The federal government and private banks currently dominate the student loan market, but a new start-up is eager to disrupt the system. CommonBond offers competitive fixed-rate loans for MBA students that are sourced from their university alumni. The company also offers the students and their financial backers a chance to mix and mingle at events in the hopes of growing their networks and advancing their careers. The fixed-rate loans are priced as low as 5.99%, presenting a serious threat to established lenders whilst promising individual investors a low-risk investment opportunity.
But that’s not all. CommonBond is also taking the much-hyped one-for-one business model into the educational space, offering educational opportunities to needy students whenever a new loan is financed. CEO and co-founder David Klein said this offering has made his business model stand out from the rest as he works to inject more social responsibility into the lending space.
Investors have taken notice of the venture, with the former chief executive of Citigroup, Vikram Pandit, investing more than $100 million into the firm along with a consortium of financial backers.
Ankur Kumar, Wharton’s director of admissions and financial aid, joined Knowledge@Wharton in a conversation with CommonBond’s Klein to find out more about his business, his motivations, his one-for-one business model and his vision for the future of student lending.
An edited version of the transcript appears below.
Knowledge@Wharton: We are joined today by David Klein, CEO and co-founder of CommonBond. Thanks for joining us David.
David Klein: Thanks Ankur. Thanks Mukul.
Knowledge@Wharton: CommonBond, as I understand it, is an alumni lending or crowd-funding platform for student loans. I know you recently started lending for the first time. Tell us about CommonBond and how you came to create this venture.
Klein: CommonBond is a student loan crowd-funding platform. We source capital from alumni and individual investors and pass it on to students to lower the cost of their education. Students can save about $20,000 to $25,000 over the life of the loan repayment, and alumni investors and individual investors receive a financial return in exchange.
But there’s much more than just the financial return. There’s also the social return. The social return is the key to this venture. From an alumni investor’s perspective, they have an opportunity to be part of a solution to a large national problem: student debt. They also have an opportunity to be part of a solution at a very localized level, and that is with a student at their alma mater. We think that’s a very strong motivator for alumni investors.
Beyond that, there’s something that we call our ‘social promise’, which is both global and local. Our global social promise is that for every degree that is fully funded on our platform, we will fund the education of a needy student abroad. Our local social promise stipulates that for every new city we bring our loan program to, we will fund financial literacy programs in a local charter school in an under-served community.
Knowledge@Wharton: How did this idea to get involved in student loans come about?
Klein: The idea came from a very personal pain point. I got into Wharton and I knew that tuition for this kind of program was high. But I didn’t realize that the cost of financing my education was also going to be high. I looked around to see what my options were and I wanted a fixed-rate loan. I didn’t want to deal with the risk of variable rates. I noticed that I had two options: the federal government and private banks. I was looking at something akin to an 8% fixed-rate loan in the traditional space.
I decided that there had to be a better way — an option where the pricing was more affordable. But there wasn’t. So I decided to do something about it and I went to business school with the express purpose of starting a business and getting it up and running before or upon graduation. My personal difficulty with student lending and my strong desire to start a company while still in school was a perfect combination. I ended up meeting my two co-founders, Michael Taormina and Jessup Shean, while studying at Wharton.
Knowledge@Wharton: Tell us more about the inspiration behind CommonBond’s social promise.
Klein: It comes from a very deeply rooted personal philosophy related to what I think, and what we as co-founders think, business should be. Businesses and corporations wield an incredible amount of influence and I think there is a huge opportunity for business to play a much larger role in local communities and our broader society.
I’m encouraged when I see other companies put their social mission front and center. For example, the eyeglasses company — Warby Parker — which also came out of Wharton, is a major inspiration. They were part of the same start-up incubator as us: the Wharton Venture Initiation Program and their ‘buy a pair, give a pair’ program is inspiring. We have met with Warby Parker’s co-founder and co-CEO Neil Blumenthal and we decided that we could also use the one-for-one model and bring it to education and to finance. That’s what we decided to do.
