The online lending startup Figure, led by former SoFi CEO Mike Cagney, is launching a blockchain-based marketplace for buying and selling consumer loans.
The idea is to provide transparency, proof of loan performance, provenance (in other words, reliable information about who owned or owns an asset at any given time), lower costs and easier audits for loan buyers and sellers through distributed ledger technology.
All those elements were missing in the mortgage crisis of 2008: Investors in collateralized debt obligations (especially mortgage-backed securities) didn’t know much about the quality of the underlying loans or whether the borrowers were paying them back.
Had a blockchain like Figure’s been in place in the days leading up to the mortgage crisis, it could have helped avert some of the problems that occurred, according to Sheila Bair, who was chairman of the Federal Deposit Insurance Corp. at the time. She is now a member of Figure’s advisory board.
“That private-label securitization market would have been reined in a bit,” Bair said. “There would have been better transparency about the quality of the mortgages that were inside the securitizations, so investors would have known better what they were investing in and would have been able to exercise some independent judgment."
As the crisis progressed, tracing ownership became "terrible problem" that contributed to the robo-signing scandal, according to Bair. "They were just robo-signing and saying they had the right to foreclose when really, there was not a good chain of title," she said. "Blockchain provides that.”
Investors relied on due diligence firms that looked at samples of loans in a pool and rating agencies that based their ratings on models rather than knowledge of the underlying quality of individual loans.
The recordkeeping the FDIC was able to get its hands on back then was "pretty ugly, very sloppy," she said.
Verifying loan facts
Figure's blockchain, which is called Provenance, is based on Hyperledger Fabric. Blythe Masters, the former CEO of Digital Asset Holdings, which built a blockchain for the Australian Stock Exchange, helped design the system alongside June Ou, Figure’s co-founder and Cagney’s wife, who runs products and technology at the company.
It validates the underlying details of a loan by going directly to the source.
Companies that provide validating documents submit data about them and digitally sign off on that data. Experian signs off on credit reports, for example. CoreLogic signs title reports.
"The loan originator doesn't have to represent that this is real data," Cagney said. "It's being signed by the data provider.”
For each deal, a smart contract is created and hosted on the blockchain that tests loans against specific underwriting standards, including FICO score minimums, loan-to-value limits and debt-to-income limits.
The smart contract will flag any loans that don’t meet the criteria. For instance, if a buyer requires a minimum FICO score of 680 and the score of a borrower behind one of the loans in a package is 675, the smart contract will identify that exception.
“We're massively reducing the friction that exists in traditional marketplaces and introducing something that can trade literally real time, where you have certainty as to what you're buying or selling,” Cagney said. “You do have to look at the smart contract and make sure that it reflects your underwriting policy, but you only have to look at it once versus having to look at every loan.”
The blockchain can eliminate the need for a custodian, Cagney said. "It reduces the audit quality control expenses related to it and it provides a medium of certainty as to what you have,” he said.
Once a loan has changed hands, all further payments on the loan accrue to its new buyer.
“This is super powerful because traditionally to trade a pool of loans, you send a loan page, you do due diligence, you move a whole bunch of loan packets over, one custodian has to deliver to another custodian,” Cagney said. “In the over-the-counter market, it can take a hundred days for a loan pool to settle. And here you can do it in real time.”
Being the guinea pig
When Cagney first launched Figure in 2018, after
“We went to a bunch of banks and said, we think this is going to transform everything that you're doing,” Cagney said. “And they said, eh, maybe, maybe not. Our stuff works OK.”
So Figure launched its direct-to-consumer lending business as a way to prove the technology works and force loan buyers to start using it.
Figure started originating home equity lines of credit in October 2018. Since then, the company has issued more than $1 billion worth of HELOCs. It also issues first-lien mortgages and unsecured student loans. It plans to make loans of other kinds, too.
In March, Figure completed its first securitization entirely on the blockchain. Figure originated the loans. Jefferies Group was the structuring agent, lead underwriter and warehouse provider. Nomura Securities was the lead underwriter. Tilden Park Capital was the loan contributor and subordinate note buyer and an unnamed large asset manager was the senior note buyer.
Figure now sells all its loans through its own marketplace. Asset managers and banks are buying the loans and holding them, or buying the loans and then selling participation to other banks and credit unions. Some are buying the loans, aggregating them and securitizing them on the blockchain.
“The idea is to create something where an originator can push a loan into a marketplace and let people then bid on it, transact to it and then repackage it, whether it's in the form of selling it as a participation to another bank or credit union or fund, whether it's packaging up and selling a larger pool or a smaller pool of assets,” Cagney said. “And everyone has the information. Everyone sees where the loans are trading at. Everyone sees the performance of the assets."
The real-time nature of Provenance matters, Cagney said. The reports from mortgage securities service providers that loan buyers tend to rely on are typically 30 to 60 days stale.
During the pandemic and resulting deferrals and forbearance on consumer loans, “the challenge everyone had is no one wanted to buy those securities, not knowing, is 5% of the pool in forbearance, is 10%, is 20%?” Cagney said. “Because of how we leverage blockchain, we provide real-time visibility to the performance of the asset. So if it's 2:08 today in California, I can go on and see everyone that's paid me as of 2:08.”
Will banks accept blockchain?
Today, more than 30 buy-side firms and banks are working with Figure, Cagney said.
“Building this marketplace on Provenance is going to transform the speed and efficiency of bringing liquidity to the loan sector,” said Chad Carrigan, vice president of whole-loan acquisition at First National Bank of America. “Figure continues to drive innovation in the financial services industry that is helping investors create new value in liquidity markets.”
Without knowing the specifics of what Figure is unveiling today, industry observers said the concept has value.
"Given all the inefficiency with multiple handoffs, exchanges of value, third-party certifications and built-in delays with mortgages currently, blockchain's smart contract features via a noncentralized, distributed ledger could streamline the process,” said Mark Parsells, managing general partner of Montpelier Ventures. “Instead of having people touch the mortgage, the blockchain can update transfers automatically as they happen. The record is transparent, immutable and traceable.”
Banking is a competitive business, and what’s halted many financial blockchain projects in the past is financial firms’ unwillingness to let competitors see their customer and transaction information and to allow a rival to have control over any aspect of their business.
Figure’s Provenance blockchain is no exception.
“There's huge sensitivity around that,” Cagney acknowledged. “The key is that we don't have control or access to the data.”
He pointed out that the blockchain is decentralized. Currently there are 12 “nodes” on the blockchain that are run by independent stakeholders including Franklin Templeton, Experian Information Solutions, Colchis Cascade Management, LS Technology Solutions and Passport Digital Currency Fund.
“What that means is there's no one who owns it,” Cagney said. “If you wanted to write something on Provenance today, you can get the software development kits and do it. I can't stop you. I can't kick you off. I can't see what it is that you've done.”
The technology now will have to prove itself, Bair said.
“This is a really good application of blockchain technology,” she said. “It directly addresses many of the problems we saw before in technology. It’s coming, so banks need to be prepared for it and leverage it as best they can and change their business models as they’ve been meaning to do. If it’s a better mousetrap, if it’s taking out costs, if it’s more accurate, it can contribute to transparency and greater market discipline. Those are all good things that everybody should encourage.”
