a16z-Backed Tellus: Another UDAAP Nightmare?
Evolve Bank's Links to FTX, Bill Harris' Email to Laid Off Nirvana Employees, Stilt & Onbo Appear to Shutdown
Hey all, Jason here.
Running any financial services business isn’t easy even in the best of times. This is even more true for startups, which help to drive innovation but also can struggle to find product/market fit or sustainable economics.
The real test — both for establishment financial services companies and startups — is how they balance the needs of all of their stakeholders when times are tough: yes, shareholders/investors, but also customers, regulators, and employees. Some companies and leaders rise to the challenge, but, unfortunately, as we’ve seen with firms from Twitter to FTX, many do not.
Mark your calendar: this Thursday, I’ll be joining Anna Stoilova and Somi Arian, hosted by LinkedIn News Europe, to discuss “What’s next for crypto?” — details here.
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a16z-backed Tellus Promises Users 22x More Interest — But Do Users Understand Their Savings Are Funding Risky “Super Jumbo” Mortgages?
Financial app Tellus exited “stealth mode” last week and announced it had raised a $16 million seed round led by Andreessen Horowitz (a16z).
The company’s website, which carries the title “Best High-Yield Savings Rates,” promises users they can “earn 22x more interest on [their] savings today, while keeping [their] cash out of the markets” —
The company explicitly compares its product to “traditional savings accounts” at household names like Citibank, Bank of America, and JPMorgan Chase:
Only if users scroll to the bottom of the page would they see disclaimers clarifying that:
“The market(s) refers to the stock and crypto markets. Tellus does not invest in the stock market, crypto or any other similar security.”
“Backed by the underlying real estate, Tellus user APY daily interest payments are made independent of Tellus real estate lending returns.”
and that “Tellus is not a bank. Tellus is not FDIC insured.”
So how does Tellus offer its users 3.85% to 5.12% returns on funds they place with the company? And if the interest payments are “independent” of Tellus’ real estate lending returns, how are they determined?
How Tellus uses multiple products to tie together different types of users in its platform is a bit convoluted, but, basically: it pools individual consumers’ funds in order to write super jumbo mortgages — which, in turn, may be sourced or underwritten in part based on data from Tellus’ rental property management platform for landlords.
Alex Johnson provided a more thorough breakdown on some aspects of the product mechanics and some potential risks here, highlighting what he views (and I don’t disagree) as three red flags:
First, “short-term multi-million dollar loans at above-market interest rates to second-home buyers who can’t get mortgages from any other lenders? Eeek.”
“Second, Tellus doesn’t have a lot of history doing this type of lending. They’ve only made about 40 of these loans, total, since 2016. And I’m guessing most of those loans were made when interest rates were extraordinarily low. How well does this model work in a high-rate environment in which property values are stalling out (or maybe even falling)?”
“Third, given all of the above, the fact that retail customers’ cash isn’t FDIC insured is pretty scary. And Tellus stating on its website that, “To date, Tellus has met every payment obligation” doesn’t really reassure me.”
Borrowing short — promising customers immediate access to their funds — to lend long(ish) — mortgages, which Tellus claims are typically repaid in 6-18 months — without the benefit of a liquidity backstop has, historically, not turned out well.
Tellus attempts to mitigate this risk by “over-collateralizing” its mortgages. Basically, if I understand its website correctly, by lending a maximum of ~77% loan-to-value for the super jumbo mortgages it is writing.
While this does offer some protection, it ignores the reality of making a claim on those “real assets” — Tellus, presumably, would need to foreclose on the property and sell it at auction, potentially at a lower price, in order to recoup customer funds.
Perhaps more relevant in the current climate is the risk of declining housing prices, which would erode the “serious protection” Tellus promises. California, the only market in which Tellus currently originates mortgages, has been called a “prime target” for home price declines in 2023.
Median home prices in many markets across California have already begun to drop, with many analysts expecting further declines to come, particularly as mortgage rates are expected to continue climbing in line with Fed rate hikes.
Terms for “Boost” Account Let Tellus Change Interest Rate, At Any Time, For Any Reason, With No Notice
Curiously, when signing up for a consumer-facing Tellus account, users are linked to and actually agreeing to terms of service from 2018, which describe the platform as “an online real estate chat platform that connects Landlords, Renters, Property Managers, Realtors, and other Service Providers.” There is no mention of terms related to an interest-bearing savings-style account.
According to those terms of service, Tellus can change or eliminate the interest rate it pays on user funds, at any time, for any reason, with or without notice. Per the TOS:
“Tellus reserves the right to alter, modify, eliminate, change the interest rate offered or provided to you at any time without prior notice as Tellus deems fit. Notification, if any, will be sent to your App and not any other place. You are responsible for tracking the status of your interest rate at Tellus.”
There are some other bizarre elements to the terms, including a suggestion that users “should check the Office of Foreign Assets Control (“OFAC”) website” before making representations regarding the funds they are depositing on the platform.
The terms also include a list of “Risk Factors” that appear to have been written as part of an investment prospectus and, I guess, poorly adapted for the consumer terms of service?