Knowledge@Wharton: Going back to the financial return part of the equation, how is CommonBond able to provide investors and students with better deals than they’re currently able to get in the public market?
Klein: It’s a really interesting time that we’re in, in terms of macro-level interest rates and credit markets. Things are a bit out of whack as a result of the financial crisis, which continues to affect the markets. The federal government had to take over the student loan market and they’re charging everybody one price. It’s a very inefficient way to price risk. Meanwhile, private banks are a different story since they’re still skittish after the financial crisis and so they’re charging a risk premium for student loans, particularly given the fact that it’s unsecured debt and they don’t want to take on too much risk.
So we’ve come in and we don’t have the structural problems of the federal government, or the baggage of the private banks. We’re a much leaner operation than any of our direct or indirect competitors. We can price risk more appropriately, leading to a 6.24% fixed rate for students, which can be lowered down to a fixed rate of 5.99% when the students sign up for automatic debit payments. We’ve essentially come to the market and said, ‘We think we can price risk better than traditional alternatives.’
Knowledge@Wharton: From a student’s perspective, if you’re looking to work with CommonBond to secure a loan, how does that process work?
Klein: A student might hear about us in the press, through campus activities or in the financial aid office where they post information about alternative private lenders. We hope udents will engage with us not just because of the lower cost offerings but also because of the community we offer to them filled with other students and alumni. Our social promise is also resonating with students, which is something that the millennial generation seems to gravitate towards. We’re all about having a values driven business. Those are the things that attract students to CommonBond.
Knowledge@Wharton: When you deal with students through CommonBond, are students mainly looking for original financing or do they also want to refinance existing student debt?
Klein: It’s both. We’re originating new loans for students who are coming into school and we are also very much participating in the refinance market. We have a refinance loan product as well.
Knowledge@Wharton: Where is the greater demand coming from?
Klein: The demand is roughly equal.
Knowledge@Wharton: How risky are these loans and how do you deal with that risk?
Klein: From an investment perspective, the risk on these loans is incredibly low. We’re focusing right now on MBA programs because the default rates are incredibly low and payback is incredibly high. It makes sense when you think about it, since employment rates and earning potentials are high for students from top MBA programs. That’s part of what allows the model to work, especially since we’re still in the early stages. It’s important that we de-risk the model as much as possible to give it a chance to succeed in the beginning, and then we can use that as a platform to build off.
Knowledge@Wharton: Can you tell us more about the value proposition for an alum that might invest in CommonBond?
Klein: The value proposition for alumni or individual investors is threefold. Firstly, it’s the financial return: it’s a competitive financial return relative to other investment products of similar risk. Secondly, we have the social return, since investors are given the opportunity to help lower the cost of education for students at their alma mater. And for every new alumni investor that comes to the table and for every new student borrower that comes to the table, there will be another child that will get the chance to study for a year at the African School for Excellence, or there will be more funding put towards the financial literacy programs in local communities. Participation drives our social mission and that’s very powerful. The third thing I’d say is that the alumni and other individual investors who participate are able to plug into a community of top tier talent.
Knowledge@Wharton: What sort of events or activities do you actually offer to alumni and recipients of these loans?
Klein: Good question. A lot of people pay lip service to community. There are many online communities that are ubiquitous but not very valuable. It’s important that CommonBond continues building a meaningful community that people want to belong to. We look to help our community build real connections in the real world, person-to-person. We’ve spent a lot of time creating environments for students, investors and forward-thinking professionals to come together under one roof, meet and connect.
We have a number of examples of students in our CommonBond family who began interacting with members of the community and have been able to propel their professional careers forward. For example, one student met the head of corporate acquisitions at American Express at one of our events. American Express is her dream company. After this meeting, the executive was able to set-up a number of interviews for her and it looks like she might be getting a full-time job at American Express when she graduates. Another MBA student with a start-up business came to one of our events and met a reporter at Businessweek. Businessweek covered her company roughly two weeks after the meeting. She wrote excitingly to us in an email, ‘Thank you so much, this was all because of CommonBond.’
