
Earnest, Fueled by Growth in Student Loans, Raises $275M - jrkelly
http://bits.blogs.nytimes.com/2015/11/17/earnest-fueled-by-growth-in-student-loans-raises-275-million/
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zaroth
Their key differentiation? "Earnest says its approach is particularly data-
intensive, which it says allows it to tailor rates to individual
circumstances. It asks its customers for digital links to their bank, credit
card and retirement and investment accounts, and information on all their
loans. “They are willing to share their data for a better consumer finance
experience,” Mr. Beryl said."

Apparently they found recent grads with very large student debt load but
commensurately high future earning potential had inaccurately low credit
scores. Bypassing the credit agencies and doing their own scoring let them
offer more competitive rates to that segment in particular, whose big loans
probably carry a lucrative underwriting fee, not to mention bigger savings for
every basis point you can shave off.

Interestingly they are underwriting as well as servicing ("Earnest will never
pass you off to a Third-Party Servicer") which I see as a huge selling point.
I wonder how hard it was to get the Federal approval for that?

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7Figures2Commas
> Apparently they found recent grads with very large student debt load but
> commensurately high future earning potential had inaccurately low credit
> scores.

Credit scores measure the risk of future default based on past borrowing
behavior. A borrower's credit score is _not_ "inaccurately low" if there is
little to no past borrowing behavior to apply the credit scoring model to.

Lenders can and frequently do take into account criteria other than credit
score, such as income, when underwriting loans. In some lending markets
(mostly commercial), individual consumer credit scores aren't even used.

That Earnest and other upstart lenders are choosing to more heavily weigh
factors other than credit score is not particularly interesting. The true test
of their underwriting criteria will come in the next down cycle. Having worked
in this space, I should point out that there are many consumers with high
incomes (or high earning potential) who are vulnerable. As such, I'd suggest
that income and earning potential _alone_ are of limited use in underwriting.
It's not uncommon to see borrowers with high incomes who also have very low
credit scores because they were over-leveraged and had serious negative credit
events occur.

~~~
zaroth
I assume as they are getting outside funding, someone has vetted their
underwriting models and loan population. I was curious to learn more about
their sources of funds, number of current employees, i.e. fund performance,
unfortunately nothing written here.

They are mining more information and winning a lower rate for it. To that end
they are succeeding. Without understanding the source of funds, and any
guarantees they are making, it's important that they provide long-term durable
ROI to justify the lower rates.

If they get the lower default rate they are paying for, then Earnest has
created a superior product. Their default rate doesn't and shouldn't have to
be zero, but I would be afraid of trying to make up on bad underwriting with
poor servicing tactics. I hope both centers are striving to be excellent at
their respective jobs.

Since default rates on these loans is high and rising, there is a strong
incentive to lower it. If default rates were consistently low, paying more for
a marginal additional reduction wouldn't be worthwhile. When default rates are
trending higher, I believe you need exponentially higher interest rates in
order to break even.

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bradleyjg
Graduate loan rates not too long ago were 6.8% for Stafford and 8.5% for Grad
PLUS, regardless of the underlying interest rate environment. But starting in
the September 2014 school year the law was changed to charge a fixed margin
over the 10 year rate -- 3.6% for graduate Stafford loans and 4.6% for
graduate PLUS loans. I don't know what rate Earnest is borrowing at, but AA
rated 10 year corporates are yielding just about 3%. That leaves somewhere
between 60 and 160 basis points to make their profit. Even if their
underwriting is near perfect, there are still servicing costs.

Certainly that's enough of a spread to make money, but it doesn't seem like
some huge opportunity. FWIW I scratch my head for the same reason about
mortgages given the narrow spreads, but there companies don't actually plan on
holding the loans on their books (most end up on some set of government books
in recent years). So that's more of a services volume business than it is an
underwriting one.

Edit: I just re-read this and I made a mistake. The 3.6 and 4.6 are above the
10 year treasury which is around 2.3. So the spread between the AA rate and
the loan is 290 to 390 bps not 60 to 160. A considerably better situation.

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mbesto
> In this round, $75 million is equity investment, and $200 million is debt
> funding.

Before people read the headline and think "OMG another big one", this line is
important. They are raising $75MM for the company and $200MM for the actual
financing of the loans.

For anyone not familiar with SoFi (the main competitor), this model makes a
ton of sense. Student loan terms do not take into consideration your future
earnings based on what school you attend. Which means someone who goes to
Harvard could have the same student loan structure as someone who goes to Foo
State College. This is simple arbitrage.

