The student loan market is big. In fact at over $1 trillion in outstanding debt, student lending is bigger than credit cards. And it is ripe for disruption, at least according to David Klein, CEO and co-founder of CommonBond.
CommonBond is a new kind of platform that connects student borrowers with lenders. These lenders, often alumni, provide financing for students at lower rates than the students can get elsewhere.
This week CommonBond announced that they have closed on a $100+ million funding round from such financial heavyweights as Vikram Pandit, former CEO of Citigroup, Thomas Glocer, former CEO of Thomson Reuters and Thomas Kalaris, former head of wealth management at Barclays. The funding was for debt and equity but Klein would not comment on the breakdown when I spoke with him earlier this week other than to say $100 million would be going to directly fund student loans over the next 6-12 months.
The Birth of a Business
The idea for CommonBond germinated right after Klein was accepted in to the Wharton School MBA program at the University of Pennsylvania in 2011. He did some research and found that private and government loans topped 8% fixed for even the most creditworthy students. Some bank loans were even higher. Then he was chatting with some fellow students who felt this had to change. So, being enterprising business students they decided to tackle the problem head on.
Klein wrote a business plan for an online student loan company in one of his classes. Then last year he and co-founder Mike Taormina spent their entire summer developing their business. In the fall they dropped out of school, launched CommonBond and quickly raised $3.5 million – $2.5 million from alumni to invest in student loans and then $1 million for operations.
Of course, it made sense to start their loan program at Wharton. With all their connections they were easily able to find their first round of students willing to sign on. They are accepting only MBA students initially because these students typically have some credit history as well as high earning potential and therefore the lowest potential default rate.
CommonBond is not just focused on existing MBA students. They are actually more focused on graduates, which accounts for 90% of the total student loan debt. Most MBA grads are paying either 6.8% or 7.9% on their student loans and taking into account origination fees this represents an average APR of around 8%.
For graduates looking to refinance, if they pass CommonBond’s underwriting standards, they will pay 5.99% with no origination fee. Current students pay 6.24% with a 2% origination fee. These are fixed 10-year loans but the average payback is expected to be just 7 years.
As I said above CommonBond raised $2.5 million from investors late last year and that has all been invested in student loans. So how is this portfolio performing? Even though they are only 6-8 months in to the portfolio seasoning Klein was happy to report that every single student loan, all $2.5 million, is current – they have had zero delinquencies and zero defaults.
The CommonBond Promise
While Klein is very focused on executing on his business plan he emphasized that CommonBond is about far more than providing less expensive student loans. He believes they have two missions that are equally important.
CommonBond is built around a social promise. This promise is both global and local. For every degree funded on their program they are funding a degree for someone in need abroad. Their local social promise is funding financial literacy at schools in their Philadelphia community. They have launched a program at the KIPP charter school in Philadelphia where the students in their loan program teach kids about financial literacy.
Student community is also very important to CommonBond. They want to proactively connect students with alumni and accomplished professionals. They do this by regularly hosting happy hours and events where students can mingle with some of the very people who are helping to fund their education.
The Investor Side of the Equation
After raising over $100 million I asked Klein whether that means they are no longer looking for investors. His answer was that the platform remains open to capital. He wants to put this $100 million to work relatively quickly and so is always open to more investors.
This much is clear. CommonBond is offering investors modest returns when compared to what many investors earn at Lending Club and Prosper. The expected returns will be between 4-6% but as Klein pointed out these are very low risk borrowers with high incomes and high credit scores.
Right now CommonBond is open to accredited investors and you don’t have to be an alumni to invest. Investors do not pick individual loans as they do in p2p lending; instead investor money is pooled together and then loaned to the students.
They are also looking beyond individual investors to a range of institutional investors including hedge funds, family office and pension funds.
While they only launched in December last year, this new funding will allow for some rapid expansion. They have already gone from the one MBA program at Wharton to 20 MBA programs. This number will be expanded in 2014. And they are looking to move beyond just business students and into engineering, law and medical students.
CommonBond are not alone in this market. The industry leader, SoFi, is expected to originate as much as $1 billion in new loans this year to graduates from about 100 schools. But with this new funding CommonBond is clearly entrenched now as the second largest player.
Plenty of Room to Grow
With a 4-6% return on offer CommonBond is not going to be flooded with investors moving over from Lending Club and Prosper. Klein said CommonBond is for investors looking to diversify the more conservative portion of their portfolio.
We all know there is a big market here. Total outstanding student loans continue to grow with each new graduating class. With this huge potential it will be very interesting to see how this plays out for CommonBond. There is no question that education funding could use some innovation. Maybe one day, probably in the distant future, most student loans will be funded this way.
Peter Renton is the chairman and co-founder of Fintech Nexus, the world’s largest digital media company focused on fintech. Peter has been writing about fintech since 2010 and he is the author and creator of the Fintech One-on-One Podcast, the first and longest-running fintech interview series.