Money Stuff: The Fintechs Are Banks Now

LendingClub If you are going to securitize bank loans, you will need a bank. You don't need to be a bank, but you will need a bank to make the loans and assign them to you for securitization.[1] If you are going to securitize bank loans and call them "peer-to-peer" loans—someone borrowed the money, someone else provided the money, maybe they're peers, why not—then you will also need a bank. I suppose there may have been a brief period when people imagined that they'd just set up an online marketplace where people with money could lend it to people who need money, on a purely decentralized peer-to-peer basis, but actually existing peer-to-peer lending companies are in the business of (1) connecting individual borrowers to banks, (2) buying those loans from the banks, and (3) selling those loans to investors. The reasons for this are essentially regulatory: U.S. law prefers personal loans made by banks and disfavors personal loans made by other companies, and is mostly pretty flexible about what happens a second before and a second after the loan is made.[2] So if you are a financial technology company you can build the website that markets and explains loans to people, and you can connect people to banks to get the loans, and you can buy the loans from the banks, and you can effectively be the entire consumer front-end and the entire financial back-end, but in the middle everything has to flow through a bank for a second to get the bank's blessing. Arguably this is good, because banks are heavily regulated and required to be prudent, so if you're doing something weird and bad with your lending platform, the second that your loans spend at a bank will give the regulators information and jurisdiction to stop you doing the bad thing. Or arguably it's bad, because banking regulators are conservative or captured or entrenched and they'll use their jurisdiction to stop you from doing weird and good innovative things. But mostly it just strikes me as sort of a technical feature. To make the loans you need a bank, but in 2020 you don't need a bank in any sort of thick old-fashioned way. You don't need to walk down to the local bank branch and shake hands with a banker to get your loans approved; banks have computers now, even APIs. You don't need to partner with a big famous ancient banking institution; there are small and new and online-focused banks that don't even have branches. If your goal as a fintech company is to disintermediate banks, to cut the traditional banking system out of your transactions, you kind of can. You just need a bank, though. It doesn't have to be JPMorgan.  A bank charter is a particular piece of technology, like a mobile app or a blockchain, only it's a regulatory technology rather than a computer technology. It is just a part of the technology stack that you are engineering, in providing your online lending platform. Perhaps you could engineer around it, as a sort of Oulipo exercise in making life more difficult for yourself, but why? A bank charter is a simple ready-made modular solution for some of the regulatory problems in making loans, so if you are making loans you might as well just plug one in. Of course to plug in a bank charter you have to rent one (by paying a bank to issue your loans). Or you could buy one: LendingClub Corp. got its start replacing old-school bankers with machines that match borrowers and investors. Almost 15 years later, it's planning to become a bank itself. The online credit marketplace is buying Radius Bancorp in a cash-and-stock transaction valued at $185 million, according to a statement Tuesday. The acquisition of Radius, which has $1.4 billion in assets, will give LendingClub greater regulatory clarity and a less-expensive form of funding for its loans, the San Francisco-based company said. "This is a transformational transaction that allows us to re-imagine banking in a way that is free from legacy practices and systems," LendingClub Chief Executive Officer Scott Sanborn said in the statement. LendingClub is the latest financial technology company to seek a bank charter, which allows firms to take deposits directly from consumers and use them to fund loans. Varo Money Inc., an online bank, has received approval from the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency as part of its own pursuit of a charter, and On Deck Capital Inc. has said it will spend about $5 million this year to seek a charter. Here is the press release, touting Radius as "a leading online bank founded in 1987" known for its "branchless digital banking platform" and "open APIs to offer 'banking-as-a-service' (BaaS) functionality to leading fintechs." This all seems … yes, obvious, fine? Good? You run a fintech, there is a technology layer called "banking," you use a specialist provider to implement that layer, eventually you bring them in-house, sure, right. It is thin banking, "banking-as-a-service," banking reimagined "in a way that is free from legacy practices and systems," banking as, you know, the split second of official blessing of the loans between your consumer front-end and your investor back-end.