Recently, our CEO and co-founder David Klein was interviewed by LendEDU's Andrew Rombach regarding CommonBond and student lending at large. David spoke about the creation of CommonBond, how government policy and mergers and acquisitions stand to affect the industry, and the overall future of borrowing and lending.
This interview originally appeared on LendEDU.
Q. What was your original inspiration for starting CommonBond?
A: The inspiration in starting CommonBond was from an experience that was pretty personal. I spent some time in corporate America and decided to finally go back to business school. I had to pay 100% of my way with student loans.
I realized three things. One, student loan interest rates were very high. Two, the process to get a student loan was quite complex. Three, the service was pretty poor among the traditional incumbents. So, I thought: Wow, this seems like a pretty broken system. So, I took all these together – my personal pain from trying to get my student loans, my background in finance, and my entrepreneurial ambition – and said this is what I'm going to dedicate myself to.
I saw there was room to give more value to both sides of the student loan market. Students were being charged high rates – about 8% fixed at the time, and investors were receiving pretty low credit yields in the credit market at say 2%. Lowering the interest rate for students and grads and increasing the returns for investors while earning a profit in between on a pairing platform that was really the genesis of CommonBond.
Q: You were going to school for an MBA when you decided to leave. Was it a tough decision to leave school?
A: It's interesting because when I went to business school, I did not have plans of dropping out. I actually had plans of building a company up to a point where I would have the luxury to work on it full-time upon graduating. As it turned out, based on what we had built after that first year in school, we had enough momentum that it seemed dropping out was the right thing to do in order to breath the appropriate life into the company. So that's what I ended up doing – I decided to drop out of business school between my first and second year to continue to focus on CommonBond full-time. The rest as they say is history.
Q: Earlier you mentioned you wanted to take a different approach while creating value on both sides. Could you elaborate more on how CommonBond differentiated itself from the incumbent competition?
A: What we ended up doing – the reason why we were able to exist as a company was we leveraged data and technology in a way that the incumbents didn't. We were therefore better able to underwrite, evaluate risk, and ultimately provide lower interest rates than the federal government and private banks.
Private banks tend to charge a higher premium and margin than we do. We think in part because their cost basis is inherently higher than ours. If you're a bank and you have a branch network, you have to spend a significant amount of money to maintain that network. Our unit economics are different. We don't have to pay as much to operate as a large, legacy financial services firm does, and we're able to pass on those savings to the borrower.
So I'd say two things really differentiated us and allowed us to come to market: One, data and technology to better underwrite and two, a less burdensome cost structure that passes on more savings to our customers than traditional incumbents.
Q: Was it hard to pitch this idea at the time?
A: When you pitch anything new to consumers that just makes a ton of sense, it can be a relatively straight-forward communication. However, when you pitch something new to investors, it tends to be a little less frictionless.
There's an interesting paradox that happens with investors. Investors are paid to find new opportunities and take on risk in order to get a return, but they also tend to be risk-averse. One strategy we had to figure out early on was how to navigate this apparent investor paradox.
Student Debt, Federal Policy, and the Private Market
Q: Today as you know, the US student loan debt total is over $1.4 trillion, depending on the sources. In the next 5 years, do you think that outstanding student loan debt is going to increase or decrease?
A: Yes, the projections all seem pretty clear on this. The amount of student debt will increase. In fact, it's expected to be around $2 trillion outstanding by 2020. We'll see whether it reaches $2 trillion, or whether it surpasses $2 trillion by the time we get to 2020. But I think given the fundamentals of A) the rising cost of tuition and B) more and more people going back to school – we'll continue to see a rising outstanding student debt load in the US.
Q: Over the next 10 years, do you think the private student loan market will become more or less significant compared to federal student loans?
A: If you believe in the status quo, then you'll probably see a similar private-federal student loan breakdown of debt in the market.
If, however, you believe that some of the new policies that have been proposed in Congress end up passing, I think what you could see is actually the mix of federal and private loans shifting a little more towards private student loans.
There's an act in Congress right now called the PROSPER Act that is looking to do a few different things with education finance. One such policy is a cap or limit on student loans offered by the federal government to graduate students or parents. If the federal government passes this, then one of three things might happen. One, people will simply go to less expensive schools. Two, people will go to the same schools, but will simply borrow more from the private sector with limited federal financing. Three, there'll be some combination of both. The bill is in the early stages, but it's something we're monitoring closely.
Q: Following up on federal policy's impact on private student loans, but how would federal policy impact the student loan refinancing business?
