So far, so good

By the Economist journal,

WHEN a financial firm boasts of offering the biggest loans at the lowest rates with the slimmest collateral, it has either devised the underwriting equivalent of a better mousetrap or is setting itself up for an almighty fall.

At first glance SoFi, a startup based in San Francisco, looks like it is up to the sort of tricks that would make even a pre-2008 banker blush: lending youthful customers $975,000 to buy a $1m house, say. Yet few “fintech” firms seem quite as threatening to America’s incumbent banks.

Social Finance, as it once was, started life in 2011 as a way to match students who needed money to pay for a degree at Stanford with alumni with lots of dough. Engineering graduates from one of America’s grandest universities, the firm’s founders reasoned, were unlikely to welch on their debts, especially with Silicon Valley booming. That allowed SoFi to price student loans below even the notionally discounted rates available under government schemes, attracting lots of customers. Well-to-do alumni, meanwhile, were happy to lend via SoFi’s platform, understanding what a safe bet the borrowers were. The firm also raised money to invest in its own loans, largely to package them as securities it could then sell on, a variant on “marketplace lending”, a crowded field in fintech.

SoFi quickly expanded—to borrowers from other prestigious universities, and to other forms of lending. Having provided many of its customers with their first loans, SoFi then worked to cater to their expanding financial needs after graduation, offering them personal loans and mortgages. Again, the firm’s lending algorithms ignore the rigid credit scores used by banks in favour of common-sense indicators of ability to pay. High Earners Not Rich Yet, or HENRYs, are its main customer base.

To distinguish itself from banks, SoFi smothers customers with personalised service. Its 100,000 or so borrowers are “members”, invited to parties thrown by the firm. Entrepreneurs among them can apply to have their loan repayments suspended, and make use of SoFi’s offices for meetings with investors. Lost your job? Whereas a bank might foreclose, SoFi will tap its network to help you find a new one. Mortgages can be obtained by pecking at a smartphone and sending snaps of required documents. Pen-and-ink signatures are for fuddy-duddies.

The easygoing branding belies an outfit that can hold its own on Wall Street. Mike Cagney, its founder and boss, is a former trader at Wells Fargo. Like many other fintech lending operations, SoFi obtains the money it lends from hedge funds and investment banks. Its balance-sheet is turned over every two to three weeks; some of the loans it issues get sliced, diced and repackaged in much the same way subprime mortgages once did.

Most fintech startups aim to do one thing well and sell that service as widely as possible. SoFi is the opposite: its customer base is focused (though it now lends to graduates of over 2,200 schools) but it is busy diversifying its offering. Beyond student loans and mortgages, it aspires to manage its customers’ wealth and offer them insurance. It even wants to launch something akin to a current account, without officially becoming a deposit-taking institution.

But SoFi faces three obstacles if it is to keep growing fast enough to justify a recent investment that valued it at around $4 billion (it is not listed). The first is growing without lowering its lending standards. Of the $6 billion it has lent in total, more than $4 billion went out the door in 2015. Such rapid growth usually comes with more than a few dud loans. Mortgages seem an obvious concern. Banks like to lend to buyers with a 30% deposit. SoFi is happy with 10%—and now has a scheme to help borrowers raise most of the down payment too, in exchange for a slice of the increase in the value of the house. Can that be sensible, given that its loans are concentrated in pricey property markets, which are likeliest to deflate?

Mr Cagney says his customers will keep paying even if their houses are worth less than their mortgages. That is placing an awful lot of faith in Americans, who have walked away en masse from underwater mortgages before, and particularly in millennials, a generation often derided for its feckless and unpredictable behaviour. Like other young fintech lenders, SoFi has never had to weather a recession.

The second obstacle is rising interest rates. SoFi has made a packet by refinancing student loans which were in effect mispriced by government programmes. If interest rates rise substantially, the scope for existing borrowers to save money by refinancing will disappear. Mortgage refinancing will also dry up. Mr Cagney says he assumes much higher interest rates are unlikely anytime soon and that the firm will have diversified enough to handle them by the time they appear.

The third is regulation. Especially if it starts gathering something resembling deposits, SoFi will have many of the attributes of a bank while insisting it should not be regulated like one. In part it simply wants to skirt the red tape that comes from accepting deposits, along with the government guarantee they attract. But there is also a libertarian bent to the shaggy-haired Mr Cagney, who clearly believes that governments meddle too much in markets. The brief he received from his biggest investor, SoftBank, which led a $1 billion funding round in September, is to reach a valuation of $100 billion or go bust, but not to settle for the status quo. That is the kind of talk that might panic regulators, who prefer financial institutions to be boring.

the article first appeared in the Economist journal