[3]  The weird thing is that anyone ever thought otherwise. "LendingClub Corp. got its start replacing old-school bankers with machines that match borrowers and investors." It's still doing exactly that. You don't need old-school bankers. You're still using machines to match borrowers and investors. It's just that one component of the machine is a bank charter. Congrats Michael Milken Now that he's no longer a felon, do you think Michael Milken will be allowed to work in the financial industry again? Do you think he'll want to? The answer in both cases seems to be "maybe but don't count on it": David Boies, managing partner at the law firm Boies Schiller Flexner said the presidential pardon meant Mr Milken was now in a position to apply to the Securities and Exchange Commission to lift its ban on him working in the finance industry. "And I think that the SEC could very well take into account the same factors that led to the pardon," Mr Boies said. The SEC declined to comment. Mr Milken's spokesman would not say whether he plans to apply to have the ban lifted but said that returning to finance was "the farthest thing from his mind. He just returned from a two-week trip to nine cities on three continents where he hosted events with attendees from 40 countries. Main topic: how to accelerate medical research. That's his focus." Oh well. "It's a shame the world was denied his expertise on that score for so long," says the Wall Street Journal's editorial page. But actually that is not true! In fact, since his conviction, Milken has had several, uh, alleged brushes with financial advising. In 1998 he settled with the SEC over charges that he had taken $47 million of consulting fees for "offering advice to such financiers as Rupert Murdoch and Ronald O. Perelman on several transactions in recent years." And in 2015 Guggenheim Partners settled a bizarre SEC case that seems to have been about Milken maybe structuring an investment for Guggenheim. The world has not been entirely deprived of Michael Milken's financial expertise in the last few decades. And those are just the times he got in trouble. He was banned from the securities industry, which meant that he wasn't allowed to give people advice on securities transactions (financings, mergers, etc.) in exchange for fees; when he did, or arguably did, the SEC would scold him and take the fees. But there was no law against him giving people financial advice for free, so he did, according to this terrific anonymous quote in the Financial Times: While Mr Milken was banned from working in the financial services industry under the terms of his indictment, he has maintained close ties to his friends from his 11-year career[4] on Wall Street. ... "He is already a trusted adviser to more CEOs than all the finance CEOs combined," said one friend. "He just does it out of friendship and kindness and intellectual challenge." It does make things a little awkward for those finance CEOs, you know? Like Jamie Dimon has dinner with the CEO of a huge acquisitive company and asks about her family and listens thoughtfully to her problems and gives her sage advice and then when the check comes he is like "this reminds me, you still need to sign the engagement letter giving us a $50 million fee to do your merger." And she is like "well I had dinner with Michael Milken last night, he gave me even sager advice about my merger, he invented junk bonds when you were still in college, and he's doing it all for free just because we're such good friends." A crucial job of a senior investment banker is to persuade corporate CEOs that you are their trusted adviser, personal confidant and selfless friend, so that they'll pay your bill. If a legendary financial genius gives them the same advice and friendship without sending them a bill, it kind of undermines your performance. I don't know, I just sort of love stories like this. I think of the time that Andrea Orcel was between investment-banking jobs and wanted to fly to Davos anyway to do deals, not because he was getting paid for it but because all his friends were in Davos and what they did for fun together was deals. Michael Milken has been in legally enforced retirement from the securities industry for the last 30 years, with billions of dollars and complete leisure to pursue whatever hobbies he likes, and one of those hobbies just happens to be advising people on investing and financing transactions. He just loves junk bonds so much that he'd do them for free, and he did.[5] Cat bonds We talked last week about which catastrophes investors like and which ones they don't. Earthquakes, great; coronavirus, bad. I exaggerate. Really what we talked about were catastrophe bonds, bonds that pay out above-market interest in the ordinary case, but that don't repay their principal if some designated catastrophe happens. Classically insurance companies will issue cat bonds referencing earthquakes or hurricanes; if there are a lot of earthquakes or hurricanes, the insurance company will have to pay a lot of claims, but then it won't have to pay back the cat bonds. It has effectively purchased reinsurance from the cat bond investors. In 2017, facing an Ebola epidemic, the World Bank issued "pandemic bonds," which are cat bonds linked to a global pandemic. If there's a pandemic, the World Bank will fund relief efforts, which will cost money, but also it will get to keep the principal of the pandemic bonds; the bondholders share the (financial) risk of the pandemic.  The point was that the appeal of classic cat bonds is that they are uncorrelated to other financial markets: If there are a lot of hurricanes one year, the global economy will not necessarily be much worse off for it, so the returns of cat bonds (high in low-hurricane years, negative in high-hurricane years) will have nothing to do with the returns of, for instance, U.S. stocks. If you are an investor you like this diversification benefit; you want to buy things whose returns are uncorrelated with everything else. You might have thought that pandemic bonds would provide a similar benefit: They were sort of built and marketed as Ebola bonds, and you might have expected an Ebola outbreak to be relatively contained and not have much effect on the world economy. But they turned out to (also) be coronavirus bonds, and the coronavirus seems to be having an effect on markets and global trade. So the bonds might trigger—that is, pay their principal out to the World Bank relief fund rather than back to investors—at a bad time for other assets. "The real problem with underwriting pandemic risk," suggested John Dizard at the Financial Times, "is that it tends to be correlated with financial markets." One conclusion you might draw from that is something like "pandemic bonds are bad because investors will not rationally want to buy them." But another, deeper, stranger conclusion you might draw from it is something like: Pandemic bonds are unnecessary, because pandemics are correlated to financial markets, and so investors will fund relief efforts without any need for pandemic-bond triggers, voluntarily, to protect their other investments. There is just a sort of weird Coasean bargaining available: If resources are needed to fight a pandemic, and if failing to fight the pandemic will lead to a market crash, then investors who own lots of financial assets will provide the resources to fight the pandemic in order to protect their own investments.  