Will VC continue to back lending platforms?

DigFin is publishing a special series on how CreditTech companies in Asia have survived the COVID-19 pandemic and what lies in store.

• More in this series:
• CreditTech after COVID
• Small P2P platform survivors retrench
• Singapore’s credit-tech leaders focus on profits

The challenges CreditTech faced in 2020 led some investors to pull back from the space, or avoid it altogether.

But venture capital partners in Singapore, Hong Kong and India remain committed to fintech lenders that are built on sustainable business models.

VCs entered the pandemic with previous crises in mind: not so much the SARS outbreak of 2002-03 so much as the dot-com bust of 2001. The instinct was to circle the wagons: encourage fintechs in their portfolios to become very conservative about lending, get out of struggling business lines, and cut costs.

That was true of VC investments across the board, not just in credit or in fintech. As it turned out, 2020 was a boom year for VCs.

• First, the coronavirus greatly accelerated the need for digitization across industries, including finance – which plays to fintech strengths.
• Second, the stock markets went on an absolute tear, creating an incredibly attractive environment for exits, both IPOs and strategic sales. The abundance of liquidity, partly caused by central banks and governments as in COVID relief efforts, has continued into 2021.
• Third, in some cases VCs were able to push down valuations of target companies.

Looking more specifically at CreditTech, however, and COVID presented a very mixed picture. VCs are now more focused on quality loan books rather than growth, on mature management, and on models that embed the lender in bigger customer-facing networks.

But some VCs are avoiding the sector altogether.

The bear: Arbor Ventures

Melissa Guzy, Singapore-based co-founder of Arbor Ventures, is bearish on the sector. Speaking at the recent annual conference of the Hong Kong Venture Capital Association, she said global liquidity is flush but lending capital is not.

Instead, COVID saw many investors pull the plug on extending credit, fearing defaults from small companies or consumers (and defaults did indeed increase). With interest rates at or near zero in most markets, it has been difficult for lending against invoices or consumers to generate a margin.

• Read more:
• What venture capitalists see in fintech after COVID-19
• Make room, China: VCs look to India for fintech startups
• Visa adds Hong Kong SME startup Neat for cards

The impact has been uneven. “Liquidity is not universal worldwide,” Guzy said, noting the cost of capital for Japanese companies looking to expand is 2 percent, versus up to 16 percent for a borrower in Southeast Asia. Some CreditTech players have responded to the loss of investors by using their equity instead of third-party money to keep the business going – a tactic she doubts will work.

Guzy says SME-focused lending and payment businesses are not interesting for venture capital seeking high returns. Lending requires margin and payments requires scale across SMEs, which in turn only succeeds if a platform can amass a huge credit line.

Both platform and balance-sheet models are looking challenged. “Some parts of fintech have gone cold,” she said.

Of the VCs profiled for this story, Arbor is the most negative on CreditTech, preferring to focus its attention elsewhere. Vectr Fintech Partners in Hong Kong also pulled back – but it continues to support certain types of fintech lenders.

Cautious return: Vectr Fintech Partners

Mark Munoz, managing partner at Vectr, says the firm decided to postpone new investments into the sector in mid-2019, before COVID, because too many other investors were pouring into fintech lenders. Valuations were too punchy for a lot of fintechs that all looked the same.

Munoz says COVID revealed other shortcomings. It turns out many CreditTechs are not actually very automated. “Technology was to drive the risk down and foster distribution, but this by and large has not proved to be widespread,” he said.

Then governments intervened, forcibly in markets like India and Singapore, less so in the likes of Indonesia. Although such support may have helped some borrowers avoid default, for fintech lenders it has skewed pricing and risk. “The cost of capital has not met the demand, making the economics of the business more challenging,” Munoz said, “but also making it less attractive from a VC perspective.”

Nonetheless, Munoz is bullish on those fintechs that have raced to improve their operations, automate, and get savvier about balance-sheet lending.

