Joe Toms is the only person who has been a C-level executive at both Lending Club and Prosper. He was the managing director at LC Advisors, Lending Club’s registered investment advisor subsidiary from 2010 to 2011, then he left Lending Club to become the Chief Investment Officer at Prosper. He remained in that position until he resigned in February of this year.
I got to know Toms quite well during his days at Prosper and have kept in touch with him since he left. He is one of the most knowledgeable people in this space and I was curious what his next more would be. In a phone conversation yesterday he filled me in on Freedom Financial Asset Management (FFAM is a division of Freedom Financial Network LLC) where he is now President and Chief Investment Officer. In January they are launching FreedomPlus, a new consumer lending platform.
So what is FreedomPlus? Is it a new p2p lender? No. But it will be originating consumer loans for investors. It will not feature a marketplace like Lending Club or Prosper but it will be open to accredited investors to invest in pools of loans.
The big news for their launch is the announcement today of a $125 million investment from Vulcan Capital, which is Paul Allen’s (the Microsoft co-founder) family office. This money will be used to invest in consumer loans originated by FFAM and marks one of the largest investments ever made by one investor in the online consumer lending space.
Catering to “Emerging Prime” Borrowers
What kind of borrowers is FreedomPlus focused on? When I asked this question Toms gave quite a lengthy answer. First, he pointed out there are approximately 80 million people in this country with a FICO score of between 600 and 749. Of these around half will remain stable or improve their credit score in the coming 12 months. These are the people that FreedomPlus will be targeting, a group he calls “emerging prime” borrowers.
They are not going to be competing directly with Lending Club and Prosper for most borrowers although there will certainly be some overlap. The question I asked is how they intend to underwrite what is clearly a higher risk loan population. Toms said they have quite an innovative approach that they have been using successfully for many years.
Their first product, Consolidation Plus, serves a small segment of their sister company’s customers. They have an extremely impressive track record of underwriting higher risk borrowers. In the last five years the average FICO score for a Consolidation Plus borrower is 576. The average loan size is over $16,000 (higher than both Lending Club and Prosper). You are probably thinking now that defaults must be sky high, right? You would be wrong. Even with this high-risk population the annual default rate has been less than 2%. That is very impressive and one of the reasons why Toms chose this organization for his next career move.
The loan amount and interest rates at FreedomPlus will be fairly similar to Lending Club and Prosper. The maximum loan amount will be $35,000 and the maximum interest rate will be less than 36%. The intent is to personalize loan terms from two to five years.
A More Holistic Approach to Underwriting
The obvious question now is how have they been able to maintain such a low default rate with a high-risk loan pool? The answer is in their unique hybrid approach to underwriting. While Toms would not give away their secret sauce he did say this. They have very experienced people with a deep history of underwriting consumer credit on their team. They use similar financial data as most underwriters but they have added in a significant human component.
Their underwriting process takes a more consultative approach than other platforms. They will spend the time to talk with borrowers, not just to verify information, but also to better understand their needs and goals such that they can provide a loan where warranted that fits the borrowers specific needs. They are looking for people who show indications of trying to get ahead by gaining new knowledge or learning a new skill for example. They want to try and identify those people who will remain stable or likely be improving their credit score in the coming year.
My first thoughts on this is that one, it is not easily scalable and two, it is very expensive. Toms agreed on both counts but he also insisted this model provides a better product for both borrowers and ultimately investors. The extra cost can be justified by the very low default rates.
A Slightly Different Business Model
Lending Club and Prosper make the majority of their revenue from origination fees with a smaller amount coming from investor servicing fees. At FreedomPlus their goal is to break even on fees. They want to make money by partnering with investors on the loans themselves.
They are confident in the ultimate performance of the loans so their success is clearly aligned with their investors’ success. Toms provided no details on how this would work exactly or what the expected returns would be for investors but one can guess with a low default rate on a higher risk pool of investors average returns will be in the double digits.
As I said earlier there will be no exchange or marketplace for investors and no one will be able to pick and choose the loans on their platform. Their focus will not be on attracting hedge funds or third party money managers – they plan on targeting the end user investor. High net worth individuals, family offices, pension funds and insurance companies – these are the kinds of investors they want to focus on. There will be a high barrier to entry for investors with a substantial minimum investment.
I realize the average Lend Academy reader will not be able to participate in an investment opportunity such as this. I am sharing it with you because I think they have a fascinating business model and I wanted to report on Joe Toms’ new company. He has landed with an organization that could well be a future leader in the online lending industry.