The ILC is the Future and Present of Big Fintech

Most of us in fintech got excited about the OCC fintech charter. It is a special purpose national banking charter for fintechs to use to offer some banking type services. The charter also provides a known path on compliance through banking. The charter was first announced in 2016 and in August 2018 they started accepting applications. Varo Money got approved for the charter in September yet applications for the charter are almost non-existent.

Why?

Because fintech and banking see a better option courtesy of my former industry, equipment leasing.

The Industrial Loan Company or Industrial Bank Charter

For years, the equipment leasing industry has lowered their cost of funds as compared to banks by going the Industrial Bank Charter (known as ILC for Industrial Loan Company) route. Utah is the most common state for an ILC charter although 7 states currently have ILC charters where businesses can apply. Here's a list of the active Industrial Banks in Utah today.

Marlin Leasing (now known as Marlin Business Services Corp) owns Marlin Business Bank. Marlin publicly trades on the NASDAQ (NASDAQ: MRLN). This Utah based bank started in 2007 and still provides Marlin with a lower cost of capital than the private markets today.

What about an ILC makes it a good option in fintech? Let's look at what makes this charter appealing.

Going into some depth on ILCs plus none of the companies mentioned would let me use their logos....

What Are Industrial Banks

An industrial bank is a state chartered depository institution that is (quoted from the Utah Dept of Financial Institutions website):

  • eligible for FDIC insurance
  • exempted from the technical definition of a “bank” for the purposes of the Bank Holding Company Act of 1956 (BHCA),
  • otherwise generally subject to the same banking laws and regulations as other bank charter types.

The exemption from the BHCA means corporate owners of an industrial bank do not necessarily have to be bank holding companies. This enables non-financial companies to own and operate an industrial bank. More importantly, it allows financial non-banking companies like fintechs to be able to own and operate.

Advantages of an ILC for a Fintech

What this means is my equipment leasing friends or those in any lending business can now become a member of the Federal Reserve and offer FDIC insurance as they accept deposits. Instead of the OCC, the FDIC is the ILC's primary bank regulator (see p.4 of the linked white paper).

Deposits and CD rates are so low that the costs of funds for these firms go down by hundreds of basis points. Lower cost of funds means the same interest rates earn them more money through what bank financial statements call Net Interest Margin. Net Interest Margin is the net difference between the rate you charge and the rate you pay for your funds.

Net Interest Margin of Bank Holding Co's courtesy of the Federal Reserve

This makes for a huge operational advantage for a lending business. Many of these businesses have to charge market rates but now have more control over their cost of funds.

Here's the other big advantage. While less true in equipment leasing, many other lending businesses have changing compliance requirements including those needing to comply with various state regulators and the Feds. Banking has a well known, well-worn path to complying with regulations and regulators. For many alt lenders and fintechs, this tradeoff of more known compliance for lesser unknown compliance is a trade they are willing to make.

Other advantages include:

  • greater independence as now a fintech would not have to partner with a bank to use their license to issue a loan and
  • unlike a state bank, this national charter allows them to 'export' interest rates to work around some states usury laws and charge higher rates to higher risk borrowers.

We already know this exporting rates advantage has been challenged in the Madden v Midland case where this was one of the big questions. Yet, it is and could be an advantage to a lender now and in the future.

But it's not just non-bank finance like equipment leasing seeing the benefits of an ILC. Fintechs are offering more services and are more closely resembling banks in those offerings so the industry is giving the ILC another look.

ILC is the future

Nelnet, the largest servicer of student loans in the country, filed for a Utah ILC in June 2018. They withdrew it in September in what they called a 'temporary setback' and hope to refile soon. Benefits to Nelnet would include more banking services to their student loan borrowers and their families, as well as operate an internet bank, and grow their private student lending business with those low cost of funds we talked about. I suspect they will try for an ILC at least one more time.

Square filed for an ILC charter and withdrew it. In December, they refiled for an ILC and hope to move forward with it this time. Square is one of the biggest success stories in fintech starting in payment processing and growing into a successful small business lender with Square Capital. It's the desire to fuel Square Capital with lower costs of capital AND give Square an understandable path of compliance and regulation for their many lines of business that they want an ILC.

SoFi filed for an ILC charter in 2017 and withdrew it. The withdrawal was due to leadership issues leading to CEO Mike Cagney's departure and nothing to do with the viability (or not) of an ILC charter for SoFi. SoFi is going further into the banking realm with their SoFi Money program and as one of the industry leaders, I'm always watching what they are up to.

These are just 3 examples of fintechs looking down the road at what are/might be nominal lines of business for them now, but with a chance for meaningful growth in the future. ILCs are not just going to be part of the future of fintech, they are part of the present.

ILCs are the Present in Fintech, too

It's easy to forget many of the marketplace lending platforms don't issue their loans. Someone with a bank charter has to issue the loan. Enter the Industrial Bank.

If you use the Patient Solutions loan option on Lending Club, you know who issues that loan? Utah Industrial Bank (ILC) Comenity Bank. You can see it's there in the URL for LC borrowers to check on their account.

If you use Kabbage for one of their loans, you know who issues that loan? Utah Industrial Bank (ILC) Celtic Bank

If you use Lending Club or Prosper, then you are getting a loan issued by Utah ILC WebBank.

If you use Can Capital, the loan is issued by WebBank.

If you use Avant, the loan is issued by WebBank.

If you use Petal for a credit card, the credit card issuing bank is WebBank.

If you use On Deck for a loan, the loan is issued by Celtic Bank.

And it's not just fintechs either. One of the nation's most beloved financial services companies, USAA, has a Utah Industrial Bank that it uses for some of its loan products including the issuing of the USAA credit card.

But Wait, There's More

The ILC does seem like an excellent option for a fintech moving more into banking services and as these lines continue to blur. There are some excellent advantages that include greater independence. Don't you think Lending Club or Kabbage or Avant would rather issue their own loans instead of having to use Celtic Bank or WebBank? I certainly do.

But it's not all rainbows and unicorns, so in my next post, I will go into the potential pitfalls of the ILC.

About the author

Stu Stu Lustman, the author of this post, is a Credit Analyst by trade trying to bring Commercial Credit Analysis techniques to the world of Peer to Peer Lending. Check me out on Twitter, LinkedIn and Google+

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