Why CommonBond's CEO says fintech charter could be a game changer

For the founder of an online lending startup, David Klein, CEO of CommonBond, talks like a sage.

The bearded entrepreneur notes approvingly that the conversations in his industry are becoming “more grounded and mature, rather than all about going to chase the shiny object,” and that company valuations are “catching up to reality.”

Since co-founding the student loan refinance company in 2011, the 36-year-old Klein has emerged as one of the online lending industry’s more vocal players. He occasionally blogs, hosts meetups at the company’s headquarters in Manhattan and speaks frequently on the ever-expanding fintech conference circuit.

I caught up with Klein over kale juice — he says it makes nights where he slept five hours feel like he slept seven — at his SoHo office on Friday. He shared his thoughts on the fintech charter in development by the Office of the Comptroller of the Currency, the maturation of the online lending space, the difficulties of valuing a fintech company and the expansion of CommonBond’s business. The following is an edited transcript of that 30-minute conversation.

What’s new at CommonBond?
DAVID KLEIN: One of the things we are most excited about is what we call the 401(k) for student loans. This is SaaS-based technology that enables employers to contribute to their employees’ student loan repayment every month. A lot of companies are clamoring for this. There is a war for talent and the top talent tends to hold student loans. They are thinking about their student loans more than they are thinking about retirement. Companies are looking for ways to captivate their employee base or potential employee base.

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It is very early days, so only about 4% of companies have a student-loan-related benefit. That number is expected to be over 20% in two years.

There is bipartisan legislation in Congress right now that would provide tax benefit to the employer and employees for these payments, much akin to tuition reimbursement. To the extent that tax reform is passed this year or early next, folks say this is poised to be part of that package.

Finally, there are stats that the workforce is now over a third millennials. Over 70% of millennials have student loan debt. Over 50% are thinking about student loans are thinking about them more than retirement and about 80% of them would choose a company to work for if they had this benefit.

What sent you down this path? The hunt for scale?
In 2015, our own employees started talking about this. It made sense to us because we are a student loan company to contribute to their student loans every month. We offer $100 a month to any employee of CommonBond as long as they have student debt and are employed. PwC and maybe one other company had announced such benefits at that point.

At the same time, we started our corporate partnerships team. The goal was to get companies to tell their employees about our student loan refinancing platform because our borrowers save on average about $24,000 over the life of their loan. So, we are going to all these companies and they started asking us to figure out how they could contribute.
So we turned it into a product and now it is a major part of our business.

The demand was there, but the scale you could gain had to be attractive, too.
Absolutely. It represents an interesting distribution channel.

In some of your talks over the last year or so, you’ve hypothesized that the number of marketplace lenders would soon shrink. Has it happened the way you thought it would? Have many hung on longer than you thought?
We believe — we have believed — that the wheat will separate from the chaff. For online lending, 2016 was a year where the strong got stronger and the weak got weaker. There were a few shops that closed up and there were some players that became better known and entered 2017 stronger than ever. I think that continues in 2017 and 2018, regardless of geopolitical or macroeconomic picture, because if you study the emergence of industry, that’s what tends to happen. There is a burst of energy in a short period of time. Then there is a journey of a group of companies that have to mature. On the other side of that, you have an industry that is maturing or is matured where capital and talent and customers concentrate.

The macroeconomic picture is also very different in 2017 than what it was in 2016. Heading into last year, the credit markets dried up a little bit and the industry hit some turbulence. In 2017, the macro environment is quite strong. You’ve seen some folks raise some capital on the equity and debt sides.

You zoomed by me at LendIt in New York last week. What was your key takeaway from the conference?
On the same theme of an industry that is going from potential and promise to delivery and maturity, there were a lot of service providers there. That, to me, is a top signal that the industry is maturing. There were data service providers, marketers, credit and analytics firms.

I’ve been to every LendIt, since we were 300 people at the Hilton in Times Square, to 5,500 at the Javits Center. I’ve seen the evolution of the exhibit hall. This one had the most noncore lending companies than any other LendIt. The speeches were much more grounded and mature, rather than all about going to chase the shiny object.

You’re seeing it with venture capital, too. Most VC investors are not going to fund a new lender at this point. Their strategy is to back the ones that have scale and are growing. But you are seeing early-stage investments on the periphery, the companies that serve this emerging mature group of lenders. They are getting like Series A, B or C funding where the lenders are at C, D, E, F levels and going public.

You raised some money last year, too.
We raised more than $300 million in equity and lending capital the middle of last year. Our calling card with the capital markets is the underlying credit quality. We still have not had a credit default in our entire portfolio and we’ve done about a $1 billion in loans over three and a half years. So capital markets are comfortable with our paper. We do securitization in addition to loan sales. We’ve done three securitizations to date — Goldman Sachs, Morgan Stanley and Barclays have all led deals. Our last deal had about four times the interest over supply. We just continue the credit performance of the platform, and as we do that the capital markets investors are quite happy.

