over the course of the ten-month period.
Such numbers do inform how Float underwrites. In terms of approving someone, Float examines a candidate's payments history. If they are approved, then the sum of the line becomes a product of three other factors: the amount of spending they do through the Float portal, the share of their line that they utilize, and their tenure as "members."
This is Not New, Just New for Credit
The mechanics work on the same rails as a program like Upromise or e-bates. Those programs generate cash flows for users through cash-back rebate programs built via an online shopping platform. I use Upromise, and in my experience it has generated between $300 and $450 in rewards payments to me each year. With Float, the customer pays for their line of credit by giving their future stream of rebates back to Float.
The key takeaway here, from my perspective at least, is that this puts a lot of holes in the idea that the only way to extend credit to some people is to charge exorbitant rates of interest and fees.