We think of ourselves as more than just a student lending company. We consider ourselves to be a company that reflects the future of finance. We have to be more than just a commoditized lending product and we have to do more than just lower the costs of being a student. Our community helps students maximize their top line.
Knowledge@Wharton: I imagine alumni affairs offices at different institutions may be worried about your offering. How do you approach and partner with alumni affairs departments at different universities?
Klein: We think it’s best to talk with everybody. So while we’re talking directly to students, we don’t want to lose sight of the fact that there are a number of different stakeholders out there, including admissions offices, financial aid offices and alumni affairs offices. We are not officially affiliated in any way, but we think it’s important to build positive relationships with them.
When it comes to alumni offices, frankly the reaction to this model is a bit mixed. There are two camps that you can fall into. One is a territorial camp where alumni offices believe there’s a finite size to the pie. There’s another camp that takes the view that there’s a growing pie. We belong to the latter camp and we believe that our model can engage an entire swath of alumni who are not currently engaged in university affairs. Our model can bring those folks into the fold because there’s a financial return component to it.
Knowledge@Wharton: Are some alumni offices concerned that you might cannibalize some of the alumni giving that might otherwise go to funding scholarships?
Klein: That’s the concern. But I think our model can compliment the efforts of alumni offices. Not everyone sees this, but that’s fine by us. We think that over time we’ll be able to prove that we live in a world of abundance, where there is a growing pie, as it pertains to alumni investor participants.
Knowledge@Wharton: How have you addressed the more territorial alumni offices?
Klein: We say that the scholarship is a different kind of investment for alumni. If you think of an investor’s portfolio, the alumni scholarship giving falls into the philanthropic side. We fall into the conservative side of an investor’s portfolio where they can get a return for their money. We see these as very different kinds of investments. So even among the alumni who currently give money to their alma mater, you can see a world in which they can participate in both sides – philanthropy and investment – allowing them to diversify their portfolios. We also tell the alumni offices that our model will engage a larger group of alumni who are currently not engaged with the university.
Knowledge@Wharton: This industry is about a year old. Who’s your competition and how have you positioned CommonBond uniquely in this space?
Klein: Our competition really falls into three different categories. First there are the traditional players — the federal government and the private banks – that represent about 93% and 7% of student loans, respectively.
Secondly, there is the social lending space, which is a bit more mature than our business model. Players such as Lending Club or Prosper.com have been in peer-to-peer lending since 2006 and 2007, respectively. They’re not in student loans right now.
The third area, I would call social lending as it relates specifically to student loans. That market is roughly a year old and this is where the problem is particularly acute and particularly large. We are excited to come in and solve this.
There are a number of things that make us different from our competitors, regardless of what segment they fall into. Firstly, the millennial generation is attracted to our social promise, which sets us apart. We’re proud that we were the first to bring the one-for-one model to both education and finance.
We also give our stakeholders a networking community, which is pivotal to our offering. While some competitors may offer this, we are working on building a community that people really value.
The third area that sets us apart is our risk management. I think our approach to risk management is different than any other player in the space because we focus on MBA students, a group that has a low risk of default. The approach that we’re taking is thoughtful and methodical, allowing our business model to succeed early and, therefore, work over the long term. Furthermore, we have been working with a professor in the statistics department who is helping us build a proprietary model to help us predict future repayments. Going forward, we will be able to find people with attributes that predict a higher likelihood of future repayment.
Knowledge@Wharton: One last question: five years from now, where would you like CommonBond to be?
Klein: We would like to be a premier lender. Period. We’re starting with MBA student loans, but going forward we are considering other areas. When you think about the future of finance, and when you think about how the financial crisis destroyed trust between banks and people, you realize that trust must be found somewhere else. It exists in trusted networks and it exists among affinity groups. Schools are a natural fit for affinity and trusted networks, which is why this model works so well. That’s why we’re starting with schools. But if you broaden out the definition of affinity groups, you can envision a world where not only are student loans being better priced, better administered and better serviced with this model, but so are all different kinds of lending products.
Knowledge@Wharton: Thanks so much for joining us today.
Klein: Thank you. Thanks for having me.