I realize that this is very stupid—Investors don't really donate to charitable causes to protect their investments! Collective action problems! Externalities! Come on!—and my only defense is that it is … kind of … happening? Here is my Bloomberg Opinion colleague Shuli Ren: As the coronavirus rages in China, the world's most prominent hedge-fund billionaires are starting to open their wallets. It doesn't hurt that Shanghai is at the cusp of a bull market.  Ray Dalio's family charity and his hedge fund Bridgewater Associates LP are donating $10 million to fight the virus. Earlier this month, Citadel founder Ken Griffin's hedge fund and securities firm put up $7.5 million. ... The coronavirus, which has infected more than 70,000, could be a black swan or a great trading opportunity. For foreign fund managers to capture this moment, however, they need to be on China's good side. Don't be shy about sending in masks and protective suits. These virus relief funds are charitable dollars, but also smart money. I mean it's not that much money compared to the cost of fighting coronavirus, or even compared to the hundreds of millions of dollars behind the pandemic bonds. Still. The conclusion here might be that it is not all bad for a catastrophe to be correlated to financial portfolios. Bieber Stuff I once wrote: There is basically one kind of joke about Wall Street: You talk about a situation in everyday life, but you use words that you have cleverly appropriated from financial jargon. "I'm a size buyer of that," you say to your buddies, as the attractive intern walks by. "Spending more time deciding which movie to stream than actually watching the movie is due diligence," says the Morgan Stanley BuzzFeed quiz. "I know you've been looking for some real satisfaction / It could be a mutually beneficial transaction / Why don't we solidify our animal attraction? / Come on baby, let's do this trade," sings a hedge fund manager about (maybe) Ken Griffin's dating life. The joke is that you are not talking about finance, but you are using the language of finance. I was thinking at the time about people who are, or want to be, financial professionals, and who are more or less amateur comedians or musicians. But here is a Pitchfork review of the new Justin Bieber album in which Bieber apparently sings "Heart full of equity, you're an asset," to his wife. I … okay? What? "We should never have let celebrities become VCs," tweeted Matt Zeitlin.  Things happen Options Market Darlings Virgin Galactic, Plug Power Are Surging Again. Food-Delivery Firms Put Mergers, IPOs on the Menu. Europe's Dream of U.S.-Style Superbank Gets Further Out of Reach. Camilla Russo on the bZx exploits. Regulate Virtual Currencies as Currency. Distressed-Debt Funds Sit Idle in Europe's Era of Cheap Money. "Fugitive financier Jho Low may have been in Wuhan, with Malaysian authorities now on the lookout for his return in light of the coronavirus outbreak." Giant Lizard Raises Money for Bushfire Relief by Painting Massive Artworks With His Claws. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! [1] I say "securitization" but actually LendingClub funds its loans in a number of ways including securitization (transferring the loans into a trust and selling slices of the trust), whole-loan sales (just selling the loans directly to institutional investors), and "unsecured, member payment dependent notes" (giving individual investors economic exposure to the loans through unsecured debt of LendingClub itself).  [2] Pages 11 to 14 of LendingClub's 10-K give an overview of the legal issues. Note that there is a bit of controversy about whether and when a bank loan still gets favorable bank-loan treatment if the bank sells it. [3] I mean, it's not quite as thin as that in practice; Radius has deposits, and LendingClub notes that this deal will help not only "by capturing the sizeable revenue opportunity that is currently being absorbed by issuing banks" (i.e. LendingClub will now supply the split-second bank layer instead of paying someone else to do it) but also by "reducing the use of high-cost warehouse lines" (i.e. Radius's deposits can fund the loans until LendingClub sells them). [4] He had an *11-year* career on Wall Street! The mind boggles. My own career on Wall Street started about 12 years ago. It only lasted four years, but I think about the people who started with me and who are still on Wall Street. Many of them are lovely people, but none of them are, like, the most famous person in finance? None of them reimagined how companies finance themselves? They're all sort of middle managers? Milken got a lot done in 11 years is what I am saying here.  [5] Do we have to talk about the pardon? Nah, let's say nah. Here are James Stewart and Max Abelson and Adam Levitin. Here's what I wrote in 2018.   Before it's here, it's on the Bloomberg Terminal. Find out more about how the Terminal delivers information and analysis that financial professionals can't find anywhere else. Learn more.   You received this message because you are subscribed to Bloomberg's Money Stuff newsletter. Unsubscribe | Bloomberg.com | Contact Us Bloomberg L.P. 731 Lexington, New York, NY, 10022