The success of the fintech industry is usually based on how disruptive (and how good) these companies’ services are, compared to conventional financial market options like a bank. So why are some fintechs looking to become more like a bank? Some are even trying to get a formal banking charter.

The OCC

Office of the Comptroller of the Currency   The Office of the Comptroller of the Currency (OCC) is the agency that issues bank charters in the US. In December 2016, the OCC wrote a white paper that called for a Special Purpose National Bank Charter for Fintech companies. Many public comments, including from the director of the Marketplace Lending Association, are adding to the conversation. The comments provide much additional insight on how different players in the market feel about the idea of a national charter for fintech companies. The first question that comes to mind is: ‘If fintech firms are beating conventional banks by doing it their own way, then why would they want to be more like a bank?’

Fintech Regulation

Major US Financial Regulators And Organizations

Prudential Bank RegulatorsSecurities and Derivatives RegulatorsOther RegulatorsCoordinating Forum
Office of the Comptroller of the Currency (OCC)Securities and Exchange Commission (SEC)Federal Housing Finance Agency (FHFA)Financial Stability Oversight Council (FSOC)
Federal Deposit Insurance Corporation (FDIC) Commodities Futures Trading Commission (CFTC)Consumer Financial Protection Bureau (CFPB)Federal Financial Institutions Examinations Council (FFIEC)
National Credit Union Administration (NCUA)Financial Industry Regulatory Authority (FINRA)Financial Crimes Enforcement Network (FINCEN) (Department of the US Treasury)President's Working Group on Capital Markets (PWG)
Federal Reserve Board (the Fed/FRB)
Fintech firms have, at best, an uncertain regulatory environment. Any and all of the agencies listed above could impact a fintech firm. A marketplace lender like Lending Club has to deal with securities laws on the investing/funding side of its business, while also dealing with consumer lending and CFPB regulation on the borrower side, including state-by-state licensing as a lender. The state-by-state issue is a primary sticking point as to why so few business lending platforms and virtually no mortgage or auto lending platforms in marketplace lending exist today. Despite the fact that more regulation isn’t typically better, in some cases, the fintech firms see the value of having more regulation in return for having a very clear path of what rules and regs need to be followed. One regulatory area that this charter streamlines for fintech firms is around the need to get licensed in each state where they do business. A national set of rules, as opposed to state-by-state rules, would provide a huge benefit by providing clarity and creating a more streamlined process for the fintech firms to follow. Better regulatory understanding is not the only reason why a fintech might get a charter.

Not Just Lenders Applying for Charter

One of the largest and best-known marketplace lenders, SoFi, a student loan refinancing platform, applied for a bank charter in June. They chose the Utah Industrial Bank charter, which is common with some credit card companies and equipment finance companies. The Utah Industrial Bank charter allows companies like SoFi to accept FDIC-insured deposits that would bring their costs of capital down dramatically, along with the regulatory clarity they seek. One of the more interesting potential uses of the specialty fintech charter comes from Varo Money. Varo is a startup in the mobile banking space who applied for the OCC charter in July, as reported on TechCrunch. Varo is a mobile-only banking product to set up checking accounts, bill pay or other everyday banking and cash management features in a mobile-only environment. How could a charter possibly benefit Varo? Two ways:
  1. They would be on an even regulatory footing with their competitors
  2. They want to become a bank themselves sometime in the future, per the article
This charter and policy change for fintech firms is controversial and has plenty of critics.

