Matt Humphrey is one of the entrepreneurs aiming to upend mortgage finance with tactics borrowed from fintech, marketplace lending and the traditional mortgage playbook
Marketplace lending is, in many respects, an evolution of the privately funded mortgage market, which has co-existed with mainstream lenders without posing much threat for years. Private-money lenders make the loans that traditional mortgage lenders can’t, or don’t want to, make. Products like commercial mortgages and fix-and-flip single-family home financing offer higher returns than vanilla residential loans, but they require a level of hands-on underwriting and local market expertise that inhibits scale.
But marketplace lending has changed that. Technology used by marketplace lenders offers deeper insights and transparency into transactions, while more easily connecting investors and borrowers in disparate locations.
And now, some of these same lenders have their sights set on disrupting the mainstream mortgage market with tactics borrowed from fintech, marketplace lending and the traditional mortgage playbook.
Take LendingHome and its CEO, Matt Humphrey. The San Francisco firm is a single-family bridge loan specialist that funds itself both through traditional sources of financing and marketplace lending and was recently approved to sell mortgages to Fannie Mae.
LendingHome has raised $110 million in venture capital since it was founded in 2013 and is looking for more. It’s done six bridge-loan secu- ritizations totaling $183 million and has a marketplace lending vehicle where accredited investors can purchase fractional interests in loans.
Earlier this year, the company established a registered investment advisor called LH Capital Management and began setting up two investment vehicles under the name LendingHome Opportunity Fund II. The parallel funds will extend up to $200 million in total funding, according to regulatory filings.
Likewise, fintech lender SoFi, which self-funds its loans, is applying for federal deposit insurance, and was the first lender to test a recent Fannie Mae home loan product for borrowers with student debt.
This suggests that the legacy of fintech and marketplace lenders will not be defined by drawing lines between this new breed of lenders and mainstream incumbents, but rather by how those lines are blurred.
GETTING MORE OUT OF PRIVATE MONEY
The competition between fintech and marketplace lenders and traditional mortgage companies often focuses on borrower-facing automation and other technology. What gets overlooked is how differences in their funding sources also create competitive differences.
While funding from government-related entities, securitizations, warehouse lines and deposits are the best-known sources of mortgage financing, there has always been part of the market that goes directly to private investors outside the institutional market.
That’s largely where marketplace lenders play.
“There is some competition for the private-money lenders that didn’t use to be there” as a result of marketplace lenders entry into the market, according to Gordon Albrecht, a senior director at private-money subservicer FCI Lender Services Inc. in Anaheim, Calif.
But are the fintech marketplace lenders really giving traditional private-money mortgage lenders much of a run for their money?
“Are they really competing? Actually, not that much,” said Albrecht, who numbers marketplace lenders among his customers.
Marketplace lenders with technology platforms started by trying to horn in on private-money mortgage lenders’ turf as originators, but after seeing the extent to which the mortgage market is regulated, many shifted gears and decided they’d rather purchase lenders’ loans, he said.
Regional private-money lenders are competitive with national lenders like banks that have “homogenized lending to the point where local nuances aren’t taken into consideration,” said Brett Crosby, co-founder and COO of PeerStreet in Manhattan Beach, Calif.
But some fintech and marketplace lenders are employing a national strategy aimed at competing with them.
LendingHome does this by analyzing “credit parameters down to each different city or state per the elevated or reduced risks levels in those market conditions,” said LendingHome’s Humphrey.
“We can control all of this and make changes daily if need be, and prefer to, rather than rely on local lenders of varying qualities that may had adverse selection bias of which loans they choose to sell,” he added.
While private-money lenders may compete against each other, on the surface it seems like the chances of many marketplace lenders competing in the traditional mortgage market is slim. So why should traditional mortgage lenders care about this development in the private-money mortgage market?
One answer is that, while the market for loans funded by small private investors has been little more than a niche, it now has growth potential it didn’t have before.
“These crowdfunding companies really aren’t doing anything that hasn’t been done before in terms of funding private mortgages, but now you have the internet, and suddenly the number of investors grows,” said Rick Sharga, chief marketing officer at Ten-X in Irvine, Calif.
The private-money mortgage investor market was originally built on word-of-mouth connections, but marketplace lending platforms have made it easier to broadly disseminate information that investors can use to size up potential investments.
“The marketplace lenders have opened up the private money world,” said Albrecht. “Investors can get into it that wouldn’t otherwise. It used to be you have to have somebody to bring you into it. It was a networking business.”
Tapping this type of funding could help traditional bank or nonbank mortgage lenders diversify their capital bases. Institutional investors can provide larger amounts of capital, but they also pose more counterparty risk because of their influence.
For traditional lenders, the value of the marketplace lending strategy is that “it’s a source of diversification of funding,” said Brad Walker, CEO of Income&. Pronounced “Income And,” the San Francisco company focuses on single-family mortgage investments.
LOWERING THE COST OF FUNDS
Lenders should not only take a page from fintech and marketplace lending strategies because they can diversify funding sources, but also because they have been focusing on strategies that lower costs.
“What’s going to differentiate which companies succeed in the fintech space is the cost of customer acquisition,” said David Norris, chief revenue officer at loanDepot in Foothill Ranch, Calif.
Whether they use a marketplace lending model or not, fintech lenders also have to be efficient when it comes to funding costs, said Steve Abreu, founder and CEO of Newfi Lending in San Francisco. “If you can’t execute a good price to the customer, your model fails,” he said.