They read in part:
Tellus is an early-state company working in the space of real estate and financial technologies. Depositing funds with Tellus implies taking a number of risks that you should consider. Below we provide a list of risks, but you should be aware that it is virtually impossible to list all possible risks.
The lending industry is highly regulated. Changes in regulations or in the way regulations are applied to our business could adversely affect our business.
Worsening economic conditions may result in decreased demand for loans, cause borrowers’ default rates to increase, and harm our operating results.
Competition for employees is intense, and we may not be able to attract and retain the highly skilled employees whom we need to support our business
We operate in a competitive market which may intensify, and competition may limit our ability to implement our business model and have a material adverse effect on our business, financial condition, and results of operations.
We are an early-stage startup with no operating history, and we may never become profitable….
As an Account holder you are exposed to the credit risk of our company.
The Account Outstanding Balance is an unsecured obligations to you by Tellus
There is no public market for the Account, and none is expected to develop.
There is a risk that the Tellus Platform may be hacked.”
Additional Regulatory Risks Abound
Setting aside some of inherent risks in the product structure and the bizarre terms of service, Tellus’ approach, as it exists today, has at least two potential significant regulatory risks.
Putting the “Deceptive” in UDAAP?
First, it appears to have significant UDAAP (unfair, deceptive, or abusive acts and practices) risk. Dodd-Frank states that:
“A representation, omission, act, or practice is deceptive when
(1) The representation, omission, act, or practice misleads or is likely to mislead the consumer;
(2) The consumer’s interpretation of the representation, omission, act, or practice is reasonable under the circumstances; and
(3) The misleading representation, omission, act, or practice is material.”
Based on how Tellus’ site and app describe the product — including explicitly saying it is “not an investment” — and compare its yield to true, FDIC-insured, risk-free savings accounts, a strong case could be made that Tellus’ positioning and marketing of the product is deceptive.
While Tellus’ website does carry some disclaimers, the disclaimers are not “clear and conspicuous,” nor can you generally disclaim your way out of arguably factually inaccurate claims.
Howey Test: Is It A Security?
Secondly, while it’s difficult to tell based on Tellus’ site, the structure of its product appears to meet the definition of a security.
The “Howey Test” is a four-prong test to determine if something qualifies as an investment contract and therefore should be treated as a security:
A party invests money
In a common enterprise
With the expectation of profiting
Based on the efforts of a third party
Based on the activity Tellus is undertaking — collecting users’ funds, pooling that money to fund mortgages, and collecting and returning a portion of the interest payments to users — it certainly sounds like it could meet the definition of a security.
Tellus also bears a strong resemblance to “fintech 1.0” peer-to-peer lenders like Prosper and LendingClub — both of which eventually had to register with the SEC.
Andreessen Horowitz Should Know Better (and almost certainly does)
Andreessen Horowitz is one of the most sophisticated, well-respected venture capital firms in the world. It has access to some of the best dealflow and lawyers in the world.
It also has plenty of experience in investing in companies that could face or have faced similar UDAAP or SEC issues — including firms like Cadre, LendUp, Coinbase, Point, Titan, and numerous others — like PeerStreet, which offers a service largely similar to Tellus, but which is restricted to accredited investors.
While Andreessen Horowitz can certainly afford to lose its entire investment in Tellus, users of the service — who may believe it’s a safe, traditional savings account — presumably aren’t so lucky.
Representatives for Tellus and Andreessen Horowitz didn’t respond to questions or requests for comment before the time of publication.
FTX Implosion May Mean More Scrutiny for Evolve, Bank/Fintech Partnerships
Fallout from FTX’s abrupt collapse continued to ricochet around the crypto ecosystem this week, with BlockFi freezing withdrawals and reportedly preparing for bankruptcy and Crypto.com admitting to “transaction problems.”
FTX’s new CEO John J. Ray — best known for managing Enron’s bankruptcy — said, in his 40 years of helping companies restructure, he’s never seen anything as bad as FTX.
In a filing in FTX’s bankruptcy, he wrote (spacing adjusted and emphasis added):
“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.
From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.”
The Evolve Angle
While coverage has understandably focused on the cryptocurrency exchange itself, its affiliated trading group Alameda, and what happened to customer funds, it’s worth remembering that crypto exchanges generally rely on banking partners to facilitate fiat “on and off ramps,” as well as other products involving US dollars, like credit cards, debit cards, and USD-denominated loans.
FTX’s bank partners included Evolve Bank & Trust — which is reportedly already under heightened regulatory scrutiny over its banking-as-a-service activities.
Evolve supported at least two distinct capabilities for FTX: its debit card program, which allowed FTX users to use the card to spend funds directly from their account; and a feature that enabled FTX users to directly deposit their payroll or other recurring deposits to the platform via Evolve.
It’s unclear what due diligence Evolve conducted on FTX and its numerous affiliated entities before entering a partnership and processing transactions for the company.
