Lend Academy's Lending and Fintech Podcast

PODCAST TRANSCRIPTION SESSION NO. 215  –  NAT HOOPES

Welcome to the Lend Academy Podcast, Episode No. 215, this is your host, Peter Renton, Founder of Lend Academy and Co-Founder of the LendIt Fintech Conference.

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Today’s episode is sponsored by LendIt Fintech USA, the world’s largest fintech event dedicated to lending and digital banking. It’s happening on May 13th and 14th, 2020, at the Javits Center in New York. Lending and banking are converging and LendIt Fintech immerses you in the most important trends of the day. Meet the people who matter, learn from the experts and get business done. LendIt Fintech, lending and banking connected. Go to lendit.com/usa to register.

Peter Renton: Today on the show, I am delighted to welcome back Nat Hoopes, he is the Executive Director of the Marketplace Lending Association (MLA), a position he has held for about three years now. We had him on the show just soon after he started in this role and I wanted to get Nat back on because obviously the MLA has matured a lot in the last three years, there’s been a lot that has happened in Washington.

I wanted to get him on to talk about the successes the MLA has had, what are some of the challenges as well, how it is to operate in the highly partisan era that we’re in now in Washington. We talk about the fintech charter, we talk about the House task force on financial technology, we talk about how he interfaces with the other trade associations that are all in Washington and we also finally, talk about the new PAC that they have created and much more, actually. It was a fascinating interview, I hope you enjoy the show.

Welcome back to the podcast, Nat!

Nat Hoopes: Thank you, Peter, happy to be back.

Peter: Alright, I was just looking, it’s been three years since we had you on. I know we had you on in your very first month on the job at the Marketplace Lending Association. I know this month is your three-year anniversary of taking this position so maybe you could just sort of start off with giving us how you feel like the last three years have gone.

Nat: I think they’ve gone as well as the founders, LendingClub, Prosper, Funding Circle and I could have hoped as we sort of set out on the journey to build an inclusive organization that is able to speak in Washington and in state capitals on the benefits of marketplace lending to consumers, small businesses, current and former students and so forth. That vision has really resulted in an organization that speaks with one voice on the issues in public policy that really matter to everyone.

Peter: Right, right, and you know, I think it’s also important that…you were a one man show for a long, long time and I think the industry has really benefited from your energy and you’ve been able to bring in pretty much all the major players in marketplace lending.

How was that process, was the industry really, you know, all supportive from day one, or how was the process in growing the Marketplace Lending Association from three members to where it is today? Maybe you can just tell us exactly how many members there are today.

Nat: Sure, so the numbers do continue to grow, but I think we are on our 35th member company and there’s always going to be a bit of fluctuation in trade associations as companies’ interests or activities in Washington and in public policy shift and change over time. But, I think that the key genesis of the whole association was really the decision to recognize that there are a lot of technology only lenders that are really, you know, departing from some of the practices of former sort of non-bank financial institutions in the way that they approach consumers, target consumers with opportunities, process applications, utilize technology and then provide those credits to investors.

So, I think once everybody sort of recognized that across the group that was to become the association of actual lenders then, obviously, all the ecosystem participants like large companies like Experian or PricewaterhouseCoopers and others, that everyone was really aligned in wanting this industry to flourish and to do so in a way that didn’t necessarily exclude models where the consumer was inarguably being treated well with lower interest rate loans and simple terms everyone could sort of understand and grapple with as they apply.

Likewise, that the model is really one where the capital markets and investors, both individuals and institutional investors, are the ones who are ultimately putting up the bulk of the funding. That model, that sort of two-sided element, even though it’s shifted and morphed and things have changed over time, that two-sided nature and the transparency that’s required to make all that go is really kind of core to our mission in the association.

Peter: Right, right. I should also add that LendIt has been a big supporter and a member of the Marketplace Lending Association pretty much from day one as well.

Nat: Thank you, Peter, that’s right, I shouldn’t forget that.

Peter: (laughs) That’s okay. So then just one last question before we move on, one last question about sort of the history here. As you look back over the last three years, maybe you could share with the listeners some of the successes that you’ve had in your time here.

Nat: So, I think if you look at it there are a couple of really big flash points. Number one, the association really launched in the heels of a really tough summer after the events at LendingClub in May of 2016. There was a real need to kind of put some of the rumors to rest about possible other issues that would drop and just steady overall the approach with questions coming from reporters and the questions coming from public policy makers, you know, questions coming from Congress and so forth.

So, you know, first I think the role of the organization was to be a public voice that didn’t exist and to do that in a way that was responsible and effective and on time. So, that was an initial, I think, success in just bringing some stability to the overall views and not allowing some of the positive views of the industry to erode too quickly in a difficult moment.

And then, you saw a few flashes with the Cleveland Federal Reserve study that tried to link marketplace lending to some sort of abusive lending and it turned out that the paper was just deeply flawed and that was another example where the industry really came together to do the research and then use the MLA to be a mouthpiece to really challenge the flawed findings of that report. Eventually, it was retracted and there was an apology issued by the President of the Cleveland Fed and so that was just another, I think, initial success.

And then, finally, we’ve had a couple of significant policy wins, proposals in different states that have been beaten back and a win on legislation with the IRS where there’s now a requirement that they build a real-time income verification system to replace one that really was outdated and has held back the industry. So, those are some examples of things that we’ve tackled at the association and also have just given a forum…

You have participated, I think, in both of our first two annual CEO meetings, but to provide a forum for the individual companies that are in the association to meet with the most important policy makers and to develop the relationship themselves because ultimately, this industry is still so small and the member companies are small enough that they don’t often have their own army of lobbyists, or their own in-house lobbyists with a couple of exceptions. They really rely largely on the association to help provide that connection to policy makers so we’ve been able to do that as well.

Peter: Right, yeah, for sure. I know that has been very, very useful for many of the companies and for the whole industry, I think, to have that sort of…it’s one thing for a company to lobby a regulator or a lawmaker, but it’s another thing for an industry. I think that really has helped tremendously.

We’ve talked about the successes, maybe we should talk about some of the things that haven’t gone the way you wanted. I know that there’s been some pieces of legislation that have been introduced and gone nowhere, maybe you should at least touch on that, the things that maybe you thought would have been successes but haven’t been.

Nat: Sure, one of the areas that has certainly taken longer than anyone would have anticipated has been trying to tackle the negative fallout of the Madden versus Midland decision from 2015. You know, that decision, although it had a nationwide impact, it has had an impact on loans made above state usury caps in the three Second Circuit states and certainly has forced companies that rely on bank partnerships to shift and the bank partners to shift in a way that they tackle that issue.

Certainly, that’s created major adverse consequences for consumers in the sense of lack of availability of credit initially following the decision and a real stark contrast to the continued growth in other jurisdictions. So, that sort of finding in that decision was challenged by the Obama administration and the Democrats in charge of, you know, obviously prior to the 2016 election and then you see continuity where the Republican administration included in a treasury fintech report a recommendation that it be overturned.

You’ve seen bipartisan legislation introduced in both the House and the Senate. The last Congress and legislation passed the House to reverse it so there’s been no shortage of activity and sort of education and thought leadership on why Madden was flawed and is creating negative consequences in this jurisdiction. But unfortunately there hasn’t been any real meaningful change from the standpoint of new legislation passed through Congress or a new regulation coming from the OCC or the FDIC.

Peter: So is that…I just would love to sort of maybe just touch on why. Is it because it’s just not a high enough priority on these lawmakers to-do lists? As you said it passed the House, why haven’t we had a bill?

Nat: Yeah, well I think…the Senate is particularly difficult, in general. These days I saw a statistic that so far this year, the Senate has only taken 19 total roll call votes on amendments. That was as of the summer and in a typical year you would have seen 200 votes as recently as 10 to 15 years ago so there has just been a major slowdown in how much policy and legislative voting there is in the Senate and that has been a bipartisan problem.

When I was in the Senate, we complained about it all the time when Harry Reid was in charge and now, Mitch McConnell is in charge and unfortunately you don’t see a lot more legislating going on. It’s just a reflection of the partisan nature of politics and just the way things have developed and so it’s very difficult to get even non-controversial legislation done.

Things that you think should happen quickly take a long time and then things that are perhaps a bit more controversial but you think deserve a vote, certainly an up or down vote, and think there ought to be a real chance of passage can get bogged down very quickly. That’s part of it, but I don’t think it’s fair also to blame it entirely on the Senate.

I think there has been significant concerns raised even though Marketplace Lending Association members partner with banks and do so responsibly and issue lower APR, longer term loans that are clearly able to be repaid without a borrower falling into a debt trap, there is concern on the part of certain advocates and others that if, you know, Madden were reversed in legislation and, you know, a clear certainty provided that that could become a loophole that less reputable market participants could use and, therefore, flout state laws.

So, that concern has created enough controversy around the issue making it a difficult one to legislate, however, I know that clearly the banking regulators, they filed briefs in the original Madden case and they certainly have an interest in making sure that banks can continue to sell loans and manage their portfolios and do so without being concerned that, you know, the people that might buy those loans might be non-banks and therefore, that the loans could somehow not be valid.

So, I think that there’s still a high probability that there’ll be some action from Washington on the issue, but your point about how high a priority is it, I think for the large bank trade associations, the ABA, the Bank Policy Institute or the community bankers, the ICBA, it isn’t an issue that ranks in their top five. It’s likely in their top ten and if you saw a number of other decisions, it could go up that priority ranking, but that certainly has been part of it that there isn’t a huge amount of industry pressure coming from those outside of the financial technology industry.

Then you also have a situation where it isn’t a huge priority outside of, you know, some pretty prominent members like Congressman McHenry who is very concerned about the capital markets and the potential impact on liquidity and on financial innovation and some others who have seen direct impact like Congressman Meeks in New York whose constituents are directly impacted by a lack of credit. You haven’t seen people feeling like there’s a huge urgent need to correct it.

Peter: Right, right. Okay, so what about the Fintech Charter which…you know, two years ago, I think if we chatted two years ago, we would have thought by September 2019 there’ll be several companies that’ll have been approved for a fintech charter. Now, we have zero and there’s lawsuits that are working their way through. I mean, is the Fintech Charter dead?

Nat: So, I wouldn’t go as far as to say it’s dead, it’s certainly tied down in litigation with New York, it’s going to be a long road for it to rebound. But that’s an example of something where, you know, I would say we would have considered our work on defending the need for a national options for companies to become special purpose banks, if they chose, without taking deposits, that that was an area where, you know, initially, there was quite a bit of resistance.

You will probably remember that in late 2016, a number of members of the House sent a letter to then Comptroller Tom Curry and said, stop working on the charter, we are concerned about this that it could be, you know, create an unfair playing field for banks, or that it could create too much regulation on fintech companies. So, there was sort of a lot of opposition initially and yet, I think, we played a pretty big role in helping create an outside voice and good rational reasons why it makes a lot of sense and it made it through the process, despite the change from Democratic nominees to Republican nominees and became very much a part of the current OCC’s agenda.

Unfortunately, you just see a bad court decision that permits one state to continue to delay it so that’s the dynamic. I think you’ve seen it’s not just the Fintech Charter that’s been a lot slower than anyone would have expected, but Square’s, ILC application, certainly, you haven’t seen, you know, a final decision there that would suggest that the window to becoming an industrial bank for a financial technology company is open either.

And so, some of that has probably to do with the resistance of the traditional banking organizations and some of it is due to the government…still it’s hard to believe, Peter, because I know you were testifying up in Capitol Hill five, six, or seven years ago, but the government is still in the early days or early innings from their standpoint of wrestling with how to properly regulate and what the proper framework is for dealing with these kind of companies. These organizations and institutions are, you know, in many cases hundreds of years old (laughs) so they don’t necessarily move with the speed that a fintech startup company would think they might.

But, the good side of that is they also haven’t decided I think that this innovation is something they want to suppress so we’ve been in a situation where a lot of these regulators that have the authority to move forward on charters or have the authority to move forward to give more certainty to purchase market participants using alternative, you know, data or AI or machine learning techniques. They also haven’t come out with negative “stop what you’re doing” instructions.

Peter: Right, right, yeah.

Nat: Frankly, Peter, that’s one of the biggest goals of the trade association is to ensure that government and policy doesn’t become a roadblock to positive development of an industry.

Peter: Sure.

Nat: And so, right now, I think it’s fair to say that we’re not necessarily getting a ton of, you know, speedy highways built for us, but we’re also not getting big giant roadblocks put in our way.

Peter: So then, we’re recording this just after Labor Day and Congress is still on recess as we’re recording this, but they are coming back next week and when this is published they will be back, but I’m curious about…obviously, you’ve had a few weeks without much happening on the congressional side so what are your priorities now that sort of Congress will be back and you’ll be talking with lawmakers? What are your priorities for the next few months?

Nat: So this fall, Peter, we are going to be quite active working up in Congress. Obviously, they return to session with the regulators and I think the regulators really have the potential to act on the Madden and true lender, either via weighing in the court case or with a regulation. And then, you’re going to see us file a letter on the SEC’s… really looking to, you know, redo the accredited investor definition and tackle the way private offerings work in the United States.

Obviously, that market has far outstripped the IPO market and companies are staying private longer and ordinary investors are really shut out from opportunities. That has a real impact in marketplace lending as well. Many MLA members have decided not to go the route that LendingClub and Prosper were able to go early in the days of the industry in creating an offering for ordinary retail investors to participate in the loans. So, how the SEC ultimately shakes out in trying to open up new opportunities is going to be very important to our industry and so we’ll file a comment letter and follow up with the SEC there.

And then we have a day of advocacy planned on issues related to student loan refinancing and repayment benefits so if you think about it today, unfortunately, if employers offer a student loan repayment benefit that’s not a benefit that comes without a tax burden. So it’s just like getting additional income and that creates a situation at the end of the year where an employee is faced with a tax hit for money they didn’t see since the money went to help pay off the student loan. So that’s an issue where there’s bipartisan legislation and I think a really decent chance that Congress may act.

So, those are some of the issues that we’re working on in addition to just continuing to do the basic work that we do regularly, you know, following up with members of Congress on their interests in our issues. The task forces on financial technology and artificial intelligence are an example of an area where there is some inquiries that are both potentially very helpful to us, but also where we need to make sure that there’s a good, accurate information being given. And finally, there’s just the good blocking and tackling that comes with all the media scrutiny and so forth as the industry continues to evolve and change.

Peter: Right. So, just going back to the House Task Force on Financial Technology, it obviously is a very key piece the whole industry is paying attention to. What do you expect…I guess, how many hearings will they have and what will be the output of this task force. Will it be a report with recommendations, is this going to leak into the next Congress, I mean, is this something you have to wrap up in the next 12 months? Just tell us a little bit more about it.

Nat: Yeah, so there are actually two. There’s Task Force of Financial Technology, and then one specifically on AI. I think that they will do hearings on a cadence that’s probably monthly to maybe not quite that often, obviously, with some of the breaks that Congress gets to get home and campaign. But they’ll certainly do a number of hearings and they’ll simultaneously be taking their findings and putting together, I’m sure, a lengthy report that will include recommendations.

The task forces don’t have a legislative power so you’re not going to see a task force mark-up of a bill. That would fall to the committee that Representative Meeks is the chair of, in our case, financial institutions. So, that’s a real, you know, important nuance, that those task forces they have certainly a lot of ability to generate news in our industry because that’s really where Washington to the standpoint of financial technology and lending, internet-based lending and so forth, are making news.

You’re going to read about it in terms of what the task force is doing, but that doesn’t mean that they’re going to be proposing negative legislation or positive legislation, it’s really going to be a longer term thing. So, they will hand over the report and the recommendations to the full committees and they’ll also, you know, probably there’s a chance that these task forces become in a future Congress, become an actual subcommittee which would have legislative powers.

Peter: Right, right, okay. We’re running out of time, but there are a couple of more things I really want to get to. The first is, there are lots of organizations these days beyond the MLA, we’ve got the Online Lending Policy Institute, the Innovative Lending Platform Association, the ETA, the ABA, the American Bankers Association, there are all kinds of associations that you’re coming across on a regular basis so how much do you guys sort of go in to bat together and how much is it that you…your agendas are obviously are going to be somewhat different. Just tell us a little bit about the interface between these other organizations.

Nat: Sure. So, I think, if you look at the banking trades, they represent the banks, purely, right, so they will certainly advocate for policy that, you know, they believe will promote innovation, but they’re also always going to be worried about a level playing field for banks. So, to the extent that they are working on issues that we care about, there’s going to be alignment, for the most part, for instance reversing the Madden decision.

That’s a great example where all the organizations you mentioned have been supportive. At the same time, there are going to be some nuances and there are going to be some differences in approach on different issues. So, for instance, APR disclosure and small business lending has been one that has kind of created some slight divisions between the ETA, the ILPA and MLA and certainly the group that worked on the Borrower Bill of Rights. So, that’s an example where, for the most part, there’s kind of a growing consensus about how to tackle that issue, but that led to some early splits.

OLPI runs a terrific event that’s coming up in October, we work with them, many MLA members will appear at OLPI and then ILPA obviously works on small business issues exclusively and ETA is largely focused on payments, but also works on lending to a certain extent. So, we really have, I think, been able to grow to effectively include not just the larger, bigger participants, but you know, there are companies that are in MLA like LendingPoint and others that are now getting ranked in some of the fastest growing companies in the country.

And so, that’s very exciting because, yes, you have some of the ones that were at the forefront of building this industry, starting it and still the largest by overall volume, but you also have smaller, fast growing companies that have really, you know, come to bring a lot of innovation and change in practices that are positive as well in our group and so I think we’ve been able to grow because we haven’t tried to get focus on payments or blockchain or digital currencies. We’ve been really very, very laser focused on the environment that will best support these new digital lenders and that includes issues…you know, bank charters, it includes issues like risk retention and securitization, it includes certainly the issues around the bank partnership model and so forth.

Peter: Right, Okay, so last question is about a new initiative you guys have started. This is the MLA PAC, the political action committee, I believe, right? So tell us, it’s a brand new initiative, why form the MLA PAC and what are you trying to achieve with that?

Nat: Sure, so I think the goal of any PAC is to support the candidates for office at the federal level that really take a view towards innovation and towards helping consumers, creating better options and a sound approach to regulation and being able to support them in a different way than simply going in and meeting with their policy staffers in Washington or with their home state directors.

So, it certainly is a different type of interaction that you have when you’re seated around a table potentially with other industries such as the banks who have very, very large PACs and are constantly having an opportunity to have those discussions, you know, one-on-one or a group setting. And so, I think, it’s going to create some new opportunities for the association, for the industry and it is all very transparent.

These organizations have been around for a long time, they’re well regulated, they’re completely funded by voluntary donations from individuals so they’re not funded by corporations, it’s individual people who work at the member companies of the MLA who say, I really like the policy positions that MLA espouses and I have been following this very closely and I really like the work that a certain member of Congress has done, whether it be something specific to marketplace lending or just something very general.

There’s no certainty requirement that we support, candidates that are only particularly focused on fintech or AI or whatever, we’re going to look broadly and we’re certainly going to be bipartisan. I expect that our donations will be almost certainly equal or a goal that it will be equal across both parties and it will really be an opportunity, I think, to foster more dialogue and potentially more focus on what matters in the growing market of marketplace and online lending

Peter: Okay, well, good luck with that. It’s certainly a new era for the industry and we’ve run out of time, I’m afraid, Nat, but I really appreciate you coming on the show today.

Nat: No problem, Peter, and we can tackle some of the other things that are happening, certainly the SEC and revisiting the accredited investor definition and private offerings. There’s certainly a lot we’re working on with debt-free/tax-free in the student loan market so if we can have another bite at the apple, I’ll certainly be glad to come on and tackle that.

Peter: (laughs) We’ll do that, we’ll do that again. Okay, thanks a lot, Nat, appreciate your time.

Nat: Terrific, take care.

Peter: See you.

You know, I look back at the ten years that I’ve been involved in this industry, or almost ten years, I guess, and how it’s changed and I feel like we really are a professional industry now. The online lending space, the marketplace lending space is far more professional than it ever has been and a lot of that is due to, I think, having a strong and vibrant trade association and that’s what Nat has been able to build over the last three years. Obviously, we’re nowhere near finished, but it’s a great sort of platform for us to really get credibility as an industry in Washington.

You know, it’s one thing for a company to engage, it’s another thing for an association to engage with lawmakers and an association that really has I think in many ways it is boxing above it’s weight. It’s still a very small organization, but has already had some major achievements and I think a lot of that has to do with Nat’s leadership and how he’s been able to bring together a disparate kind of array of voices and bring them all into a common purpose. I think it’s been fun to watch, I’m sure it’s been a huge amount of work on his part, but we are very well positioned now for the future.

Anyway on that note, I will sign off. I very much appreciate you listening and I’ll catch you next time. Bye.

Today’s episode was sponsored by LendIt Fintech USA, the world’s largest fintech event dedicated to lending and digital banking. It’s happening on May 13th and 14th, 2020, at the Javits Center in New York. Lending and banking are converging and LendIt Fintech immerses you in the most important trends of the day. Meet the people who matter, learn from the experts and get business done. LendIt Fintech, lending and banking connected. Go to lendit.com/usa to register.

