Fintech entrepreneur Mike Cagney is not a man without ego.
Having left SoFi, the online personal finance company that he co-founded, in 2017, he is now focusing all of his considerable self-belief in nothing less than the systematic disintermediation of large parts of the capital markets.
He will achieve this using blockchain – a technology that he describes as the most disruptive to hit financial services since the spreadsheet.
Cagney has a lot to prove, having been ignominiously removed from his previous position by the SoFi board after complaints of sexual harassment and compliance missteps. He quickly founded his new firm, Figure Technologies, in 2018 with his wife, June Ou, who acts as chief operating officer and who served as chief technology officer at SoFi.
His new revolution will be realized by attacking the large number of ancillary services that attend the capital markets. Cagney, who has in the past described himself as “the meteor that will kill off the dinosaurs of old-fashioned banking”, reckons there are $3 trillion of global financial assets burdened by rent seeking and inefficiency.
There will be no more information asymmetry- Mike Cagney, Figure Technologies
These rent seekers include auditors, administrators, trustees and other intermediaries, all of whose activities Figure plans to undertake more efficiently and cheaply by putting them on a blockchain. The firm claims to have identified $90 billion of value that can be created across fixed income, equities, debt issuance, securitization and remittance payments in this way.
Described by this magazine in 2016 as the Donald Trump of fintech, Cagney is living up to his name, at least on Twitter. On August 22 he tweeted: “It looks like lightning will strike twice as Mike Cagney breaks the mold once again by moving quickly to embrace new technology to create something that is better than what came before.”
Ambition is not in short supply here.
Figure comprises both a blockchain, dubbed Provenance.io, and a loan origination operation that creates the assets to put on it. Together with Caliber Home Loans, which white-labelled the origination process and started putting loans on blockchain in September this year, Figure has now originated more than $600 million of loans and has over $3 billion in warehouse and takeout capital.
It has secured a $1 billion loan warehousing facility from Jefferies, with WSFS Institutional Services acting as trustee. As the number of loans on Provenance.io grows, the next target in Cagney’s sights is – of course – securitization.
Figure has raised $115 million in equity financing from Silicon Valley venture capital firms including initial investors DST Global, DCM Ventures, Ribbit Capital, RPM Ventures and HCM Capital. It raised $65 million in B-round funding earlier this year and will likely close a C round soon.
Provenance.io is a distributed stakeholder blockchain that was developed with a native token called Hash. The network was spun out of Figure, which has retained 72% of the Hash outstanding (it intends to reduce its holding to below 50%). The other 28% of Hash tokens are held by other financial institutions, after $20 million was raised via a Hash security token offering on April 10 this year.
All loans so far have been Helocs (home equity lines of credit) of up to $150,000. Figure claims to have realized 65 basis points in origination savings on the Helocs it has done thanks to blockchain. The firm takes one third of this benefit as its fee.
The process is not straightforward. When a loan is made, the lender delivers the loan amount to an omnibus bank. These banks perform know-your-customer and anti-money laundering checks, and provide settlement services. They are the interface between the fiat currency and the token on the blockchain. So far there are three omnibus banks: First Republic Bank, Silvergate Bank and one other.
This is a seminal moment for the blockchain industry in financial services- Sheila Bair
The omnibus bank then gives the lender Hash tokens in return. Those tokens are immediately sold back to the omnibus bank, which releases the funds – and it is this second transaction that forms the packet that then sits on the blockchain. The loan then amortizes and is serviced entirely on the blockchain.
“The first way we did it, you actually had to buy Hash, but people didn’t want to touch crypto,” Cagney revealed at the ABS East conference in Miami in September. “So now no one is touching Hash – it’s just distributed on the back end.”
This is where Provenance.io is different: the actual assets sit on the blockchain rather than tokens. The blockchain acts as ledger, registry and exchange. A loan packet is submitted to the blockchain that contains the title deeds, the automated valuation model, a promissory note and evidence of funding. The origination process is entirely automated and takes less than five minutes.
