One of the more interesting panels of the day at LendIt USA 2017 was the panel titled “Every Originator Will Launch a Fund.” It’s an interesting title because it could very well have been styled as a question since most of the panel discussion centered on the thought process an origination platform should go through when considering whether to launch its own fund. Panelists included Dan Vetter, CEO of Money360; Geoffrey Kott, Senior Finance Executive at Cross River Bank (CRB); Glenn Goldman, CEO of Credibly; Jay Bernstein, partner at Clifford Chance; and Joe Toms, president of Freedom Financial Asset Management.
Not all of the businesses represented on the panel have launched a fund, but they have all had to think it through, so their expertise and the lessons learned can benefit other originators considering a fund.
The first question asked was “Where does the fund structure fit into the business strategy?”
Vetter said, “There are two types of customers, borrowers and investors. So we’re sellers of money and sellers of risk. We view money as a commodity.”
Kott took a more rhetorical approach to the question. He said, “We ask, ‘what’s the right financial strategy’? We start with risk and diversification. You should have as many different ways of financing a business that you can.”
“We’re a bank,” Kott said. “We want to finance loans that are on our balance sheet. But we’re prepared to put skin in the game. As we continue to execute on our strategy, we’ll become more reliant on the fund. And we can diversify the fund. While we feel we have the expertise to manage fund, that’s not the approach we want to take.”
Instead, CRB wants to work with a third-party fund manager.
“Our view is this,” Kott said. “we have an inherent strength to run a bank. We don’t want to confuse ourselves with the added label of fund manager.”
So right away, originators interested in launching a fund must ask themselves if they want to become a fund manager or focus on their core business. It’s an important question and one that can determine a lot of other things down the road.
The mod asked another question, “When you view other funds out there, how do you view a fund in comparison to other capital forces?”
Bernstein was first to answer. “People don’t think of the cost of not having diversity in place. When times are great, you don’t need it. Not everybody should have a fund, but when there is liquidity in the back end of the market, that’s when you need it.”
That was a nice segue into the kinds of liquidity investors have.
“We launched a fund management company two years ago,” Vetter said. “We took in new capital for about a year and learned some lessons.” That fund didn’t do so well, so Money360 launched another one. “The loans we’re investing in are short term commercial real estate loans. The minimum investment is $50,000. Funds generate a lot of liquidity.”
Freedom Financial Management launched their fund in June 2016. They started with $30 million of their own capital and then raised additional money with insurance companies.
“We have $170 million total assets today,” Toms said.
Kott said Cross River Bank is asking whether they should set up a fund or pursue securitization, so they don’t have one now.
One of the advantages to an online lender having a fund, according to Vetter, is proprietary deal flow to invest in.
If loan originators do set up a fund, one of the questions they’ll have to ask is, What is the right structure?
“At the end of the day,” Bernstein said, “you have to look forward and ask yourself how big you want to scale. There are a number of different scales of gray.”
Goldman said there is a timing element involved, as well.
“How does the originator want to view themselves?” he asked. “You want the loan to come off the platform in a real-time basis. You want it capital light.” Originators have to decide if they want to be balance sheet-light or balance sheet-intensive.
Toms compared the alpha approach to the index approach and noted that alpha is more risky.
“You have to understand the different risks,” he said.
Goldman added that knowing the right allocation is important while Kott pointed out that each finance source has its own idiosyncrasies. Therefore, diversification is important.
“What it all comes down to,” he said, “is it’s an optimization game. You have to make sure you have the financing that allows you to originate all the loans that borrowers want. You have to be flexible and diversified in how you price assets.”
Toms noted the risk to investors.
“You now have a different risk,” he said. “How is the originator allocating assets, and are they doing it in such a way to alleviate risk?” He said Freedom Financial Management doesn’t let people pick products off the shelf. “We buy our own cooking. What we offer is what you get.” Off-the-shelf assets involve more risk and more problems, he said.