PODCAST TRANSCRIPTION SESSION NO. 214  –  SAFWAN SHAH

Welcome to the Lend Academy Podcast, Episode No. 214, this is your host, Peter Renton, Founder of Lend Academy and Co-Founder of the LendIt Fintech Conference.

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Today’s episode is sponsored by LendIt Fintech USA, the world’s largest fintech event dedicated to lending and digital banking. It’s happening on May 13th and 14th, 2020, at the Javits Center in New York. Lending and banking are converging and LendIt Fintech immerses you in the most important trends of the day. Meet the people who matter, learn from the experts and get business done. LendIt Fintech, lending and banking connected. Go to lendit.com/usa to register.

Peter Renton: Today on the show, I’m delighted to welcome Safwan Shah, he is the CEO and founder of PayActiv. Now PayActiv, I think, are a very interesting company, they are a mission-driven company and we get into their mission in some depth in the show, but basically  what it’s all about is earned wage access. This is where workers can get access to the money, the income they have already earned.

PayActiv has a system, they work with employers to enable that, to make that happen. Safwan talks about the early days of the company, how difficult it was to kind of get traction and why it’s suddenly becoming a hot topic. We also talk about the regulatory initiatives that they have taken and how the regulators feel about this and we also look at the many other services they’re offering to really providing a full suite of products to encourage financial wellness. It was a fascinating interview, I hope you enjoy the show,

Welcome to the podcast, Safwan!

Safwan Shah: Thank you, thank you, Peter, for inviting me.

Peter: My pleasure. So, I like to get these things started by starting on background and sort of talking a little bit about what you’ve done in your career to date before you started PayActiv.

Safwan: Like most careers that are more than 20 years long, there are a lot of things one has done, but I will specify/highlight a couple of things. Right before PayActiv, I wasn’t doing anything, I’d taken some time off after the sale of my previous payments and fintech company called Infonox.

By training, I’m an engineer, I guess payments expert by experience, been in fintech since 1999/2000, almost 20 years. By education, my Ph.D. was in aerospace engineering and I shouldn’t be judged on that (Peter laughs), my masters was in computer engineering and my undergrad was in electrical engineering, a reflection of the confusion at that stage of my life. That’s a summary of my background, I’m an engineer by training, basically.

Peter: Okay, okay. So, you’re an engineer by training, but you’ve decided to start this company that is…it’s somewhat unique because I know you started it at a time where I don’t think anybody else was really doing much in the way of, you know, this sort of earned income access. Tell us a little bit about…what was the idea that led to the founding of PayActiv?

Safwan: To me, it was an idea that came during a phase in my life where I wasn’t doing anything so I had a lot of time to think and, you know, when you have a lot of time to think, you do think about the human condition and what’s going on. One of the thoughts that kept occurring to me and I’m talking ten years ago was why is it that the richest country in the world has such a large pool of people living paycheck to paycheck. That term hadn’t yet been coined, we were in the post 2009 time frame and I just was kind of wondering what’s going on here, what are the underlying issues here and it is in that situation that this idea of PayActiv first struck me.

The question I ask is why is the richest country in the world…why does it have so many lower income people, cash-strapped and then it finally dawned that it could be related to, you know, of course, the divergence of wages and productivity, but that again wasn’t very clear. Credit was getting tighter and if you recall, ten years ago, nine years ago, eight years ago, we’ve seen this sort of tightening of credit. When there is no credit and there is a growth of debit, I could see that one thing that the world had missed was the sort of timing of pay when it comes to how people are paid.

To me, that was a big blind spot that nobody thought about because all credit/most credit takes your income/expected income as one of the big variables. However, many people, during that pay period, during that two-week pay period, were leaning on, they could get money from payday lenders/online lenders and many people were paying late fees and overdraft fees and those statistics were coming out.

So, it suddenly dawned that we have missed one thing, which is the timing of pay. The money is literally sitting there with the employers and the employees at the same time when they need $100 or $200 are absorbing overdrafts, deficits and late fees to make ends meet. So, the answer was somehow unlock that money which is stuck there because it’s not helping the employer per se with a very low interest rate environment so why don’t we get that money unlocked and that was the genesis of the idea.

Peter: Okay, okay. How big of a problem is this, like do you have any stats on the fact that workers don’t get access to their pay, I mean, how much that really costs them, on average?

Safwan: So, one can safely assume that when you are short of $20,50,80,100 between paychecks and you are paycheck to paycheck which means you do not have a buffer or savings and you do not have credit, so a small deficit can lead to an overdraft. An overdraft is typically $35. The published stats in the US are $35 billion in fees are charged in overdrafts every year so that’s one number.

Another number is the sort of payday lending industry. If you’re kind of desperate, you end up leaning on a payday loan which is $200/300, has a high fee to it. That number in fees is about $6 to 7 billion a year. Late fees is another $15 billion a year, a low balance fee charged by banks is about $5/6 billion a year. When you aggregate these numbers and the Center for Financial Services Innovation (CFSI), now called Financial Health Network, they published every year this data and the number in 2018 was $173 billion in alternative financial services. I’ve already related a few of those numbers like overdrafts, etc.

So now, on a working population of about 150 million people in the US with more than 50% cash-strapped, financially stressed, paycheck to paycheck. We’re really talking about 75 million people paying about $150 billion a year or more in various types of fees. That’s $2,000 per person per year, loss of income, right, or reduction in purchasing power because if you are making $3,000/$4,000 a month and one overdraft is $35, one late fee is $30/40/50 depending, if it’s your landlord who is charging you, it could be $60.

That’s a pretty large sum of money and the bills are always as you know, Peter, they come everyday while paychecks are batch processed, they come every two weeks or every month or every week. So, this misalignment leads to serious reduction in purchasing power and accumulating of financial stress. So, it’s really about $200 a month literally going to waste.

Peter: Right, right, I’ve heard that many times. It’s very expensive to be poor because you pay all those fees. So, anyway I’m curious about the timing because…like you started this company, it looks like, in 2012 and I know we’ve had you speak at LendIt a couple of times now, but it seems like this year…I know there are some regulatory things we will talk about in a little bit, but it feels like in the last 12 months there’s been a lot more attention paid to this space, why do you think that is?

Safwan: I think it takes time for the industry to realize, you know, this is the way it is typically, you go slowly for a little while and then suddenly, people understand, particularly in the case of PayActiv because our model is business to business and businesses are thoughtful buyers, [inaudible]. So for the first two/three years, if I really look at the…in hindsight for PayActiv, we went live with our first customer, first business in 2013.

I actually sat on the idea for two years before just thinking, how do we kind of navigate through the various behavior and other challenges we might face in doing a product like this, but I was convinced that businesses were the way to go to it.  So, when we started in 2013, it wasn’t that, you know, some business was looking for earned wage access. The term hadn’t been coined.

What they knew they were doing is they were giving advances to their employees who were in an emergency and employers and HR would have programs to help their employees. We arrived in that kind of marketer environment with a particular customer. The customer actually was in New Jersey and kind of said, you know, I bring money every week to give advances to my employees, this could be an interesting way for me to not do that.

Peter: Right, right.

Safwan: So we said, okay, and that’s how we started and it wasn’t easy. It took the next two years, we had, you know, just a handful of businesses, various parts of the country, but all very sort of cutting edge, thoughtful, visionary HR leaders and payroll leaders who chose us. So it was a long journey in the first two/three years and somewhere around 2015/2016, The New York Times wrote an article about us and I remember, that was kind of a watershed event in some ways.

And then just a few weeks before that, I had spoken at Finovate, one of the fintech conferences and we were awarded Best of Show. People walked up to me and said, what is this? Next week, Barron’s had an article about us and Barron’s doesn’t target, you know…it’s a very specialized publication. They kind of got to the bottom line that this is a change in the velocity of money…

Peter: Right.

Safwan: …money moves faster and then, you know, for the next, I would say, 2016/2017 were very fast growth periods and everybody was interested of what were we seeing in the data.

At that time Baton Rouge General Hospital was using us for a little while and in 2017, we compiled all the data for about 20 odd companies over 18 months and shared it with some researchers at Harvard Kennedy School. They published, they analyzed the data and, boom, they discovered something which was very big and that was that the employer that was offering the service was…they had reduced their turnover by 20/30/40% and that was the eureka moment that it’s good for the employer and we knew it was good for the employees, but for the employers, suddenly, there was a huge business case.

Peter: Right, that’s really interesting. You know, as I said, it’s a benefit that people, really, really value. So, let’s dig in, I want to just find out about how the system works. You said, you really are a business-to-business company so just talk us through how your system works.

Safwan: So, we work with employers, we utilize already earned hours so let’s say, Company ABC will decide to deploy PayActiv as a financial wellness benefit so we are a financial wellness benefit and they offer it to their employees. The employer offers it to their own employees, we are in agreement with the business and there are three types of guard rails in it.

First, we use the hours already worked so it’s not money that is not yet earned, it is earned money. The first guard rail is a portion of the earned money so it could be 30/40/50/60/70% of already earned hours so if you work 50 hours, you can get 20 hours. That’s one guard rail which is on how much of the money you’ve already earned you can access.

The second guard rail is around the frequency of access so you can do it every day as long as you’ve earned it, you can do it. So what we’ve discovered over the last few years of doing this is that the need is more, not ad hoc, but it’s a timely need, it’s not like clockwork every day people need money. They need it once, twice, three times during the pay period, but it can occur in a random way. Imagine, you’re on a tight rope which is 10 feet long, you don’t know when exactly you will feel you’re about to fall off, so life for cash-strapped, financially distressed people with no savings, it’s like on a tight rope. So, whenever you feel unstable that’s when you need money so that’s the second thing we provide.

We provide them sufficient frequency of access, two/three/four times, but they can get it. We’ve removed this issue that every time they access, they have to pay a fee. It’s not like that, it’s more like Netflix, once you’ve paid your $5 bi-weekly fee, you can use it multiple times so that’s another guard rail.

Finally, the entire model is not just about accessing money. Very early on, we discovered that people when you ask them, why did they take, you know, 50% of their already earned wages, whether it’s $100/200, they said they needed to pay a bill, or they needed to deal with something, a car repair, a daycare expense. So, what we did was we connected BillPay into our app and we kind of broke it down into four/five things.

First one was Get, Get means you can get money, you can take your hours, turn them into cash so we made time fungible and you could apply that money and PayActiv would take care of it, we could pay all your bills. So we connect into the BillPay system just like a bank. Another thing we did was some people had bank accounts, some people have pre-paid cards, some people have different needs, some even needed cash immediately so we solved all of them. For somebody who has a bank account we’ll ACH the money same day, next day. For somebody who has a pre-paid card, any card, Visa, Mastercard, debit card, we would instantly load money on it using things like Visa Direct and things like that.

We also launched our own Visa card so we are program managers of our own card, but we don’t mandate to use one card or the other, whatever method they want the access, the format they want it, we would move money, whether it’s through a bank, through a card. A lot of people…Peter, not surprised, right, don’t even have bank accounts. The dilemma in the US these days is financial exclusion so many people who can’t maintain a bank account for them, we deliver it with Walmart, they just get a PIN number, they can go to a Walmart store and pick it up in cash 24/7.

Peter: Yeah, yeah, I saw that, that is a really great innovation, I think for that population. So then maybe tell us a little bit about who these people are. I mean, you mentioned the 75 million people who live paycheck to paycheck, are we talking about the minimum wage worker or someone earning $40,000/50,000 a year, who is the typical user of PayActiv?

Safwan: So it’s a great question. Over the years, we’ve formed a very a good idea of who they are. They range all the way from about $75,000 to 80,000 a year down to $25,000, $30,000. The poverty line in the US is around $26,000/$28,000 a year, okay, so our users are, I wouldn’t say, evenly distributed between $30,000 to let’s say $75,000.

They are mostly in the…you know, up to $60,000 a year, $5,000 a month so the first fallacy that existed that these are desperate people, that is not accurate. These are regular people who just don’t have savings and they’re living paycheck to paycheck and a small discrepancy/misalignment, a $50 gap, can cause them to get into very, very difficult situations fee traps, debt traps, etc. So, I would say somewhere between the $15.00 to $25.00 per hour range is the evenly distributed user base.

Peter: Okay, so then I’m curious about the…when you’re selling this to an employer, obviously, you said that the retention rate becomes better for the employer, where are you finding pushback? Do employers think their employees don’t need this, I mean, what’s the pushback you get?

Safwan: So, the pushback is…I always joke about it in some ways that I used to have a big whiteboard in my office called 50 shades of no (Peter laughs) and over the years, the 50 shades of no has become much less. The biggest pushback in the early days was just the fact that this was something new. One reaction was…and you can say it’s rooted in paternalism; one reaction was, I didn’t grow up like this, waiting to get paid is very good, it builds character if somebody takes money between paychecks.

So that used to be the pushback and today also, the pushback…in many cases it’s paternalistic, that it’s a change from what employers are used to, but there is really no major pushback, other than the realization in most employers that it’s not just about access to money. It is timely access to money and it is all the other services that go with it.

The pushback now is more like, what else do you do, how is it financial wellness and what are the other services and that’s where we are growing as well. Now we offer Uber and loading Amazon Cash and things like that, savings programs, budgeting. So, it’s really reimagination of what lower income workers need and when you say that to the employer, they see the value of this. It’s not just I make payroll faster, that still has pushback.

Peter: Got it, got it. So then, where do you make money? You talked about this $5 per payroll fee the end user pays, does the company pay something as well? How do the finances work?

Safwan: So, the companies do pay, if they choose to, they don’t have to. In order to bring this service in operation, there is no upfront or set-up cost to a business, there’s no cost to the business. PayActiv does all the heavy lifting.

We are already partners with ADP, the largest payroll company in the country, we are partners with all the major payroll companies, either through APIs or through various types of file and other exchange mechanisms. We are also connected into all time and attendance systems, even big ones like Kronos so we work with the entire set of payroll companies, entire set of time and attendance companies and those two, we take care of those expenses, the employer has no cost to pay us.

Once we go live in a business, the employer can choose to pay the $5 fee or half of it because that fee is only applied if you use it, you know, unlike most subscription services, if you don’t use PayActiv in a particular pay period, you don’t pay.

Peter: Okay, okay, that makes sense, that makes sense. So, I want to switch gears a little bit and talk about regulation. I’ve read that there’s a bill in the state of California right now that’s working it’s way through talking about regulating what you’re doing and there’s also other states jumping on board and looking into what you’re doing. Tell us a little bit about how you’re engaging with the regulators and what their activities mean for you.

Safwan: Yes, so the bill in California is called SB-472. I don’t know if you’re aware of that, PayActiv is the original sponsor of the bill.

Peter: Okay, I wasn’t aware.

Safwan: California is unique, California companies can sponsor the bill and then a particular senator or somebody can then introduce it to the senate.

Peter: Right.

Safwan: So SB-472 is actually a landmark bill, it covers all the aspects of earned wage access types of service. All the stakeholders have been involved so different companies, a dozen companies have contributed after it was originally brought in and there are three key elements to it.

First, the over arching reason to have a bill is to bring clarity in the industry because this is a transaction or a transaction type which was unknown. You can say that in this day and age something got invented which no one knew existed before, particularly in an industry where lending and products like that are very well understood, it’s kind of like a “loanless” loan. So, in the bill there are three types of caps to protect the consumer which are, in some ways, inspired by the PayActiv model, but not necessarily.

For instance, we have even more conservative metrics, for instance, the amount you can access so it’s 50% of your earned wages. The fee that you can charge, the bill mandates the fee which is less than $15 a month maximum and the frequency of transactions that you can do because they also want to avoid the addiction type of issues which can happen when people use this type of system. So, the bill is very landmark, I think our motivation to be involved in it was to bring clarity.

There is a fundamental challenge being faced by low income people. The biggest issue right now is that, you know, we have three variables when it comes to wages. One is the level of salary, how much you’re paid and that’s not something businesses can do much about, fintech businesses, a business can choose to pay more or less, but I can’t do anything about that.

The second variable is the structure of pay or how you’re paid, taxation, or variable compensation. Again, a company in fintech can’t do anything, but the timing of pay is a definite variable which has not been used when you are paid. So, this bill actually brings clarity around how these people…if people access a certain amount of money between paychecks, when is it not a loan? That’s the key question, at what point does it become a loan, given this transaction is non-recourse. So, for instance, if somebody accesses the money and for some reason that money does not come back to the provider then there’s no recourse.

Secondly, the fee that is charged has no connection to the amount that is accessed so you pay $5 not for the actual amount you accessed, it’s for a service. So there are all kinds of things which require clarification and California is leading the charge and we are very hopeful that this bill will become the law very soon.

Peter: Okay, okay. Good luck on that one because I know states move quicker than the federal government and, hopefully, that does move through in other states, take California’s lead. Anyway, just moving along, I want to ask you about…you’ve been a B Corporation for a while and we were just talking before we started about a Public Benefits Corporation so tell us what that means and why you’ve taken that route.

Safwan: There’s a little bit of history or back story to it. When I started PayActiv, I needed motivation or some sort of purpose to do it and the purpose was that this company was meant to make a difference in the lives of cash-strapped, financially stressed people so we had a purpose statement which was to alleviate financial stress for lower income hourly workers by providing them access so it always had a motivation or a purpose. So, we were looking for some way to make that part of our overall…you know, it was in our individual DNA, we wanted it to be in the company DNA as well and we came across B Corps which are B-certified benefit corps.

About four years ago/three and a half years ago, we went ahead and went through the test and got certified with a very high score and basically the certifications says that, you’ve considered people, profit, community, all those things as important aspects of your business and since the work we do is a lot about social responsibility, etc. it’s great for us.

After three years of being a B Corp, the requirement is now you have to go and change your articles of incorporation and actually put it in your articles which means you get board approval full transparency, etc. so we became a Public Benefits Corporation which is how you change your articles of incorporation a few months ago. As a Public Benefits Corporation, now we can again get certified by B Corp. so we are not only a B Corp, but a very mature, multi-year B Corp and now a Public Benefits Corp.

Peter: Okay, okay. So, we’re running out of time, but there are a couple of more things I really want to get to. Firstly, can you give us some sense of the scale you’re at like what sort of volume of advances are you doing right now?

Safwan: So, we made an announcement last year that we’ve settled more than a billion dollars and this year, it should be several orders of magnitude more, maybe higher than three.

Peter: Okay.

Safwan: So, that’s a large amount of money which is moving, $150/200 at a time and the money goes, money comes back so that’s a big number. The report that came out from the Aite Group which said that the industry is close to somewhere between $15 to 18 billion a year right now and it is growing. I would say that we’re simply scratching the surface of this industry.

Peter: And you’ve also recently…I watched your movie, I guess you’d call it, it’s like 18/20 minutes long, very professionally produced and you’ve also written a book which we’ll link to both these things in the show notes here. What’s the reason for taking this sort of multi media approach to your business?

Safwan: It’s all about educating the users, every kind of constituent. This is a fundamental change in how money moves. When you bring timing of pay and, you know, my book is called “It’s About Time: How Businesses Can Save the World One Worker at a Time.” The video documentary is called “It’s About Time” and it’s a double entendre because it’s about time we did something and it’s about the time, the actual time because, Peter, the unit of work is time and time is tracked in databases across the world.

Putting a book out or a video documentary out is to a) highlight that there is a massive issue, a blind spot globally and people during these periods where they are earning but not yet being paid and that drought, cash drought or money drought, they are leaning on a lot of very, very predatory products.

It shapes our society, it shapes their lives, it shapes their children’s lives so if you want it and you need it, you should be able to access it. To get that point across to the world, you know, multi media, book, I’ll even climb up on a big mountain and yell and scream and say (Peter laughs), please, for God’s sake, do something.

Peter: Right, right, okay. So, last question then, what’s coming down the track for PayActiv, what are you working on now that we might see in the next six to 12 months?

Safwan: A lot of things, it’s all about helping people get money, pay for things on time, plan, save and that’s the journey. We are kind of becoming the bank for the underserved, we’re not a bank, but we are the bank for the underserved. We are bringing a lot of services, we already have BillPay, we have an amazing savings tool/savings product, we have a pre-paid Visa card, we have Uber directly connected to us.

You can call Uber from the app without having money in the bank just for using your hours, Amazon Cash is connected so it’s all about giving access. We want to provide access to affordable financial services at scale and where that journey takes us, I don’t know, but we want millions of people to enjoy the benefit of affordable financial services.

Peter: Okay, we’ll have to leave it there. It’s a noble cause and I wish you all the best, Safwan, and thanks again for coming on the show today.

Safwan: Thank you very much, Peter, thank you.

Peter: Okay, see you.

Safwan: Bye.

Peter: You know, I’m a big fan of the work that Safwan and his team at PayActiv are doing as well as other companies in the industry. I truly believe that earned wage access…I wrote about this on Lend Academy a couple of weeks ago, that earned wage access should be an option for every single employee in this country because this is not a loan, it’s not like you’re taking something out that you haven’t earned.

