➤ Balance sheet funding model likely to win out among marketplace lenders, and they need permanent, diverse capital sources to weather credit cycles.
➤ OCC fintech charter applicants should expect significant oversight from regulators.
Digital small-business lender Fundation Group LLC CEO Sam Graziano spoke with S&P Global Market Intelligence about the company's balance sheet funding model and expectations for the OCC's proposed fintech charter. Graziano also shared his take on the broader digital lending industry. He pointed out that the word "profitability" was floated more at a recent industry conference and suggested that there is "an acute awareness" among digital lenders that they must prove they are sustainable by making money.
The following is a version of that conversation which was edited for clarity.
S&P Global Market Intelligence: Last time we spoke, which was in December 2016, we talked about your new partnership with Citizens Financial Group Inc. We also touched on bank partnerships and the merits of the OCC's proposed charter. What's new at Fundation since then?
Sam Graziano: We're just continuing to execute our strategy, which we're even more confident in. We do see the competitive environment within small business to be softening a bit, which is good for our long-term prospects, as well as the other well-capitalized institutions in the market. We have nothing new yet to announce on other bank partnerships, but our pipeline is very strong.
Fundation announced March 21 that it secured an asset-backed credit facility from MidCap Financial Services LLC. Graziano said the deal is another example of how the company is optimizing its balance sheet structure and gathering the capital and flexibility it needs to lend to more small businesses.
It adds leverage to our portfolio. We are a balance-sheet driven business predominantly. We put our balance sheet at risk. We do believe adamantly that that is the right model for the broader marketplace lending industry.
In fact, I think most marketplace lenders will end up with some form of balance sheet funding, probably by the end of the year. I think almost every firm in the space is taking that viewpoint, which is that developing businesses that make money in lending is hard to do if you don't have a balance sheet.
Do you feel confident in Fundation's ability to shore up funding in the event of something like a turn in the credit cycle?
It's always harder in the midst of a credit cycle to secure funding. The magic is to be able to develop as many permanent and diverse sources of capital as you can with very strong institutions ahead of a cycle, so that when you go into a market cycle you can take advantage of market dislocation. I think that's really what we're trying to do.
None of the arrangements that we will end up with from a capital supplier perspective will be like a marketplace model where it's: "Hey, you can buy loans today, but if you don't feel like it tomorrow you can stop." That's not sticky, defensible capital. We're looking to develop more permanent, more long-term relationships with our capital suppliers that can support our balance sheet across cycles.
More details have come out on the OCC charter and more broadly there is the sense that financial institutions will benefit from regulatory roll-back. What's your take on how the new environment in Washington could affect digital lenders?
There are still more details to come, but I thought the OCC bulletin on the initial framework was extremely interesting. I thought it actually did give a pretty good amount of details. It does feel like there's a lot of momentum in that direction, to allow the industry to basically operate under a national framework, which I think ultimately would be beneficial to both consumers and small businesses.What's interesting though is they also do make it clear that regulation of those that adopt the special charter will be substantial. It's not as if it's going to be a free pass. It's not as if it's going to be much more lax than [what] the banks operate under. That said, I imagine, where warranted, it would be a little bit more lax because at the end of the day, these are not deposit-taking institutions. Most of the companies I imagine will pursue the charter are lending institutions, none of which present any type of systemic risk to the financial services industry or to the economy at large.
One of the things that came to mind as I was looking at it was, given all the things that these institutions would need to do to be able to operate under the special charter framework, I could see some institutions saying "heck, if we're going to go this far, we might as well go all the way and basically apply for a banking license to be deposit-taking institutions."
Are you all more or less interested in applying for a charter after all of these details have come out?
I'd say we're more intrigued for sure. But we're still a ways off from making any decision. For us, it doesn't necessarily scare us off from what we've read because they make it very clear in terms of the types of products that they're going to be able to allow to have this charter.
We feel that we as a company are already in a pretty good place and potentially the level of investment we would have to make relative to others perhaps wouldn't be as large.
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