Under-the-radar Wilmington fintech companies burst onto consumer credit scene

Karl Baker | The News Journal

Show Caption Hide Caption Wilmington fintechs are attracting millions of dollars to Delaware A band of high-tech financial entrepreneurs are bringing in millions of dollars to greater Wilmington's financial technology, or fintech, scene.

As Wilmington struggles with violent crime and vacancies in offices buildings, a band of high-tech entrepreneurs, many of whom left jobs with big banks, are bringing in millions of dollars to the city's financial technology, or fintech, scene.

One is Fair Square Financial, which last week snagged a $100 million investment from Vikram Pandit, the former CEO of Citigroup.

It's an infusion of cash that the online credit card company says will allow it to expand beyond its downtown co-working space this year while doubling its workforce to 100 employees during the next two years.

The expansion decision is the result of surprisingly strong customer demand for its online-serviced, low-fee Ollo cards, Fair Square CEO Rob Habgood said. The credit cards carry a variable interest rate that currently sits at a lofty 24.99 percent.

Their high demand emerged as the company last year secured a $200 million private equity investment as well as a nearly $800,000 grant from the state of Delaware.

"It does take a substantial investment to build out a credit card company from scratch," said Hapgood, who spent two decades in the credit card industry and at Bank of America and Capital One.

With machine-learning algorithms and access to big data sources, Fair Square and its brethren of similarly situated early-stage companies are carving out a niche in the Delaware lending industry, even as credit card operations at Wilmington's largest banks have declined or stagnated.

"Who wants to work for these large, regulated banks anymore where you can't do interesting things?" asked Sabrina Basht, chief strategy officer at Marlette Funding, a Fairfax-based company that offers online fixed-rate, lump-sum consumer loans.

"A lot of people like ourselves. We were at Barclays, we were at JPMorgan Chase – we've come to these environments because these are thriving energetic places to be in contrast to the doldrums of the big banks," she said.

For decades, it was those big banks that built Delaware's reputation as a consumer loan hub. Without state laws limiting interest rates, MBNA and other massive financial institutions hired thousands of Delawareans for their credit card businesses.

A decline began in 2005 when Bank of America purchased MBNA when it had over 10,000 Delaware employees. While Bank of America doesn't reveal the size of its Delaware workforce, thousands suffered layoffs or were transferred in subsequent years.

A possibility that Delaware fintechs could fill a credit card job gap first began to emerge last year when SoFi, a San Francisco-based online provider of personal loans, announced it would add 400 workers to its Claymont office by the end of 2018.

Also, last year, a Wilmington-based online student lender, College Avenue, announced it had received a $30 million venture capital investment.

Then, in March, Marlette Funding told The News Journal that it would nearly double its Delaware workforce to more than 200 employees.

Like Fair Square, the company uses machine-learning algorithms to determine if borrowers are creditworthy for its loans.

Unlike Fair Square, Marlette says it is profitable.

The company, which lends money through the website Best Egg, says it took in a net income of $11 million in 2017. Its current loan portfolio is worth $2.5 billion, and it has lent $5 billion during its 4-year life at interest rates ranging from 4.99 to 20.99 percent.

"We kind of think this as a little fintech hub of the United States," Basht said. "There are like six or seven fintech companies, and it's not like they're so startupy. They are companies that are really substantial."

Even the once-controversial Delaware Board of Trade, which has yet to meet employment promises it made before receiving $3 million from taxpayers in 2016, sold in December a 27 percent stake of the company to Beijing-based Seven Stars Cloud Group – a transaction likely worth more than $6 million.

While the millions of dollars flowing to Wilmington is positive for what has been a volatile Delaware job market, consumer credit analyst Sanjay Sakhrani said it still is uncertain whether the state's cluster of fintechs will be able to survive a future economic downturn.

"We're in a pretty good part of the cycle right now, and so there might be opportunities to fund and, obviously, receive funding," said Sakhrani, who works for the Manhattan-based investment bank Keefe, Bruyette, & Woods Inc. "The issue comes when things aren't as good because then there are a lot more jitters in the marketplace."

There are opportunities in niche areas, he added, but Delaware's fintechs could struggle to capture market share in core consumer lending areas where big banks are dominant.

Other New York-based analysts, not including Sakhrani, have predicted that the consumer credit market is, in fact, headed for a downturn as interest rates have begun to climb above historic lows that have persisted since the end of the Great Recession.

Pandit turned Citi around, but issues remain The resignation of Citigroup CEO Vikram Pandit comes after an extraordinary period in which he helped the bank emerge from government conservatorship. (Oct. 16)

Still, Pandit, who led Citigroup through the tumultuous years of the Great Recession until being ousted in 2011, is bullish about Fair Square, saying in a statement that the company is beefing up the credit card business "with the latest data and machine-learning technology."

Pandit and two other executives connected with his investment firm, the Orogen Group, now are members of Fair Square's board of directors.

Are credit scores accurate?

Hapgood argues that his company is well-positioned to ride out a future economic dip, noting that his team of executives, on average, have decades of credit card experience.

"There's a lot of understanding of how the credit card market performs through different credit cycles and how to structure our business to be resilient," he said. “We are developing machine-learning models for both the targeted marketing and the underwriting stages of our business.”

While his company aims loans at traditionally sub-optimal borrowers, with credit ratings in the 600s to low-700s, Habgood doesn’t think a financial score is always an accurate gauge of a customer's potential value.

"It's an imperfect score. It's built for lots of uses across multiple industries," he said.

Instead, Fair Square uses 150 variables "to assess risk at the individual customer level," he said.

"It's driven by using all of the data that's available in the market, deeper credit bureau data, and there's also alternative data that we're tapping into to help us in driving those models," he said.

The company does not use personal data from Facebook or other social media sites "at this point in time," Habgood added.

After it issues a credit card, the money that flows to borrowers is not actually derived from Fair Square's own balance sheet. Unlike a bank, it doesn't have depositors who regularly stash money in accounts.

Rather, the money comes from prearranged contracts with undisclosed, well-heeled investors, Hapgood said.

"And over time, we're looking to get into the securitization market as well, you know, with asset-backed securities," he said.

Asset-backed securities typically are bundles of assets, like a loan, that offer investors a fixed return.

Just outside of Wilmington, down U.S. 202 from Fair Square's headquarters, Marlette Funding also does not have depositors supplying its loan funds.

The company uses its underwriting platforms and its credit return models to loan money obtained from big investors, such as hedge-funds and medium-size banks, company CEO Jeffrey Meiler said.

The loans are then sold off to other banks, but still are serviced by Marlette, he said.

“We are not a bank," Meiler said. “We use institutional investors to lend money to consumers."

Yet, it is the lack of a security that customer deposits provide that causes Sakhrani, the consumer finance analyst, to question in part the staying power of many fin-tech startups.

Whether investors will continue to see companies, like Marlette and Fair Square, as a profitable place to put money, even during rough economic times, is unclear, he said.

"In fairness, there's a little bit of a vacuum in that space because ... the larger card issuers are now relying more on deposits so there is an appetite," Sakhrani said.

Meiler said the industry has evolved since the Great Recession. Big banks are reluctant to lend their customer deposits even as credit card demand grows with a drop in unemployment rates and an upward creep in wages.

In the past, small banks would have filled the void, he said, but they are disappearing, leaving the opportunity for Marlette.

"What has happened over time is the bigger guys have gotten bigger and bigger and squeezed these other guys out of lending," he said.

Contact Karl Baker at kbaker@delawareonline.com or (302) 324-2329. Follow him on Twitter @kbaker6.

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