It’s just getting access to what you have already earned and getting access to it in an easy and convenient way. If we’re able to do that, I think the payday lending industry, the bank overdraft industry would shrink dramatically and I think companies like PayActiv are really doing a great job at enabling these people who are living paycheck to paycheck, enabling them to get money when they need it.

Anyway on that note, I will sign off. I very much appreciate your listening and I’ll catch you next time. Bye.

Today’s episode was sponsored by LendIt Fintech USA, the world’s largest fintech event dedicated to lending and digital banking. It’s happening on May 13th and 14th, 2020, at the Javits Center in New York. Lending and banking are converging and LendIt Fintech immerses you in the most important trends of the day. Meet the people who matter, learn from the experts and get business done. LendIt Fintech, lending and banking connected. Go to lendit.com/usa to register.

PODCAST TRANSCRIPTION SESSION NO. 213  –  ZAC PRINCE

Welcome to the Lend Academy Podcast, Episode No. 213, this is your host, Peter Renton, Founder of Lend Academy and Co-Founder of the LendIt Fintech Conference.

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Today’s episode is sponsored by LendIt Fintech USA, the world’s largest fintech event dedicated to lending and digital banking. It’s happening on May 13th and 14th, 2020, at the Javits Center in New York. Lending and banking are converging and LendIt Fintech immerses you in the most important trends of the day. Meet the people who matter, learn from the experts and get business done. LendIt Fintech, lending and banking connected. Go to lendit.com/usa to register.

Peter Renton: Today on the show, I am delighted to welcome Zac Prince, he is the CEO and Founder of BlockFi. Now BlockFi is in the crypto space, they’ve been around a couple of years now and they just closed a significant Series A. I wanted to get Zac on the show just to tell us a little bit about this platform, it’s somewhat unique and what they’re trying to do, they are positioning themselves as a sort of wealth management firm.

We get into that in some detail, we talk about how they’re offering works, as far as both investing in bitcoin and borrowing US dollars by pledging bitcoin, we go into the nitty gritty about all that. We also talk about how the fluctuations in bitcoin’s price has impacted his company, we talk about the difference between what he is doing and the Decentralized Finance movement or the DeFi movement. We also talk about what’s next for BlockFi, they’ve got some very interesting things coming down the pipe. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, Zac!

Zac Prince: Hey Peter, thanks for having me.

Peter: My pleasure. So, I like to get these things started by giving the listeners a little bit of background about yourself. Many listeners would know you from some of your previous stints in the fintech space, so why don’t you just give us some of the highlights of your career to date.

Zac: Yeah, sure. So, I’ve always worked at venture-backed technology companies. Early on in my career, I was in the ad tech space, two different companies that were part of the kind of real-time-ification or exchangeification of the online advertising industry, both of which were acquired, one by Google and then more recently and more relevantly for both this podcast and BlockFi, my current company, have been in fintech, specifically the online lending side of fintech.

So, I was the first employee after the founding team at Orchard Platform and then after the Series B at Orchard, I left and joined Zibby, which is a point-of-sale retail financing lender, very similar to Affirm, but targeted towards thin file or non-prime consumers and started BlockFi about two years ago now, Q3 of 2017.

Peter: Okay, and so when was your interest first sort of piqued in cryptocurrency? I’m curious about…did you buy bitcoin in 2010 like when it was a dollar, what’s your background there?

Zac: Well, I wish I bought it at a dollar now. While I was at Orchard, because of our role in the market, I was getting a ton of exposure to really interesting platforms, a lot of which had an ability for accredited retail investors to participate on the platform and I kind of became the fintech investing guy amongst my friends group and they would ask me, you know, should I invest in commercial real estate over here or buy loans from LendingClub.

I started writing a little blog just on the side to put down some of my thoughts on this stuff and I expanded that a bit, started writing about robo-advisory and other things happening in the fintech sector and that’s what led me to bitcoin. So, the first time I bought bitcoin was early 2015, after it had gone from a thousand back down to around three hundred and I really just kind of took a flyer on it. I was like, okay, looks like this thing went up and cooled down, it could be big, it could go to zero, who knows.

So I bought somewhere around 300 and just got lucky in terms of timing and had a little more than doubled my money in a month or two and I sold it all. (Peter laughs) I just patted myself on the back, and I was like, oh, great job, you’re a fantastic trader. Then maybe six months after that, it was up over a thousand and I purchased more and kind of started going down the crypto rabbit hole, as a lot of people in this sector call it, and when I bought back in, I started reading more about it.

In 2016, I started attending a few crypto related events in New York City. I was fortunate to invest in ethereum pretty early and I made this analogy in my head that bitcoin was kind of like a Blackberry and ethereum was like the iPhone. The iPhone would be ten times bigger than the Blackberry so I did pretty well on ethereum.

And then, early 2017, when prices were really starting to accelerate and it seemed like there were a number of things pointing to mainstream adoption and mainstream attention in the sector, I started thinking seriously about what could I do to get involved in the space fulltime and that’s what led me to start BlockFi.

Peter: So then what was the actual thing that you saw that really prompted you to start BlockFi, I mean, was there something specific that you felt the industry really needed?

Zac: It was a combination of things. So, I started going to these meetups. In 2016, the meetups were largely comprised of the hardcore early crypto adopters, libertarians, computer scientists and in early 2017, the composition of those events started to change and there were venture capital investors, some people in suits, you know, after leaving their job on Wall Street, some entrepreneurs from a variety of industries and things started to happen.

For example, like the Enterprise Ethereum Alliance getting announced which had Microsoft and insurance companies and major corporations saying they were going to, you know, invest time and effort and resources into building on the technology that was coming out of the sector so that was one thing that was happening.

Another thing that was happening or that happened is that I was making some real estate investments in Texas and as part of one of those I needed to submit a financial statement to a bank that we were getting a loan from and just to see what would happen, I listed bitcoin and ether on the financial statement that I submitted to the bank. And kind of expectedly, the bank wouldn’t value the assets at all, you know, it counted as a big zero in terms of their view of my finances, but additionally, they got a little nervous that I might be affiliated with some illicit activities.

Peter: Oh, geez.

Zac: They said that they needed to do an additional compliance review on me and that was a bit of, you know, my lightbulb moment, that one, a lot of the drivers of success and addressable market for online lending companies and other fintech companies was also going to be true in crypto space in terms of banks being slow to participate or not willing to participate and the other thing was just looking at the crypto ecosystem at that time…

The financial services infrastructure was very nascent and incomplete and the first slide that we made for BlockFi trying to capture that concept and we said that the ability to buy and sell existed, you have exchanges, the ability to raise capital was something that kind of looked and felt like an IPO, but was called an ICO existed, but things like debit and credit, insurance, a suite of banking products, none of that stuff existed yet.

So it seemed like a really big opportunity and there were also a number of things that I had learned were possible in just investing in and using these assets myself in terms of how you could deliver these products if we built them that made the opportunity really exciting and so I started, you know, putting pen to paper and talking to people about it a little bit and when I told Flori Marquez, the Co-Founder of BlockFi about it she was basically like, let’s do this, let’s do it now, it’s going to be big. So, we just decided to pull the trigger and start a company.

Peter: Okay, so then maybe you can take us through sort of the evolution and the initial product and how that product has evolved to date?

Zac: Sure, so the place we decided to start was with a secured loan product. Flori and I both came from the online lending world, she was at Bond Street previously, so we were very familiar with, you know, the components that we needed to start making loans. The product that we launched is analogous to a securities-backed loan or a liquidity access line in the traditional financial world.

The difference is just that instead of public equities being used as collateral, we were going to use bitcoin and other cryptocurrencies as collateral. So, we raised the seed round of funding in Q4 of 2017 and launched that loan product in January of 2018.

The way it works is someone has, for example, ten bitcoin and bitcoin is around $10,000 right now so their ten Bitcoin has a current value of $100,000, we would lend them up to 50% of the current value of their bitcoin. We take possession of the bitcoin throughout the duration of the loan and we build a risk management system that is able to take certain actions that correspond to price fluctuations, specifically, downward price fluctuations.

We launched the product in Q1, we were the first company in the crypto lending industry to receive institutional backing in the form of a $50 million credit facility from Galaxy Digital to support that type of lending and we scaled up our volumes throughout the bear market that crypto saw in 2018. So crypto was down about 85%, but our business was growing pretty quickly.

Peter: I’m curious about that because if you look back over the last five years, probably the worst time, in my perspective to launch something would be in Q1 of 2018 it was sort of…I’m not sure when the exact high was, it was either late December or January around then and then it just went steadily downward so I want to talk a bit more about the mechanics, but how did you find….you said your business kept on growing even as bitcoin’s price plummeted. How did that impact you, I imagine there were margins calls, what have you on your customers.

Zac: Yeah sure. I mean, we were benefitting…the reason we were able to grow is because we had a bit of a first mover advantage in terms of being the only kind of reputable place at the time that was offering this type of a product. So, as we were starting to do marketing and generating awareness that this existed as an option, we started to see adoption and users and volume flow through the platform.

The upside to having started the product at that point in time is that we do have a lot of data on both user behaviors in a time when crypto prices are moving down and also we kicked the tires really well on our risk management system. You know, the good news is that we’ve never had a late payment or a loss of interest or principal on any of our loans. So, the product performs a lot like margin lending or securities-backed loans and those are some of the least risky types of loans that exist out there. So, that type of activity had a 0% loss rate throughout the financial crisis and is very low risk and we believe that, you know, our loans are too.

From a user behavior perspective, what we found is that the majority of our clients were not taking every bitcoin that they had and pledging it as collateral to get a loan from us. So, the most common user behavior was that, you know, the first time someone starts to get a warning even before they’re getting a margin call, they would add more collateral or pay off the loan.

But really, when the market was kind of truly hitting that capitulation phase, which was around Thanksgiving of 2018 and bitcoin went from around 6,500 all the way down to 3,000 in a pretty short period of time, we did need to use the, you know, most extreme parts of our risk management system which basically take our client’s bitcoin and sell it on the open market to repay the loan well in advance of us being underwater in terms of the collateral value relative to the loan value. So, we did have to do that for about 8% of our customers that were affected.

Peter: Okay, okay. So, let’s dig back into the offering itself. Firstly, what crypto do you work with is it just bitcoin today or what do you work with?

Zac: As collateral for a loan, we support bitcoin, ether, litecoin and zcash.

Peter: Okay, okay. And so, what about the terms of the loans themselves, I mean, what sort of US dollar type, what’s the size? What was the LTVs, was it 50%? Tell us about LTV, duration, that sort of thing.

Zac: Sure, so we’ll do up to a 50% initial LTV. All of the loans to date have been one-year term loans with interest only payments throughout the duration of the term and a bullet payment of principal at the end of the term; also, an ability to, you know, refinance at the end of the term.

We have a bit of a tiered pricing structure based on the initial LTV and also the loan size. So, at a 20% LTV, we offer an annual interest rate of 4.5%; at a 35% initial LTV, the price is 7.9% and at a 50% LTV, the interest rate is 11.25% and then we have a 1 to 2% origination fee that goes down the larger the loan size is. So, that’s how the loans are structured.

Peter: So, you don’t underwrite the individual taking out the loan, or do you do some like AML type stuff, or what do you do on the actual person?

Zac: Sure, so we do KYC and AML type screens and identity verification, we ask a few questions that help us understand where the crypto that they’re posting as collateral came from, what they’re going to use the proceeds of the loan to do, but we’re not pulling any credit variables as part of our underwriting decision. We’re primarily or exclusively rather relying on the collateral that’s posted for the loan.

Peter: Right, right. Okay, so that’s one side. You’ve obviously got the other side which is the capital providing and, you know, the ability…I mean, I look at your homepage right now and you lead with wealth management, BlockFi wealth management which means to me that you’re trying to get people into that side of the equation where they’re actually giving you their bitcoin and earning interest on it. Just explain a little bit about how that works.

Zac: Yeah, sure. So, go back to the first time you learned about what a bank does in elementary school or whenever it was and, you know, the concept of there’s some people who have extra cash and they’ll deposit it at the bank to earn interest and there’s others that, you know, want to borrow money to start a business or do something else and the bank basically, you know, facilitates both of those activities by acting as a central place for both parties to transact with.

We’re doing that exact same thing, except we’re doing it with bitcoin and because we’re doing it with bitcoin some of the protections that have been built into the banking system over the years, like FDIC insurance, for example, don’t exist. But functionally, what our depositors and borrowers experience is very similar to what you would see in the traditional banking sector, except with bitcoin being the asset rather than dollars.

So the way it works is people who have bitcoin and want to earn interest on it can create an account at BlockFi, deposit their bitcoin into the account and earn currently a 6.2% annual yield on their bitcoin with interest paid monthly in bitcoin and the interest compounds after it’s paid into the account.

In order to generate that yield that we’re paying to the depositors, we lend to institutional borrowers. So one of the things that happened throughout the bear market of 2018 despite prices going down is that we did see increased adoption from certain types of institutions, most notably proprietary trading firms and market making firms who are very active in traditional markets.

The crypto market reached a size where it was large enough for them to participate and there were plenty of opportunities for them to make money given that the market was nascent, dominated by retail and very fragmented, in terms of liquidity being distributed across a lot of different exchanges and also geographies.

So, we lend to firms like that and transactions that are denominated in bitcoin, depending on who that institutional borrower is we have varying collateral requirements so for someone who’s really small that wants to borrow a million dollars worth of bitcoin, they might need to give us $1.2 million of cash to secure that borrow. For other firms that are very large, we might take some credit risk to them and so we basically provide that function to both sides of the market.

That product we launched in March of this year and it grew incredibly quickly so we on-boarded in under a month thousands of new users and tens of millions in new AUM and up till now, currently, we have tens of thousands of users on the platform and over a quarter billion dollars in AUM. So, we’ve seen tremendous growth there and what we’re going to do and what we’ve always planned on doing is having a platform that has a suite of products targeted towards this niche consumer who owns cryptocurrency. So today, we have the ability to borrow money at a low cost and the ability to earn interest.

In the future, we’re going to be launching additional products, but to answer your question of, you know, how did we land on leading with wealth management, it was kind of partially driven by the fact that we can’t just say we’re a crypto bank because that’s a little bit of loaded language from a regulatory perspective here in the US. So, we were trying to find, you know, a bucket that we could put ourselves into that would, you know, make sense for both what we have today and also the incremental products that we plan on bringing to the market in the future.

Peter: Right.

Zac: And we landed on wealth management.

Peter: Okay, interesting, that’s super interesting. So then, you talked about Galaxy Digital the $50 million line that they provided, is that money going to the individual borrowers who are pledging their bitcoin to you, or you’re taking custody over it? I mean, I’m just trying to figure out how the mechanics work because you’ve got multiple currencies here, how do the mechanics work with that funding line?

Zac: Sure, so it’s really two separate pools of capital. So, the SPV that we created with Galaxy looks a lot like the SPVs that are used to purchase consumer loans or business loans so it’s a forward flow loan purchasing bankruptcy remote SPV, there’s a split on the economics of the loans when they’re sold to the SPV and the interest that’s earned on the loans that are sold to the SPV.

That capital is used exclusively to, you know, finance the US dollar loans that we’re making. Then we have basically, a separate pool of capital that consists of the deposits from our clients that are depositing to earn interest and then the borrowers who borrow bitcoin are providing the interest that flows through to the depositors.

Peter: Right.

Zac: The Galaxy facility doesn’t really touch that…

Peter: Okay.

Zac: …bitcoin side of BlockFi’s capital structure.

Peter: Right, right, got it. Okay, then as far as the investing, I mean, obviously you’ve got to own bitcoin to invest, but is this just US investors? I presume you don’t have to be accredited, right, so who can invest with you guys?

Zac: That’s correct, you don’t have to be accredited. We currently have a minimum balance requirement to be eligible to earn interest of half a bitcoin which is about $5,000 worth of bitcoin at today’s prices and a minimum loan size of $10,000 so you need to have at least roughly two bitcoin to be able to take a loan from BlockFi, but there’s not a accredited or qualified investor requirement to be on the platform. We’re currently about 85/90% US in terms of the region that our clients are coming from, but we have clients in over 50 countries.

One of the really unique things about operating a business that uses cryptocurrency as the primary asset for certain products is that you can on-board users from regions without having a local payment processor or a local banking partner without needing to use their specific fiat currency so you’re able to get some distribution there that you wouldn’t necessarily be able to get in other business models.

Peter: But you’re still doing, as you say like the anti-money laundering type checks because, I imagine, there’s certainly been some bad press about bitcoin over the years with organized crime, that sort of thing, but I imagine, no matter where they are, they have to go through that process, right?

Zac: Yeah, that’s right. I mean, we’re an MSB at the federal level here in the US. We’ve had KYC and AML policies and procedures and training in place since day one so there’s not a single user on the platform that hasn’t given us a government-issued ID, you know, we’re not open to users from just any country.

We block IPs from certain regions, we block user registration from certain countries and we have a risk-based AML framework that triggers flags based on, you know, size limits and activity levels from certain regions so it’s not just a completely, you know, open source platform that anyone could come into.

Peter: Sure. So, it’s interesting because you’ve experienced a pretty significant bear market in bitcoin and then 2019, has seen quite the opposite. You’re not quite, obviously, reaching record levels, but bitcoin has come off its lows and now is consistently north of $10,000. So, how has the rebound in bitcoin impacted the demand on both sides of the business?

Zac: It’s been a massive tailwind for us. So, our numbers and metrics are up across the board and we do see some correlation, especially on the loan volume side of things, with market sentiment and the level of demand. One of the primary drivers for pledging an asset as collateral rather than selling it when you need cash is that you’re bullish on the price. So, the more bullish people are on the price, the more likely they are to consider a financing option like what we offer at BlockFi.

Additionally, if we’re measuring our AUM in US dollars, even if the assets on the platform are in bitcoin and we have $100 million when bitcoin is at $5,000 and bitcoin goes from $5,000 to $10,000, our AUM just doubled organically without us actually receiving any incremental deposits. So, it’s very helpful for our business, I also think it’s a fantastic time for the sector.

The end of 2017 was the first time that bitcoin and cryptocurrencies entered the radar for most people and there are a lot of people who said it’s just a big bubble, it’s going to pop and with bitcoin down at $3,000 and continuing to trend lower, that idea could be validated by the market. But now, with it going back up and recovering, it doesn’t matter how you look at the charts, it’s clear to see that it’s not dead. You know, it’s bullish for us and it’s bullish for the sector overall.

Peter: Sure. So, I want to switch gears a little bit and talk about something I’ve been hearing a lot about and I don’t understand it fully, but this MakerDAO the Decentralized Finance, the DeFi Movement that seems to be getting a lot of airplay these days, maybe you can just tell us…maybe explain what that means and then tell us what are the differences between what BlockFi does and sort of the MakerDAO CBP.

Zac: I’ll give you a quick story first. I actually first heard about MakerDAO about three months after we started BlockFi so Q4 of 2017 and I spent probably around a week wondering how the hell we were going to compete with something like what they were planning on building at the time. I think that the two core defining traits of decentralized finance which is commonly known as DeFi are one, that there is no concept of KYC or user registration whatsoever.

So a user from anywhere in the world is able to access the financial product without having to provide their personal information or be subject to the restrictions that generally exist in the financial services ecosystem.

The second thing is that the platforms are built using blockchain languages and smart contracts so if you’re someone that has the chops to look at computer code anybody can go and, you know, review and audit exactly what is happening behind the scenes because the entire platform is built on open source software, so that’s what DeFi means.

In terms of how we’re different, so a bit of a story on MakerDAO, so when I was scared about them in 2017, their plan was that they were going to create this stablecoin called dai which now exists and is pegged to the dollar, but it’s not actually backed by dollars and they were going to let people borrow dais secured by their ether the same way BlockFi makes loans, except using US dollars, and they were going to charge people half a percent a year.

The reason I was scared is because I was like how are we going to compete with something that doesn’t have to put a user through a KYC on-boarding process and only charges half a percent a year because their cost of capital is zero because they’re printing the money that they’re lending to people out of thin air using this protocol that they’ve created.

What’s happened since then is that as a result of that dai coin that MakerDAO is creating, not being able to hold it’s peg to the dollar very effectively, the interest rate that’s charged to users on the MakerDAO system has increased to over 20%, I believe it’s 22.5% per year now.

Additionally, there are things that BlockFi can do, both in terms of future products that we can bring to the market and in terms of doing things to reward and incentivize and delight our users that we can do because we know who our users are that a platform like MakerDAO can’t do.

So, that’s really the things that I think are the biggest differentiators, that ability to focus on your users if you’re a centralized provider and an ability to change rates based on decisioning that exists at the company level where with a lot of these decentralized platforms the rates are purely driven by market forces that are interacting with their protocol and they never know who their users are by design.

Peter: Right.

Zac: So, they can’t do things like offer, you know, users in a certain segment a discount or a reward or market to them in a different way because they have no idea who any single user is on the platform, or much less how to contact them.

