Hey all, Jason here.

Yesterday marked the traditional feast for Sinterklaas here in the Netherlands, though with COVID restrictions in place, celebrations were limited to small household gatherings and lighting off fireworks.

While a socially distant holiday season has been a bit boring, there is no such thing as a dull week in fintech - or, it seems, a week without Stripe launching game-changing new functionality. If you were distracted by that flood of coverage, here are some things you may have missed this week.

Regulatory Developments in Brief

CFPB Advises on Early Wage Access

The CFPB has finalized its Advisory Opinions Policy, whereby entities can request an opinion from the CFPB when regulatory ambiguity exists, and issued two such opinions.

One opinion covered whether education loan products to consolidate/refinance pre-existing federal or private education loans meet the definition of “private education loan” and require certain disclosures

The second advisory opinion provided increased clarity on whether early wage access products (EWA) meet the definition of “credit” under Reg Z.

Key elements to an EWA offering not being considered “credit” under Reg Z:

• EWA Provider contracts with employer to offer the service to employees

• Amount of EWA transaction(s) doesn’t exceed verifiable accrued cash value of wages (eg, can’t be employee-provided or estimated)

• EWA provider doesn’t charge the employee - voluntary or otherwise (eg, no “tips”) - exception for nominal processing fees

• EWA must disburse funds to an account of the employees’ choice; if it is disbursed to a pre-paid card facilitated by the provider, must allow reasonable use, including cash withdrawals

• EWA provider recovers advance only via a payroll deduction from next paycheck

• If payroll deduction attempt fails, EWA has no legal or contractual remedy against employee

• EWA cannot directly or indirectly assess credit risk of employee (eg use credit bureau data)

Good news for startups like DailyPay, Even, Immediate, and PayActiv, which integrate with an employer’s payroll system.

Potentially bad news for startups like: Dave, Earnin’, Brigit.

One should note, the Advisory Opinion creates a clear safe harbor for certain product configurations, rather than prohibiting products that don’t conform to the opinion.

CFPB Sues LendUp for Alleged MLA Violations

LendUp, which settled previous problems with the CFPB and California DBO in 2016, is in trouble again. On Friday, the CFPB announced that, as part of a broader sweep of lenders, it is suing LendUp for alleged violations of the Military Lending Act (MLA).

The suit alleges that, since 2016, LendUp made over 4,000 single payment loans or installment loans that exceeded the Military APR cap of 36% (“Military” APR is calculated slightly differently and can include a broader set of fees.)

Given LendUp’s payday loan product has an APR well in excess of 36%, the problem here probably isn’t the difference in how Military APR is calculated.

Rather, it would appear that LendUp may have failed to correctly verify applicants’ military status and ended up writing loans in violation of the MLA.

Proposed Stablecoin Legislation

Congresswoman Rashida Tlaib, along with Congressmen Jesus “Chuy” Garcia and Stephen Lynch stirred up heated debated in cryptoworld by introducing a bill that would require issuers of cryptocurrencies tethered to traditional currencies (eg, “stablecoins,” like Facebook’s Libra) to:

• obtain a banking charter

• follow appropriate banking regulations

• notify and obtain approval from the Fed, FDIC, and appropriate banking agency 6 months prior to issuance

• obtain FDIC insurance or otherwise maintain reserves at the Federal Reserve, ensuring that stablecoins can be converted into US dollars on demand

The bill’s authors argue that USD-linked crypto poses systemic risks to the financial system.

Given the small market cap for stablecoins vs. the traditional dollar economy, this seems unlikely; but the opportunity for regulatory arbitrage with USD-linked crypto is bound to receive increasing legislative and regulatory scrutiny.

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Interview with Stephanie Klein, CEO of Braviant Holdings

Stephanie Klein is CEO at Braviant Holdings, a Chicago-based lender focusing on combining technology with machine learning to offer consumers better online credit solutions.

She has previously served as an executive at lenders Springleaf (now part of OneMain) and led the launch of Enova’s near-prime product, NetCredit.

She’s also been named to Crain’s Chicago Business 40 under 40 and testified before Congress on alternative consumer financial products. What follows is our written interview.

Jason: You and I worked together at Enova, which has been doing online lending since long before the term "fintech" became popular. What do you make of the explosion of popularity of the term?

Do you think of Braviant as a "fintech" company? Why or why not?

Stephanie: It's true; When I joined Enova back in 2007, I knew I was joining a rocket ship led by some incredible entrepreneurs (Al Goldstein and team), but the 4 year old startup was certainly not pitching themselves as a "fintech" at that time.

Nevertheless, I do think Braviant and most other online lenders rightly call themselves fintechs these days. Perhaps the term has become a bit overused, but all it really means is financial technology. If a business is leveraging new or innovative technologies to deliver financial services, then I think it's fair game to call yourself a fintech.