In response to questions about what due diligence Evolve conducted before agreeing to work with FTX, an Evolve spokesperson said:
“Evolve offered banking and debit cards to a small number of FTX consumers. Evolve has a comprehensive and thorough due diligence process when onboarding fintech partners. We have implemented numerous risk identification and mitigation processes that we have used to reduce our liability should one of our partners experience a material disruption. Evolve is confident that these processes have been effective and our exposure to the decline of FTX and others is minimal.”
Evolve’s relationship with FTX is an unwelcome invitation for more scrutiny of Evolve, specifically, and bank/fintech partnerships, in general.
It comes after months of signs from banking regulators that they will more closely examine “banking-as-a-service” relationships and at the same time as a Treasury Department report calling for “additional oversight to close gaps, prevent abuses and protect consumers” in bank/fintech partnerships.
Bill Harris-Founded Nirvana Money Abruptly Calls It Quits — Just Weeks After Official Launch
Nirvana Money made its public debut during Money20/20. Less than a month later, it has already shut down.
On LinkedIn, Harris clarified that no one — customers nor investors — lost money (except for him.) He pointed to the economic climate to explain the abrupt shutdown, saying:
“It’s primarily the economic outlook. We’ve got a great concept and a stellar team, but as a credit company lending to the lower end of the credit spectrum into a recessionary environment with interest rates spiking — and all the means for cost of funds. Unfortunately, that’s a formula for a sunnier day. Very disappointed, but the right decision. My priority is to land our top notch team on their feet.”
Harris’ public comment is consistent with the internal email he sent to Nirvana Money staffers — exclusively obtained by Fintech Business Weekly — which reads in part:
“To my teammates —
I am heartbroken to tell you that we must shut down Nirvana Money. We’ve assembled a talented team of pioneers and built a unique financial service – I am intensely proud of all of you and of what we’ve built. But the economic reality will not support our ambitions to launch this innovative product.
The reasons include external factors such as the economic outlook and the interest environment, and company factors such as customer behavior and unit economics.
The economy has worsened throughout the year and some form of recession is likely next year. The fed funds interest rate has surged from 0% to 4% in just seven months and is heading higher. This dramatically increases the cost we pay for the money we loan to our customers, and will inevitably put greater pressure on our customers’ ability to repay those loans.
These changes hit fintechs particularly hard, and many of the strongest companies have already reduced their workforce. Valuations of public fintechs are down 60%, and the impact on young companies is at least as harsh.
In our own market testing, we’ve hit two obstacles. The credit quality of most of the people who enroll is too low for us to give them an immediate credit line. This has contributed to problematic levels of fraud and mis-use.
Equally challenging, the proportion of enrolled customers who fund and become active card users is below expectation. This makes our cost of acquisition and unit economics – the marginal revenue and expense generated by each new customer – unsustainable.
We’ve built an innovative product that could be of assistance to many people. But, sadly, now is not the time. Over the coming weeks, we will close all existing accounts, return customer funds and shut down Nirvana Money. In this process, we will honor our obligations to the customers and serve them well.”
Other sources close to the company indicated the shutdown was not caused by funding issues nor any problem with bank parter Coastal Community.
Soon-to-be-former employees painted a picture of the layoffs being handled as well as could be hoped for, given the circumstances. Staff will remain as “full-time employees” until the end of the year — time during which they are expected to fulfill company-related responsibilities, but can use any remaining time to job hunt.
Those who haven’t found new roles by the end of the year are entitled to five weeks of severance pay. Workers who relocated to Miami for Nirvana will get an additional four weeks of pay.
One major gripe? That Nirvana continued hiring and onboarding employees up until the very end — with one unlucky employee having their first day of work the same week the company announced it would shut down.
Stilt and Sister Company Onbo Appear to Have Shut Down
Stilt, which offers loans for immigrants, and sister “lending-as-a-service” offering Onbo, both appear to have shut down.
Just this March, Stilt announced it had raised a $14 million Series A accompanied by a $100 million debt facility. The company announced Onbo at the same time, describing the offering as:
“the first of its kind credit as-a-service offering that allows any business to build and offer a credit product, without needing a bank sponsor in the background. Onbo leverages Stilt's state lending licenses and compliance framework so companies can focus on developing their own product. Onbo manages all the complexity of origination, payments, and credit reporting for customers.”
But now, Onbo’s site has been taken offline.
Stilt’s website is no longer accepting new loan applications, and, as of October 18th, it had transitioned to its backup servicer, Launch Servicing:
According to NMLS, Stilt’s lending licenses are no longer active. Per NMLS records, Stilt began voluntarily surrendering its licenses on September 29, 2022, with the most recent license turned over effective October 31.
Disclosure: I worked on a short-term consulting project for Stilt regarding Onbo prior to the offering’s launch.
Representatives for Stilt/Onbo didn’t respond to a request for comment.
Other Good Reads
Fintech’s Steroid Era (Fintech Takes)
Digital Banking Didn’t Kill Bank Branches — But Chatbots Will (Ron Shevlin/Forbes)
Listen: What Bank Partners Want From Fintechs (Fintech Layer Cake)
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