Peter: The other piece is, I feel, regulatory risk, there’s a lot of regulatory risk for the DeFi Movement, I would think, because if it gets big, governments aren’t going to like the fact that there’s complete anonymity when it comes to sort of handling these types of financial products.

Anyway, I want to move on and we’re almost out of time, a couple of things I want to get to. I want to first talk about your Series A which happened fairly recently, tell us about that process, you’ve got some big name investors on board and just tell us how…you’re obviously not a typical kind of fintech company, just tell us a bit about how you’re able to get people comfortable and how that process went.

Zac: Yeah, sure. So, the process went really well and, fortunately, our timing was good, both in terms of the growth metrics on the business and also the way the crypto market was shifting, we were looking for a lead investor that really understood our approach to building the business which is much more driven by fintech fundamentals and strategies that have been honed in on versus, you know, the decentralized new crypto-type strategies that exist out there.

So, we had a few, you know, qualities that we were looking for in an investor and were fortunate to get to spend a lot of time with Valar Ventures team and get something across the finish line with them as the lead. They’ve led Series A rounds in companies like TransferWise, N26 and Petal, so we were really, really thrilled to bring someone on board who has that level of experience and expertise. I think other companies have this experience too, but really once we had decided that we were going to work with Valar and finalize the terms, we were instantly oversubscribed.

We have some existing investors like Fidelity and Susquehanna, Galaxy Digital and others who have always anticipated continuing to invest as the company grows and so the round was effectively closed as soon as we finalized things with Valar. And they really understood our pitch which is, you know, basically that we’re building a diversified retail financial services platform that is crypto first. Its strategy is to acquire this valuable segment of users with some core products focused on crypto and then expand from there.

Peter: Okay, okay. Last question then, what’s on your…I’m curious about the short term horizon here, what are the other products because you…I can imagine a hundred different products that you could probably come out with here, but what’s…maybe you could tell us a little bit on what’s on the near term horizon.

Zac: Sure, so before the end of this year, we’ll be launching the ability to buy and sell crypto through BlockFi and we’ll be doing it in ways that, you know, will be somewhat differentiated and don’t necessarily exist today. We’re kind of incorporating this ability to earn interest with the ability to buy and sell. It starts to feel a little bit more like a robo-advisor in some ways than just a crypto exchange, so that’s coming out very soon.

Next year, we want to launch a bitcoin rewards credit card, so a normal credit card, but instead of earning airline miles or normal cash back for your rewards, you earn bitcoin. The key thing strategically, that both of those products will enable us to do that we’re not able to do today is that we’ll be able to market them to people that don’t own cryptocurrency yet. And so, we’re really excited to bring those to market and grow the addressable market that we have in terms of customers that we can target.

Peter: Okay, that sounds super interesting. I’d love to dig into all of that, but we’ve run out of time. I really appreciate you coming on the show today, Zac.

Zac: Yeah, thanks for having me, Peter.

Peter: Okay, see you.

Zac: Bye.

Peter: So, if you believe that cryptocurrency and bitcoin have a future, then that future is going to demand all kinds of financial services that will help support it and BlockFi is obviously in a very good position to help create that future.

We were chatting…Zac and I were chatting after we hung up, after we stopped recording and talking about how, you know, like their credit card they’re coming out with. It’s super interesting because suddenly you’ve got a way to market to the majority of the population because let’s face it, even today there’s only a very small percentage of the population that own bitcoin that really could be a potential customer of BlockFi as they stand now. Adding in a traditional product like credit card is a way to bring many, many more people into this space.

Anyway on that note, I will sign off, I very much appreciate you listening and I’ll catch you next time. Bye.

Today’s episode was sponsored by LendIt Fintech USA, the world’s largest fintech event dedicated to lending and digital banking. It’s happening on May 13th and 14th, 2020, at the Javits Center in New York. Lending and banking are converging and LendIt Fintech immerses you in the most important trends of the day. Meet the people who matter, learn from the experts and get business done. LendIt Fintech, lending and banking connected. Go to lendit.com/usa to register.

PODCAST TRANSCRIPTION SESSION NO. 212  –  ARAD LEVERTOV

Welcome to the Lend Academy Podcast, Episode No. 212, this is your host, Peter Renton, Founder of Lend Academy and Co-Founder of the LendIt Fintech Conference.

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Today’s show is sponsored by LendIt Fintech Europe 2019, Europe’s largest fintech event for lending and digital banking. It’s taking place on the 26th and 27th of September in London at the Business Design Centre. Lending and banking are converging. LendIt Fintech Europe delves deeply into this new world bringing you the latest developments in the most important areas of fintech. LendIt Fintech, lending and banking connected. You can find out more and register at lendit.com/europe.

Peter Renton: Today on the show, I am delighted to welcome, Arad Levertov, he is the CEO and Co-Founder of Sunbit. Now Sunbit are a very interesting company, they’ve been flying under the radar somewhat, but I think you’re going to hear about them more and more because they have a really unique and interesting approach. You know, they are a lender, they actually work though in the offline world as opposed to the online world, they work at the point-of-sale.

They have a number of different verticals, specifically, the car repair vertical is a big one for them, and they’re able to approve a very large percentage of applicants, while at the same time keeping interest rates low and actually defaults low as well. So, how they do that, we actually get into it in some depth, we talk about their underwriting, what their approach is there, how they’re able to do it, how they’re able to make a very quick and painless process for the consumer when they are applying for this loan.

There’s a bit of a secret sauce they share there. We talk about who this typical consumer is, how they find these customers, the different verticals they’re operating in and what they’ve got planned for their future. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, Arad!

Arad Levertov: Thank you, Peter, happy to be here.

Peter: Okay, so I I like to get these things started by giving the listeners a little background about yourself. You’ve had an interesting career, not very typical of a fintech executive, I would say, including stints in the military, so why don’t you give us a little bit of background about what you’ve done in your career to date.

Arad: Sure, so actually, you’re right, I started my career at the military, in the Special Forces, where I spent five years, then I worked at Intel Electronic as a Manufacturing Manager. After moving to the US, I actually got into the fintech world when I joined a company that was providing online lending based out of Chicago first as an intern, but then became the chief operating officer of the company that probably was the pioneer in online lending, provided consumer loans, customers in the US, UK, Australia, Brazil and China and this was where I really learned everything about fintech, about lending, about the regulations, about marketing and gained all of this experience which led me about three and a half years ago to leave and start Sunbit.

Peter: Okay, okay, and that company obviously, was that Enova, we were talking about there, right?

Arad: Correct, that’s Enova International, we started small and we went public. It is right now a public company that provides hundreds of thousands loans to customers.

Peter: Okay, so then what was the catalyst, what was the idea…you know, you were working at Enova, obviously you got to know the online lending space and how it all worked, but what was the idea that led to the founding of Sunbit?

Arad: That’s a great question. So, as you mentioned, I worked at Enova, I knew all the details about online lending. Also, you can hear that I’m an immigrant and, you know, as an immigrant you don’t really have credit when you come to the US, you actually start as a subprime customer. Actually, when I started working at Enova, you know, I was making salary, I said this was the time to get a credit card so I went to Costco with my kids, I said, maybe I’ll get a credit card right now because I can pay for it.

Applied for the credit card, you know, at the cashier…when the cashier asked me how much do I make, where do I live, my social security number and then got declined. It was pretty embarrassing to get declined in front of other people, in front of my kids, in that case, at the point-of-sale, and then I realized that it wasn’t only me who got declined. Actually, it was 50% of people who apply for point-of-sale financing are getting declined and the people who do get financing, who do have credit cards sometimes pay high rates for the credit card.

I thought there should be a better way to provide financing for everybody to improve the operational inefficiency by the cost of the marketing, the cost of the fraud and give the savings back to the people. So, I thought to develop a product that will be able to allow all customers to sign up for what they need in a fair and good rate. That’s how I thought about Sunbit.

Peter: Okay, you know, I think it’s interesting because you came from the online world and I sort of was doing some digging about your company, it’s like you really decided, it seems like, to focus on the physical point-of-sale, like what you just experienced you said at Costco. So what was the reason, even though you’ve got this online lending background, and you decide to focus on the physical point-of-sale?

Arad: That’s a great question. You know, many people were focusing on the online, everybody is moving online and Enova was one of the pioneers in online lending, but at the end of the day, 90% of the purchases are still happening in the brick and mortar. People need to fix their car, people go to the doctor, people go to buy glasses, people go to the veterinarian and people go to buy in the mall.

When you look at the innovation, there were some good innovations online, companies that do online lending, companies that do online lending at the point-of-sale, but when you actually look at the brick and mortar, the main player there are still the credit cards. When you want to fix your car and it costs you $500 or $600, you don’t really want to apply for another credit card. You don’t have the time to fill out an application and at the end of this ten minutes to get declined if you are one of the two who didn’t get approved.

So we saw that there was opportunity to bring machine learning and innovation and to build a unique product for the brick and mortar which will serve 80 to 90% of the purchases which many of them will stay in the brick and mortar. People will still need to go and fix the car, people will still need to go to the doctor and they have to do it face-to-face.

Peter: Right, okay. So, you just mentioned a couple of different verticals there, but can you just share the main verticals that you’re focused on today, what industries is Sunbit available in?

Arad: Sure, so Sunbit products, and we’ll dive into it later, allows us to basically approve customers within 30 seconds, approve nine out of ten customers while maintaining credit quality and when you think about it, it can work in any vertical. It can work for people that buy things in the mall, people that fix their car, people that buy furniture.

We like to focus on verticals that are…we call it “non-discretionary verticals”, we help people to get things done and continue their life. People need to fix their car, this is one of the biggest verticals that we have, the car repair in the dealership market, with authorized dealerships with Toyota and Honda and Kia. There are a lot of people who come and fix their car and they need to go back to work. We love this vertical.

We also have verticals in healthcare, you know, in dental, in eye care, in veterinarians. People need to do it and go back to their life. Usually, sometimes this is a surprise, they didn’t know they need to fix their car, they didn’t know their glasses got broken and they need to get glasses because they need to continue their life and we are there to help them.

Peter: Okay, so, obviously, many of these verticals…there are other companies, I’m just curious how you…I mean, how does the process work where you…we can take the auto vertical…I mean, there are other companies offering different auto financing for not just for cars, but for car repair and that sort of thing. So, how does it work, how do you get into these established companies?

Arad: So, there are many companies that maybe offer financing for buying cars and some companies do offer financing for car repair, but when you think about car repair, when you think about fixing a car, the dealership, when you go to fix your car, a customer really doesn’t have a lot of time. You want to drop your car, you want to go to work and you want to pick it up at the end of the day. You don’t have the time to go and fix the car or fill out an application and spend time so we came with a value proposition that tells the merchant that with Sunbit customers can get approved within 30 seconds.

Not only that, we are able to approve almost every customer while maintaining credit card rates and while providing each customer with a better offer compared to its alternatives. So, our offer which is fast on one end, high approval from the other end and also maintains good rates basically gives us the ability to get into places where the other lenders or the credit card companies couldn’t penetrate because it didn’t fit into their process.

Peter: Okay, so let’s dig in there for a little bit. It sounds great to be offering lower rates, higher approvals, quicker response time, but how are you able to do that? What’s your underwriting like, tell us a little bit about that whole process.

Arad: That’s a great question because, you know, when I started the company I said, let’s make sure the loans are coming back before we scale…

Peter: Exactly.

Arad: …you don’t want to build a business…you know, you give loans and then it doesn’t come back so that’s a great point. Right now, we have many loans that came back because our average loan is around ten months so this was a time to start scaling and we did that about a year ago. So, how does it work? You know, the exciting thing about what we do is how we deploy machine learning and artificial intelligence into the process, not only into the underwriting process.

Because we are in the brick and mortar, we know what’s going on before the customer applies. The customer that goes and fixes the car in the authorized dealership, this is a different customer that will go to fix his car in the store around the corner. This is a different customer who will go and use financing to buy jewelry or to get dental treatment so we take it all into account and that’s even before the customer went to apply for the loan.

The second thing that’s unique for us is because the process is so fast, basically, we scan the customer’s drivers license, fill out an email and a phone number and with the click of a button they get approved. Again, scan the driver’s license, phone, and email and click of a button they get approved. It feels like a payment method versus financing so we get actually more customers to apply than a customer that is really desperate to get financing and this is all before we get into the underwriting, but it all takes into account with our artificial intelligence and behavioral economics.

And then when you go to the underwriting, we underwrite the customer to the specific transaction in the specific location. So most of our loans are in the hundreds of dollars, you know, the average loan is maybe $600, $500. This is really different than when you apply for an online loan worth $10,000 or $15,000. If you think about it, let’s say that our average loan is $600 on three, six or 12 months, let’s say the average is ten months, which means that the average monthly payment may be fixed to $70.

When you think about the customer, whether it’s a subprime customer, a near prime or a prime customer, I can tell you that many customers can figure it out to find $70 a month. So it’s not that we need to analyze if the customer has the ability to pay, everybody has the ability to find $50/$60 per month. What we are focusing is in the behavioral economics of the customer is the customer’s willingness to pay.

We treat the customer well so the customer gives us back the money that they owe us. We take it all into account with sophisticated artificial intelligence and therefore, we’re able to really approve almost all customers, nine out of ten customers, and provide all of them a rate which are far from the payday loan or predatory rates.

Peter: Okay, so a couple of things there before we move on. I just want to go back and you said that you do a driver’s license, you said there was three things, there’s no form to fill out necessarily, you only need three pieces of information and I just want to clarify that. That’s it, like they’re not filling out a form? Just go back and tell us these three…I remember the driver’s license, you scan the driver’s license, and what were the other two things?

Arad: Sure, so we provide the retailer a tablet and with this tablet the retailer would ask the customer to scan their driver’s license.

Peter: Right.

Arad: From this information, we take the driver’s license. In addition, the customer has to enter an e-mail, they need to have access to e-mail, of course, so we can communicate with them via e-mail, and the third thing is to have a debit card on hand. So with this debit card, we basically register the customer to a monthly recurring payment and we take a small down payment from each customer.

So with these three things, the debit card, the driver’s license and access to an e-mail, we are able to approve the customer. As I mentioned, we do it in seconds, there is no form, there’s no questions, nothing to fill out. Scan the driver’s license, e-mail and phone number, get approved, and the debit card before we sign the contract.

Peter: Okay, so obviously, there’s a lot of information you can get from just those data points. I’m curious about like the 90% number, so is it because…there’s no way in the world an online operation could duplicate this and I think the thing I think that’s interesting is it’s because this is offline because this is face-to-face.

If you have taken your car to the car dealership, you obviously are not…you have an asset for a start, you have a car and so I’m guessing that because this is face-to-face that takes away a lot, I imagine, of the fraud piece where someone’s trying to scam you. They’re not trying to get a loan to go blow money in Vegas, they’re trying to get a loan to actually do something. I just want to dig more into the 90%, it’s because this is not deep subprime, this is more mid-prime, is that right?

Arad: I think you nailed it. Our mission as a company, we call it “to eliminate the waste and give it back to the consumer” and when we say eliminate the waste we mean, if you were able to get a customer without fraud so you don’t penalize your other customers, they don’t need to pay for the guy who committed the fraud. The fact that we are in the brick and mortar, the fact that we know that the customer came to fix the car. As you mentioned, they have a car, and by the way, when they came to fix the car, they knew they were going to pay something, right, that’s why they came to fix the car so they have something in their pocket so they are willing to pay.

On the top of it, with the driver’s license and the debit card, we have a lot of information that we can compare and to make sure that this is the right person, this is the right reason to use it and as you mentioned, we do not transfer the money to the consumer, we actually transfer the money to the merchant. So, this allows us to really reduce a lot of the fraud, a lot of the waste.

In addition, we don’t go direct to the consumer, we basically go to the merchant, but the merchant actually helps the consumer…the merchant is able to sell more by closing more transactions and we get more consumers and we pass the savings back to the consumer, give them a better rate compared to the alternatives.

Peter: Right.

Arad: With this savings, we are able to really approve all customers. We do go to some subprime, we go down to 500 credit score and thin file, we approve all of these, and we do not go above the credit card rate.

Peter: Okay, okay. So, who are these people? You said you go under 520, I mean, you talked about yourself being an immigrant. I am an immigrant as well, I had a similar problems when I moved to this country many years ago. So, just give us a little bit of…more information about these customers that are applying for loans.

Arad: So first of all, I would say that when you work with a brick and mortar, you need to be able to serve all customers and that’s what we do, we serve all customers across the credit spectrum because when a customer goes to fix a car at the car dealership, it’s not like they have a sign, I am a subprime, I am a near-prime or I’m a prime customer and we work with our partners which is the merchant which helps them increase the sales by providing financing to all customers.

So we do have customers across the credit spectrum. We do have customers that are prime and super prime and even though they do have in their pockets, I’m sure they have great credit cards with a high credit limit. Because of the ease of application and the driver’s license, e-mail and phone number, they will try it and then when we see that they are there, we’ll give them an offer which is much better than the credit card so we do have customers across the credit spectrum.

When you look at the entire portfolio, of course, we have more customers that are near and subprime just because this is the loan amount of $500 to $600, but when you look at the entire book, our book, average book, is in the near prime which means we do have customers in the prime and super prime.

Peter: Okay, so what are the terms…. I think you mentioned ten months, $600 whatever, what are the interest rates and are you charging like an origination fee, what are the terms of these loans?

Arad: Sure, first of all, we like to be transparent with the consumer. There is no origination fee, there is no extra fee other than the straight interest of the installment loan that we provide the customer and it’s all clear in the process and every customer sees it right away. For each customer we give a personal loan, usually loans are…the APR is 9% up to 36% and each customer gets a different rate, a different approval amount and as I mentioned before, a different down payment to put on the debit card.

So, if you’re a prime customer, you’ll probably get maybe 9 or 10 or something in the teens which is better than your credit card rate. If you’re a subprime customer, you might get 29 or up to 35.99%, but it’s much better than your other options to go to a payday loan and take in the hundreds of APR for this loan.

Peter: Okay, and then what can you tell us about the performance of these loans because if you’re…like there might be people that are willing to pay, but something happens, they lose their job or whatever, I mean, we know that these things happen. I’m curious about…I know you haven’t been lending a long time, but these are fairly short durations so tell us a little bit about the loan performance, if you would.

Arad: Sure of course, so we’ve been lending for almost three and a half years so we do have a lot of loans that came back and we do have a happy portfolio. We see performance on par with the prime groups of the online lenders. Our loss rate is on par with what you see from LendingClub or Prosper which is in the public market.

When we underwrite people, it’s really across the credit spectrum and the reason is that one, as we mentioned, we use artificial intelligence to underwrite the customer to the right amount, to the right duration, to the right transaction specifically, and also, we underwrite for three, six to 12 months.

It’s much different than underwriting a customer for three or five years so altogether, with the process that is fast, transparent and small dollar amount, allows us to really, basically, serve customers across the credit spectrum and basically have loss rates of a prime book which gives us a really healthy IRR for the business.

Peter: I’m sure, and so because you’re working with brick and mortar, you’re serving your customers’ customer in a way, how are you getting…I imagine, this is somewhat labor intensive, you’ve got to go out to these brick and mortar places to get them to offer your products…I mean, and then really it’s up to you to…they just want you to approve everyone because they want to do the business, but how are you getting into the different retailers you’re working with?

Arad: So you mentioned that they want to approve everyone which I agree with. The brick and mortar…I think, in order to be successful in the brick and mortar, you need to have high approval rates and you need to have overall low APR, you don’t want to be in the predatory world which is what I think is unique about Sunbit because we are able to approve everybody while maintaining credit card rates.

As you mentioned, it does require us to actually have boots on ground and be in the brick and mortar location. So it is  …(inaudible)…and make it happen, you need to go there, you need to train them, you need to serve them and you need to work with our partners which is the brick and mortar stores to basically help them help their customers which will become our customers. We developed a tool, we developed a theme here so, basically, to be able to grow the business.

We are right now operating in more than 40 states in the country so we actually have locations that use and offer Sunbit in 40 states and we developed a tool to work with them, to train them, to communicate with them, to communicate not only with the manager, but also with the associates in the store in a nice way, in an electronic way also using machine learning and artificial intelligence to encourage people to offer, to give a good word if they did offer, if they did close a transaction and to work with them hand in hand to basically help them sell and get more customers for them and for us.

Peter: And then, are you working with an originating bank to actually issue these loans?

Arad: Yes, we do have a charter bank that’s working with us and helps us to originate the loans.

Peter: Right, okay. I want to switch gears to the capital providing for these loans. I know that you have Eric Thaller, who many of the listeners would know from his time at Prosper, he’s your Chief Capital Officer there, but can you just tell us where the capital for these loans is coming from?

Arad: Of course, sure. We are fortunate that Eric could join us after his experience at Prosper marketplace. Right now, we have a debt facility that we use to fund the loans and our strategy says first, who can you underwrite a loan that the loan would perform, what do we mean, like have skin in the game, show that the loans will perform and now, we use this debt facility and in the future we are going to diversify our funding sources with maybe more debt facilities, selling some forward flow and other options.

