If you glance left as you come over the traffic-clogged expanse and make your way onto Interstate 95, you’ll see a red granite office building. On its 14th floor, overlooking America’s busiest toll plaza, is the headquarters of a tiny FDIC-insured bank named Cross River.
Cross River is not a typical community bank. There are no tellers here, or ATMs or safe deposit boxes. Instead there are 175 bank staffers and traders stuffed elbow to jowl into about 23,000 square feet, peering into hundreds of computer monitors—often stacked three per desk. There are startup touches—a kitchenette stocked with LaCroix sparkling water, gourmet coffee and a game room.
Cross River is on a lending tear. It is underwriting loans at the rate of more than $1 billion a month—some $30 billion worth in just nine years. But unlike in banks of yesteryear, virtually all Cross River’s lending officers aren’t human beings. They are apps. Cross River’s loans originate mostly from 15 or so buzzy venture-capital-backed financial technology startups, so-called fintechs, that go by names like Affirm, Best Egg, Upgrade, Upstart and LendingUSA. The fintechs provide the customers; Cross River provides the licenses and infrastructure. It holds 10% to 20% of each loan it issues, and the massive volume of fintech loans has propelled Cross River to $2 billion in assets, up from $100 million a decade ago.
“We’re in the moving business, not the storage business,” booms chief executive Gilles Gade, 53, an immigrant from France, balding and wearing clear-framed glasses and a navy Hugo Boss sweater. “We move assets. We originate [them], we package them, and we sell them.”
Gade is being modest about Cross River’s role in the fintech revolution. State-chartered banks like his have the regulatory and compliance framework in place and the lending licenses necessary to originate loans. Most fintechs do not and thus rely on banks for funding. It’s the industry’s dirty little secret. Once you get beyond the slick iPhone apps and inflated tales of big-data mining and AI-generated lending decisions, you realize that many fintechs are nothing more than aggressive lending outfits for little-known FDIC-insured banks.
Home Improvement Loans
IPO: May 2018
Market Value Loss: $3.7 billion
Cofounded in 2006 by David Zalik, a serial entrepreneur whose businesses have ranged from selling refurbished PCs to real-estate investing and cofounding a bank that failed, GreenSky uses tech to make loans—often at zero interest—for home improvements and repairs. Roofers, plumbers and other contractors with mobile phones are its loan officers. For banks it provides great fee income and off-loads a good deal of the upfront credit risk.
Last May, GreenSky went public, raising $955 million. But not long after the IPO, cracks in GreenSky’s business model became apparent. In 2018, GreenSky cut its full-year adjusted earnings guidance from $192 million to $175 million, spooking investors.
Things have gotten worse since, as its lenders, including Cross River, have pulled back. The startup is also dealing with legal trouble over its contractor relationships. GreenSky reached a $160,000 settlement in 2017 with New Jersey’s attorney general to resolve consumer complaints, and it is now facing a similar problem in Alabama. Since its post-IPO peak of $26, GreenSky’s stock has fallen to $7, but Zalik has siphoned out so much that his net worth of $1.6 billion is now larger than the company’s market capitalization.
Since 2010, Silicon Valley venture firms and others have invested some $175 billion to disrupt the financial system, according to Accenture. This has inevitably resulted in astronomical valuations for many privately held fintechs. But just as WeWork’s prospectus laid bare the fact that the company was little more than an overpriced lessor of real estate, a glance under the hood of many fintechs reveals similar sleights of hand.
Take out a $2,000 zero-interest, 39-month installment loan from Affirm to buy a Peloton bike this Christmas and it is likely that Cross River is actually making the loan. Cross River holds onto such loans for a few days, then typically transfers them to the fintech, which will sell the debt to hedge funds and bond buyers, or securitize it into bundles of thousands of such loans.
On the stock market, banks tend to trade for a fraction of the multiple technology stocks do. That’s why fintechs are eager to position themselves as tech firms, not financial firms. The VCs are eager to sell that story, but the market hasn’t been that stupid. Many fintech unicorns that have managed to stage public offerings have been severely punished in the aftermarket.