He also sites a number of fintechs that have responded to the chaos of COVID: the pandemic, lockdowns, and remote working have created new problems that fintech can address. Some Vectr portfolio companies that Munoz says have rolled out new products include Gigacover, an insurtech that has added payroll advances in Indonesia, Hong Kong non-bank lender Neat launching a Visa card program for SMEs, and Hong Kong fintech gini’s new financial forecasting tools.

The upshot, Munoz says, is embedded finance, with financing options included in consumer or business-facing brands, powered by CreditTech. “This is where we are seeing opportunities and will deploy into those companies this year,” he said.

Conservative victories: Quona Capital

Bangalore-based Quona Capital bills itself as the largest VC for emerging-market fintech, and CreditTech is a big part of its portfolio, especially in Indonesia.

This has been a growth story fuelled by the expansion of local economies, says Ganesh Rengaswamy, co-founder. But 2020 forced a retrenchment and a return to sustainable credit models.

“2020 was an unusual year for lending,” Rengaswamy said. Experience of other crises led Quona to focus on cost rationalization. “We told our portfolio companies to stop originating new credit and hunker down.”

Conservatism meant survival. Although he saw platform lenders growing fast, he preferred to back companies with solid credit and risk frameworks. This led to a surprisingly good year, as his portfolio companies were able to raise bridge loans or new equity rounds.

Digitization among SMEs in the wake of COVID is also creating the means for lenders to get better data. Embedding lending into e-commerce makes consumers more willing to engage with lenders online. “This is a very positive counter-trend” to an otherwise tough year, Rengaswamy said.

Together, these factors are creating what Quona sees as clear advantages for the COVID survivors.

“These companies will be in a position to capitalize on growth once the world stabilizes,” he said. “The crisis made clear which companies are good at managing credit and risk.”

The types of lenders Quona backs are diverse. Among his companies are:

• ZestMoney, a BNPL startup in India;
• NeoGrowth, the largest SME lender in Indonesia, focused on digital payments and receivables;
• SMECorner, which blends P2P with balance-sheet lending;
• KoinWorks, another Indonesia P2P SME lender;
• Julo, a use-based consumer lender in Indonesia that ties its loan book to certain needs such as healthcare and education.

Embedded finance: Integra Partners

Singapore-based Integra Partners (spun out of hedge fund Dymon Asia) has a large exposure to fintech lenders, but its bets are based around understanding the nitty-gritty of the lending process, says Christiaan Kaptein, partner.

For example, one of its companies is Flow (previously known as AsiaCollect, which focuses on ethical debt collections.

“A lot of VCs are investing on the origination side, but that’s only one part of the lifecycle of a loan,” Kaptein said. This has led to money going to fintechs that lack good credit standards, and which were lending more for growth than for margins – behavior often encouraged by VCs too eager to burn cash in a race to dominate a market.

This reflects a misreading of the credit landscape, Kaptein argues. “Power is shifting from the originators to distribution. The power is with platforms like Grab, Shopee or Lazada – whoever owns the SME or the consumer. Fintechs and banks have to embed themselves into those processes.”

The power is with platforms like Grab, Shoppee or Lazada

Christiaan Kaptein, Dymon Asia Ventures

Doing so is not just about winning access to borrowers. It’s also about gaining access to borrower data. In many emerging markets, CreditTechs lack good or standardized data to feed into decisioning algorithms. It’s still too easy for borrowers to pledge assets to different lenders, or to conceal their other borrowing activity.

As more SMEs digitize business – with COVID providing a strong tailwind – and as more consumers shop online, more data becomes available in real time. This is one reason why BNPL, embedding installment loans at the point of sale, has become so hot.

Embedded finance comes with another twist that Kaptein likes: use-based lending. One company he is watching is Jenfi, which provides advances to SMEs for clearly defined and trackable purposes such as a marketing campaign.

Another play is Advance.PH in the Philippines, a portfolio company of Integra that lets employees borrow against their salary, with disbursements and repayments managed through the employer’s systems. This combines credit with benefits and employee wellness (embedded finance), visibility (safer lending) and specificity (use-based lending).

• More in this series:
• CreditTech after COVID
• Small P2P platform survivors retrench
• Singapore’s credit-tech leaders focus on profits