Silver Lake SoFi deal shows lure of high-end online lending

Some investors are not waiting for mass market loan performance to improve.

Private equity firm Silver Lake and Japanese asset manager SoftBank Group were part of a group that agreed this month to invest $500 million in Social Finance, or SoFi, an online lender that has started as a student loan refinancer and quickly transformed into a private bank. for new Silicon Valley recruits. The latest round of funding created a $4 billion valuation for the company, according to the the wall street journal. Silver Lake and SoftBank declined to comment on their investment in SoFi, which has been one of the most profitable online lenders.

While Lending Club, Kabbage, and SoFi have been hot spots for investors looking to bet on “fintech,” the nascent online lending industry has fallen on hard times. Last year, investor confidence in online lending declined sharply amid a federal regulatory investigation into Lending Club and lackluster lending performance in the industry. To help improve performance, online lenders reduced the number of loans they made in the second half of 2016, tightening credit standards to limit high-risk ones, according to the US data provider. Orchard Platform Advisors.

SoFi’s model diverges from other online lenders in several important ways. Rather than completely ignoring traditional financing structures, SoFi combines them with technology to create a high-tech private bank for sensitive, high-wage Silicon Valley borrowers. Borrowers who work with SoFi to refinance student debt are offered career counseling, mortgages, and wealth management services to keep them in the business.

“SoFi is really using student loans to surface the future 1% by getting them at student loan time and then offering them financial products for the rest of their lives,” says Brendan Ross, CEO of La Cañada Flintridge, Calif. . Direct Lending Investments, a $940 million hedge fund that provides credit to and invests in online lenders.

SoFi recently bolstered two big traditional banking pillars of its business: savings and checking accounts and mortgages. The fintech announced on Feb. 1 that it had purchased mobile banking startup Zenbanx, a deal that gave SoFi the platform it needs to start offering products that look and work much like traditional checking and savings accounts. Also in February, Fitch Ratings agreed to add SoFi to its mortgage origination reports. Fitch had already said in December that it would assess SoFi’s first residential mortgage-backed securities issuance.

“SoFi’s 2016 issuance had an average FICO of 777, which tends to equate to strong performance,” said Roelof Slump, chief executive of New York-based Fitch. FICO scores provide a measure of consumer credit risk.

So it’s no surprise that top names in private equity are lining up as investors. But it’s also different from the egalitarian anthem that fintech largely sings.

Companies like Lending Club, which was one of the first players in the industry, started by offering loans in the market to almost everyone. The vast majority of loans refinanced high-interest credit card balances to something more affordable or paid off other consumer debt. This model has allowed online lenders to grow rapidly and attract the attention of institutional investors interested in private debt. But as Direct Lending’s Ross points out, that attention has led them to lower overall credit standards because they have too many investors and not enough performing borrowers.

Mass market lending platforms tend to attract borrowers through a somewhat generalist approach: they rely on direct mail, website advertisements and other forms of advertising to attract the candidates. SoFi, on the other hand, creates a proprietary transaction flow network from its affluent user base.

“Without an exclusive deal flow, that means the worst deals are accepted every time, so the overall level of the loan portfolio starts to drop,” Ross says.

When sourcing lenders for his fund, Ross looks for a differentiated business model that benefits from exclusive deals and shows more consistent performance. A lender in which Ross invests, for example, is available in medical offices and offers direct financing for medical procedures.

As the industry matures and winners begin to emerge, the old guard of online lending seems to be looking for its own exclusive angles to add value. Ross notes that Lending Club recently began working with investment bank Jefferies to bolster its lending business. Lending Club management said it used last year’s decline in lending to reinvest in operations.

“2016 was a year of investing in the business,” Lending Club chief financial officer Tom Casey said in the company’s fourth-quarter earnings report on Feb. 14. “We have developed better internal processes, stronger controls and a diverse investor base that will help us compete in the future.”


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David A. Albanese