ON DECK CAPITAL
Harnessing Big Data To Make Small-Business Loans
IPO: December 2014
Market Value Loss: $1.6 billion
Founded in 2006, On Deck uses data and algorithms to quickly approve small-business loans—a group many banks are reluctant to lend to. On Deck’s loans range from $5,000 to $500,000, and its biggest bank partners have been JPMorgan Chase and Utah-based Celtic Bank. Celtic accounts for some 20% of its loans.
By 2013, On Deck had originated $400 million in loans despite charging sky-high rates of up to 36%. In March 2014, it raised $77 million from Chase Coleman’s Tiger Global and others. A few months later it went public. On Deck’s stock soared 40% to a $1.9 billion valuation on its first day of trading.
It was downhill from there as marketing expenses ballooned, growth slowed, and a new crop of competitors like Fundbox, Kabbage and BlueVine gained steam. In early 2017, On Deck reported a 15% net charge-off rate of its loans due to defaults. Two years later JPMorgan said it would stop working with it.
The original strategy was to “grow, grow, grow—which doesn’t usually translate into good credit performance,” says Giuliano Bologna, an analyst at investment bank BTIG. “What people really started to realize is that, while there was a lot of tech, they’re really more ‘fin’ than tech.” On Deck’s stock is down 75% from its IPO.
LendingClub went public in 2014 with a valuation of $5.6 billion. Today it is worth $1.2 billion. On Deck Capital, a New York City–based fintech that makes superfast small business loans, is worth $290 million today, down from $1.9 billion the day it IPO’d in late 2014. It’s a similar story for other fintech IPOs like Funding Circle and GreenSky.
“[These] companies positioned themselves as tech companies, [but] in reality [they] are just leveraging tech to further an old-school business solution like consumer lending,” says Andrew Marquardt of Middlemarch Partners and formerly of the New York Fed and BlackRock. “You have investors looking at it and saying, ‘This is a bank, it is not a tech company.’ ”
By Forbes’ count, some $15.6 billion in market value has already been wiped out thanks to ill-fated fintech public offerings. Other large lenders like Prosper Marketplace and LoanDepot have either filed to go public and abandoned plans or remain private. More inflated valuations are hiding in plain sight.
All of this could eventually spell big trouble for Cross River. Some fintechs it has done business with, like GreenSky and LendingClub, have already become investor fiascoes (see sidebars). There may be more train wrecks coming. Five of its biggest fintech clients by market value have raised $2.25 billion at a combined value of $50 billion. None seems ready to undergo the scrutiny of a public offering even as the stock market hits highs and consumer defaults remain near record lows.
IPO: December 2014
Market Value Loss: $8.8 billion
Launched by Frenchman Renaud Laplanche on Facebook in 2007 as a loan marketplace, LendingClub’s mission was to replace bankers by directly connecting borrowers to lenders, lowering costs. Still, bank partners like Cross River helped LendingClub grow at blistering speeds. By 2014 it reached $5 billion in loans and went public, peaking at a value of $10 billion.
Not long after, financial filings revealed that LendingClub was burning 43% of its revenue on sales and marketing. In its first four years as a public company, LendingClub lost $340 million.
Then, in September 2018, its asset-management arm, LC Advisors, and Laplanche, plus another executive, agreed to pay $4.2 million in penalties to the SEC for misleading investors about the loans they were buying. Regulators alleged they used LC Advisors to prop up loan underwritings and improperly adjusted monthly fund returns to downplay risk. Laplanche was barred from the securities industry, and today LendingClub’s stock is down 80% from its peak.
“LendingClub was brought public by Morgan Stanley’s tech bankers. They tried to sell it as a tech deal,” says Derek Pilecki of hedge fund Gator Capital Management. “It’s a loan originator.”
At the moment, though, it’s boom time in Fort Lee. But the party could end fast. Filings with the FDIC show personal loans—virtually all from fintech lending partners—account for a high 60% of the loans on its books. A good deal of the loans Cross River carries have sky-high interest rates, forbidden in states like New York and Connecticut with strict usury laws. The bank itself is venture-funded, attracting money from the likes of Andreessen Horowitz and Battery Ventures—some $28 million in late 2016. A year ago, KKR & Co. led a $100 million investment round, valuing Cross River at nearly $1 billion, roughly three times what a similar-size regional bank would typically be worth.