Notarization is done by video interview: customers verify their identity by uploading a photo and ID such as a driver’s licence or passport. Both data and files, including full asset documentation, are stored on the ledger: one loan packet is a gigabyte of data.
This is where the benefit comes from – it is possible to see real-time data on remittance payments and performance instantaneously and the data is immutable.
Jennifer Mitrenga, Figure
“Investors are excited as the experience is so much better,” says Jennifer Mitrenga, head of Americas, Provenance.io at Figure in San Francisco. “The real-time performance of the assets is significantly improved and the auditing process is more efficient online because the entire loan packet lives on the chain. You can diligence a smart contract – can immediately see the exceptions – for example, you can see that loan 2375 of the pool is missing a driver’s licence.”
The Provenance blockchain has multiple nodes, which are large buy- and sell-side firms, including Franklin Templeton and Experian. The original plan was for them to store the encrypted information in a distributed format. This would have meant competitors hosting other firms’ data, however, so now while they validate data they do not store it.
The obvious next step is securitization – something that Figure has been planning for some time. Cagney reckons that the $3 trillion-a-year industry pays $30 million a year in intermediation fees that are ripe for disruption.
The implications of such a deal would be enormous.
“This is a seminal moment for the blockchain industry in financial services,” said Sheila Bair, former chairwoman of the FDIC recently.
Bair is an adviser to Figure along with, among others, former SEC chairman, Arthur Levitt and former Digital Asset chief executive Blythe Masters.
“Provenance.io has the potential to bring massive improvements to the industry, across asset originators, the buy and sell side, as well as regulatory benefits and better consumer protections,” says Bair. “In particular, it will provide loan-level transparency around the quality of securitized assets and a clear, unalterable record of ownership—two things that were sorely missing during the financial crisis.”
According to a corporate presentation dated October 2019, Figure is working on a $200 million Heloc securitization deal with Jefferies as lead left and Nomura as lead right. Jefferies has a long track record in the securitization of non-bank originated consumer loans, having underwritten the first rated prime marketplace lending ABS for Lending Club in February 2017.
Dentons is named as counsel and Jefferies and Nomura are both providing warehouse facilities for the loans – Figure says that JPMorgan and others are in the near-term pipeline to do the same.
The presentation states that the deal was expected to take place in August this year, but according to Mitrenga, details are now expected to be announced in November. Figure reckons that the deal will realize 20bp of cost savings and it expects full execution benefit of 50bp to 100bp.
In Miami, Cagney said the economic benefit could reach 200bp to 250bp. This figure comes from totalling projected savings across origination, sales and financing, securitization, ratings and execution. The firm claims possible global savings of $60 billion to $75 billion across these functions and a total addressable securitization market for provenance.io of $20 billion to $25 billion. But the potential doesn’t stop there. Figure is also projecting additional opportunity of $33 billion in non-securitized loans, $33 billion in corporate bonds, $12 billion in public debt, $16 billion in public equity and $1 billion in private equity – claiming this will be achieved from costs savings, risk mitigation and revenue enhancement.
Is this realistic?
Firstly, the assets don’t need to be re-underwritten as the loans are all on the chain as an immutable record. The smart contract is the trustee and there is real-time visibility of the collateral. Figure says that it has received legal opinion from Dentons on the enforceability of contracts and the perfection of security interests on the blockchain.
“We see these as highly digitized files of data that allow us to do our job better,” Brian McGrath, head of the securitized markets group at Jefferies told the ABS East conference audience. “This is a better way to originate loans that produces better data. The fact it is open-source is allowing people to adopt it quickly. There are a lot of conceptual ideas out there, but this is the first functioning blockchain. There was a lot of scepticism at first, but the ease of use has surprised us.
“The bridge between conceptual and practical is bigger than a lot of people realize. Blockchain is immutable, which means you can’t go back and delete things, but you can update things. You can amend if a file is missing, and it shows when there has been a modification.”