Peter: Okay, so then I read recently that you raised, I think it was $26 million in a Series B, tell us a little bit about that process, you know, who is backing you and what it was like going out and raising that money.

Arad: So, we just raised another $26 million, the round was led by the Zeev Ventures and Oren Zeev which is the general partner, he has invested in the past. He is known in Silicon Valley and invested in companies like Audible, Chegg and in later fintechs like TripActions, which is a really successful company. In addition to him, we were fortunate to have investors from really day one who loved the story and were with us from really the seed level to the round A which is different investors, mostly Group 11 which is based out of Los Angeles and focused on fintech and Chicago Venture based out of Chicago and, basically, have deep understanding of fintech and retail. They were with us alongside from day one and now with the investment of Zeev Ventures we’re excited to have investors that support us on this mission.

Peter: Sure, so we’re almost out of time, but before I let you go, I’m curious about what your mission is here, what the future holds for you guys. Maybe you could give us some sense of what you’re working on in the short term and where you want to be in the long term.

Arad: Of course, as I mentioned, our vision is really what we call “eliminate financial waste and give back to the people,” Eliminate the operational inefficiency and give back to the people, whether it’s for consumers, by giving them a better offer, or for merchants and partners by giving them more tools. We started here about three and a half years ago, small and now, we’re scaling.

With this capital in the short term, we want to scale, you know, the car vertical which is our leading vertical and we are scaling very nicely on this one. We are also looking for other verticals which we are looking at scaling and this is what we’re going to do in the next 12 months. In the future, we’re going to add more products, both for the consumers and for the merchants. So basically focused on leveraging technology to eliminate the waste, increase operation efficiency and give the savings back to the consumers.

Peter: Okay, that is a laudable mission and I wish you all the best. Thank you very much for coming on the show today, Arad.

Arad: Thank you very much, Peter, it was great having been here.

Peter: Okay, see you.

You know one of the keys, I think, to be successful at the point-of-sale is you’ve got to make it as frictionless as possible for the customer. They don’t want to fill out a long form, particularly for something that’s under $1,000, they just want to get the loan and get out of there. The fact that Sunbit is really focused on that and they’ve got just three pieces of information that they’re gathering and that points to the how they’re able to get all the different data sources that are available today for lenders like Sunbit really makes it possible that they can take just the small numbers of data points and be able to make an accurate credit decision. That would not have been possible a few years ago and certainly, Sunbit is taking advantage of the situation today.

The fact that they can do that and maintain a low default rate, that’s going to be the big thing, I think, as they scale to really be able to maintain that default rate that really is…it’s pretty impressive, what they’ve been able to do.

Anyway on that note, I will sign off. I very much appreciate you listening and I’ll catch you next time. Bye.

Today’s show was sponsored by LendIt Fintech Europe 2019, Europe’s largest fintech event for lending and digital banking. It’s taking place on the 26th and 27th of September in London at the Business Design Centre. Lending and banking are converging, LendIt Fintech Europe delves deeply into this new world bringing you the latest developments in the most important areas of fintech. LendIt Fintech, lending and banking connected. You can find out more and register at lendit.com/europe.

PODCAST TRANSCRIPTION SESSION NO. 211  –  JOHN GOODALL

Welcome to the Lend Academy Podcast, Episode No. 211, this is your host, Peter Renton, Founder of Lend Academy and Co-Founder of the LendIt Fintech Conference.

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Today’s show is sponsored by LendIt Fintech Europe 2019, Europe’s largest fintech event for lending and digital banking. It’s taking place on the 26th and 27th of September in London at the Business Design Centre. Lending and banking are converging. LendIt Fintech Europe delves deeply into this new world bringing you the latest developments in the most important areas of fintech. LendIt Fintech, lending and banking connected. You can find out more and register at lendit.com/europe.

Peter Renton: Today on the show, I am delighted to welcome John Goodall, he is the CEO and Co-Founder of Landbay. Now Landbay are a UK-based buy-to-let mortgage company and we explain exactly what that means in the show, they’ve been around for a few years and they’re really starting to get some serious scale.

I wanted to get John on the show just because they operate in a sort of unique part of the market, particularly when it comes to fintech players and they have seen tremendous growth and they’ve had a really significant commitment, one of the largest commitments of capital of any of the the UK fintech platforms, and wanted to talk about that.

We talk about that state of the UK property market, how they’re bringing technology to bear on underwriting and how they’re competing against banks. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, John!

John Goodall: Thanks a lot, Peter.

Peter: So, I like to get these things started by giving the listeners a little bit of background about yourself. Maybe you can give us some highlights in your career to date and what you did before Landbay.

John: Yes, certainly. I did quite a few different things before I co-founded Landbay. Initially, I set up an executive search business, it was focused on financial services and I ended up selling that in January 2007. As it happened, obviously quite good timing as we were focused on pretty much investment banking and at the time it was obviously, it was eight or nine months before things started going wrong. I then actually went and taught economics for three years at an economics university, it had been been a deep interest of mine and this is as it happened during the crisis, 2007 to 2010.

If you remember, it was also at that time that Zopa had started going in the UK so I started investing on Zopa and then, luckily, Funding Circle. And then after I taught three/four years, I then went on to study an MBA and I started thinking about peer-to-peer and then I met my co-founder who I worked with again in the city. I met my co-founder, Gray Stern, in 2013 and we set up Landbay.

Peter: So then what was it that you saw back then, what was the idea that led to the founding of Landbay?

John: So, I had always been really interested in the peer-to-peer market, as I said I was very early on in Zopa as an investor in the loans and thought it was a really good business idea and a good innovation. Obviously, during 2007/2010, I was teaching economics and a lot of my focus at that time, obviously, was on the mortgage market because the mortgage market around the world was blowing up and that was what was driving it.

When I did my MBA and I was thinking about business models, particularly in peer-to-peer, about setting a business up and, you know, I was thinking about mortgages and peer-to-peer. As I said I then met Gray, Gray’s background was not in buy-to-let mortgages, but he’d worked in property finance and we started looking at various areas of property lending, initially, and then we settled on buy-to-let. So, it was always a case of actually…as it happened, buy-to-let in the UK had performed very well through the crisis.

So that was always part of the draw, to create something that was relatively low risk, relatively stable, but also, you know, a large market. Most of the people in property lending had gone into development and bridging which we always thought would be a lot more typical and obviously it performs well in good times. Typically, they also do well in downturns.

Peter: Okay, so before you go any further, I want to just get something straight here for our US listeners, specifically. What is buy-to-let, what does that actually mean?

John: Buy-to-let, in very simple terms, it is a residential mortgage, in the sense that it’s on a residential property, but it is for the sole purposes of letting out, if that makes sense. So it is not a regulated activity, they’re not home loans, but the sort of properties you’re lending in are very similar to owner occupied as we call it here in the UK, but effectively, it is a business or commercial loan but on residential property.

Peter: Right, right and obviously letting means renting, we don’t use the word “let” in this country. Okay, so then you founded the company and you got going, but what was the…tell us about the loans themselves like these are residential mortgages on, I presume, single family homes or apartments or whatever. What’s the loan size, the duration and the interest rate, that sort of thing?

John: Yeah, they’re typically on houses or flats, so single family units in US terms, or apartments, occasionally there are what’s called multi-unit freehold blocks where there might be one building with four flats and that sort of thing. There are a few other nuances, and also some small student housing type properties, but a typical loan size is…average is right about a quarter of a million sterling, 250,000 to 300,000, but that will range anything from maybe 75,000 pounds and our max loan size is 2 million, but the vast majority sits between 100,000 and 400,000.

The duration of the loans can be up to 30 years, but this is an important thing and again, this is very different to the US market and other European markets, the nature of the UK market is you have typically a fixed rate period which is either two or five years in most cases, and then they revert on to a floating rate.

Normally in the UK market, these mortgages are arranged so when they revert to the floating rate, people typically refix them on to a new 2-year or 5-year fixed rate product. So, although the duration is technically long, the expected duration would typically be two or five years.

Peter: Okay, okay, that makes sense.

John: And we’re lending out…our weighted average sort of borrower rate is about 3.5% on buy-to-let and that is typically…buy-to-let is typically 100 basis points higher than owner occupied typically. One other thing that is important is they are typically interest only loans.

Peter: Ah, interesting, interesting.

John: People are paying monthly interest payments, but no capital repayments.

Peter: Right, right, okay. So then when they refinance, they really haven’t paid any of the principal off. They’re refinancing the full principal.

John: Exactly, and the way we think about these as business loans, if that makes sense, so we are lending to businesses, the business just happens to be renting out property. The nature of that business model is they want to maintain leverage on their assets all the time, if that makes sense.

Peter: Right, so what are we talking about as far as loan to value? What is the average?

John: The average is about 70%. We do occasionally go up to 80%, but again, the bulk is between 60 and 75%. We underwrite typically based on, partly on loan to value, but the large part is around affordability in terms of what the rental payment is relative to the interest payment.

For those listeners outside the UK, they may not be surprised to hear that property values in London are typically much higher than the rest of the country and therefore the yields are much lower in London for the landlord, for the investor and so you typically find the lower loan to values are actually the more expensive but lower yielding properties in London and to a lesser extent the southeast.

Peter: So, does that mean that most of your business is outside London?

John: No, total mix actually. We’re probably by pound amounts we’re probably 50% or so. London is such a large part of the market and as I said, they’re typically larger loans so what you do find is…you know, our average loan size in London is probably half a million whereas in parts of the north they’re typically 80,000/90,000 so you don’t do as many loans in London, but actually by pound amount it still is, by far away, the biggest region in terms of money out the door.

Peter: Right, right. So then who are these borrowers? Are these sort of professional landowners, like professional investors, shall we say, or is this someone that’s doing this on the side, I mean, who is the typical borrower?

John: So, in the broader market in the UK, it can range from people who’ve got one buy-to-let that maybe….you know, they call them accidental buy-to-lets where perhaps they inherited a property, or two people got married and they both have properties and they kept one and let one out, or people who move out of London, they keep their London flat and rent it out, or something like that. But they end up having a spare house which sounds very…a nice position to be in, but then on the other end, there are professionals who have got 20, 30, 40, 50, 100 houses.

We’re typically lending more to the latter group, people who typically have more than four properties and maybe 10, maybe 20. It’s not exclusively our point, but we consider that what we call the professional/semi-professional market so they are running it like businesses. They may have another job and sometimes you find that, for example, it’s something that contractors do or consultants that might work four days a week and they spend the day looking after their property portfolio and they outsource some things.

They might not be out and out professionals in the sense that they have another income, but it’s also a material part of their income. So, that’s the market we typically focus on in terms of most of our lending, for people that are really, the way we look at it, people who are treating it like a business.

Peter: Right, right. Okay, so then I’m interested in the technology side of this business because, you know, property, I know, in the UK as well as in the US, it’s a very old fashioned, paper-based business with lots of manual paper going back and forth or PDFs being e-mailed, but how have you kind of brought technology to bear on sort of the loan application process?

John: Yes, the application process is totally online so it is paperless in that sense, for us. It’s all uploads online, all signatures are digital. We’re still in the legal system on the actual final mortgage document, the borrower has to do a wet signature that’s done between them and their lawyer and those are posted  so we still do get physical loan docs that are in post completion, but the rest of the application is fully online. There is still a physical valuation and all that, we do insist that a valuer goes to the property, but that’s all instructed online, etc. etc. It’s automatically instructed, that’s quite a slick process.

Peter: And what’s the time period from the time someone comes on to your site to when the loan is provided, what’s the typical duration of that?

John: Well, often the thing that is important thing to say here is, if people are purchasing a property, they may not be in a rush to buy. I think that’s one of the myths that’s peddled, that people always want quicker. Sometimes for various reasons…the person that’s buying it may not be wanting to transact for a few months. If they are remortgaging, they may not be in a rush because they know their current fixer might finish in six months time so they just want to lock in an offer and not actually transact for a while.

So, generally speaking, we are not the slowest part of…we’re a fast part of the process that we have…we’ve completed mortgages in 21 days and that’s faster than most bridging lenders can do and people that are bridging, which is very expensive, that are in a rush, but we do it very quickly if the borrower needs to in terms of weeks that is very different from our competition. But in most cases, the vast majority of our cases take two to five months, but that’s not because of the speed of our process, it is very much because the borrower, whether it be purchasing or remortgaging, is not in a rush to transact.

Peter: Right, right, okay.

John: That is they are in a rush to lock down an offer and, actually, they just wait to transact.

Peter: Right.

John: They want certainty of funding, but they don’t necessarily need funding if that makes sense.

Peter: Right okay, that makes sense. So then, I’m curious about the investor side of your platform because you’ve talked about…you know, these interest rates are pretty low and, obviously, this is backed by property, but who are the typical investors? I mean, you’re set up as a peer-to-peer, what’s the mix of like these individual investors versus institutional?

John: Yeah, so when we set out, we were out and out retail peer-to-peer, it’s also worth saying like a lot of markets around the world, we set up…we completed our first loan pretty much five years ago, a week ago, so July 2014  we completed our first loan. At that point, we were lending at typically 5.5% or something in the 5’s and obviously, base rates in the UK haven’t changed. Therefore, we were giving retail investors typically 4/4.5% or so.

Over that time, there has been compression in interest rates in the UK, even though the base rate has stayed the same, so various monetary reasons mortgage rates have just continued to fall, continued to fall as have savings rates on the other side. I’ll say now we’re typically lending sort of 3.5% or so, maybe slightly higher, therefore, the retail return is much lower, it’s about 3% and as you rightly say, for retail investors that’s less interesting potentially than the other sites that give 5/6%. Rates in peer-to-peer in the UK have fallen in the last three years, probably on all sites.

Peter: Yeah.

John: And now, 90/95% of what we do is institutional. We have institutional funding, sustained institutional funding for over two years now and that’s really driven the growth over the last two years because like you say, institutions like mortgages, banks, funds, they can securitize them, they can leverage them and because of the yield, institutions typically want to do them at scale. So when we do sign institutional agreements, they generally are quite large which is a nice problem to have, but the problem is then you can’t do that many of them.

Peter: Right, right, of course. And then what about…obviously, these are interest only loans backed by property, I’m sure there’s been instances where, for whatever reason, there’s been some default or been late payments, is that just a tiny fraction of your book, or how does it work? Give us some insight into loan performance.

John: Yeah, so we’ve had zero non-performing loans to date. We’ve had some late payments, but, you know, a month or two here and there; there has been only one that went into two late payments and that’s now been totally cured and that’s fully performing, if that makes sense. So, there have been no defaults, there’s been no arrears…you know, that hasn’t happened in our case and the reason this is very different from other forms of property lending is these are all backed by rental income.

Typically, the rental income would be 170% on average of the interest payment and we have the legal right to take control of the rental payments. So, if a borrower doesn’t pay, we can then become what’s called receiver rent, get the rent paid directly….we actually haven’t had to do this, we’ve had to threaten it once, but we haven’t actually done it yet and that very quickly means that loans do perform because we can manage the property ourselves or with third parties who can help us do that.

So, buy-to-pet is typically very, very well performing. The other thing that’s important to say, again, particularly for your US listeners and maybe some other European listeners, mortgage lending, including buy-to-let lending in the UK is full recourse lending so people can’t just walk away. If the property value is lower than the loan amount, they are still on the hook for it.

Peter: Interesting, yes, that’s not the case here. The financial crisis would have been very different in the US, if that was the case. So, I want to go back and look at the competitive landscape because you’re offering very competitive rates, I imagine, banks are not going to be that much lower, so tell us, in the buy-to-let market who do you compete against? Is it the banks, are there other sort of non-bank lenders out there, what’s the landscape?

John: Yeah, the buy-to-let is really typically two markets. One is a market where, we sort of slightly alluded to earlier, where it’s amateur landlords who don’t do it as a business, it’s not their main form of income and therefore, banks view it as almost a residential mortgage and they underwrite it and price it like a residential mortgage as well. In that space, historically, that’s the largest part of the buy-to-let market.

For people who don’t know, the buy-to-let market in the UK is roundabout 250 billion in terms of outstanding so it’s about 20% of the UK mortgage market. It’s about 36/37 billion a year in terms of gross lending which again, is about just under 20% and the bulk of that market still is those much smaller landlords, historically, and that is served by the big banks, Lloyds, Natwest, Barclays, you know, the very large high street banks who are the dominant players in that.

The other part of the market, which is probably around 15/20% of the buy-to-let market is this more specialist part and in that part we are generally still competing against banks, but these are not the high street banks. They are mid-sized challenger banks who wouldn’t be household names, but these are people like OneSavings Bank, Paragon Bank, there is many of these FTSE 250 listed banks and then some other non-bank lenders.

The interesting dynamic is that former market which is the large part is shrinking in total volume, whereas, this specialist part is growing roundabout 20% a year or so. The former part in terms of pricing, again, it’s priced like owner occupied mortgages so people are typically lending in the 2’s whereas the specialist market is lending in the 3’s if that makes sense.

Peter: Okay, yeah, yeah, makes sense.

John: Most of our competitors are banks, but it’s really not the high street banks.

Peter: Okay, so then the investors, the institutional lenders you’re working with, are they typically the large financial institutions? I want to talk about the 1 billion pound funding commitment that you got as well, like what segment of the market is coming to Landbay to put money to work?

John: It’s a mixture of banks and then funds which I suspect is a bit different to most other marketplace lenders or peer-to-peer lenders in the UK. In most cases, what we’ve seen is funds who then buy loans and securitize. In our case, we’ve worked with some of those and we have others that we’re speaking to and those are interested in assets. They, typically…credit funds have bought books of mortgages and then securitized them, it’s one of the things that they’ve done, but actually, at the same time banks like mortgages, they’re very efficient from a capital point of view.

In the UK, most banks’ balance sheets is predominantly mortgages, it’s how they can get volume. Typically, I think the thing that’s different with us than with other peer-to-peer marketplace lenders is actually a lot of banks that we speak to…some banks do lend on our platform as well which is slightly different to the rest of the market.

Peter: Right, right. And so then, let’s just talk about that…it was just a couple of weeks ago as we’re recording this, the 1 billion pound funding commitment you received from a nameless financial institution, or an unnamed, shall we say, financial institution. So, tell us a little bit about the genesis of that deal because obviously, you know, that’s a pretty significant deal for a company of your size.

John: Yeah, it is. You know, actually it came out relatively quickly, it was a relatively quick process. I mean, obviously, we were already starting to lend at a decent volume, we already had institutional funding on the platform. In the UK, we’ve won numerous awards for best buy-to-let lender and not just best buy-to-let specialist lender but best buy-to-let lender, so without blowing our trumpet, we’re quite well known in the market within the people that look at mortgages. They know about us, we’ve hired people from a lot of the top buy-to-let lenders, you know, quite high profile people in the mortgage industry, so our brand in that world sort of backs up at our side, if that makes sense.

Actually, we were not aware that this particular institution was actually looking to invest in mortgages and someone introduced us and said oh, you should go speak with them, I think they’re interested in funding mortgages and I think they hadn’t contacted us directly. They thought we were fully tied up already with other institutional funders and so, we met mid-February and we wrote term sheets, you know, within a matter of weeks, and having done due diligence, and then obviously the legal process took a little bit longer. It was, actually, a pretty quick deal for something of that size.

You know, obviously, we’ve been through due diligence before a number of times by institutional investors, and they had it on the other side, so we both knew what we were doing and we got through it pretty quickly. Obviously it went to legal, that naturally took a little bit longer and starts to become a bit more expensive.

Peter: Right, I’m sure. I presume they decided they don’t want their name released. Are we going to find out about it eventually, or is this going to be something that will always be hush hush?

John: Yeah, I mean, I think, as you can imagine, we would have loved to name them. They’re a very blue chip financial institution, it’s someone we’re quite proud to be working with, but unfortunately, we can’t name…at some point, the expectation is those loans will be securitized, that’s the likely outcome and so at that point, obviously, then it does become in the public domain. But that’s their call when they securitize loans and then, by definition, it does come out.

Peter: Right, right, okay. So, that was a billion pound commitment, can you tell us the scale that you’re at today?

John: Yes, so now…you know, I think, to date now, we’ve lent 350 million and we’re sort of…this month, we’re sitting in the middle of 2019, we’ll lend about 30 million a month, I think, by year end that will hit close to 40 or so. So, we’re running at sort of a decent scale, but that will take us a few years to get through and, bear in mind, not all of our origination is going to this institution. We have other institutions so we haven’t removed any institutions from the platform at all.

So, the expectation is that billion will be fully deployed in about three years, and again, in very simple terms, we would expect, broadly speaking, for them to do a pool of roundabout 300 a year and then to securitize every year. So, the way we think about it, it probably is three securitizations, broadly speaking, every year.

Peter: Right, right.

John: It may not work out exactly like that, but that’s kind of back of the envelope of how it should work.