Not one default?
No credit defaults. We’ve had one default and that was unfortunately related to death.

Do you ever think about downplaying that stat since inevitably defaults will happen?
One absolutely will come and I’m ready, willing and able to talk about it when it happens. Until then, I’ll share the data as it comes in. For now, that’s zero credit defaults. We’ve always expected a low level of defaults, and frankly, we’ve just been outperforming since we launched.

What’s the key to that default rate? Are you chasing only the HENRYs?
We look at past credit and future prospects. We look at credit reports and FICO scores, but we look at cash flow, employment, industry of employment. We are looking at a host of factors.

We also focus on ongoing relationship management. If you’re a customer and you’ve lost your job and you’re facing economic hardship, we have a program to bridge you to your next job. You’re allowed to forbear your payments for three months at a time for as many as 12 consecutive months. We will help you find a job. Our team has done a good job of managing people out of forbearance in under three months.

Do you look at which school someone attended as part of your underwriting?
When we launched we launched at a few schools and then methodically expanded to where we are now in virtually every college and university across the country, except for two-year, for-profit or online colleges. But no, school isn’t part of our underwriting.

What are your thoughts on the OCC’s proposed fintech charter?
We are fans of it in spirit, because it levels the playing field with big banks. Our mission is to make student loans more affordable, more accessible and easier to manage. The more we can level the playing field, the more competition we create, the consumer wins. As online lenders, we’ve already played that role but to the extent that we become chartered institutions, it institutionalizes that competition a bit more. It institutionalizes the better rate, the better product, the better service to the consumer and I love that.

The OCC charter would allow us to comply with regulation in one jurisdiction, instead of 51 jurisdictions including D.C. To the extent that we can save on costs, we could pass that along to customers.

It would affect capital costs. We might get access to low-cost deposits like banks do, we might get access to the Fed discount window to get close-to-free money and we might get access to better pricing in the capital markets by being a chartered institution. We’d be poised to significantly lower our cost of capital long term.

But a lot would have to happen to get access to deposits, namely you’d have to get FDIC insurance.
Right, I’ve raised the same issue but the thinking is that if you can get an OCC charter, the FDIC will insure you. But you’re right. They are not the same agency.

So, why not just buy a nationally chartered bank and figure out how to maneuver the existing framework, rather than being essentially a guinea pig with a new charter?
One main reason — the special-purpose charter is poised to not be the national banking charter. If it was going to be the same, they wouldn’t have designated it. They are doing so to allow companies that don’t look, feel and act like banks to get some of the access to capital or regulatory streamline that the big banks get. The hurdle can’t be as high as it is for the big banks. It would cap special charters at the knees and then we’d go back to your point about why not just buy a bank? That’s the key question to me.

There are probably more questions than answers at this point — what are the capital ratios and liquidity requirements going to be? What types of controls and compliance responsibilities will there be beyond what we already have and what is that going to cost? Once we know, we will make the determination if it is worth it.

If OCC defines those metrics too far out of reach, not many fintechs will go for it. The OCC recently put out more guidance, not perfect guidance, but a bit more detailed principles.

If you had to express your opinion on the charter in a couple of words, what would you say? Cautiously optimistic? Provisionally interested?
Interesting. Potentially game changing. If you asked me about its prospects, I’d say this is a years, not months thing.

As the industry evolves, what happens to valuation? Do you start getting treated more like “fin” and less like “tech"?
We consider ourselves a finance company that heavily leverages technology to reduce our internal cost and provide a better experience to customers downstream. That’s what we all are and what we always have been.

It is less of a shift in thinking, and more of a catching up to reality.

If you value a tech company, you’re assigning a multiple to revenue. For SaaS companies, it is recurring revenue. For banks, it is book value. Those are very different metrics.

We are not a pure tech company, but we are not a bank, so it is a valid question — what metric should we be using to apply a multiple to? There isn’t a consensus about what that metric is, but it is probably not book value or just a revenue multiple. Some say it should be gross margin or gross profit for online lenders. We’ll see what happens.

What’s the future of monoline fintech? Do you see an expansion of products?
It is bound to happen. It has started to happen and will happen further. We’ve always said that our long-term strategy is to serve our customers over time and that means other products and services, on the lending side and on the asset management side. We are at a stage in our development where we could go at it directly or partner. For 2017, our focus remains on student loans. Each year, we have a choice to go broad or go deep and we entered this year, with the size of the student loan market at $1.5 trillion, we decided to keep going deep.

What’s the next step for you in terms of capital or ownership?
As a lending business, as a fintech lending business, we are always in the market to raise money particularly in the lending capital side because we have to meet the demand. From time to time we will continue to raise equity to support the business on the way to profitability. We will continue to keep you informed as we have major announcements to make.