The securitization market is going to do everything that it can to protect itself. People have difficulty in realizing that change has arrived, but the early adopters are going to win- Michael Weisz, YieldStreet Capital
The arrangers also argue that better data visibility on the blockchain will lead to higher credit ratings for the securitization.
“Over time there will be rating enhancement on the blockchain,” Cagney said in Miami. “You can log on and see every loan that has paid, so there will be no more information asymmetry.”
McGrath agreed: “The ambition is to get higher ratings for structures on the blockchain. We will get real-time remittance data and can feed the rating back onto the chain. As the data is in real time the ratings are more up to date.”
Morningstar Credit Ratings is working on the upcoming deal.
“We are in discussions with Morningstar to rate on-chain transactions, including securitizations,” Mitrenga confirms. “Since all of the data is in the same place and in the same format, there is a much higher level of conformance and it makes auditing much more reliable. The securitization will be the first on-chain Heloc securitization ever completed.”
If Figure can achieve its aim of disintermediating anything that requires a trustee, custodian or administrator, the implications are enormous.
Michael Weisz, YieldStreet Capital
“What Mike Cagney is building is incredible and it is building enormous efficiencies,” says Michael Weisz, founder of YieldStreet Capital, an investment platform that connects accredited investors to asset-based alternative investments.
Figure is in the process of onboarding a YieldStreet and Saluda Grade real-estate investment trust with Figure and non-Figure Provenance-custodied assets.
“The securitization market is going to do everything that it can to protect itself,” Weisz warns. “People have difficulty in realizing that change has arrived, but the early adopters are going to win.”
When Euromoney visited a number of top 10 US ABS banks in New York following the Miami conference, enthusiasm for the Figure project was certainly far more muted.
“Mike has been in here a few times,” sighed one banker, looking out of the window with a bemused expression.
It is hardly surprising that the banks do not seem to be rushing to embrace something that could disintermediate large parts of their own business. US ABS is a $200 billion to $225 billion a year market, 90% of which is triple-A rated. It is a steady, reliable source of business for the banks, a tried and tested funding source for consumer lending.
“Securitization is migrating back towards a more traditional model. There has been some progress around tech and there is a role for blockchain in lending,” muses the banker. “Securitization of blockchain-originated loans would change the process massively, however, as it would run counter to the principle of secured interest and perfection of true sale.”
The October corporate presentation from Figure suggests, however, that the smart contracts are enforceable and that security interests can be perfected on the blockchain.
Ownership of the securitized loans would move to a special purpose vehicle that will sit on the blockchain and will have a different set of permissioned owners.
“I don’t know how applicable blockchain is for securitization,” says another banker. “We have spent a lot of time looking at where blockchain is really scalable. The question is whether there is a better way to source a loan.”
As ever, this gets to the heart of securitization’s problem: the structures are only as good as the assets that back them.
There is no doubt that holding the loan package on the blockchain and providing instantaneous data and trading is a huge advantage. As is reducing the need for intermediary functions. But all of the Helocs that Figure has done so far have been for super-prime borrowers.
It has stated ambitions to start originating a range of other assets in this way, including mortgages and student loans and even whole business securitizations and microlending. This could see the credit quality of borrowers fall.
“Blockchain is a great label but it shouldn’t take away from what is disruptive,” says the ABS syndication head at one large US securitization bank. “Using older tech in smarter ways may be just as powerful. A lower cost of origination may not always be the right model – particularly in sub-prime. You need to understand the difference in how prime and sub-prime perform. If Figure can originate loans better, then great. But can those loans perform?”
A five-minute approval process is bound to raise eyebrows among many loan originators. But nearly instantaneous online approval has been a staple of the market for some time now, pioneered by the wave of peer-to-peer lenders, such as SoFi, that emerged more than a decade ago.
