In March of this year it was reported that total outstanding student loan debt in this country had topped $1 trillion for the first time. More students are taking on more debt than ever before. Even for those who qualify for federally subsidized programs, the debt burden can be immense. Enter SoFi (short for Social Finance). They are bringing a hybrid p2p lending model to student loans and are already making a big impact.
Recently I chatted with Dan Macklin, co-founder and VP of Business Development at SoFi, about his company and how they are changing the student loan business.
Why did you start SoFi?
The original intent was to offer new ways to provide financing within trusted communities. With the rise of Lending Club and Prosper it is clear that there are new ways to do things. And we felt the student loan market was in desperate need of some innovation. The advantage of student loans is that there is already an existing affinity between the students and alumni communities.
Like p2p lending it is designed to be a win-win for both sides. The students get a better loan rate and the investors get a market rate of return. Unlike p2p lending borrowers also get connections and potential mentorship from a group of alumni that could be beneficial to them if they choose to pursue it. Fundamentally, though, borrowers get a good interest rate saving them on average $9,500 over the life of their loan.
I read that you raised $77 million in equity financing which is quite an achievement in itself. How is that money being used?
It has allowed us to be aggressive in our hiring; we now have high quality senior staff with extensive experience in the financial services and student loan industry. This includes Rob Lavet, previously general counsel at Sallie Mae who obviously has a great deal of student loan experience. Another key hire has been Nino Fanlo, our Chief Financial Officer who was the former CEO of KKR Financial and Treasurer of Wells Fargo. We also recently hired Chris Lalli, a 25-year veteran of Goldman Sachs to head up our institutional sales team.
What kind of loan volume are you doing today?
We started off with a small pilot program at Stanford University last year. We funded 100 students at an average of $20,000 in loans per student. The $2 million was funded by 40 Stanford alumni investing an average of $50,000 each.
We launched in 40 schools in July of this year and we’ve now expanded to 79 schools and have processed $110 million in loans. We are on a current run rate of around $25 million per month and we expect to lend over $500 million in 2013.
That is very impressive growth. Obviously students are very open to your offering. What interest rates do the students pay?
I should make it clear that the most of our borrowers are recent graduates. These people have jobs, typically good paying jobs, so they are a better risk than the average borrower. Once they graduate they pay 5.99%, if they are in school the rate is typically 6.49%.
How does your funding actually work? Do you give the borrower the money or does it go directly to their school?
No money ever goes directly to the borrowers. We have two kinds of loans. One is the refinancing (refi) loan that pays off existing debt that may be in several places. We pay their existing loan providers directly whether that is a government loan or from a private lender. So the borrower is simply swapping out debt paid to their existing loan providers often with rates over 7% for a SoFi loan at 5.99%.
The other kind of loan is an in-school loan to existing students. Here we distribute the loan through the financial aid office of the respective schools. This helps prevent fraud because the school verifies that the borrower is a student at the school. In this way, too, the school can then directly apply the loan to the tuition without the student taking direct possession of the money.
Some student loans can easily get into six figures so what is your average loan size?
For the refi loans the average loan size is $85,000. For the in-school loans the average is around $40,000 – keeping in mind that universities will only let you borrow one year of tuition at a time.
Can you give us an idea of what kind of person is a typical borrower?
We are focusing to begin with on some of the lower risk areas of the market. Our loans are primarily to MBA students or recent graduates of MBA programs.
For MBA graduates these people are typically 28-31 years old, they have an average salary of $125,000 and an average FICO score of 740. These recent graduates make up 80% of our loan book. For our in-school loans the typical age of the borrower is 27-29 years of age. They are usually earning no income while they are in school but they tend to have a good earning history from previous jobs. These people do not have to make any payments while they are in school and there is a six-month grace period after graduation.
How does this work from the investor side? Do investors pick and choose their borrowers like they would on Lending Club and Prosper?
No. It is very different at SoFi. First, the investment is only available to accredited investors right now. Second, the investors cannot decide who gets their money. There is a private placement fund for each school and it is this fund that provides the loans. Investors decide whether they want to support the students from their alma mater but they don’t get to pick and choose which individuals get their money. SoFi takes the money in the funds and distributes it among all the students who qualify for a loan from each respective school.
What return can a typical investor expect?
As I said the interest rate the borrower pays is 5.99% for our refinancing loans that make up the bulk of our portfolio. After SoFi’s management fees and an expected conservative level of leverage, investors should expect to end up with a mid single-digit return.
What about attracting regular investors? Most of the alumni in your target schools would not be accredited investors?
Very true. With the JOBS Act we think there will be less restrictions on how we can operate. We are following the developments of this legislation very closely so when the SEC implements the rules we hope to be able to promote our offering to non-accredited investors as well.
I know you are just getting started but where are you hoping to take this company? What is the master plan for SoFi?
We believe that the student loan market is a great place for SoFi to start but we don’t see any reason why it should end with student loans. Within a couple of years we will have built up a very healthy client base of borrowers, primarily recent business school graduates working for some of the best companies in the country. Additionally we will have a large number of investor clients who are successful alumni. We have a lot of ideas for different types of products that can be marketed to this customer base.