Can Upstart Make Small Loans Work; Bootcamp's Tuition "Guarantee"
Crypto Roundup: Volcano Bonds, Crypto Sprint, Sen. Brown's Stablecoin Questions
Hey all, Jason here.
I hope everyone had an amazing Thanksgiving and Black Friday (well, sounds like Revolut didn’t…)
I’m wrapping up this issue (ever so slightly late) from Mexico City, which I arrived in late last evening. Here just for a day before heading down to Oaxaca — looking forward to a week of rest, relaxation, and amazing food and weather. Don’t worry, you’ll still get next week’s issue as scheduled (plus or minus a few hours.)
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Upstart Wants to Help Banks Offer Small-Dollar Loans Below 36% APR
Fintech lender Upstart says it’s planning on partnering with banks and credit unions to offer small-dollar loans at rates below 36% APR. The company had this to say in its recent earnings call (emphasis added):
“We're working toward a small dollar loan product designed to help consumers with unexpected and immediate cash needs: think a few $100 repaid in just a few months. But importantly, we're building a bank-ready product at bank-friendly APRs, always operating within the 36% rate cap prescribed to nationally chartered banks and to those who serve U.S. military service members. In short, with better technology, superior risk models, and a dramatic reduction in the cost of origination, we hope to welcome millions of Americans into the mainstream financial system, who would otherwise be left with far less attractive options.”
The specifics of the product — loan amounts, fee / interest structure, credit policy, and repayment practices — are unclear at this point, as the offering is still in development; Upstart hopes to roll it out before the end of 2022.
The effort appears intended to serve borrowers who would typically resort to payday or other high-interest installment loans. According to American Banker (emphasis added):
“The San Mateo, California-based company, which already partners with banks and credit unions on installment loans and auto loans, announced plans Tuesday to help supply credit to consumers who need emergency cash.
Such loans are typically quite expensive — payday lenders often charge triple-digit annual percentage rates — but Upstart says its artificial intelligence underwriting models will enable loans with APRs below 36%.”
While it would be great news for subprime borrowers if Upstart is able to fulfill on this promise, it is hardly the first fintech to attempt to use AI, machine learning, and “better technology” to underwrite cheaper small-dollar loans.
Artificial intelligence isn’t a magic wand that all of a sudden lets subprime borrowers qualify for sub-36% loans
There are several realities driving higher APRs on small-dollar loans, which almost always carry terms that are less than a year.
For a standalone small-dollar loan product (eg, not attached to a deposit or spending account a customer already holds), key costs include cost of customer acquisition, cost of funds, origination and servicing costs, and provisions for loan losses.
Despite the promise of digitization and automation, break-even APRs from loan amount have remained largely unchanged from the pre-digital era, according to analysis from Federal Reserve researchers.
Achieving a sub-36% APR means controlling these costs and/or tolerating losses on a small-dollar loan product in hopes of making it up somewhere else (eg, interchange income from a spending account).
What are potential avenues to controlling the cost drivers mentioned above?
Cost of customer acquisition: for a stand-alone small-dollar lender, cost of customer acquisition is often the biggest driver of unit economics. Because of the competitive marketing environment and thus high CPAs, some small-dollar lenders may not break even until a borrower takes several loans. Lowering the cost of acquisition — say, by offering loans to existing customers of another product — would limit growth rate of originations but improve unit economics.
Cost of funds: for small-dollar, non-bank lenders, a cost of funds exceeding 10% is not uncommon. If a non-bank lender is borrowing in capital markets at 10%, that forms a floor in terms of what it can charge end borrowers — even before taking into account marketing cost, origination and servicing, and defaults. Banks have an inherent advantage here, as their cost of funds are less than 1%.
Origination and servicing: Intuitively, yes, there should be opportunity to lower origination and servicing costs through automation. That said, lower income and lower credit score consumers are often more difficult and expensive to service than prime consumers. Underwriting and originations may be more likely to require human review or intervention (and fully automated processes may shut out those already marginalized). Subprime borrowers require greater sophistication and resources from a “curing” (collections) perspective, which is key to controlling losses.
Loan losses: finally, controlling losses through tighter underwriting can help keep the unit economics manageable at lower APRs — with the obvious result that fewer will qualify.
This is essentially what Bank of America is doing with its Balance Assist product, which lets existing BAML customers borrow up to $500 for a flat $5 fee. The caveat is in who qualifies: BAML customers who’ve had an account for at least a year, with positive balances across all BAML accounts, and traditional credit underwriting is considered. Translation: a typical payday loan user likely would not qualify.
