Fintech: US non-bank lenders close in on mortgages
JPMorgan teams up with On Deck Capital; SoFi lends $4.5 billion in 2015.
JPMorgan Chase is moving into small business loans after forming a partnership with marketplace lender, On Deck Capital. On Deck, one of the new breed of disrupters to have emerged since the financial crisis, has lent more than $3 billion to small businesses since starting up in 2007, and already has partnerships with banks including BBVA Compass.
Such partnerships between traditional banks and marketplace lenders are on the increase. Citi joined up with Lending Club last spring.
While banks lack the technology to make fast decisions on loans, the online lenders have developed algorithms that allow them to make near-instant decisions. They also focus on small loans, generally no higher than $200,000, but more often in the $20,000 range – too small to be worthwhile to banks, but make enough of them at low cost and high speed, and all of a sudden it becomes a very profitable business that banks want in on.
JPMorgan chief executive Jamie Dimon says the new partnership will enable it to do “the kind of stuff we don’t want to do, or can’t do”.
That includes student loan refinancing, a sector that marketplace lender, Social Finance (SoFi) set itself up to serve over four years ago. It has now lent $4 billion in refinancings of both federal and private loans.
Dan Macklin, SoFi
Co-founder, and vice-president of community and member success, Dan Macklin, says it has filled a gap in the student loan market that banks had left open. “Some banks do offer refinancing but only of private student loans, which are only about 10% of the entire student loan market. It’s really a new market that companies like ourselves have created.” What started with student loans, has broadened into mortgages and personal lending, taking the total amount of loans for SoFi to $6 billion to 90,000 individuals, 70% to 80% of which have been made in the last 12 months. That’s the worry for banks – that what starts as a non-competitive product to consumers can quickly morph into loan sectors that compete for the bread and butter of the traditional bank industry.
While providing student loan refinancings may not put the newcomer in direct competition with banks, extending mortgages certainly does. SoFi offers regular mortgages based on 20% deposits, but its growth sector is in originating mortgages requiring no insurance and only 10% as a deposit, something the banks cannot do. SoFi underwrites mortgages based on cash flow, rather than a debt-to-income ratio – the industry standard. Most of its borrowers do not need to show tax returns, and electronic signing means the process is far less painful than dealing with a traditional bank.
SoFi is not alone. Lenda also offers mortgages, as do several other non-banks. They are gaining market share fast. According to Inside Mortgage Finance, non-banks were responsible for 37.5% of 2014 US mortgages, up from 26.7% in 2013. Macklin points out that the $10 trillion-plus US mortgage market leaves plenty of room for competitors and he says SoFi has no intention of teaming up with a bank.
The question of adequacy of risk underwriting has to arise though for these fast, almost robo-signing, alternative lenders. The Consumer Finance Protection Bureau oversees them, but ratings agencies point out that they have yet to be stressed by a market downturn.
Fitch Ratings’ senior director Tracy Wan says: “Credit performance so far has been stable across most marketplace lending platforms, though it has yet to be tested through a full economic cycle, [and] the rapid growth of marketplace lending is also drawing increasing attention and scrutiny from various regulators.”
Fitch says non-balance sheet marketplace lenders in particular face more regulatory uncertainty due to the concern of ‘true lender’ status.
For SoFi, loans are made on balance sheet, and then sold on four to six weeks later. SoFi’s loans are funded by individual investors, although most of those are institutional investors – the usual cast of characters: hedge funds, pension funds, not-for-profits. Returns and yields attract them, says Macklin, although some also view their investments as having a positive social impact, given crippling student debt within the US.
“The hybrid model means we have skin in the game. There is risk, but we are comfortable with the risk we are taking,” says Macklin. So far SoFI has had just five defaults on all its loans.
Interestingly, among SoFi’s risk mitigation strategies is unemployment protection. SoFi employs six career advisers dedicated solely to customers who have lost their jobs and therefore may be at risk of defaulting. So far it has helped 155 borrowers find new jobs. Says Macklin: “We offer generic life and career coaching – working out what industries the member should be in, helping with resumés, and then connecting them with open positions and helping in negotiations. That is where the community kicks in. We have a huge network among our borrowers and lenders that we can tap into.”
Can that model survive a full credit cycle? Macklin is confident it can, but admits that some marketplace lenders are likely to be shaken out if the market becomes less favourable.
Banks need to be careful which ones they partner up with.