Who keeps funding when borrowers start paying late?

The FT's reporting on neobanks reaching profitability through the SME lending gap puts a useful complication into the bank versus fintech argument: some of the challengers are banks. A digital distribution model doesn't tell us whether the capital behind a loan comes from deposits or a wholesale facility with performance triggers.

Where businesses access loans through specialist providers or embedded channels, the brand originating the loan can be remote from the institution supplying its capital. A bank may still fund the exposure, but through a senior facility to a non-bank lender rather than a direct relationship with the SME. I find that distinction more useful than treating alternative finance as an entirely separate pool of money, because it determines who can tolerate a delay when repayment doesn't arrive on the agreed schedule. A lender can have sound credit judgement and still be forced to stop advancing money while its borrowers remain viable.

Deposit-funded banks can have a funding cost advantage, although capital requirements and liquidity obligations mean the deposit rate alone isn't a fair comparison. Specialist lenders can justify a higher price through appetite or execution, particularly where a conventional bank can't make the relationship economic.

The moment a facility stops revolving

For a wholesale-funded lender, the critical price may sit in the provisions governing when its facility stops revolving, rather than in the interest margin. Delinquency thresholds can suspend reinvestment or require collections to repay the senior funder, cutting off new lending before realised losses become material.

Consider a hypothetical £40m loan portfolio financed with £32m of senior debt and £8m of equity; none of these terms is a market benchmark. Assume its warehouse agreement permits reinvestment only while the outstanding principal of loans more than 30 days past due stays below 4% of the total portfolio, tested at each month end.

At 3%, the delinquent balance is £1.2m; another £600,000 of loan balances crossing that ageing threshold takes it to 4.5%, assuming the overall portfolio hasn't changed and no delinquent accounts have cured. Under the assumed contract, reinvestment stops and principal collections go towards repaying the senior facility instead. If £2m would ordinarily have been recycled into new loans that month, that capacity disappears even if the late borrowers subsequently pay in full.

The SME may only need time because its own customers have paid late, yet its lender now has less capacity to bridge that delay, regardless of eventual recovery. As performing loans amortise, the delinquency ratio can also rise without another account missing payment, because the denominator shrinks while overdue balances remain.

Arrears consume more than interest

The financing cost of that delay is the most visible component, and it's often modest compared with the disruption around it. On a 365-day basis, £1m of principal delayed by 30 days costs roughly £4,600 in additional senior interest, assuming 80% remains debt-funded at an illustrative 7% annual rate throughout the delay. Contractual late interest doesn't settle the funder's cash bill unless it's collected.

Operational cost depends less on the balance than on the number of exceptions and how much judgement each requires. Assume 200 late accounts each need 40 additional minutes of work in a month beyond their normal servicing, at a fully loaded staff cost of £45 an hour: that's another £6,000. Existing salaries don't all become new cash expenditure, but the capacity consumed can't also process new business.

A failed payment requiring a retry is different from a repayment arrangement that needs repeated review by an experienced colleague. When the second category grows, an apparently manageable arrears queue can absorb the people needed to resolve it, so resolution times lengthen and more accounts cross the funder's contractual threshold. The cost then spreads to otherwise performing loans through reduced funding capacity.

There's a useful discipline in keeping those costs separate rather than producing a single, misleading figure for the cost of arrears. Interest carry and staff time belong in the operating model; a reinvestment stop belongs in the liquidity forecast, while eventual write-offs require a separate credit assumption.

A higher margin can buy more time

Cheap senior funding can still be the right choice, especially for a lender with predictable collections and enough genuinely available liquidity to survive a recycling stop. I wouldn't pay for flexibility without modelling its value, but I wouldn't describe two facilities as equivalent merely because their commitments have the same headline size and their senior margins look similar. Arrangement fees and the return required on committed equity also belong beside the debt margin in any comparison of lending economics.

A more expensive private credit facility might allow wider delinquency tolerances or a longer cure period, although neither feature comes automatically with the label. Equally, a deposit-funded bank can restrict new lending because of capital pressure or deteriorating risk appetite, even without a warehouse trigger forcing its hand.

A forward flow agreement can move loan ownership to an institutional buyer, but its purchase obligations still determine whether the platform can rely on that funding when arrears rise. The originator's lack of a loan book doesn't remove its exposure to a buyer changing appetite at renewal.

The comparison needs to include facility maturity and refinancing exposure alongside the amount of cash the lender must retain outside the structure, because nominal commitments can remain undrawn precisely when they become unusable. Equity already invested beneath senior debt absorbs losses, but it isn't necessarily accessible cash for tomorrow's drawdowns. Nor do two facilities provide much diversification if both stop revolving under the same portfolio conditions.

This is where I think investors should challenge the growth model rather than merely the credit model. Holding eventual losses constant while moving borrower receipts back by 30 days isolates a question that a conventional default stress can obscure: can the business keep funding its existing commitments?

The answer should flow through the actual contractual waterfall, including any cure period and restrictions on cash releases, rather than an assumption that the funder will be reasonable. A waiver may be commercially sensible for everyone, but it can arrive with a higher margin or a demand for fresh equity.

There is a genuine trade-off here: cash held outside a facility depresses returns in ordinary months, while looser terms can raise the price paid by borrowers. The evidence I'd want is whether those costs buy enough continuity to preserve good customer relationships through a plausible collections slowdown.

If the plan needs a waiver to honour contractually committed drawdowns, the forecast already contains an unpriced dependence on someone else's discretion.