So while I hope Upstart is able to work with banks to enable them to offer sub-36% APR small-dollar loans, I’m skeptical that what they’re able to offer would actually serve as a replacement product for many of borrowers using high-interest lending products today.
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Lambda School, Now “Bloom Institute of Technology,” Offers Tuition Refund Guarantee*
Controversial coding bootcamp Lambda School has changed its name. The company, often credited with “pioneering” income share agreements (which have been around since at least the 1970s), has changed its name to Bloom Institute of Technology (“BloomTech”).
In a press release, the company claims the name change is to better reflect its mission:
“This new identity better aligns with the school's mission of cultivating opportunity for learners not well served by traditional higher education.”
The rebrand has the benefit of putting distance between Lambda (now BloomTech) and its past legal and PR problems, which include students suing the school, operating without state approval in California, a settlement with the California DFPI for its deceptive educational financing practices (which Lambda appears to have violated within days), and a trademark lawsuit from similarly named Lambda Labs, not to mention a slew of critical articles and comments on social media.
While BloomTech will continue to offer ISAs as a financing option, students choosing to finance the program this way will now be required to make a down payment.
According to the press release, the new tuition payment options include (emphasis added):
“An income share agreement (ISA) where students pay a $2,950 down payment and, once they are employed and earning $50,000 per year (or $4,166 per month) or more, pay 14% of their income for up to four years (capped at a maximum of $40,000).
An ISA where students pay a $7,950 down payment and, once they are employed and earning $50,000 per year (or $4,166 per month), pay 14% of their income for up to three years (capped at a maximum of $30,000).”
The updated structure would see students make a down payment of as much as $7,950 — which, regardless of employment and income achieved after the program, they do not get back — and 14% of gross income for 36-48 months, once they exceed $4,166 gross income per month. After taxes and other deductions, the ISA burden could easily exceed 20% of a student’s take home pay.
BloomTech has also rolled out what it’s referring to as an “Outcomes Based Loan,” which requires no upfront payment. According to the release (emphasis added):
“An Outcomes-Based Loan for the full tuition of $21,950, which requires no upfront payment. If a student graduates and is unable to secure a job paying $50,000 per year (or $4,166 per month) or more after 365 days of job search, the school's 110% Tuition Refund Guarantee refunds the entire loan, including fees and interest from an approved lender, and directly pays the graduate 10% of their tuition.”
BloomTech is emphasizing the new “tuition guarantee” option, with visitors to its homepage greeted with the following:
The site positions the guarantee as quite straightforward: if you don’t find a job paying at least $50,000 within a year, your tuition is refunded.
But examining the terms and conditions reveals students are making a much more onerous commitment. Specifically, students must fulfill the terms of a “Career Commitment” to qualify for the guarantee, which includes:
Submitting 10 employment applications each week and following up on one previously submitted application
Must be available for up to four interviews each week
Will contact at least 10 individuals each week “for professional networking”
Will report all job offers, interviews, or other positions to BloomTech
Will post at least five public contributions on GitHub
Will respond to any communication from the BloomTech “outcomes team” within three business days
Will meet with any member of BloomTech as requested to discuss their job search (permitted to cancel a maximum of two such meetings)
Provide documentary proof of job search activity “as required”
Must meet all of the above for at least 46 weeks out of the 52 week period
There are additional specifications around how “a job” paying at least $50,000 per year is defined.
BloomTech considers any combination of permanent, temporary, contract, or hourly positions — whether or not related to the field of study — where the total gross amount offered or actually earned for three months exceeds $4,166 on a monthly basis ($50,000 on annualized basis) as meeting its obligation under the guarantee.
“Guarantee” Option Likely to Appeal to Most Vulnerable
Like its previous ISA option, which required no down payment, BloomTech’s new loan with a “guarantee” of a job paying at least $50,000 or your money back is designed to appeal to lower income students.
But such students may be poorly positioned to take advantage of such a guarantee. To do so, they would have to make below BloomTech’s threshold — or, more realistically, be without any income at all — for the 24 weeks of BloomTech’s coursework and the 365 day job search period following the completion of their coursework.
Few students are likely to have the financial resources to go without working for nearly a year and a half. Further, BloomTech’s obligations under the guarantee are fulfilled if a student receives an offer that exceeds $50,000/year — undermining a student’s negotiating power by encouraging them to accept the first offer they get.
BloomTech may be a new name, but its new “Outcomes-Based Loan” doesn’t appear to be any better of a deal for its students.
