Finding Innovation in SBA Loans

The bank sent me to investigate potential financial opportunities related to Small Business Loans. I was chosen to lead a team since the bank was interested in innovative products that could spin out of the bank and not efficiency plays. I took along a business lead to help with the financial analysis and industry expertise.

Understanding the Lifecycle of an SBA Loan

I interviewed dozens of stakeholders and for each discrete step I outlined who was involved (circles) and what actions were taken (boxes), starting from the beginning of the process when an SMB was looking for a loan:

To origination:

To data gathering on the bank side:

Until we had a model of the entire load process from conception to the bank servicing the loan, all the way until the bank would sell the guaranteed portion of the loan off to a secondary market:

And ended with a finalized flow diagram outlining all parties, actions, and documents.

By that time, I had a hunch that the largest opportunity was in the secondary market where people would splice loans together into credit-rated tranches. The rest of the process was performed in-house with manual processes, but the bank did not currently participate in the secondary market and didn’t have the expertise of Pool Assemblers to splice loans into credit rated tranches.

We did a quick analysis of the money left on the table, and decided that a digital marketplace for guaranteed portions of SBA loans slated to be handed off to the assemblers was a new spin on an old market. Instead of creating sets of loans for sophisticated buyers, why not offer government-backed business loans as investment vehicles for consumers?

Bank returns with secondary market transactions

Gaining Buy-In at All Levels of the Organization

A one-pager for internal stakeholders to understand the value of the project and how future iterations could seep back into the bank increasing efficiency through the loan process

Finding a Home in the Bank

PNC bank offered loan management services to smaller banks and FCUs. By piggy-backing on the sales team for those services, we could offer smaller banks alternatives to the broker-assembler groups that these loans were shipped off to. Even if the smaller banks didn’t want to make a big change, assemblers rejected smaller unprofitable loans, and those could still be handed off to our platform to be sold to individual consumers.

Financial Analysis for Consumers

By taking the guaranteed portions of Small Business Loans slated to be chopped and sold on Bloomberg terminals, and offering them to consumers, we saw that we could fill a gap in the market with better Risk to Yield ratios than most current investment opportunities.

Build versus Buy Analysis

For all projects at the bank, or any organization of its scale, there are always conversations about building a product versus buying a company in the market.

Background

Our back of the napkin estimates gave this project a timeline of 12-18 months and cost of 1-3MM to MVP.

Pros of Building	Cons of Building
Greater control of development timeline and quality	Challenges associated with generating buy and sell-side demand due to lack of initial transaction volume
Ability to prioritize / deprioritize all features through continual feedback from PNC clients	Reliance on PNC (e.g. Origination Team) during near-term until platform matures
Greenfield initiative reduces risk of inheriting customer contracts with unfavorable terms	Initial go-to-market strategy (i.e., SBA only) limits volume and value of a marketplace
Limited legacy code helps mitigate issues from integrating into other applications (e.g., BlackRock loan portfolio management tool)	Limited subject matter expertise within PNC to effectively capture various market mechanics
	Other digital marketplaces have a head start

Potential Solution

After three months of market and product diligence, the team identified a potential acquisition target that could help mitigate the cons associated with building a digital loan marketplace:

With several desired features:

Automatically crack any existing loan tape
Customizable auction parameters
Track due diligence within the platform
Integration with LOS to automatically categorize diligence docs
Buyer-seller communication within the platform
Research analytics platform

Rationale for Buy Approach

Cons of Building	Stackfolio mitigates concerns
Challenges associated with generating buy and sell- side demand due to lack of initial transaction volume	Existing transactions across loan types help create “critical mass” issue for early-stage marketplaces
Reliance on PNC (e.g. Origination Team) during near-term until platform matures	Existing sales force and customer base create base business upon which FIG can drive incremental growth
Initial go-to-market strategy (i.e., SBA only) limits volume and value of a marketplace	Supports multiple loan types so declines in the volume of one loan type can be offset by other types
Limited subject matter expertise within PNC to effectively capture various market mechanics	Several subject matter experts with prior loan trading experience already exist within Stackfolio’s org
Other digital marketplaces have a head start	PNC do not need to start from scratch and can inherit best practices / lessons learned

Revenue Model

Transactions	Research Platform	White Label Solution
35-50bps	Subscription Fee	Subscription Fee + 15-20bps
Per transaction	Monthly or annually	Per transaction

Valuation of Acquisition

In order to initiate the confirmatory diligence process, the team recommends submitting a non-binding indication of interest to acquire Stackfolio at a valuation multiple between 4.0x and 6.0x Adj. EBITDA

Stackfolio Valuation Assumptions - Acquisition
Estimated Annual Loan Amount Transacting on Platform	$200,000,000
Estimated Stackfolio Avg. Transaction Fee	0.43%
Estimated Annual Stackfolio Revenue	$850,000
Estimated Adj. EBITDA Margin	40.00%
Estimated Adj. EBITDA	$340,000
Acquisition Multiple	6.0x
Estimated Enterprise Value	$2,040,000

Buy versus Build Conclusion

The bank opted to build in-house given our team had the product skills to take this concept to market, and the build costs were trivial compared to the longterm upsides of owning the entire system.

Concept Development

We created a site architecture and pixel-perfect mockups of the final product and handed the project off to the loan team to develop the product in its entirety with their own engineering teams.

List view where consumers can see relevant information for each loan