The many intermediaries in the secondary mortgage market and securitization can look very inefficient when compared to reaching out directly to investors through a marketplace lending platform, said Crosby.
So it could be worth considering whether there are efficiencies in the marketplace lending model that could be incorporated into housing financing reform.
“There are a lot of assumptions baked into what I’m saying, but the existing market is ripe for transformation,” said Crosby, who works for a marketplace lender that primarily funds investors’ single-family bridge loans, but would consider funding home mortgages in the future.
It would take time given the sheer size of the mortgage market, the number of influential and entrenched players and the heavy regulation, but “there is no reason that the whole industry can’t go this direction,” he said.
“There is no reason the whole industry can’t go in this direction.” — Brett Crosby, Co-founder and COO PeerStreet
While fintech strategies may have some potential to be transformative long-term, they aren’t going to be the sole winning business model in the mortgage market. Some fintech companies have had a tough time making a go of it. And when it comes to the marketplace lending strategy, several companies have found they can’t get by using that type of funding alone but rather in conjunction with traditional sources.
This suggests that what will emerge is a convergence of models.
THE HYBRID APPROACH
Already there clearly are marketplace lenders that are buying loans from the traditional mortgage market and starting to diversify into traditional funding sources, and vice versa.
There also are traditional lenders aspiring to be fintech companies, and fintech companies working to be more like traditional mortgage lenders.
In addition, more and more mainstream mortgage lenders are adopting the kind of borrower selfserve technology platforms originally more commonly associated with technology startups.
Quicken Loans in Detroit has for some time been a volume leader in the mortgage market and companies like Abreu’s Newfi Lending and Norris’ loanDepot were founded by mortgage industry veterans but are known for their fintech-style automation, among other things. For example, loanDepot also has a fintech-like strategy in that it is a nonbank that offers multiple consumer finance products.
While a lot of nonbanks in the mortgage market are monoline companies, Norris finds carrying a full range of consumer finance products borrowers are likely to need and the volume of business it generates compelling enough that he thinks it will be the wave of the future.
“Specialists will not survive longterm,” said Norris.
Nonbank companies competing in the fintech space do seem to be more frequently offering expanded product lines than mortgage lenders tradition- ally have in the past, but there are varying opinions on how far to take that diversification, and how fast.
“We think very few will be truly exceptional at one vertical, let alone mastering multiple,” said Humphrey.
His firm, which started by using traditional funding sources to primarily finance single-family bridge loans, has expanded into more traditional loan products and marketplace lending, but at a deliberate pace.
Originally fintech and marketplace lenders gravitated more toward other forms or consumer finance with higher risks and higher returns, like “fix and flip” and personal loans, but as they strive for scale the size of the single-family mortgage market has attracted them to it as well.
Traditional single-family mortgage lending “definitely isn’t one of the low-hanging fruits in the market but it is a large market,” said Walker.
LendingHome and SoFi are approved to sell loans to the traditional secondary mortgage market’s biggest participant, Fannie Mae.
LendingHome started with traditional institutional nonbank funding sources and a focus on the kind of single-family real-estate-secured bridge loans startups tend to favor, but recently diversified into marketplace and consumer mortgage lending as well, said Humphrey.
“We created a private capital marketplace, and now we’ve moved over to help first-time homebuyers and a lot of those loans actually fall into a more conforming specification. They could be sold to Fannie or midmarket or mainstream banks,” he said.
Traditional mortgages represent about 20% of its volume currently and are growing at a faster rate than its bridge loans did, he said. Bridge loans only represent about 2% to 4% of the mortgage market, Humphrey noted.
The size of the traditional mortgage market helped draw the company to it, he said. And the more recent diversification of its funding into marketplace lending helped it price its loans more attractively for borrowers.
“We were able to really diversify that [funding] strategy to where we weren’t beholden to any one investor group,” Humphrey said.
The company’s top executives reflect its blend of traditional mortgage and fintech expertise.
While Humphrey is a millennial who has founded several startups and went to college at age 13, the company’s chief financial officer, Robert Stiles, is a mortgage industry veteran who previously was the CFO of Nationstar Mortgage Holdings in Dallas.
Another company blending different old and new mortgage funding strategies is Income&.
Income&, while reaching out directly to investors, is working to serve retirees potentially more interested in accessing the mainstream mortgage market’s lower-risk cash-flows than taking on more risk in order to reach for yield the way marketplace lenders’ investor bases tend to.
The company structures the investments through a twist on traditional securitization.
Income&’s investment vehicle, the Prime-Rated Mortgage-backed Obliga- tion, is backed by individual loans that investors can identify as specific through their needs through the company’s platform.
But generally for marketplace and fintech lenders, traditional mortgages can be “a hard place to start” because of the higher returns their investors tend to want, said Crosby.
It’s not always so easy to blend old and new mortgage lending models.
“The words ‘innovative’ and ‘game changing’ and ‘financial services’ typically don’t go together,” said Sharga.
Traditional mortgage lenders can find “plug and play” fintech- style borrower systems to purchase; but they also have to replace legacy systems. Startups don’t. At fintech lender efforts to enter the traditional banking system, like SoFi’s, have not always gone so smoothly.
How well each type of mortgage lender handles the challenges in this convergence of models will determine which companies survive.