Peter: Right, got it. Okay, so I do want to ask you about the state of the market and the dreaded “B” word which I’m sure you’re totally sick of talking about, but I think….

John: B for Boris? (Peter laughs)

Peter: Boris and Brexit, might be very, very well intertwined here pretty soon, but yes, I mean, obviously, Brexit is still looming and with the current state of affairs, it’s possible that a hard Brexit might actually be on the horizon. I wanted to get your sense about how are you thinking about that?

Obviously, the impact is unknown, but the impact is going to be negative, that much I think everyone would agree on, particularly on the property market which had some challenges in the financial crisis, I know you said that your particular part of the market did well, but how are you thinking about Brexit and the possibility of a hard Brexit that is going to cause an economic shock to the UK?

John: Yeah, I mean, as you know, Peter, you’re a regular visitor to the UK and obviously, this is now three years since the referendum and a hard Brexit has loomed as a possibility a number of times and certainly this year and it’s made zero impact in terms of unemployment to date. Quite the opposite, the employment and wages have been pretty resilient, actually, but quite the opposite, more than resilient, I mean, it has been phenomenally strong figures throughout.

So, the broader economy, you know, still continues to perform pretty well and again, as you can imagine, certainly around the turn of the year when obviously at that point March 31st was kind of the deadline, or late March so we’re sort of back there I suppose in terms of the amount of time to potentially leave the EU.

We went to speak to institutions that fund us and say, look, what’s your take, you know, what’s your view on the mortgage market, what happens if we do, are you still committed? And we’ve certainly seen this over the course of this year, you know, not just the deal we have announced, the appetite to invest in the UK mortgage market for different types of funders, whether it be banks or non-banks, is still there. Obviously, we are quite an established platform with less execution risk, but there doesn’t seem to be any funding risk, as far as I can see, despite Brexit on the horizon. There’s still an appetite for various types of institutions to deploy into the mortgage market.

Considering what you’ve said, like you say, it’s quite surprising, when you think…a lot of people would think, well, let’s just sit this out, but that does not seem to be happening in our market, maybe it’s because what we do is relatively defensive. You’re right, in terms of the broader property market, in London, we’ve definitely seen, over the last two years, the softening of the London market not by a huge amount, I mean, it’s fallen by a few percent here and there.

Where actually, the high value properties have fallen more, but it’s worth pointing out there have been some changes to stamp duty roundabout the same time as the Brexit referendum, and so more expensive properties got quite a significant hike in stamp duty just before the Brexit referendum so that hit the London market quite seriously anywhere at that point. Obviously, there is then this concern in terms of how it affects bankers, and obviously, in terms of people with high income, bankers are a significant part of it, in terms of the banking sector.

And also, it’s worth saying the threats at the same time which is maybe linked to Brexit…there’s obviously a potential threat of a Jeremy Corbyn government who have been quite vocal about property taxes and bankers’ taxes as well. So you’ve got this sort of perfect storm in some ways for high value London properties who are potentially going to be taxed more by Jeremy Corbyn, there might be some Brexit impact directly at the property market, but also in terms of bankers’ pay and jobs market, etc. etc.

So London has definitely been affected and part of that is Brexit, I think some of it is stamp duty, some of it is probably a potential risk of further property taxes by a changing government. So, you’ve definitely seen that in London. Actually, in the rest of the UK market, we haven’t seen that.

We’ve seen actually property prices continuing to pick up slowly, not at fast levels, maybe 4/5% a year growth. Inflation in the UK is 2 to 3%. So, there’s been a bit of a catching up in the rest of the UK where, obviously, the London property market was running at sort of double digit price growth up until roundabout three years ago. You know, in some ways, I think, actually, it’s probably a good thing that the London market…the sting has been taken out a little bit.

Peter: Right.

John: Obviously, in terms of Brexit and what happens, whether it’s hard, whether it’s soft, whether there is a deal, if there is a hard Brexit, how quickly we adjust to it. What the Bank of England might do, in terms of things like term funding scheme which they did after the referendum in terms of injecting money to the system, we don’t know, but, you know, while I think people are talking about a lot, that there doesn’t seem to be as…people seem to be getting on with stuff, they don’t seem to be delaying decisions based on, oh, we might have Brexit in three months and we don’t quite know what it looks like.

So for most businesses, we know…you know, it’s business as usual which, like you say, with something that could be very hard and could be quite a shock to the system. It’s covered more in sort of the political page of newspapers compared to what actually people talk about on the ground.

Peter: Right, right, understood. Okay, so we’re almost out of time, a couple more questions here. I know you’ve been to the US many times, you’ve come to LendIt several times, I’m curious about any plans for international expansion, not just the US, but maybe into mainland Europe as well?

John: Yeah, so it’s something we can always look at, it’s not on the immediate horizon. We still think…saying that the UK market in the buy-to-let is, you know, just under 40 billion a year, 240 billion outstanding. We want to become a leading player here, not just a leading fintech in the space, we want to be the leading buy-to-let lender so, we’ve got a long way to go. This year we will be about 1% of gross lending in the UK buy-to-let mortgage market.

You know, we want to get that to at least 5% and maybe as much as 10% over the next three/four years, so, we’ve got quite serious growth plans in the UK and we’re pretty focused on that, we do keep an eye on the markets. The US market, because of Fannie and Freddie, is quite complicated, particularly the buy-to-let market, there is some element of regulation in it.

So, we looked at it before, it’s very different to the UK market so our instinct is what markets are similar to the UK. There’s the Irish market, but that’s pretty small, there’s the Dutch market which is quite interesting, but still very small but it seems to be growing and there’s the Australian market which is interesting, but a long way away. (Peter laughs)

They’ve all got issues, but we do keep an eye on all of them and we sort of look at them, but there’s nothing on the horizon over the next two/three years because whenever we looked at it in detail, we say, well, where is the best place for us to grow today, next year, even the year after and the answer to that question is always the UK.

Peter: Okay, yeah, that makes sense.

John: At some point, when it ceases to be the UK then the question is, okay, do we move naturally into other parts of the mortgage market, or do we do something, you know, exactly what we do in the UK, but then transport that into another geography.

Peter: Okay then, so looking over the next 12 months, what are you working on, what’s next for Landbay?

John: You know, a lot of it is to do more the same, you know, to continue to diversify funding. We’ve got this billion we want to sort of get through as quickly, but as safely as possible. We’re about 80 people now and that’s up from about 55/60 at the beginning of the year as I was saying to you earlier before we started recording this, we’ve just taken on additional office space, so we’re making a massive investment in technology and the focus over the next year is to grow our brand, our business in the buy-to-let market on one side with our sales team.

We’ve already made a lot of progress there, but the next thing, actually, we think we can use technology a lot better, not just on the origination side, but how we allocate loans, how we process loans, how we automate bits of the process, how we report to our institutions, how we allocate loans, etc. etc. So, there’s a big investment that we’re doing there and growing the team, so we’re quite…over the next year, I think a lot of what we do is going to be quite internally focused on that side, just sort of really build what we’ve got, it’s not just on the front end origination side.

Peter: Right.

John: I think longer term, I think I’ve said this before so I’m not giving away any secrets, our plan for the business is to IPO it, that’s still quite a number of years off, but we’re always thinking, we’ve got to get the structure, the governance, the reporting in line so that we can operate in a few years now as a publicly listed company. So that’s always been at the back of my mind, but that’s a longer term, that’s not 2020, that’s probably 2022 or something.

Peter: Okay, great. We’ll have to leave it there, John, I really appreciate you coming on the show today.

John: Thanks a lot, Peter.

Peter: Okay, see you.

You know, it’s interesting to me that when I talk with people in the UK, particularly the CEOs of these fintech companies, it’s amazing to me how many of them just…one, they’re sick of talking about Brexit, but two, they just want to get on with it. You know, Brexit is still looming large certainly in the political pages and most people are just getting on with it and, you know, will deal with whatever ramifications it creates.

Obviously, a hard Brexit is going to be terrible, I think, for the UK economy, but investment is still flowing. John talked about the billion pound commitment he’s done, that was in the light of obviously knowing a hard Brexit is a distinct possibility. Hopefully, we’ll know completely in a few months time, but right now, the UK is just getting on with it.

Anyway on that note, I will sign off. I very much appreciate your listening and I’ll catch you next time. Bye.

Today’s show was sponsored by LendIt Fintech Europe 2019, Europe’s largest fintech event for lending and digital banking. It’s taking place on the 26th and 27th of September in London at the Business Design Centre. Lending and banking are converging, LendIt Fintech Europe delves deeply into this new world bringing you the latest developments in the most important areas of fintech. LendIt Fintech, lending and banking connected. You can find out more and register at lendit.com/europe.

PODCAST TRANSCRIPTION SESSION NO. 210  –  RADKO ALBRECHT

Welcome to the Lend Academy Podcast, Episode No. 210, this is your host, Peter Renton, Founder of Lend Academy and Co-Founder of the LendIt Fintech Conference.

(music)

Today’s show is sponsored by LendIt Fintech Europe 2019, Europe’s largest fintech event for lending and digital banking. It’s taking place on the 26th and 27th of September in London at the Business Design Centre. Lending and banking are converging, LendIt Fintech Europe delves deeply into this new world bringing you the latest developments in the most important areas of fintech. LendIt Fintech, lending and banking connected. You can find out and register at lendit.com/europe

Peter Renton: Today on the show, I am delighted to welcome Radko Albrecht, he is the CEO and Founder of Bitbond. Now Bitbond are a really interesting company, they actually are the first global SME lending platform in dozens of countries around the world. They operate out of Berlin, they’re also a regulated platform, they have registered with BaFin and they’ve broken new ground in many areas, particularly when it comes to blockchain and cryptocurrency and they just completed the first ever regulated security token offering in Europe.

We talk about that in some depth and we talk about a lot of the other groundbreaking work they’ve done and how their business has evolved really from a bitcoin lending platform to really a 21st century SME lending platform globally. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, Radko!

Radko Albrecht: Hi Peter, well, thanks for having me. It’s a great pleasure.

Peter: No problem at all. Okay so, you know, I like to get these things started by giving the listeners a little bit of background about yourself and particularly in your career, what you did before you started Bitbond.

Radko: Yeah, so in a wider sense, I have a background in financial services. I studied economics with a focus on finance then had my first career position with Deutsche Bank in London in sales and trading of structured equity products. After that, I moved into management consulting and I spent four years with a company called Roland Berger, which is a German strategy consulting firm.

Most of the projects that I worked on were banking-related projects, mostly post merger integrations where we were setting up new strategic concepts for a combined entity, business planning, strategic plan and integrating two organizations. So I’ve done that for a good number of years, but I always knew I wanted to start my own company at some point and so around 2011/2012, I got really excited about online lending.

Actually, Lend Academy was one of the first sources that I had (Peter laughs) that educated me about the whole online lending space. So definitely, you have a good share in the fact that I actually started a marketplace lending platform.

Peter: Oh, that’s great to hear, great to hear, Radko. Before we get there, I’m interested in your sort of relationship with cryptocurrency because that’s sort of what the founding of Bitbond was based on. So when did bitcoin first get on your radar, when did you first become interested?

Radko: I was in a really fortunate situation, in 2012, a really good friend of mine told me about bitcoin. Personally, he didn’t have anything to do with it, but he knew that I’m super excited about finance and about financial technology and so he said, Radko, I read a newspaper article about this internet currency called Bitcoin, have a look at it, I’m sure you will find it interesting. And so, I looked at it, it was really technical, everything that you could read back then about bitcoin was super technical and it took me a while to get my head around it.

But then once I thought I understood a little bit more about it, I found it a super exciting, super fascinating concept and I had the impression that it could change a lot in the world of finance and that the underlying concept of blockchain and the problems, the technical problems, that it solves can be something that’s very important for the financial industry.

But at the beginning, it was very theoretical for me. I bought a little bit of bitcoin at $35.00, (Peter laughs) but I did not really see it as an investment. I just bought one or two BTC in order to test it and, you know, in order to do transactions in order to know what it feels like so those were the first days that I kind of got in touch with bitcoin and the technology.

Peter: So then tell us about the start of Bitbond and what was it…you know, you could have done what other European platforms have done. You wanted to start a lending platform, but you did a twist on it and you started it based on cryptocurrency so tell us about the idea that you had and why you decided to go that way.

Radko: The original idea that I had was actually not related to cryptocurrencies. I had the idea to start an SME lending platform, first of all, because I really found online lending/peer-to-peer lending a super exciting concept and the platforms that were operating back then were all focused on consumer loans with probably the only exception being Funding Circle which was already up and running, which was focusing on SME loans.

I felt like there’s a big market opportunity in SME lending in Europe and also elsewhere in the world. So, on the vertical, I wanted to focus on SME lending and then at the same time, I was quite puzzled by the fact that all of the P2P lending platforms that already existed back then…I mean, LendingClub already had a considerable size, Zopa in the UK, Auxmoney in Germany and a good number of other platforms. All of them were just operating in one market.

I thought, well, if you look at the internet and if you look at internet-based services, most of them are accessible to customers from multiple countries. So what I wanted to do, I wanted to start an SME lending platform that is accessible, more or less, to everybody who has an internet connection. And so I had this idea and I wanted to get it started and I thought I knew a lot of bankers so it would be easy for me to find a partner and to solve kind of cross border payment processing which was one of the challenges that we had at the beginning, however, it turned out to be a lot more difficult than what I originally thought.

When we have conversations with banks, they said, well, it’s expensive, or we’re not even capable of providing that for relatively small loans because it’s just not economical to do cross border payments that go beyond Europe, especially, and the transactions are expensive. And that was when I remembered bitcoin that I had heard about, about half a year before I was about to start an SME lending platform, and I looked into it and I tried to understand whether bitcoin could help us to launch our international SME lending platform.

And when I saw the back then really low transaction fees and the universal accessibility of bitcoin then I had the idea to launch an SME lending platform where the underlying payment network in order to get money from A to B between borrowers and investors on the platform is actually bitcoin. So, that’s how it all started and then we actually came up with the name Bitbond once we knew, well, we’re not going to work together with banks in order to send payments from A to B, but we will actually channel them through cryptocurrency.

Peter: Okay, so then you launched the company, did you target specific countries, or did you just sort of open it up for anybody? Where did your initial business come from?

Radko: At the beginning, Bitbond was a bootstrapped startup funded by my own savings and we hacked together the first version of Bitbond in just three months. As you can imagine, if you hacked something together, two people in three months, you know, it’s not the greatest product with the greatest features. It was literally bare-bones.

Investors and borrowers could sign up, borrowers could disclose a relatively limited amount of information for a credit check and the payments worked so that an investor who signed up, funded their account, could fund a loan and there was a payment schedule and the money got collected automatically when the borrowers repaid it. It wasn’t more and it looked awful.

We also had no marketing strategy for it, we really just focused on getting something out so that people could use it. The good thing was it was international. At the beginning, we accepted literally everybody from any country and so what we’ve done is, since this was a bitcoin-based service back then already…we launched it in about July 2013, there was already a pretty big bitcoin community on forums like Bitcointalk and a couple of others.

So what we’ve done after launch, we posted about the newly launched platform on these forums and were really asking people to start using it just for testing purposes. At some points, we even went so far to, you know, offer other newly founded platforms that we would be testing their platform and in return they should sign up with Bitbond and test what we have built. So really, the first users were people who were maybe not the biggest peer-to-peer lending enthusiasts or experts, but those people who were really excited about the fact that there were some real life use cases for bitcoin which back then there weren’t a lot.

And so these were actually our first users and the first real borrowers that we had on the platform were actually people who were doing bitcoin mining. Back then, it was still profitable to do bitcoin mining from your bedroom with your own hardware running and so a lot of the first borrowers of Bitbond were borrowing bitcoin in order to finance their mining hardware.

Peter: Okay, got it. So, what was it like, how were your repayments back then, I mean, I presume one of the things working internationally, it’s harder to do underwriting and credit checks. How did you go about that and how was the repayment rate?

Radko: It’s been an interesting evolution. At the very beginning, when we had a relatively small number of users, we had very good repayment rates. I think we didn’t have a default or considerable late payments for the first six to eight months, but at the same time, for fairness we have to mention it, in those first six to eight months we funded perhaps 30 to 50 loans so a really small amount and the loan amounts on these loans were also pretty small, ranging between $100 to maybe $2,000, but most of them more at the $200/$300 scale, so really, really small.

But those users were enthusiasts and had really good repayment rates despite the fact that our credit and underwriting model was not sophisticated at all. Then as we were ramping up marketing and we were growing the business, we started to have more and more users and kind of had a bit of a viral effect at the beginning because for the first year we did not really have a marketing budget, but we actually managed to grow the number of users quite considerably and also default rates started to go up.

Probably our worst time in terms of credit was year number two, number three of Bitbond when some of the monthly cohorts went above 30/35% in default rates which were obviously not sustainable.

Peter: Right, right. So how did you transition then to where you are today? Maybe just give us a little bit of a…I don’t believe you’re doing…tell us, are you still doing bitcoin lending? I’d like to know sort of how it kind of transitioned to where you are today.

Radko: So fast forward to today, the platform functions in a completely different way. Today, we use bitcoin only for a very small portion of the transactions on our platform. We have switched the payment processing to the Stellar blockchain which is more efficient, more scalable and highly optimized for payment processing. We’re not using the native cryptocurrency on top of Stellar which is Stellar lumens, but instead, we’re using a so called stablecoin which is a cryptocurrency that is backed by the Euro.

So for Euro-based investors and borrowers there’s actually no exchange rate fluctuation because we work together with a French payment processor called Tempo which issues euro tokens for every euro that arrives in their bank account from investors or borrowers. So that has changed a lot, investors and borrowers can interact with the platform through their bank account with this payment processor that we work together with.

So we have managed to completely eliminate any exchange risk, at least from a euro perspective. For the investors and the borrowers, they can interact with the platform either through the euro tokens or through their bank accounts. We have integrated multiple of these payment providers, for example, in some African countries we work together with m-Pesa, with Flutterwave so that’s our borrowers from Kenya, which is also a strong market for us, can get payments through their bank account or through their mobile money account.

So a lot of this has changed and today, we’re also highly focused on only SME’s. Most of our customers today are online sellers on eBay, Amazon, Jumia and some of the other big e-commerce marketplaces and restaurants, these are our two biggest verticals today.

And so how did we get there in very short terms, I mean, after the first year of Bitbond raised the first funding round with outside capital, with Point Nine which is a Berlin-based early stage VC and then over time we brought on more investors, both business angels and institutional money, who helped us to grow the platform into an actual SME lending platform with technical aspects that were really exciting at the beginning are actually under the hood.

Our users today don’t care about which technologies we use, obviously the only thing that is relevant to them, how quickly can we make a credit decision, what are the terms on the loan, what’s the loan amount that they can get. From the investors’ perspective, what kind of returns can they earn on our platform. So we have transitioned into a more conventional type of platform from the types of customers that we serve, however, I would say pretty innovative on the technology side that we use in order to make our service available.

Peter: Right, right. I saw your license, you’ve got a BaFin license, BaFin being the German regulator, so you are regulated by BaFin?

Radko: That is correct. So a lot of startups in the fintech space in Europe go a way where they rent a license from a bank so they work together with a fronting bank, but I had the goal from the beginning to make ourselves independent of banks on the infrastructure side. And so, from the very beginning of Bitbond we decided to apply for our own regulatory approval instead of having to work together with a fronting bank. This was a pretty long process, it took us three years.

So we applied immediately when we founded Bitbond and we got the license in late 2016. This was also a relatively long process, but today, we see it as a big advantage to operate on our own license, especially when we work together with other financial services providers. Compliance-wise, we speak the same language, all the documentation that we have is highly valuable in setting up partnerships with banks and with other financial service providers. So, yeah, it’s been a long way to get there, but we’re happy about operating the business with our own license.

Peter: Sure. So tell us a little bit about the loan terms, what is the average length of the loan, the interest rate, the loan amount, what are you offering?

Radko: So in the SME spectrum, we really focus on the small ones. The average loan amount on Bitbond is approximately 12,000 euros, so right about $14,000/15,000. We offer three terms: three months, six months and 12 months. The majority of our borrowers take on a 12-month installment loan so the average term, if you calculate, is right about 11 months across the whole loan book and the interest rates are pretty different from country to country and borrower to borrower, depending on what kind of credit risk they represent, but to give you a range, it’s between 10 to about 35% per year. The average in that range is about 24%.

Peter: Okay, okay. What are your top three countries you operate in?

Radko: Today, the top three countries are Germany, France and Italy, so by volume, these are the top three countries today.

Peter: But you said you still have the ability to offer these loans globally?

Radko: Yes, although today, for compliance reasons, we have excluded some countries. One of the things that are driven by the fact that we operate under our own license because we have to do a know your customer check, according to German anti-money laundering standards, which means that we are required to do a video identification with every customer who registers with our platform. For this video identification, there are relatively strict rules that are defined by the regulator.

