Orchard Platform, a financial technology company founded in 2013, occupies a small office in Manhattan between two art studios. It is Orchard’s third home and soon its 25 employees will relocate a few blocks away to a space that can hold 78 people. It thinks it will have to move again within a year.
Orchard is just one of many “fintech” firms sprouting in Wall Street’s shadow. But it stands out due to the prominence of its seed investors, including former chief executives of Citigroup (Vikram Pandit) and Morgan Stanley (John Mack). In their former jobs, they struggled to adapt vast, complex institutions to new regulations and fast-changing markets. Orchard, in contrast, is one of the agents of change. It serves as a conduit between large entities that have money to invest and an emerging world of firms that originate loans.
In 2011 Matt Burton, Orchard’s boss, lent $700 via Lending Club, an online platform which links borrowers and creditors. He was pleased with his return of 8% until he discovered it was half that of Angela Ceresnie, now Orchard’s chief financial officer, who was working at the time in small-business lending at Citigroup. That prompted two insights: first, that there was money to be made by working with “originators,” meaning startups providing credit in novel ways; and second, that institutional investors would struggle to seize on this opportunity without an intermediary.
There are now at least 450 originators, Mr Burton estimates, focusing on half a dozen niches including loans to consumers, small businesses, students, and property investors. To the extent the originators resemble one another, it is that they tend to make relatively small loans and use innovative methods to evaluate risk.
For example, SoFi, based in San Francisco, refinances law-school debt for graduates who have passed the bar and are thus particularly likely to repay. OnDeck provides loans to merchants and collects (in tiny increments) each time their customers pay with a credit card. Kabbage also provides credit to merchants, monitoring borrowers’ solvency by tracking PayPal receipts and UPS shipment records.
So far Orchard’s platform is connected to seven of these originators and 36 institutional investors. It expects both numbers to multiply rapidly. It collates information on the loans being offered in forms that big institutions can use to invest on a suitable scale. In the brief period it has operated, it has channeled several hundred million dollars of investment into loans of as little as $2,000. Its profits come from collecting a fee of a few hundredths of a percentage point on the sums lent with its help.
Conventional banks will remain a force in all of the niches that are being targeted. They retain a huge marketing advantage in the form of their branches, and can raise money cheaply thanks to government backing for deposits and implicit government guarantees on their own debt. Still, neither of these advantages is without cost, and the price of government engagement is becoming particularly stiff. The level of capital banks must hold is rising and the overall process of extending credit is becoming an increasingly politicized, bureaucratic quagmire.
Most originators, in contrast, are not regulated as banks, and are not subject to the same expensive capital requirements or suffocating red tape. Indeed, regulators like them, since they are unlikely to need bail-outs. They do not take in deposits backed by a government guarantee and cannot make big losses on loans, since those are passed directly to other investors.
Banks retain an advantage in the case of large, complex loans that must be individually structured, but room for incursion exists even here. Within a year, Burton predicts, originators will enter the mortgage market, which will not prevent defaults but might add a level of transparency lacking in the once vast market for mortgage-backed bonds. The scope for banks to be “disintermediated” is enormous. In time, of course, intermediaries like Orchard could be cut out of transactions too. Some of the biggest originators, including Lending Club, already do business directly with institutional investors.
© The Economist Newspaper Limited, London (January 24, 2015)