Their chequered progress ever since has, however, highlighted some of the shortcomings in the model. Marketplace lending, which amounted to $25.7 billion in 2017, was hit by high default rates that year and has since tightened lending standards.
The current focus on super-prime borrowers should allay performance concerns over the first securitization pool of blockchain-originated assets. Helocs are among the best performing US consumer loan asset classes with a delinquency rate (60 days overdue) of just 0.52% in the second quarter of 2018. That compares with 3.21% for personal loans, 1.53% for bank cards and 1.67% for mortgages.
Although the Figure loans are serviced on the chain, any underperforming assets will be taken off the blockchain and dealt with.
“Once a loan is more than 60 days due it will be taken off the chain and placed in special servicing,” Mitrenga tells Euromoney. “We are working to put special servicing on the chain – in some asset classes there might be the need for multiple servicers, all of which would have to be a member on the chain.” Blockchain’s potential as a centralised database has clear implications for the servicing function, and banks and fintechs are working on initiatives to streamline the process using this technology.
Figure certainly seems to embrace the idea of using blockchain to originate assets across the credit spectrum.
“All the loans we have done so far are super-prime, but blockchain opens up opportunities for new asset classes,” says Mitrenga.
Peter Silberstein, Figure’s head of capital markets, told the Miami conference: “We have completely streamlined capital markets processes and are reducing the friction of transacting. For example, people who didn’t trade whole loans/illiquid assets as they were not set up to do this can do it now, so this will translate into lower cost to the consumer.”
It will also translate to higher risk and an increased likelihood of default. That is something that Rich Tambor, chief risk officer at One Main Financial in Wilmington, Delaware knows all about. One Main has $17 billion non-prime, near-prime and prime net finance receivables and is the largest branch-installed lender in the US.
Tambor believes that assets outside the prime and super-prime space need traditional, high touch servicing.
“The near- and non-prime portion of the credit market is not as amenable to low-touch servicing or underwriting,” he tells Euromoney. “There is a piece of the non-prime market that could be done that way but it is not as big as people thought. You cannot do servicing like this."
Tambor is a firm believer in boots on the ground: "We have a very large servicing infrastructure with over 7,000 people and more than 1,500 branches. They originate loans and do early stage collections, but if there is a recession, that capability can pivot to focus more on early delinquency and less on loan growth. In this way, we have an embedded advantage."
If Figure is to achieve its aim of showing how blockchain can disintermediate and add value in the capital markets, it would do well, therefore, to stick to low-risk assets for the foreseeable future. There is no shortage of opportunity at the top: the US has 100 million prime and super-prime borrowers and another 100 million classed as near-prime. The deep sub-prime market in the country has 50 million borrowers. But even in super-prime there is no guarantee of protection when the cycle turns.
"The most volatile part of the market after the crisis was super prime and prime followed by deep sub-prime,” warns Tambor. “That part of the market is underprepared for when the cycle turns."
Tightly controlling the type of assets that will sit on Provenance.io seems to be very far from the company’s mind, however.
“Provenance is a public utility for the capital markets,” declared Silberstein in Miami. “We are going to open-source the code and allow people to onboard themselves.”
Figure will encourage others to white-label its origination process and may, in time, stop originating its own loans altogether when enough lenders are onboard.
“There is a huge application for stocks, complex derivatives, real estate,” Silberstein enthused. “This is a better way to manage and encrypt data.”
It probably is. The fact that files are immutable offers complete and instantaneous transparency on loans – something that was certainly not available in 2008. Mistakes can be immediately identified and rectified, and the process efficiencies are undeniable.
The technology, if successfully applied, will change the role of securitization trustee and custodian beyond recognition.
But, as ever, it all comes down to discipline and credit quality, and just how much momentum Figure can initially build.
“There have been technological advances, but if you actually dive into the detail of the reduction in the cost of origination, it is often not that great,” reckons one New York-based banker. “Marketplace lenders are still doing direct mail – disrupting the origination channel is harder than people think.”