One of the rules includes that the identification document that our customers are using have to include certain security features like a hologram and a certain set of these security features. Some countries around the world, the passports and the ID cards that people are using don’t have these security features and if this is the case, then for regulatory reasons we have to reject such users despite the credit quality or other characteristics of these applicants. But we still can serve easily over 80 countries around the world and it still remains an international platform.

Peter: Okay, okay. So I want to move into your recent security token offering that I kept reading about again and again, it seemed, over the last few months. I know you just recently wrapped it up, but maybe before we even talk about that, just explain, for the listeners, what is a security token offering or STO?

Radko:  So a security token offering, first of all for my business or an economic standpoint, is a public offering of a security, something that’s existed for hundreds of years. So it’s a way for a company to offer a security in order to raise funds. Now, the token aspect that comes in here is about how the proof of ownership in a security happen. In a regular security offering there is still the concept of a paper certificate that represents proof of ownership in a security.

Today, around the world, people hold securities electronically typically within their bank account. Somewhere there is still an underlying paper document that represents the ownership in that security typically held with a central clearing house in Europe. This would normally be Clearstream which is almost like a monopolist for central clearing. So, the security token offering is a security offering where there is no more paper certificates, other types of physical paper-based documents, but a digital token represents the ownership in that security. So, that’s from a very, I would say, basic concept, the idea behind a security token offering.

Peter: Right, okay. Maybe we could start off with why did you decide to raise money this way rather than going out in the traditional…either equity markets or VC or something like that?

Radko: So first of all, the security token offering that we launched at Bitbond has the purpose to refinance our loan origination so this is not funding for Bitbond as a company, but primarily used in order to grow our loan origination. Our goal has been, when we launched a project to diversify and to increase the amount of refinancing that we have for the loan originations on our platform.

One idea that we had was simply go to the public markets and do a bond offering. So, when we had that idea, that was around the time when ICO’s were still really big and a lot of ICO’s were running and we looked at them and we said, well, the general idea of an ICO is pretty cool, however, we as a regulated financial institution would put our license and our whole company at risk if we were running an unregulated offering which frankly looks very much like a security offering which is something that I believe is true for a lot of the ICO’s that were running, maybe not for all of them, but a good deal of the ICO’s that were running very close to what you would normally consider a security offering.

And so when we saw that, we said, well, we have a lot of experience with blockchain technology because we’re using blockchain-based payment methods on our platform, we want to address the public financial markets, however, let’s use the knowledge and the expertise that we have in order to do a security offering where the proof of ownership happens through a token which then brings us to an STO and this was about January/February 2018 so that’s when we first started to seriously approach this project.

Peter: You did register this with BaFin, right, that’s my understanding.

Radko: So the first thing that we did was we internally drafted a legal concept together with the law firm that we work together with and we knew that if we present a securities prospectus for a security token offering to the regulator, it will most likely be rejected because there are so many new aspects to it that the regulator simply won’t have enough time to evaluate all of that. Because securities prospectus approval happens in a relatively short time frame, the regulator has only 20 business days to get back to you, either with an approval or with a set of questions or remarks around the prospectus and there’s not enough time if we present them with something that’s completely new to them.

And so what we’ve done is we have approached them with a general concept which was not a prospectus filing, but just a concept that laid out to them, this is what we want to do and we would highly appreciate if you gave us feedback so that when we ultimately hand in a prospectus for approval, it will address the topics that you see as relevant here. The regulator really appreciated this approach, they did give us feedback which is not very usual because, normally, the regulator wants to see finished contracts, finished prospectus and will, normally, not always help you to create something new.

But I think in this case, they recognized that security tokens will be a thing. They, as a regulator, need to have an opinion to them and they need to educate themselves. So what they did was to ask a lot of questions, not just around the security token offering, but also around how proof of ownership on the blockchain works; what opportunities come with it, what additional risks might come from that. After we went through the whole process, we kind of knew what were the concerns, what would be the risks that we have to address in the prospectus and we knew that when we hand in a prospectus after that process, it will have a relatively high likelihood to be accepted.

Peter: Right.

Radko: Looking at it from today, it was a good decision to kind of take this long path with the regulator because it turned out that before us there were over 130 other companies filing for security token offerings, but of all their prospectuses got rejected and we were in the lucky situation to be the first ones to receive approval.

Peter: Right, probably not the last, I would imagine, but that’s great, you’re breaking new ground there. And so, maybe you can start like how much did you raise with this offering? I believe it just recently ended earlier this month, right?

Radko: Yes, the offer period ended Monday last week, on the 8th of July, and we haven’t announced the final number yet, but now, it’s relatively clear that it is 2.2 million euros raised.

Peter: Okay, so I’m curious, maybe just one thing as an aside, I noticed that US investors were not able to participate. Why couldn’t US investors participate in that?

Radko: Because we have not registered the prospectus with the SEC, that’s simply the reason. We could have done a Reg D registration, for example, which would allow us to accept accredited investors, qualified investors, but we already had quite a good deal of complexity with the whole prospectus dealing with the request from the German regulator that we wanted to at least reduce the complexity in this part.

For the next offering, we could easily see ourselves also registering a prospectus with the SEC, but for a first project we felt like there was already enough complexity in there that we don’t need to also go the way to the SEC which would definitely have created more legal work and would have slowed down the project.

Peter: Not to mention it would have been more expensive. If you’re not raising $50 million then that would make it a bit more challenging. So then, I’m curious about the tokens now, are investors able to start trading these tokens and what do the tokens represent?

Radko: We call the tokens BB1 tokens, BB1 standing for Bitbond 1 and we plan to do further token offerings in the future. Each token has a face value of one euro and represents a share in the bonds that we have issued. So when you hold a token, you have a partial ownership in the bonds that we issued. The ownership of this token entitles you to receiving the coupon payments that we’re paying.

We have two types of coupons on this bond. One is a 4% per year fixed coupon that is paid out quarterly, so every three months we’re paying 1% to the token holders. And then we have a variable coupon which is 60% of the pre-tax profit of the investments that we’re doing from the proceeds and this is paid one time per year, once the financial statements of the issuer are finalized. And so, on 1st of October, the first coupon payment of the 1% quarterly coupon will be paid and everybody who holds the BB1 token on the 1st of October 2019 will receive the coupon payment.

After that, if you decide to sell your tokens in the secondary market, they will exchange hands and then in the next payment coupon payment date which will be the 1st of January, the people who hold the BB1 token then will receive the coupon payments. You asked about the secondary market, so there are two ways, or actually three ways how you can trade.

First of all, you can trade in a truly peer-to-peer fashion so if you, Peter, decided not to buy the BB1 token in the primary market, you could tell me, hey, Radko, I really want to hold a couple of BB1 tokens, do you want to sell them to me. So, I could sell you, I don’t know, ten BB1 tokens and we could literally send them from my phone to your phone and this is one of the truly revolutionary aspects about the security that it can be traded peer-to-peer or over the counter, as you would say it in the securities world, without involving any third parties; no bank, no custodian, no third party, no intermediary would need to be involved in that transaction so that’s one way to trade them.

The other way to trade them is through the so-called Stellar Decentralized Exchange. We have issued our token on the so-called Stellar blockchain, the same blockchain that we use for payment processing on the Bitbond platform and the Stellar protocol has integrated a so-called decentralized exchange which is an exchange where everybody who holds an asset that has been issued on the Stellar blockchain can use it and put up sell or buy orders. It’s not a real exchange in that sense that there is an anonymous matching of counterparties.

It functions more like black box, someone wants to sell something, they create a sell offer and this is now visible in the Stellar blockchain and there are wallets that can display these buy and sell orders and you can decide to buy, for example, at that offer. We expect that there will be some trading going on on this platform. The third way to trade the token will be through bigger exchanges. We have signed agreements with two relatively big exchanges where we will be listing the token.

These are exchanges that currently operate only as cryptocurrency exchanges and they are, at the moment, in an approval process from a regulatory standpoint, you will also be allowed to list securities because from a regulatory standpoint there’s a relatively big difference between cryptocurrencies and securities and so they are filing and expect to receive approval to list securities within the next three to six months. Once that happens with these two exchanges, we will list the token and these are pretty big exchanges where we expect a significant trading volume also in the Bitbond security token.

Peter: Okay, we’re almost out of time, but there’s two more questions I wanted to get out. Like when you want to raise money again, you’re going to go into another STO, or do you feel like you may end up raising money in the traditional way? I mean, how do you feel…like now that you’ve gone through this and you’ve put a massive amount of work in to make this happen, is this going to be your main mode of raising money going forward?

Radko: I don’t think it will be the only mode. I think it will be one out of two or three sources of capital going forward. Right now, we’re negotiating a relatively big credit line with a bank which is our kind of next step in our refinancing of our loan originations, but then after that, I could very well see ourselves going into the next security token offering because we have learned so much in the process and our goal is actually to get a rating on the BB1 token because this is an unrated product.

I think that when we get a rating on top of that, the next offering will be again easier because we will be not a first time issuer anymore, but a second time issuer with a rating which will allow us to access other sources of capital, including institutional investors. Right now, the 2.2 million that we raised was purely from retail investors.

Just one final aspect, the fact that we’ve learned so much in the process also led to the fact that a lot of other companies approached us, were asking whether they could use the expertise and the technology that we’ve built for our STO and we’re actually working together with other companies who are using the very concept that we have defined from a technical and a legal standpoint in order to raise capital. So, we’ve actually also introduced a second revenue stream to our company based on what we’ve learned.

Peter: That’s good because I’m sure that was a lot of time and effort and expense so it’s nice to be able to actually leverage that. So anyway, last question then, what’s on the horizon? How are you growing Bitbond, what’s next for you guys?

Radko: So right now, we have the capital available from the STO and potentially from the bank financing that we are about to close. The next big step for Bitbond will be to further scale the demand on our platform and we’re currently in the process of talking to a lot of potential partners on the origination side.

This includes comparison sites, this includes e-commerce marketplaces and this includes banks who know that they themselves can provide a good loan product to the SME customers that they have, but they want to serve them and we’re working together with some banks that are in the process of setting up a partnership with us where they will be referring SME customers to Bitbond when they need financing. This is one of our next important steps.

Peter: Interesting, it’s fascinating. I really appreciate you coming on the show today, Radko, you’ve broken some new ground here for the fintech world.

Radko: It’s been a pleasure, thank you so much for having me.

Peter: Okay, see you.

Radko: Cheers.

Peter: You have to take your hat off to Radko and the team at Bitbond really for the groundbreaking work they have done. They certainly have not done this the easy way and they’ve done all of this innovation under the watchful eye of the German financial regulators. So, clearly, they have done things carefully and, you know, they’ve broken new ground, as I said.

I’ll be very interested to see how this all develops whether they really maintain this security token offering as a way for them to continually raise money, or whether this was just a one off thing. Regardless, we were talking afterwards that…Radko was saying there’s like 60 applications now pending at BaFin for doing something similar to what Bitbond have done but I said, there’s only going to be one that’s first and that was them.

Anyway on that note, I will sign off, I very much appreciate your listening and I’ll catch you next time. Bye.

Today’s show was sponsored by LendIt Fintech Europe 2019, Europe’s largest fintech event for lending and digital banking. It’s taking place on the 26th and 27th of September in London at the Business Design Centre. Lending and banking are converging, LendIt Fintech Europe delves deeply into this new world bringing you the latest developments in the most important areas of fintech. LendIt Fintech, lending and banking connected. You can find out more by going to lendit.com/europe.

PODCAST TRANSCRIPTION SESSION NO. 209  –  AL GOLDSTEIN

Welcome to the Lend Academy Podcast, Episode No. 209, this is your host, Peter Renton, Founder of Lend Academy and Co-Founder of the LendIt Fintech Conference.

Today’s episode is sponsored by LendIt Fintech USA, the world’s largest fintech event dedicated to lending and digital banking. It’s happening on May 13th and 14th, 2020, at the Javits Center in New York. Lending and banking are converging and LendIt Fintech immerses you in the most important trends of the day. Meet the people who matter, learn from the experts and get business done, LendIt Fintech, lending and banking connected. Go to lendit.com/usa to register.

Peter Renton: Today on the show, I’m delighted to welcome Al Goldstein, he is the CEO & Chairman of Avant and the CEO & Chairman of Amount, their digital banking-as-a-service brand. I wanted to get Al back on the show, he was on four years ago, and a lot has changed since then and we wanted to talk about the new developments at Avant, talking about their new credit card and some of the new things that are coming down the pipe there which were fascinating.

We also talk about Amount because they already have signed up a few large banks for their banking-as-a-service platform and some of them are public like Regions Bank, HSBC and others and we talk about that in some depth, how they were able to get these banks over the finish line, who really are their competitors and what their vision is. It’s a fascinating look at where banking is going and Amount’s role in the future of banking. It really was a fascinating interview, I hope you enjoy the show.

Welcome back to the podcast, Al!

Al Goldstein: Yeah, thank you for having me back on, Peter, it’s been a while.

Peter: Yeah, it has. In fact, it was four years, the summer of 2015 when you were on and that was back in the go-go days of online lending and obviously, a lot has changed over the last few years, but why don’t we just get started maybe by telling the listeners how Avant has changed over the past four years.

Al: Yeah, I like how you say the go-go days, I’m not sure of we’ve ever stopped going. It feels like we are running a marathon here at sprint pace which is always fun and it’s been phenomenal and you and I get to spend time together all over the place so great to be here talking to you about Avant and Amount and our journey.

So, the last time we spoke, really we were talking about the Avant vision which we started this company about six and a half years ago to be the digital bank for non-prime, middle income consumers in the US. That’s still the vision, we’ve executed really well, the company is now profitable, we have multiple products. Credit cards is our latest product that we’ve now launched and are really scaling up nicely that will be a huge growth engine for Avant.

Over the next three to five years, we’re in the process of rolling out additional products, rolling out a secured personal loan product and then, ultimately, rolling out a full depository product so really completing that vision, that mission of being the full service digital bank for those middle income consumers.

Peter: I want to get into a lot of that stuff in a little bit, but before we actually dig into the details here, I’d like to ask you to reflect back. You know, this industry has gone through some challenges, I know Avant has had some challenges as have most companies in the online lending space over the last few years. Before we sort of get talking about what’s happening now, looking back, knowing what you know now, do you think…would you have done anything differently in building Avant over the last three or four years?

Al: Yeah, so that’s a great question and clearly the industry has faced its share of challenges,  the public companies haven’t fared nearly as well as I am sure they would have hoped, we scaled up very, very quickly when we started our business from zero to nearly a thousand people and we were trying to do a lot of things.

We also scaled down fairly quickly and fairly publicly as soon as the public markets melted down and I’ll tell you the reason we did that. We wanted to control our own destiny and we went from a thousand people back to about 500 and grew profitably from thereon. I mean, in hindsight, it would have been great never to have gone through that experience, never to have grown so quickly, only to realize that markets were going to change that dramatically and take it more linearly.

But the reality is I don’t know who could have predicted that and at the same time, I think, our DNA as a company is much stronger for having lived through that experience so I am very, very comfortable that if there’s another time when we face a similar challenge, we’re going to rise to the occasion which is really important in this world.

Peter: Right, right. Obviously, you’ve survived, you’ve come out stronger, it sounds like. So, now when you look at the lending landscape today, and it does look pretty different to what it was, you know, five/six years ago when you guys were getting started, so how do think online lenders like Avant have changed lending?

Al: Well, so I think you’re exactly right, the landscape is quite different, not only the fact that at some point there were probably 400 digital lending platforms of various forms in the US. I don’t know what the number today is, but it’s quite a bit smaller than that, probably sub-ten of any meaningful scale.

There are a lot of banks that are very active in the market who are looking to jump in and that’s something we saw starting three or four years ago which is a big reason that we really focused on creating a technology business to enable banks to operate. But the online lenders of today that are focused on delivering products to prime consumers, to high income consumers are really going to have to face the challenge of the large behemoth banks coming in and that’s something completely new.

Peter: Right, that makes sense. And so then with you guys…I want to talk about your banking-as-a-service offering in a little bit, but let’s just talk about the credit card because that’s new and, you know, you didn’t sort of make a really big splash about it when it came out, so just tell us what the thinking is there. Is it the same demographic you’re focusing on with the consumer loans, tell us a little bit more about the credit card.

Al: Yeah, our thesis continues to be that the middle income consumer in the US, and we define middle income as consumers between $40,000 and 100,000 of household income, depending on where they live. We believe that consumer is pretty heavily underserved by great financial products and to the extent that they have those products available to them, those products tend to be pretty fee-heavy, they are not very transparent, not very user-friendly.

So, the thesis for our credit card offering is to provide that kind of a product that’s really clean, transparent and easy to use to those middle income consumers and huge overlap between our personal loan borrowers and our credit card borrowers. The beauty of a credit card product, again, whether it’s a physical card or a virtual card, whether it’s plastic or a card that you can use via your mobile phone, via something like a Samsung Pay app or an ApplePay app, you’re using it every day.

It’s something that’s really transactional that you carry around versus a personal loan that you really use once in a while when you need it. So our whole goal is to make ourselves high utility, to create products that customers that we serve value every day.

Peter: So then are you…obviously, you’ve got a massive customer base now that have taken out personal loans, but are you marketing the credit card yet beyond your customer base?

Al: No, so today we are marketing our personal loans and credit cards to new customers and offering the opportunity for them to move across to additional products. So, a card customer can then apply for a loan and a loan customer can apply for a card and I think that’s really the long term value proposition, is providing the product the customer needs and wants at the time that they need and want it.

Peter: Right, right. And so, are you partnering with WebBank on both of those initiatives?

Al: So, WebBank is the originator of both the personal loan product and the credit card products that are marketed by Avant. We are the servicer, we are the ones interacting with the customers day to day.

Peter: Right, right, sure. Okay, so then when we last chatted you…I remember you saying the same vision that you just articulated, but back then your interest rates went beyond 36 APR. I just checked on your website, I see that 36 is your…you are below 36 now on all of your loans. Why did you decide to do that and to sort of come down below that level?

Al: Yeah, so Avant’s products, credit products, have been below 36% for over three years at this point, maybe shortly after we spoke and that was really part of the original vision. I think the whole idea to start broader was to really expand our availability of data so ultimately we could provide credit to the most number of consumers because it really is a data game.

The more information that we have to make decisions, the better quality decisions we can make so we can offer a lower cost product to the customers that are going to ultimately perform well, we could say no to the customers that are ultimately not going to be able to repay their loans or their credit card advances.

In the US, 36% has been an accepted level by the banks, by the various banking regulators and that’s our view. We want to provide mainstream products for the middle income consumers that deserve them.

Peter: Right, right, okay. And so then, like what is your lowest rate? I mean, I imagine you won’t turn someone down if they are a super prime credit will you, or I mean, are you pricing for the full spectrum of customers?

Al: So again, I think this is where the vision for what we do at Avant and at Amount which is our tech business makes a ton of sense when you look at it holistically because Avant’s focus is really providing value to those middle income consumers and we offer rates down to 9% at our lowest level on the personal loan product.

But really our partners, our bank partners, through the Amount tech platform are focused on prime consumer credit and their rates go down to as low as 3% with no fees.  They hold those loans on their balance sheet, they expand their product mix to suit their customers and really, that’s the holistic offering. We think our bank partners are the ones that are best suited to really provide great products to the prime, super prime consumer segment. The beauty of Avant is customers that don’t fit that segment will still get a great product.

Peter: Right, right. So, are you actively referring on to banks yet today, or is this just something you’re planning on?

Al: No, we’re actively working with our partners to make sure that the customers that want a loan option get the broadest possible option.

Peter: Right, right. Okay, and so where are you at today as far as loan volume goes at Avant? Can you give us some sort of sense of the scale you guys are at?

Al: Yes, so at Avant, between personal loans and cards, we have originated over one million transactions to date since inception, about six years/six and a half years, which we’re really, really excited about that milestone, are originating north of a billion dollars in personal loans, scaling up credit card very, very nicely…and our personal loan data is public because of our various securitizations.

The performance has been really, really strong. I think that’s what has set us apart in the capital markets and we plan to continue to make sure that’s the case. We’ve taken it a little bit slower in credit card to make sure that we come out of the gates with strong credit card performance, but the goal is to originate over 200,000 credit cards this year and to scale up from there, so we’re really excited about that progress.

Peter: Okay, so when you said a billion dollars, that’s a billion dollars annually? Is that what you’re talking about for the personal loans?

Al: Correct.

Peter: Okay, so let’s move on to Amount and you know, I appreciate when we email backed and forth earlier this week and you made a clarification for me which I think is really important that the listeners understand and you said that Amount is a tech platform and Avant is one of the customers of Amount and obviously you’ve got other banks which we’ll get into in a little bit. So, I guess, the first question on Amount is why did you decide to launch the new brand and not just keep it under Avant?

Al: Yeah, that’s a great question and originally, you may know we started this tech business calling it “Powered by Avant” and the reality is that was when we were first testing it out really trying to make sure that it made sense for our partners and that the market was really big.

But, two or three years ago, we really came to believe that the opportunity to build a standalone technology business was gigantic; very different than Avant’s vision, very different than Avant’s goals in terms of serving partners, serving banks as its first priority where Avant’s vision is to serve consumers.

