Bank Behind Fintech’s Rise Reels in Billions in Pandemic’s Wake

(Bloomberg) — One of the fastest growing banks in the US is on a mission to rewire the industry. It has also touched some nerves.

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Cross River Bank began turning heads across the financial realm soon after Congress started unleashing $800 billion in emergency loans to help small businesses survive the pandemic. The little-known 14-year-old suburban New Jersey firm was soon arranging aid faster than almost every other bank.

Cross River is the regulated bank behind a slew of fintech startups, ranging from online lenders to cryptocurrency venues. As tech ventures attracted borrowers, Cross River created the loans that generated roughly $1 billion in gross fees for handling US aid.

Two years on, the firm’s growth helped it win a more-than $3 billion valuation in a recent funding round. Some of those US-backed loans, meanwhile, are showing some signs of trouble. Forgiveness rates for the debts are unusually low, a potential indication that online borrowers might have abused the program and didn’t bother to follow through on paperwork to get debts canceled. Banks such as Cross River that the US encouraged to rush out pandemic aid haven’t been accused of wrongdoing.

It’s among a few concerns that have arisen in the past few years around the closely held company providing a swath of consumer financing, which is also packaged for sale to Wall Street investors. Since its founding on the brink of the financial crisis in mid-2008, Cross River has struck up partnerships with a who’s who of tech-fueled ventures challenging traditional banking — such as crypto giant Coinbase Global Inc., payments heavyweight Stripe Inc. and financing platforms Upstart Holdings Inc., Kabbage Inc. and Affirm Holdings Inc.

Now Cross River is planning to use its pandemic-era earnings and the capital injection that followed to expand. As fintech ventures mature, they’re seeking to add services — transforming from apps that perform one or two functions into something more like diversified financial services firms. Cross River intends to help them branch out.

“A marketplace lender wants to become a payment company, and vice versa the payment companies want to become lenders,” said Cross River Chief Executive Officer Gilles Gade. “We want to be there for both of them.”

Some of Cross River’s activities have irked state authorities. It was among a group of firms that hashed out an accord with Colorado in 2020 after the state accused a pair of nonbank lenders of partnering with national banks such as Cross River to make loans with interest rates that local laws deemed too high.

Disagreements over which firm is the “true lender” in such situations, and which laws apply, have been simmering in recent years. At the time of the accord, Cross River praised Colorado’s attorney general for creating a framework to resolve the issue. But the broader debate continues. When analysts at Moody’s Investors Service examined a $196 million issuance of securities backed by consumer loans from Cross River and another bank in June, they said investors should consider the possibility that authorities could revisit the true-lender issue.

“The social risk for this transaction is high,” wrote the report’s authors, Selven Veeraragoo and Pedro Sancholuz Ruda. “Marketplace lenders have attracted elevated levels of regulatory attention at the state and federal level,” and there’s still a chance that some of the loans could be deemed void or unenforceable, they said.

Lending Vacuum

Cross River’s rise presents an irony: One of the fastest-growing banks in America happens to embrace the idea that it’s a utility, a label scorned by many traditional lenders that have been trying to pitch themselves as tech platforms.

The bank focuses on structural issues in the financial system that Gade blames for neglecting some potential customers. Cross River’s name even refers to that mission, invoking the Jewish tenet of tikkun olam: providing a service to repair the world. “We’re trying to cross the spiritual river of banking by not trying to offer something that has been stuck in antiquity,” he said.

Another irony: Big banks keep accidentally helping the upstart along.

The venture started weeks before the collapse of Lehman Brothers Holdings Inc. ignited a global credit crisis. Big banks were groaning under the weight of their soured loans, and as they pulled back from consumer finance, that created a vacuum and an opportunity for online lending platforms. Many of those financial startups needed a commercial bank that they could plug into to underwrite their loans.

Over the years, Cross River notched rapid growth. And when the pandemic hit in 2020, traditional banks again ceded an advantage. The largest were initially slow to complete loans as they built systems to automate the process, leaving legions of small businesses clamoring for funds. Some branch staff began telling customers to try online lending platforms. Those funneled loan applicants through Cross River. In 2020, it ranked among the top three providers of the loans.

Leading up to the pandemic, Cross River made only a few million dollars a year on fees and interest from commercial and industrial loans, according to data filed with federal regulators. That changed rapidly once PPP aid started flowing. Between the second quarter of 2020 and the end of June, the bank made well over a half-billion dollars in revenue from commercial loans, the data show.

Forgiving Loans

By the end of the relief program, Cross River had originated almost 480,000 loans from the Small Business Administration’s Paycheck Protection Program, a tally second only to Bank of America Corp.’s, the nation’s second-largest lender. The program allows for loans to be forgiven if borrowers later show they used the money to cover eligible costs.

Yet, forgiveness rates for loans originated by Cross River lag behind debts created by many competitors. That’s a worrisome sign, because legitimate borrowers are more likely to file the paperwork to avoid repayment.

“Outstanding loan forgiveness applications are a potential indicator of fraud,” a February report from the office of SBA Inspector General Hannibal “Mike” Ware said. “Borrowers who fraudulently obtained a PPP loan are unlikely to apply for loan forgiveness.”

Of Cross River’s PPP loans in 2020, 16.4% were unforgiven as of July, versus 5% of loans across the program for that year. Forgiveness rates for Cross River’s 2021 loans have likewise trailed the broader landscape.

Cross River points out that such indicators flagged by watchdogs aren’t the same thing as actual evidence that borrowers engaged in fraud. Indeed, there are a variety of reasons why borrowers may decide not to seek forgiveness, including that they may not have spent money in ways that qualify for that step of the program. Or they may simply fail to follow through on the paperwork.

Cross River notes that the hastily created US program succeeded in the goal of keeping businesses afloat. It also cites research showing fintech lenders were more effective in helping Black and Hispanic business owners.

The government has been expressing alarm over the number of loans that the broader program extended to people who lied on applications, often using stolen identities. The SBA’s watchdog said in May that it had detected 70,000 potentially fraudulent loans totaling over $4.6 billion. This month, President Joe Biden signed legislation that established a 10-year statute of limitation for fraud related both to the PPP program and the SBA’s Covid-19 Economic Injury Disaster Loan programs.

Yet lenders are generally shielded from recriminations. The SBA offered explicit guidance early in the pandemic indicating they were only responsible for performing “a good faith review” of calculations and documentation submitted by borrowers — a high bar for imposing liability.

“When it comes to the lenders, I think only the really egregious cases are going to be the ones where the government really goes after people,” said Elisha Kobre, a partner with law firm Bradley Arant Boult Cummings.

It’s unclear exactly how much Cross River’s growth in the past few years has benefited executives and founders with stakes in the company. A filing indicated the CEO had a roughly 7.9% fully diluted stake at the end of 2016. But the closely held firm doesn’t disclose his compensation, which at many banks includes stock, nor does it specify the dilutive impact of its fundraisings.

Gade declined to comment on his net worth. “God runs my checkbook,” he said when pressed in an interview.

But after the latest funding round, he said, institutional investors hold about 30% of the firm, with the rest in the hands of “legacy” private investors.