Volcano Bonds, Bitcoin City
The President of El Salvador, Nayib Bukele, announced plans to raise $1 billion via so-called “Bitcoin Bonds.” According to Bloomberg:
“El Salvador plans to issue $1 billion in tokenized U.S.-dollar denominated 10-year bonds to pay 6.5% via the Liquid Network, according to Samson Mow, chief strategy officer of Blockstream. Half of the funds of the so-called “volcano bond” will be converted to Bitcoin and the other half will be used for infrastructure and Bitcoin mining powered by geothermal energy.”
The bond, which is, you know, a loan, is denominated in US dollars. The proceeds of the bond sale will be used to purchase bitcoin directly and used to develop infrastructure for… mining more bitcoins. The bonds, presumably, need to be repaid in US dollars.
Which could turn out great! If the bitcoin increases in value, which, these guys seem pretty confident that it will (emphasis added):
“Blockstream models show at the end of the 10th year of the bond, the annual percentage yield will be 146% due to Bitcoin’s projected appreciation, [Blockstream Chief Strategy Officer Samson] Mow said, forecasting Bitcoin will hit the $1 million mark within five years”
This gambit would be interesting or maybe even funny, if it weren’t the tax payers of one of the poorest countries in the world, who derive ~25% of their income from remittances, on the hook to pay back the bond in the event bitcoin isn’t headed to the moon.
Regulators’ Crypto “Sprint” More of a Slow Jog
The long-awaited report from regulators’ inter-agency “crypto-sprint” dropped last week and it was… anti-climatic is putting it lightly.
Perhaps the readout is best interpreted as regulators signaling they are trying to get on the same page, they’re taking crypto seriously, and expect increased scrutiny and regulation… next year.
The page and a half document highlights crypto-asset activities regulators believe banking organizations “may be interested in engaging,” including:
Facilitation of customer purchases and sales of crypto-assets
Loans collateralized by crypto-assets
Activities involving payments, including stablecoins
Activities that may result in the holding of crypto-assets on a banking organization’s balance sheet
And ended by stating that “the agencies plan to provide greater clarity on whether certain activities related to crypto-assets conducted by banking organizations are legally permissible, and expectations for safety and soundness, consumer protection, and compliance with existing laws and regulations related to:”
Crypto-asset safekeeping and traditional custody services
Ancillary custody services
Facilitation of customer purchases and sales of crypto-assets
Loans collateralized by crypto-assets
Issuance and distribution of stablecoins
Activities involving the holding of crypto-assets on balance sheet
(weirdly, no mention of stablecoin-related payments activities in areas regulators are seeking to provide greater clarity?)
Sen. Sherrod Brown Is Looking For Answers from Stablecoin Issuers
Sen. Sherrod Brown (D-OH), the Chair of the Senate Banking Committee, last week sent letters to stablecoin issuers and exchanges seeking information about how they’re protecting consumers and investors.
Brown’s letter follows the President’s Working Group report and recommendations on stablecoins earlier this month, which highlighted a number of risks, including of “stablecoin runs,” payment system risk, systemic risks, and the risk of concentration of economic power. The report ultimately recommended stablecoin issuers being regulated similarly to traditional banks by requiring issuers to be insured depository institutions and implement appropriate risk-management standards.
The issue isn’t purely theoretical. The total market cap of stablecoins has reached about $150 billion, with Tether, the largest USD-linked stablecoin, weighing in at about $74 billion in circulation. But Tether has been the subject of intense speculation and multiple government actions about the existence and quality of its reserves.
With that background, Brown wrote Circle, Coinbase, Paxos, TrustToken, Binance.US, Centre, and Tether, to ask the following, focusing on USDC, a stablecoin issued in collaboration between Coinbase and Circle:
about purchasing, exchanging, or minting processes for USDC
the process for customers to redeem USDC for US dollars, including any requirements, waiting period, etc.
how many USDC tokens have been issued and redeemed since inception
characterize conditions that would prevent the redemption of USDC fo US dollars
identify any trading platforms that have enhanced capabilities, privileges, or special arrangements with respect to USDC (including contractual or common control)
summarize any internal reviews or studies conducted about how specific levels of redemption would affect USDC, including its convertibility into US dollars, or would affect the financial position of your company
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Other Good Reads This Week
AmEx Pitched Business Customers a Tax Break That Doesn’t Add Up (WSJ)
Behind “Buy Now, Pay Later” US Boom, Federal Regulator Looms (Bloomberg)
Free Trades: A World Without Payment for Order Flow (Net Interest)
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