Mike Cagney launches blockchain for loan trading. Are the banks going to do it?

Online lending startup Figure, led by former SoFi CEO Mike Cagney, is launching a blockchain-based marketplace for buying and selling consumer loans.

The idea is to provide transparency, proof of loan performance, provenance (in other words, reliable information about who owned or owns an asset at any given time), reduced costs and audits. easier for buyers and sellers of loans with distributed ledger technology.

All of these things were missing in the mortgage crisis of 2008: Investors in secured debt securities (especially mortgage-backed securities) knew little about the quality of the underlying loans or whether borrowers were repaying them .

If a blockchain like Figure’s had been in place in the days leading up to the mortgage crisis, it might have helped avoid some of the problems that arose, according to Sheila Bair, who was president of the Federal Deposit Insurance Corp. at the time. She is now a member of the Advisory Board of Figure.

“This private label securitization market would have been held back a bit,” Bair said. “There would have been better transparency on the quality of the mortgages included in the securitizations, so that investors would have better known what they were investing in and could have exercised independent judgment. “

As the crisis progressed, the search for property became a “terrible problem” that contributed to the bot signing scandal, according to Bair. “They were just signing bots and saying they had the right to shut down when in reality there wasn’t a good chain of titles,” she said. “The blockchain provides that.”

Investors have relied on due diligence companies who have reviewed loan samples in a pool and rating agencies who have based their ratings on models rather than knowledge of the underlying quality of individual loans.

The record keeping that the FDIC was able to get hold of at the time was “pretty lousy, very sloppy,” she said.

Checking loan facts

Figure’s blockchain, called Provenance, is based on Hyperledger Fabric. Blythe Masters, the former CEO of Digital Asset Holdings, which built a blockchain for the Australian Stock Exchange, helped design the system alongside June Ou, co-founder of Figure and wife of Cagney, who manages the products and technology of the company.

It validates the underlying details of a loan by going straight to the source.

Companies that provide validation documents submit data about them and digitally validate that data. Experian signs credit reports, for example. CoreLogic signs the title reports.

“We are massively reducing the friction that exists in traditional markets and introducing something that can literally trade in real time, where you have confidence in what you are buying or selling,” Figure CEO Mike Cagney said at About the company’s new blockchain marketplace for loans.

“The originator of the loan does not have to declare that this is real data,” Cagney said. “It is signed by the data provider.”

For each transaction, a smart contract is created and hosted on the blockchain that tests loans against specific underwriting standards, including FICO score minimums, loan-to-value limits, and debt-to-income limits.

The smart contract will flag any loans that do not meet the criteria. For example, if a buyer demands a minimum FICO score of 680 and a borrower’s score behind one of the loans in a package is 675, the smart contract will identify this exception.

“We are massively reducing the friction that exists in traditional markets and introducing something that can literally trade in real time, where you have confidence in what you are buying or selling,” Cagney said. “You need to review the smart contract and make sure it reflects your underwriting policy, but you only need to review it once instead of having to review each loan. ”

Blockchain can eliminate the need for a custodian, Cagney said. “This cuts down on the associated audit quality control expense and provides a means of certainty as to what you have,” he said.

Once a loan changes hands, all additional payments on the loan go to its new buyer.

“It’s super powerful because traditionally, to negotiate a loan pool, you send a loan page, you do your due diligence, you move a whole bunch of loan packages, one custodian has to deliver to another custodian.” , Cagney said. “In the over-the-counter market, it can take a hundred days to settle a pool of loans. And here you can do it in real time.

Be the guinea pig

When Cagney first launched Figure in 2018, after he left SoFi the previous year amid allegations of sexual harassment which made headlines, he approached several banks with the idea of ​​a blockchain for loans. They weren’t ready for this.

“We went to a bunch of banks and said to them, we think this is going to transform whatever you do,” Cagney said. “And they said, eh, maybe, maybe not. Our stuff is working well.

So Figure launched its direct-to-consumer lending business to prove that the technology works and to force loan buyers to start using it.

Figure began creating home equity lines of credit in October 2018. Since then, the company has issued over $ 1 billion in HELOCs. It also issues first mortgages and unsecured student loans. It also plans to make other loans.

In March, Figure completed its first securitization entirely on the blockchain. The figure is the origin of the loans. Jefferies Group was the structuring agent, primary underwriter and warehouse supplier. Nomura Securities was the primary underwriter. Tilden Park Capital was the funder and buyer of the subordinated notes and a large anonymous asset manager was the senior buyer of notes.

Figure now sells all of its loans on its own marketplace. Asset managers and banks buy the loans and hold them, or buy the loans and then sell the stake to other banks and credit unions. Some buy back the loans, consolidate them and securitize them on the blockchain.

“The idea is to create something where an originator can push a loan into a market and let people bid on it, make a transaction and repackage it, whether in the form of selling it as a stake in it. another bank or credit union or fund, whether it’s packing and selling a bigger pool or a smaller pool of assets, “Cagney said.” And everyone has the information . Everyone sees where loans are traded. Everyone sees the performance of assets. “

The real-time nature of Provenance is important, Cagney said. Mortgage title service provider reports that loan buyers tend to rely on are typically 30 to 60 days out of date.

During the pandemic and the resulting postponements and abstentions on consumer loans, “the challenge everyone had is that no one wanted to buy these securities, unknowingly it’s 5% of the pool in forbearance. , is it 10%, is it 20%? ” said Cagney. “Because of the way we leverage blockchain, we provide real-time visibility into the performance of the asset. So if it’s 2:08 am today in California, I can go on and see everyone who paid me as of 2:08 am.

Will banks accept blockchain?

Today, more than 30 buy-side companies and banks are working with Figure, Cagney said.

“Building this market on Provenance will transform the speed and efficiency of delivering liquidity to the lending industry,” said Chad Carrigan, vice president of full loan acquisition at First National Bank of America. “Figure continues to drive innovation in the financial services industry, which helps investors create new value in liquidity markets. “

Without knowing the details of what Figure is unveiling today, industry watchers have said the concept has value.

“Given all the inefficiency of multiple transfers, value swaps, third-party certifications, and delays built into mortgages today, blockchain smart contract functionality through a non-centralized distributed ledger could streamline the process,” he said. said Mark Parsells, Managing Partner of Montpelier Ventures. “Instead of letting people touch the mortgage, the blockchain can update transfers automatically as they occur. The record is transparent, immutable and traceable.”

Banking is a competitive business, and what has stopped many financial blockchain projects in the past is the reluctance of financial companies to let competitors see their customer and transaction information and allow a rival to ‘have control over any aspect of their business.

The Provenance de Figure blockchain is no exception.

“There is a huge sensitivity around this,” admitted Cagney. “The key is that we don’t have control or access to the data.”

He pointed out that the blockchain is decentralized. Currently, there are 12 “nodes” on the blockchain that are managed by independent stakeholders including Franklin Templeton, Experian Information Solutions, Colchis Cascade Management, LS Technology Solutions, and Passport Digital Currency Fund.

“What that means is that there’s no one who owns it,” Cagney said. “If you wanted to write something on Provenance today, you can get the SDKs and do it. I can’t stop you. I can’t start you. I don’t see what you did.

The technology will now have to prove itself, Bair said.

“It’s a very good application of blockchain technology,” she said. “It directly solves many of the problems we’ve seen in technology before. This is happening, so banks need to prepare for it and take advantage of it as best they can and change their business models as they intended to do. If it’s a better mousetrap, if it cuts costs, if it’s more precise, it can contribute to transparency and greater market discipline. These are all good things that everyone should be encouraging.

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