Where I do see a bit of abuse of the term is with larger, legacy organizations who offer one digital product and suddenly declare themselves a fintech. That said, innovation and progress should be celebrated not only at fast-growing startups, but also at more established companies, so the occasional overreach doesn't bother me.

When it comes to Braviant, we certainly consider ourselves a fintech platform. The way I like to describe what we do is that the "tech" enables the "fin." We absolutely could not do what we do without technology, but at the end of the day, we are still a financial services company.

No amount of technology can overcome poor underwriting or negative unit economics. I think it's incredibly important for any tech-enabled lender, whether balance sheet or marketplace or hybrid, to remember that first and foremost, you are in the business of financial services, not technology.

Jason: You recently spoke at Lend360 about how banks and fintechs can work together to serve non-prime markets (and Braviant partners with Capital Community Bank to make loans in some states).

Can you talk about key challenges and opportunities from your perspective (as the fintech parter) in this model?

Stephanie: A decade ago, most fintechs were out to disrupt the banks. In more recent years, there's been a notable shift toward partnering with or even becoming a bank.

From my perspective, banks and fintechs are the perfect marriage due to complementary capabilities. Banks tend to excel in areas like compliance, credit risk, and operational oversight.

Fintechs, on the other hand, bring a wealth of capabilities in new customer acquisition, advanced analytics and digital technology. When it comes to serving non-prime markets, I think there's a massive opportunity for banks to partner with fintech vendors in order to bring lower-cost credit products to market.

Nonbank lenders like Braviant are able to leverage all of our historical data as state-licensed lenders to build proprietary decision models that consistently outperform off-the-shelf data like a traditional FICO or Vantage score.

Our expertise with alternative data and machine learning is a huge asset to a bank who is looking to serve the underserved but doesn't quite have the wherewithal to do so without putting significant capital at risk due to a steep learning curve.

A couple key challenges from the fintech perspective are getting your business bank-ready and adapting to an ever-changing regulatory landscape. Bank-level vendor due diligence is no joke, and not every fintech has the compliance culture, disciplined operational policies and procedures, and financial strength required to land a bank partner.

On the regulatory front, as guidance and precedents change over time, both the bank and its fintech partner need to be willing to continuously evaluate and, if needed, adapt the program to ensure long-term sustainability. While these models are highly complex and take significant time, sometimes even years, to structure and implement, it's well worth the effort given the upside for the bank, the fintech, and the end consumer.  

Jason: What role does "tech" play in better serving non-prime markets? Could you give an example of how Braviant utilizes technology to serve this market?

Stephanie: Non-prime consumers, like all consumers these days, demand a streamlined, frictionless user experience. We use technology at every step of the loan lifecycle to ensure that our customers are receiving the experience they expect and deserve, including a real-time loan offer within seconds of submitting an application.

However, I think the most impactful way we are helping our customers through technology is the work we are doing with machine learning. To serve non-prime markets effectively, you need to be able to look beyond an off-the-shelf credit score in order to identify those consumers who have the ability and willingness to repay despite their less than stellar credit score.

We have found that ML techniques based on alternative data sources are the way to do this. As such, a lot of our technology efforts have been focused on ensuring that we can build and deploy non-linear decision models throughout every aspect of the originations process, from marketing analytics to underwriting and verification, while continuing to adhere to the FCRA, ECOA, and other relevant rules and regulations. 

Jason: The OCC recently issued its "true lender" rule. How has this impacted Braviant's bank partnership(s) and business in general?

Stephanie: The OCC's "true lender" rule, as well as the "valid when made" rules issued by the OCC and the FDIC, provide much-needed clarity and simple bright-line tests to ensure that the bank partner is in fact regarded as the true lender and that receivables can be sold to third parties without impacting the legality of the rates and terms that were defined upon origination.

Prior to these rules, banks and their non-bank partners had to evaluate both the language and the spirit of a complex set of regulations and case law to ensure that these partnerships were set up in a way that was not only compliant on a federal level, but also appropriate from the perspective of the individual states where each consumer resides.

While the new rules are a huge step forward in terms of simple, logical, and effective federal guidance, our preference is still to look holistically at all of our partnerships and take into account a broader set of factors rather than rely solely on the recent rule-making as our justification for program structure.

Jason: Braviant uses a hybrid licensing model - where, in some states, it writes loans under its own state licenses. How does a changing regulatory environment (for example, California's Fair Access to Credit Act) impact your business model?

Stephanie: Given Braviant's hybrid business model, we have a duty to comply not only with federal law, but also with a patchwork of state laws. When state laws change due to regulatory acts or ballot initiatives, we must evaluate the new rules and regulations to determine if we can still operate profitably in that state.

In some cases historically, the answer has been no, so we have had to stop originating new loans in those states and transition into servicing mode. When this happens, it's tough to know that we are leaving our customers high and dry if they have a future credit need, but our top priority at all times is to operate a compliant business model. 

Jason: Are interest rate caps an effective way to protect consumers? Why or why not?

