Like many fintechs, Grain Technology promises its bank partners it will stand by its product in the event of fraud, covering any losses when it fails to identify a scammer. Now it's time to pay up.
Ponce Financial Group told shareholders this week that it had to take a $6.3 million charge in the first quarter tied to unsecured microloans on its books that were originated on its behalf by Grain. Ponce also added $1.7 million to reserves.
The $1.65 billion-asset Ponce, based in the Bronx, New York, held 54,247 microloans with an aggregate balance of $31 million on March 31, according to a related securities filing late last week.
While those loans “were performing, in management’s opinion, comparably to similar portfolios,” Ponce noted that over the past three years it had kicked back 24,719 fraudulent loans to Oakland, California-based Grain.
Per their partnership agreement, Grain is responsible for repaying Ponce for the principal and any losses on the kicked-back loans, a sum that had grown to $11.8 million as of May 5, the securities filing says.
Grain’s status as startup that has yet to report a profit made it difficult to foresee when the fintech would be able to pay down a debt of that size.
“Although we are confident that Grain will grow from a pre-profit startup to a solid company, the write-off and write-down reflect the current economic conditions and regulatory requirements,” Ponce CEO Carlos Naudon said Monday in a press release.
Ponce added it has frozen new microloan originations and informed Grain that further credit extensions to existing borrowers are contingent on a fraud check.
Ponce, which maintains a $1 million equity investment in Grain, has not indicated whether it plans to continue the partnership. A spokesman had not responded to an email seeking comment by deadline. Naudon, however, said in Monday’s press release that working with minority and underbanked consumers remains an important part of Ponce’s business model as a minority depository institution and a community development financial institution.
The write-down and the provision, combined with a $5 million contribution to Ponce's charitable foundation, resulted in a $6.8 million first-quarter loss for Ponce, a recently converted mutual thrift with deep roots in New York’s multifamily real estate market.
Ponce, holding company for the 62-year-old Ponce Bank, reported its first-quarter results this week. It was the bank’s first quarterly report since it completed its second-step conversion to a fully stock-traded company on Jan. 27, when it raised $133 million from investors.
What's next for Grain
Carl Memnon, Grain’s co-founder and chief operating officer, said in an interview that the company became aware of the dimensions of the synthetic fraud issue toward the end of 2020 and began taking steps to remedy it.
“By the end of the first quarter in 2021, we began implementing a five-tier system and by November we had installed all five steps,” Memnon said in an interview. Grain’s multilayer defense includes IP device tracking, knowledge-based authentication and biometrics. The fintech is working with third-party identity security providers to build out its system.
“That’s just the point it's gotten to when it comes to fraud,” Memnon said. “The criminals have gotten so sophisticated.”
While Ponce’s disclosures appear to call Grain’s ability to cover the fraud charges into question, the bank hopes that it will be made whole. Ponce noted in the 8-K filing that Grain has agreed to erase its deficit “upon the completion of a series A financing.”
Memnon declined to discuss Grain’s investors or its other bank partners. He described Grain’s state of affairs with Ponce as a “pause,” after which he remains hopeful the partnership can return to normal.
“We’re committed to working with Ponce to further mitigate fraud throughout the Grain life cycle,” Memnon said. “We don’t necessarily take this pause as an indication that they’re not still aligned with our mission but rather a reflection of, 'OK, this is the circumstance. Let’s get a better handle on it and when we do we can go back to the mission at hand. … We’re committed to broadening credit access to communities that are locked out of the financial system."
Grain uses an alternative underwriting methodology to provide borrowers with lines of credit as large as $1,000. The lines are linked to a borrower’s debit card. The vast majority of the 50,000-plus credit lines Grain has originated for Ponce went to minority borrowers and borrowers in low-to-moderate-income census tracts, according to Ponce.
Synthetic fraud, real problem
In its 8-K, Ponce described cyber fraud — particularly synthetic fraud, which uses a false identity constructed from a combination of real and fake personal information — as “a phenomenon that has become prevalent with fintechs.”
It can be perpetrated by individuals seeking to avoid linkage to a damaged credit history, or by gangs of criminals leveraging stolen personal data, according to Naftali Harris, founder and CEO of SentiLink, a San Francisco-based provider of identity verification technology.
“Identity fraud impacts lenders across the spectrum, not just those serving the subprime segment or those with digital originations,” Harris said in an interview.
Since this type of fraud doesn’t usually impact real people — who have grown increasingly vigilant about protecting personal information — in some cases it’s easier to perpetrate than classic identity fraud, where an actual individual’s credit profile is hijacked. Indeed, the problem of synthetic fraud has grown measurably worse over the past five years, Harris said.
“A decade ago, fraudsters were skimming credit cards. During the pandemic they targeted government stimulus programs. And as they discovered how easy it's been to do, they've started committing synthetic fraud,” Harris said.
The fraud surge has led to a corresponding uptick of interest in identity verification solutions. SentiLink, which Harris and partner Maxwell Blumenfeld founded in 2017, now counts more than 100 banks, credit unions, fintechs and other financial institutions as clients, Harris said. SentiLink’s product set relies on advanced analytics to provide clients with a real-time analysis of applicants’ personal data at account opening.
“Fraud is rampant and continues to be a big problem,” Harris said. “It’s an unsolved one, frankly. There are many aspects of life where there’s a problem and a solution. I don’t think for identity verification we’re there yet. We’re getting there as an industry.”
What's next for Ponce
Analysts who cover Ponce said issues with Grain overshadowed an otherwise solid quarter, marked by loan growth, an expanding net interest margin and excellent core credit quality. First-quarter revenue of $19.6 million increased 17% year over year, despite a steep decline in mortgage banking revenue.
“Lower-than-expected expenses and higher net interest revenue … more than offset weak mortgage banking income,” Jake Civiello, who covers Ponce for Janney Montgomery Scott, wrote in a research note published Wednesday.
Compass Point’s Laurie Havener Hunsicker, who had previously flagged Ponce’s Grain relationship as “an area of risk,” reiterated her “Buy” rating on the stock in a research note Tuesday, highlighting what she termed “pristine” credit, excluding microloans. Ponce “is a real estate-focused lender with very discounted loan-to-value" ratios, Hunsicker wrote.
At March 31, real estate loans made up 90% of Ponce’s $1.3 billion loan portfolio. Multifamily loans made up the largest single segment, totaling $368.1 million.
“We continue to view our microloan portfolio as important to our mission and are pleased that … we have been able to provide over 54,000 new customers a reasonably priced alternative to otherwise high-cost, predatory lending options,” Naudon said.