“Our strategy is to be the only financial services provider to the fintech ecosystem globally,” Gade says excitedly. “Changing people’s lives is why we do this, before anything else.”
Prior to his arrival at Cross River, Gade had a decidedly conventional career. He’d done stints at Bear Stearns and Barclays and as CFO of New York mortgage lender First Meridian, known for issuing loans under the licensed name Trump Financial. Early in his career, Gade, who was born in Paris, took two years off to study the Talmud. In 2008, he decided to make his move, pooling some $700,000 in savings with $9 million from friends and others to invest in Cross River, a community bank that had received a bank charter but had no assets.
During Cross River’s first year in operation, Gade and his small team mostly traded in and out of government-backed and auction-rate securities. Then, less than two years after the bank opened, Gade was approached by David Zalik, an entrepreneur whose fintech, GreenSky, was growing rapidly by enlisting contractors to make no-interest loans to property owners for home improvement projects.
Peer-To-Peer Business Lending
IPO: September 2018
Market Value Loss: $1.5 billion
Funding Circle was conceived over pints in a London pub by a former management consultant named Samir Desai, 36, during the financial crisis. As with LendingClub, the idea was to match borrowers—in this case small businesses—with institutional investors on the internet. Funding Circle listed on the London Stock Exchange in September 2018, raising nearly $400 million at a value of $2 billion.
That was the high point. Within nine months the company cut its revenue growth target by half, citing reduced demand for its loans and a proactive effort to “further tighten” lending to riskier businesses. Its stock has plunged by 77% in just over a year.“Funding Circle is talking about not making a profit until 2022–23,” says Russ Mould of British broker AJ Bell. “People lose faith.”
Gade began originating loans for GreenSky and realized the nascent fintech could become Cross River’s engine for growth.
Gade quickly refashioned Cross River to serve the fintech’s interests. His timing was perfect. It was 2010, and the financial crisis had created widespread distrust of traditional bankers, consumers had little equity to tap in their homes and banks largely stopped extending credit. Cross River and several other specialty banks like Utah’s Celtic Bank and WebBank were eager to fill the void, through a growing field of fintech frontmen.
The rise of fintechs has some benefits. By tapping data and using behavioral economics, many of the new companies, like Acorns and Betterment, have increased savings rates and made personal finance more efficient. Fintechs have been responsible for some $170 billion in refinancings and loans to date.
Everything was going smoothly for the sector until about 2015, after a handful of big outfits like LendingClub went public. Suddenly investors outside of Silicon Valley began to scrutinize the books—and they saw cracks in their foundations.
Today Cross River continues to expand, seemingly oblivious to the looming risks. Just as banks competed in a frenzy to issue “low doc” and low-rate mortgages while the housing bubble inflated, some fintechs have begun making riskier loans.
Last year, one of Cross River’s biggest fintech partners, Freedom Financial, agreed to a $20 million settlement with the FDIC after the regulator determined Cross River used “unfair and deceptive” practices by failing to effectively oversee its partner during the origination of over 24,000 loans. Cross River was forced to pay a $641,750 fine.
An even bigger threat to fintechs is an economic downturn.
In the third quarter of 2019, Cross River reported that its problem loans doubled to nearly 2% of total, led by a $17 million problem in commercial real estate, where 10% of its assets were past due. (Cross River says most of the loans are now current.) But since the fall of 2016, Cross River’s provision for loan losses has nearly doubled as a percentage of average loans. Even more recently its reserve coverage ratio of “past due or nonaccrual” loans has declined from 489% to 114%. This at a time when the overall environment for credit—thanks to record-low unemployment and low interest rates—is ideal.
“Our revenues have had a compounded annual growth rate of 45%,” says Gade, who has adopted Silicon Valley speak to describe his operation as an “everything as a service” company. “The talk about a recession or a credit cycle that’s going to start going the other way is much ado about nothing.”