Stephanie: Based on the facts and data I've evaluated, rate caps are very effective at restricting credit access, but not particularly effective at lowering the cost of credit.

There's a common misconception that if you cap rates at, say, 36%, then the vast majority of borrowers who previously accessed credit at higher rates will suddenly be able to qualify for a sub-36% loan.

In reality, this simply isn't true. Instead, consumers with less than perfect credit end up locked out of credit access altogether. Even after leveraging cutting-edge analytics, annualized charge-off rates for non-prime consumers are often as much as 10x higher than annualized charge-off rates for traditional unsecured products like credit cards.

Unfortunately, it's just not mathematically possible to serve non-prime consumers at the same APR as those with good or excellent credit. You recently covered the study by the Fed quantifying ~100% as the APR required not to earn a profit, but to merely break even on a $500 unsecured loan to a subprime borrower, so I know it's no surprise to you that rate caps eliminate access to credit.

In my humble opinion, the best path to reducing the cost of credit over time is competition - the more, the better! I do think it's important for regulators to ensure that products are not unfair or deceptive, either via their structure or their marketing.

That said, the more participants in the market, including traditional banks, fintechs, and bank-fintech partnerships, the better off consumers will be. Given how easy it is to shop around for credit online these days, increased competition for a limited number of borrowers forces lenders to offer a fair product at a competitive rate. And with appropriate guardrails around key areas like disclosures, consumers remain protected from bad actors.

This isn't just theoretical, by the way. I've seen this in action as large online lenders whose primary product 10-15 years ago was a 400% APR payday loans have transitioned to more affordable, longer-term installment and line of credit products that are less than half the cost and require just 5-15% of a borrower's net paycheck instead of 40-80% to repay successfully.

If competition is allowed to thrive, the cost of borrowing will continue to come down over time for deserving non-prime consumers as lenders continue to test new data sources and innovative modeling techniques.  

Jason: COVID-19 and the ensuing economic uncertainty has presented unique challenges for lenders, in particular, using historic customer data to predict future behavior in what is now a very different environment (and some specific technical challenges, like loans with 'accommodations' being reported as current as required by the CARES Act).

How has Braviant adapted its underwriting to deal with the current environment?

Stephanie: The good news for Braviant is that our models already look beyond a traditional credit score to make approval decisions.

Given the challenges you mentioned, in particular the lack of timely and accurate performance data form the credit bureaus as necessitated by the CARES Act, we have increased our reliance on alternative data sources such as cash flow data in order to continue to originate loans to deserving consumers.

Outside of tightening our underwriting standards a bit at the start of the COVID-19 crisis and increasing our efforts around employment verification, we have not needed to make many changes to our automated underwriting process.

Although we were initially worried that our models would become distorted during the current environment, we've been happy to see that they continue to rank-order nicely, albeit with some fluctuation in default rates for a given score over time.

The good news for our borrowers is that the swift government stimulus, including one-time checks and increased unemployment benefits, seems to have made the majority whole or, in some cases, better than whole during late spring and summer.

In fact, JPMorgan Chase released some interesting data about a month ago showing that as of July 2020, employed consumers typically had about 25% more cash in their checking accounts compared to January 2020, while unemployed consumers actually had more than doubled their cash balances year to date!

While the data did indicate that cash balances were starting to decline for the unemployed population in August, we continue to see strong repayment rates across our portfolio. Of course, we still have a variety of hardship plans available for any consumers who may need them, and only time will tell how the trends from the past 6 months evolve in the coming months.

Nevertheless, Braviant is well-positioned for whatever the future may bring given our expertise with non-traditional credit data and ability to quickly adapt our technology and processes as needed.

Jason: Anything about Braviant or fintech I haven't asked that I should have?

Stephanie: I feel like we've covered a ton, but the one thing I'd like to touch on is Braviant's mission of a Path to Prime. Building on our earlier conversation about rate caps vs. competition, we have a sincere desire at Braviant to not only serve the customer's immediate credit need, but to also help our borrowers graduate to lower rates over time.

While it can take a bit more effort and creativity, I truly believe that the right way to build a sustainable business in any industry, fintech or otherwise, is to seek out products or features where you can create mutual benefit for your customers and the business.

Ideally, when the customer wins, the business also wins. I know I'm not alone in this mentality, especially within the fintech world, where financial wellness has been a hot topic for the past several years. With that said, I feel lucky to be doing our part at Braviant and am excited to see what future innovations the next generation of fintech entrepreneurs can dream up and bring to life.    

Jason: And, finally, as a Chicagoan: Cubs or White Sox?

Stephanie: I grew up in the NW suburbs of Chicago and have lived within walking distance of Wrigley Field for over a decade now, so Cubs all the way!

Can’t Let it Go

In what might truly be “peak fintech,” Square’s Cash App launched a clothing line, “Cash by Cash App.” I can only hope Marcus by Goldman is next 😂

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