Strong Opposition

Thomas Curry, who was running the OCC in 2016, was very much in favor of fintech firms going in this direction. The current Acting OCC Keith Noreika is on board as well from one of his recent speeches. The most intense opposition comes from state bank regulators and most notably the NYDFS. State regulators think the OCC has overstepped its authority and they filed suit in late April. American Banker has some excellent coverage on this situation, explaining how it came about and why, which is mainly based on the idea that state regulators are more likely to enact and enforce consumer protections. Nothing has happened with the suit yet, and not much has happened with the two fintech charter bank applications either. We are all waiting to see if the charters get approved, how the suit moves forward, and if this leads to a new direction for fintech firms in the US.   Rising Rates   As of the printing of this article the Federal Reserve had raised its benchmark lending rate a quarter point. There are an additional two rate hikes projected by most analysts for 2017. While the increased rate hike is an indicator of a strengthening economy, what do higher interest rates augur for commercial real estate investment trends and how do investors evaluate the rate hike vis a vis their investment portfolios? Here are a few subplots as interest rates march upward. Rates rise in response to good news. It’s important to keep in mind that the anticipated rate hikes are in response to sustained GDP growth, improved consumer confidence, healthy job creation forecasts, and employment settling at or near capacity levels. After moving cautiously for years, the Fed’s hints of rate hikes mean a robust conviction that the economy has made a full recovery, and is operating at or near productive capacity. From this standpoint, CRE investors should not be too disheartened by looming rate hikes; strong rental housing demand, a healthy retail sector, and stimulus in manufacturing should help grow demand for all types of commercial real estate. An eye toward secondary markets. As Fed Chairman Janet Yellen noted during her February meeting with the Open Market Committee in February, there are some concerns of frothiness in high-density core markets, where inpouring of foreign investment and a glut of supply continue to compress cap rates. With a rising cost of debt capital, it may become more critical than ever to pursue opportunities in non-gateway cities. Fortunately, there are a handful of secondary markets – such as Austin, Denver, and Seattle – experiencing above-average overall population growth, driven by an influx of millennial professionals who will drive multifamily, retail, and office demand for the foreseeable future. Watch for Movements in the Regulatory Environment. With Republicans in control of the executive and legislative branches, the future of several Dodd-Frank-era regulations are in question. In particular, the rule requiring commercial mortgage-backed security issuers to retain five percent of the credit risk on issued securities. Should this rule stand, traditional lenders may be constrained, compounding the increased cost of debt capital stemming from rising rates. This could expand opportunity for hard money lenders and yield more margin opportunities for real estate crowdfunding platforms and their investors. With higher interest rates, inflation becomes a wildcard. While rising rates typically have the eventual effect of tempering inflation, it’s likely that the underlying growth and consumer confidence driving the Fed’s decision will also mean higher rates of inflation in the short and medium term – growth and a relatively high velocity of money should push prices up in the short term before monetary policy reins in growth and inflation. CRE investors should keep a close eye on price movements. Managers should be ready, able, and willing to push rents upward in response to rising interest rates and inflation. Flat long term leases are suboptimal in this environment, and won’t create as much value on a relative basis. What About Cap Rates? There’s a common misperception that cap rates and interest rates move in lockstep – in other words, that rising interest rates will have a negative effect on pricing and increase cap rates, ceteris paribus. While it’s true that cap rates and interest rates (using 10 year treasury yields as a proxy) show a modest correlation of 0.7, correlation does not imply causation – cap rates are influenced by a wider network of variables beyond interest rates, including real estate market fundamentals, investor appetite for risk, and capital flows. NPI transaction cap rate and U.S. 10-year Treasury yields   The more critical takeaway is that any corresponding increase in cap rates stemming from an interest rate hike (as consequence of increased cost of capital) is likely to be mitigated over time. The effect of an increased “exit cap rate” on return diminishes over time, as the compounding effect of net operating income (NOI) carries more weight. This is all to say that rising interest rates may have some impact on cap rates, but it should not be substantial in the long run – investors can protect themselves against the risk of rising cap rates by pursuing longer-hold projects. IRR differentials for 4 exit cap rate scenarios  

Conclusion

For investors in online real estate (crowdfunding) platforms, the chief consideration should be whether the platform’s real estate team is considering these factors, and whether the originators behind the platform’s constituent projects have experience through business cycles, and can make wise investments and management decisions in a fluid interest rate and regulatory environment.   About the author: EquityMultiple EQUITYMULTIPLE is an online marketplace for private real estate transactions. It enables individual and institutional investors to invest alongside the market’s most sophisticated sponsors in many commercial real estate assets. EQUITYMULTIPLE was launched in February 2015 and is based in New York, United States. back to top