A: While it's still too early to tell what the final PROSPER Act will look like, I would point to another part of the bill where there might be effects on the refinancing market: limiting income-based repayment programs. If students no longer have access to that pretty neat protection, it might lead them to think about refinancing more than they would have. It's through refinancing where you'll likely save a significant amount of money. So, if that particular protection is gone, then there are going to be folks who find that refinancing makes sense for them.
Q: To cap it off, in your opinion, do you think we'll see a move towards privatizing the market fully in the next decade?
A: It's a good question. And if I told you I knew the answer, I would be lying. While I do not know the answer to that question, what I do know is that there is a private sector for student loans today, and there's a federal government student loan program at the same time. If you're looking to see a change, the current momentum is actually geared towards those changes in the federal government system. With that, you could see the mix of student loans increase on the private side relative to the federal government side. All of that being said, it's important to note that today, the current mix of student loans is about 92% - 8%. So 92% of all newly originated loans are government loans, and 8% are private loans.
Q: Do you think that privatizing the market would be good for CommonBond? How would CommonBond react to privatization?
A: Again, here it depends on what you believe. If you privatize, or more likely cap federal financial aid, then you would see students and families either going to less expensive schools or you might see students and families decide to forego school or a graduate degree. Or, you might find they're still going to the same schools, but they're looking for financing elsewhere.
To the extent that the latter case happens, the market for private student loans would increase. If the market for private student loans increases, it would mean CommonBond operating in a larger market.
To that extent, we would be sure to maintain a customer-first focus by ensuring that our product is easy to manage, transparent, and saves customers a good amount of money. CommonBond is at the ready to create better experiences and healthier bank accounts for people with student debt.
M&A Activity in the Student Loan Space
Q: So competing refinancing company, Earnest, was recently acquired in the student loan space. Can you foresee additional acquisitions or consolidations occurring in the next couple years in the student loan space?
A: I wouldn't be surprised if M&A (merger and acquisition) activity continued in the broader fintech space, independent of student loans.
In the broader finance space, you have the traditional incumbents and the newly formed fintechs operating. As the fintechs are becoming more mature, the banks are becoming more aware and educated about the possible benefits that fintechs could bring to their franchises and customers. Banks and fintechs both bring different advantages to the table; if we brought them together, it would make finance better for the consumer in the end.
For example, big banks have a really low cost of capital, and they also have channel access to millions of customers. While at the same time, fintechs excel at customer engagement, and we're able to acquire customers and operate for a fraction of the cost compared to banks. On top of that, the quality of a fintech customer has proven to be quite strong relative to traditional incumbents. The service fintechs provide tends to be significantly better, and the technology built from the ground up is new and sleek.
So, I think we'll continue to see partnerships between fintechs and banks, if not additional M&A activity, in the months and years ahead.
Q: Since we're on the topic of customer service and mergers, do you think the consolidation of federal student loan servicers would be good or bad for consumers?
A: As a general matter, more consumer options can be important for consumers to determine what works best for them. I can understand what the federal government wants to do in terms of consolidating federal servicers into one.
From an internal management perspective, it might have been easier to manage. After all, it will be easier to manage one vendor instead of 4, 5, 6, or 7 – generally speaking. So I get that. But, you want to be cautious and conscientious when you consolidate the number of vendors because you don't want to do it at the cost of the consumer.
Sometimes you have to make that call, but you should be thoughtful about what the cost is to the consumer versus the cost to you. I would hope that the people making those decisions are thinking about the consumer more than themselves.
That's how we operate. If I was projecting, that's how I would suggest that others operate whether we're talking about the federal government or anyone else. In short, I think consumer choice is ultimately a good thing, and I think market competition is ultimately a good thing for consumers.
Looking Forward in 2018 and 2019
Q: Does CommonBond plan on launching any new products in 2018 or 2019?
A: Moving forward, we have a real opportunity to follow our customer over time and offer financial products and services that meet their needs as they evolve.
Within education finance, we started as a refinance company and then broadened out to an in-school financing company as well as an employer platform with a suite of benefits. We'll continue to build out those three main businesses lines of refi, in-school, and employer platform.
Additionally, we'll continue to be thoughtful about what our next product is. The good news is we have the option value to decide what new products we want to come out with next - whether it's education finance, outside of education finance, a lending product, or an asset-based product.
As I look out on the horizon and think about our long term growth and value, I absolutely see us following our customer, who's at the relative beginning of their customer life cycle now. I see us following that customer over time with other financial products and services that meet their needs in the same way as education finance – meaning save money, provide best-in-class customer service, and offer technology that simplifies and speeds up the experience in a way that is unrivaled in the space.