And just to avoid any sort of confusion because if one of our banks has a product and Amount is its provider of technology, its vendor, we want to make sure that they’re not even afraid of the fact that one of their customers could confuse their tech provider with Avant, the consumer brand…

Peter: Right.

Al: …so number one, and they’re just two different businesses. They have different risk profiles and different fundamental goals so the more and more we invest and think about these businesses, we think of them as two different businesses completely.

Peter: Okay, so then who is the target market for Amount, I mean, I know you have signed up Regions Bank and HSBC and a couple of others, I think, so who is the target market exactly?

Al: So if you think about what Amount is today, we started really providing technology around personal loans because that’s what we know really, really well and helping banks with the experience, with understanding how to deal with fraud, with understanding how to digitally host their credit policies and service loans.

We’ve really expanded that vision, the vision for Amount is to be the company that helps banks digitize financial services and notice I say financial services, not only credit, because our vision expands to account origination around deposit accounts, definitely around credit card accounts, around lending in various forms. And so our vision is we want to be the tech partner to large financial institutions that enables them to go digital so a la what Goldman Sachs has done with Marcus, building the digital bank from scratch, that’s what we’re helping our bank partners do.

To your point, we have about ten partners today, not all are public. TD Bank is another one of our partners that’s public, HSBC Bank, you mentioned Regions Bank, Banco Popular through their brand Eloan, etc. and we’re really, really excited. We now have partners that are using our technology beyond just personal loans, expanding that to other products and we’re now really catering to, I would say, banks above $50 billion of assets.

That’s the market that we’re going after today, but the long term vision is to expand products that really are useful for smaller banks as well.

Peter: So it sounds like you’re going to go head-to-head with companies like Fiserv and Jack Henry, is that the case?

Al: It’s actually not, just from the standpoint that I admire those companies, I think they’ve done phenomenally well, but their DNA is really around the payments and deposits universe and really focused on providing the core banking system for the large banks. That’s not what our goal is.

Our goal is to be the digital origination platform that integrates with all those different core banking platforms, but enabling these financial institutions to go digital in a native way, to be able to originate credit, to originate deposit accounts online seamlessly, integrate into their core servicing platforms which work really well, which are very proven and very, very hard to replace, but provides them with a modern user experience for their customers, for their bankers with great analytics that they just don’t have today.

Peter: Okay, okay, that makes sense. So, you just mentioned some of the banks you’ve signed, some of these are very large banks. What is the process like and…I mean, obviously, the timeline, I imagine, is measured in years, from first contact to public announcement, so tell us a little bit about the timeline and how the process works.

Al: Yeah, no, you hit the nail on the head, unfortunately bank timelines tend to be pretty long. It makes sense if you think about the regulatory environment in which banks operate and they need to be sure that their partners are going to be able to comply with those rules and the process takes a long time.

Having said that, we’ve now been in the business for four years plus where we launched Regions Bank in 2016 and we launched one bank in 2017 and another bank in 2018 and we’ve launched four banks so far this year. So, we’re really accelerating that timeline and part of that is it takes time to get that first product to market.

Our goal is once we launch a product with a bank, that’s really just the first of hopefully many products that we’re going to be able to help that bank launch. The product number two, three, four and five should be a lot simpler, a lot quicker, a lot easier just given that we, Amount, are hopefully at that point already a proven commodity, having shown that we know how to execute.

Peter: Right, but to date it’s really focused on the personal loan offerings, right, is there anything beyond that you’re offering today?

Al: No, we are. So, I would say the latest offering that we have is what we’re calling our “Amount 360” platform which is a cross product verification platform that we’re now selling across personal loans, credit cards, deposit account opening, all sorts of unsecured loans to help financial institutions with fraud, with identity, with income and bank account verification to create a seamless experience for customers.

Peter: Okay, so that could be even on-boarding a deposit account, or it could be on-boarding a credit card potentially….

Al: Correct.

Peter: Okay, okay.

Al: And we’re already doing that, by the way, with some very large banks, it is just we haven’t been able to share that publicly.

Peter: Right, right. So, when you’re talking to these banks, what is the biggest challenge to get them over the line, are they looking to say, right, we can just build what you’re offering. I’m sure many of the banks could, they have the capacity to build the technology that you guys are offering, but is that sort of…are you competing against that, or are you competing against other competitors, or are you competing against inertia? I mean, what is sort of the challenge with the banks?

Al: Yeah, I feel like it’s one of those questions where you just say D, all of the above (laughs), but the reality is there are not a lot of competitors like Amount that have reached critical mass. There are some great companies like nCino and Blend that are attacking different parts of the ecosystem and I think that’s great because the market is gigantic, as you said, these banks are very, very large.

Some banks want to build things themselves that tends to be only the largest banks that have giant technology budgets and it takes them a really long time. I personally think our target market is the regional and super regional banks. Today, I would say $50 billion to $500 billion is the target market because banks north of $500 billion, the largest banks, tend to want to build and control everything…

Peter: Right.

Al: …but the banks that are just a little bit smaller and you just look at the example. Even someone as big as a Suntrust and a BB&T decided to merge and the number one reason why they have publicly stated that they merged is to be able to have a larger technology budget to compete with the largest banks.

Our product and I think some of the products of a few of our newer competitors allow these regional/super regional banks to leapfrog, to really bypass the billions of dollars of tech investment and years in order to get digital products to market and ideally, pick up marketshare.

Peter: Right.

Al: So that’s really where we are today. We’re actively working on products to be able to sell products to smaller banks, call it the next leg down being the $10 billion to $50 billion banks. That are less customized, that are more off the shelf, that are easier to implement and use, but provide their customers with the same level of experience that the larger banks can provide.

Peter: Right, right. And so, one thing that we’ve noticed at LendIt is that we’ve had a lot more bankers coming to our event every year and this past year, we noticed there’s a lot more senior bankers in attendance. So, it feels to me like the bankers are very aware now of their own challenges. How were the conversations, you said you started this three or four years ago talking to banks, is it an easier conversation today because banks are more open, how has it changed over the last few years?

Al: Well I think, you’re exactly right, inertia, and you mentioned that earlier, was something that a lot of banks were probably facing five to ten years ago because they saw digitization happening on the horizon, they saw what I’m calling the “Amazon effect” start to really materialize where customers are demanding the product they want when they want it, virtually in real-time, but they didn’t see their competition doing it I would say over the last three to five years.

And also, digital lenders have come in, but also banks have come in. Banks like Goldman Sachs have pushed the envelope with Marcus. I think it’s raised the stakes and today, bank CEOs and bank product heads are more focused on the fact that they need to bring products to market and that’s what we get excited about is working with champions at these banks that have timelines and have specific product goals. We have not had a lot of success going and convincing someone at a bank to do something they don’t already feel like they need to do.

Peter: Right.

Al: But working with product heads, whether it’s a personal loan product or credit card product or student loan product or whatever it may be, that have goals and business initiatives that they need to fulfill, those are the customers we want to work with because we think we can add a lot of value for them.

Peter: So when you’re talking to them do you get ever…I mean, because a lot of these banks have significant branch networks, particularly some of the regionals are very committed to these branch networks and they’re not actually reducing that much in the way…the number of branches, are they committed to 100% online or mobile, obviously digital, or is there…do you have to sort of incorporate how they’re going to be using this in the branches to kind of make it a person-to-person experience as well as digital?

Al: Well, so for Amount, the goal is to create the omni-channel experience. So, in an ideal state, we value branches. A lot of banks have very strong branch networks and they are shrinking a little bit, but I think, largely, it’s the type of branches that are being swapped over and they’re becoming more urban.

Our goal is to create the same experience for customers, whether they are a brand new customer to a bank, they’re in footprint, they’re out of footprint, they’re an existing customer, they’re going into the branch. So, we’re not always starting there, whether it’s a personal product or everywhere else because we have to work our way in. Integrating into bank existing processes and systems is complicated, it’s going to take more time, but that’s the end goal, is to create the most seamless unified experience that we possibly can for our partners.

Peter: Right. So, is the way into these banks still today the personal loan market? The things you’ve released publicly has all been related around personal loans, is that still the way in to most of these banks?

Al: I would say I think it depends on the bank and our Amount 360 product which we used to call Amount Verify. I think we’ve put that out publicly at one of the conferences and that’s very exciting. I think it’s unique, it’s something where we may be the best…we think we’re one of the best in the world in really providing that seamless experience for banks to handle fraud and handle the customer on-boarding process across products.

And so that, we think, is a great way to get started that is in some ways easier to integrate with because it’s more back-end facing versus front-end facing, it can integrate into the front-end experience and help banks scale their personal loan product, etc., but we’re going to continue to build these more modular products that are easier to plug into, that ultimately, over time end up in big relationships. That’s the goal.

Peter: Right, right, okay. So, you know, I want to actually go back…you’ve mentioned deposits a couple of times and you even talked about, you know, you said you want Avant to become the digital bank for the middle class. You haven’t talked publicly about deposits at Avant as far as Avant offering them to their customers, where’s that on your product roadmap, or can you sort of give us some sense of when you want to have a complete offering beyond loans and credit cards?

Al: We have a few additional products that we’d like to launch to really complete the credit offering but by the end of 2020. We want to make sure that we have a complete bank offering, including deposits for customers. So, it’s something we wanted to do for a long time, we all have to prioritize and we have to stay focused, but we think that our customers today want a clean, transparent deposit account offering and that’s the goal…would be to help them achieve that.

Peter: So, are you going to achieve that through a charter of your own of some kind, or through a partnership?

Al: I would say both. We’re interested in a charter, we’ve said that, I’ve said that publicly. At the same time, we acknowledge the fact that there still haven’t been really charters granted to any of our peers and so we continue to be interested in that process, but in the meantime, we’d love to partner to provide great products to our customers.

Peter: Right, right, okay. So, we’re running out of time, but before we go a couple of more things. I’m curious about…you personally, you’ve talked about a lot of initiatives, you’ve got a lot on your plate, I mean, how are you spending your time between Avant and Amount these days?

Al: Yeah, so I’ve been spending more of my time on Amount for the last three years and really that’s just the function of the people that we have. We have some great people at all levels of our company and I really pride myself on the fact that I do very few things well (Peter laughs), but I’ve been pretty successful at trying to surround myself with really smart, hungry people that like to fight. We like the idea of creating value and we understand that it’s going to be difficult and challenging so we have great people like that throughout the organization.

We have great people like Adam Hughes, who’s our President, who’s really been driving the Avant business from the very beginning, we have James Paris who has been helping me run the Amount tech business, who has been with us really for four or five years, we have some great folks throughout the organization.

So, we try to continue to be selective, we have a lot of interests, but we really focus on prioritizing what’s really important and making sure our partners…If I put my Amount hat on, our core goal is that our partners, be it Avant, be it the banks, are happy, they get what they signed up for.

Peter: Right, right, that makes sense. So, do you spend any time on Spring Labs? I know they’ve been sort of been incubated by you guys, are you an advisor, or are you completely separate from Spring Labs?

Al: So, Spring Labs is a really exciting company, I think you’ve met some of the folks there and we really seeded the company here at Avant and the goal of Spring is to be a decentralized credit and identity bureau and network that is much safer, much more secure that addresses really some of the same needs that our partners at Amount, our bank partners have, in terms of being able to share information, share their views on customers without sharing underlying data and putting that at risk.

We seeded it, it’s got a phenomenal team that we know very, very well. So, Avant has an interest in that company and I’m on the board, but really representing Avant’s interest and really, I would say, Amount’s interest, and helping to make the Spring Labs product available to our bank partners.

Peter: Okay, I’m a big supporter of Spring Labs. I think that kind of offering is so desperately needed today and I hope to get Adam on the show at some point. I’ve chatted with him about it, I’ve got to go follow up with him. Anyway, before you go, what’s coming down the pipe the next 12 months, what can you share about what you’re working on right now?

Al: Yeah, we’ve talked about a lot of stuff. So, I’m really focused on our collective vision of these two businesses, two separate companies driving value on the Amount side. We have a number of banks that we’re in the process of helping to launch and helping to extend them into different products and verticals, so really excited about really building beyond just personal loans as we’ve talked about, really putting out that Amount 360 product and making our product available to a larger array of banks, not only the largest banks and that’s a big push, that’s a ton to do.

On the Avant side, we want to continue to scale our existing products and you’re going to see us launch a couple of new products as we’ve talked about. Secured lending and deposits is definitely on the horizon.

Peter: Okay, well that’s exciting. It’s impressive what you’ve been able to achieve, Al, and your team there. I really appreciate you coming on the show today.

Al: Thank you so much, Peter.

Peter: Okay, see you.

Al: Bye.

Peter: After hanging up the phone with Al, I was struck by really how much we have matured as an industry. You know, we really began as this peer-to-peer lending, online lending offering and people dismissed us and then we had a few hiccups and challenges and scandals along the way and people dismissed us even more. Now, it feels like companies like Avant are changing the banking world.

We are going to be completely embedded in the future of financial services through initiatives like what Avant and what Amount is actually doing and I can really see a day where, you know, the digital footprints that really had their roots in the online lending space are going to be prevalent in all of banking and all of the different areas of banking and really all the different online offerings, consumer facing offerings. I feel like the online lending industry really began all this and now it’s branching out into all areas of banking.

Anyway on that note, I will sign off. I very much appreciate you listening and I’ll catch you next time. Bye.

Today’s episode was sponsored by LendIt Fintech USA, the world’s largest fintech event dedicated to lending and digital banking. It’s happening on May 13th and 14th, 2020 at the Javits Center in New York. Lending and banking are converging and LendIt Fintech immerses you in the most important trends of the day. Meet the people who matter, learn from the experts and get business done, LendIt Fintech, lending and banking connected. Go to lendit.com/usa to register.

PODCAST TRANSCRIPTION SESSION NO. 208  –  MELISSA KOIDE

Welcome to the Lend Academy Podcast, Episode No. 208, this is your host, Peter Renton, Founder of Lend Academy and Co-Founder of the LendIt Fintech Conference.

Today’s episode is sponsored by LendIt Fintech USA, the world’s largest fintech event dedicated to lending and digital banking. It’s happening on May 13th and 14th, 2020, at the Javits Center in New York. Lending and banking are converging and LendIt Fintech immerses you in the most important trends of the day. Meet the people who matter, learn from the experts and get business done, LendIt Fintech, lending and banking connected. Go to lendit.com/usa to register.

Peter Renton: Today on the show, I am delighted to welcome Melissa Koide, she is the CEO and Founder of FinRegLab. Now FinRegLab are a fascinating new organization, they are actually an independent non-profit innovation center and what that means is they’re analyzing, doing research on different topics and they’re taking that research and they’re trying to help inform public policy and really help drive the financial sector forward.

Their first big project was around cash flow data used in underwriting and I wanted to get Melissa on the show because they’ve just released their report, as you’re listening to this, and wanted to talk about what they found out. Firstly, what the questions they were asking, what they were looking for, what they actually found out and so we go into that in some depth. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, Melissa!

Melissa Koide: Hi, Peter, it’s great to be with you.

Peter: Okay, so I’d like to get this thing started by giving the listeners a little bit of background about yourself so maybe you can tell us what you’ve done in your career before FinRegLab.

Melissa: Sure, happy to do that. As I thought about the question, Peter, it’s like, gosh, I feel like I’m kind of boring, but maybe not (Peter laughs).

Peter: I don’t think so.

Melissa: Well, I basically have set up FinRegLab which is a non-profit research organization that was founded on the premise that independent rigorous research is really a primary ingredient in helping to develop market norms and policy solutions that are ultimately what I think we’re all after, right, which is enabling safe, certain innovation in financial services and I know that’s a priority for policy makers as well as the market more broadly.

But, I think, one of the sort of notable things about me and what I’ve done is this, if you will, policy entrepreneur is I definitely became an entrepreneur at the age of 47 which is apparently the average age of female entrepreneurs (Peter laughs) and I decided to establish FinRegLab after a number of tours, if you will, inside federal government and inside policy making halls, particularly of the US Treasury Department. I led the Office of Consumer Policy for four and a half years at the US Treasury in the Obama administration and part of my team’s responsibility, which actually you know well, Peter, and you came in and met with me, at least once…..

Peter: Yeah.

Melissa: …was really trying to develop the administration’s understanding of the real opportunities and benefits, as well as the risks of using data in the financial system and new types of data in the financial system and really understanding the opportunities and risks of new technology in the financial system. And what does this mean for consumers and what does it mean for retail financial services and small businesses and what’s the implication for making sure that people are protected in our financial system and these new interests into the financial system really are still maintaining safety and soundness of our overall financial system.

So, we heard from hundreds of people. I, my team, the Treasury Secretary, my colleagues or cause, the regulatory community, hundreds of people with lots of very thoughtful points of view, but all coming in the door really with an agenda which, if you will, an advocacy point of view. What we didn’t have was any independent resource that, frankly, wasn’t coming in the door with an advocacy agenda, but, instead, just coming in the door and saying, you know what, you have these particular policy questions or regulatory questions when it comes to using a certain type of data for a certain type of financial product or financial service and here’s what, empirically, that information will tell you.

So, it was the lack of that type of independent research that was apparent to me and, frankly, I think it’s quite apparent to regulators, legislators. So, that lack of that role was the kernel of an idea that I had while sitting at Treasury that when my time was over that I would try to, you know, sus out see if I could setup an organization that could go out and try to do some of that much needed research.

Peter: Okay, so then you obviously left Treasury when the new administration came in. How did you actually go about it like, I mean, who did you reach out to? I guess like who were the supporters, who were the people that are sort of working with FinRegLab to make it a reality?

Melissa: Yeah, that’s a fair question. Well, the first thing I did was, frankly, while no longer a government employee, I made the rounds to sit down with the folks and the regulatory agencies and, in particular, the parts of the regulatory agencies, both federal but also state, consumer protection as well as the prudentials, to really start to create a set of….. basically a list of questions that would help to inform the research agenda for this research organization.

At the same time, I knew how important it was to really structure FinRegLab as this honest broker, meaning an entity that really could engage industry because, ultimately, to do research of the type that we’re doing, we have to have the trust of industry and importantly, we also obviously have to have the trust of the policy maker community and that meant that it was standing up this organization as a not-for-profit organization and also raising money from the philanthropic community, from philanthropists who really also understand the need for this type of sophisticated research and evaluation.

So, we felt really fortunate, the Omidyar Network, they are now…they’ve renamed themselves Flourish, the Financial Services Division, came in in a really thoughtful way and I think really wanted to continue to support, if you will, entrepreneurs of the type that I was setting out to be, policy entrepreneurs, who were trying to think about how do we leverage the data and technology for good. So, they have come in, they basically said to me, you know, we believe in your mission, show us you can do it, show us that you can engage industry and get the regulators to the table and we’ve been able to do that, so it’s been a real “win win.”

Peter: Okay, so then you got set up and, you know, I imagine, many, maybe dozens of topics that you could choose to really dive into as your first research project, so I’m curious about why you decided to choose cash flow data in underwriting as the first sort of deep dive research topic.

Melissa: So, our true north, while mapping the organization, our true north is around financial health and financial inclusion and I think we all realize that access to affordable credit plays a really central role in helping consumers, but also small businesses in improving their financial health, managing short term financial gaps, unexpected expenses for small businesses, really enabling the small businesses to manage revenue gaps, but also build and grow.

But yet we do have millions of people across the country who lack access to affordable credit. We have over 15 million sole proprietors who you know, at some point in time, are going to need to be able to access affordable credit and so really honing in on where data could be advantageous for helping to evaluate some of these individuals as well as small businesses felt like a really meaningful opportunity to help sort of evolve our small business credit market for consumers and small businesses.

Peter: Did you have specific goals with the project, things that you really wanted to find out?

Melissa: Absolutely, we have up to 26 million Americans who are considered no file, right, they lack any traditional credit history to be evaluated under traditional means of credit underwriting. We also have another 90 million Americans in this country and there’s the CFPB data research who are considered to not have a sufficient traditional credit history.

So, right there, we’re looking at, you know, 40 to 50 million people in the US who, if we have other means and if data would provide other means for evaluating them, could potentially be provided access to affordable credit. So, it was with input from the regulators, it was with engagement from a number of the fintechs in the market that we decided to really hone in on this question of how might this new type of data, and it’s actually not all that new, it’s transaction activity data, how might information that you can glean from a bank account of a consumer or small business, how might that data help lenders evaluate credit risk of people who otherwise might be turned down or might be priced differently than they would have otherwise been evaluated under traditional means.

This was an area that was a priority for the regulators, in fact, one of the regulators of the Federal Reserve Board has talked about the potential value of cash flow data in underwriting and so that’s how we decided to hone in on this first research evaluation.

Peter: Right, right. So, I imagine, you need to gather data yourself from lenders so can you share like some of the companies that you went out to that provided data for this research.

Melissa: Absolutely, yeah, we are so pleased to have engaged six lenders who have shared information and data with us to do this independent evaluation. The companies who came to the table with us are companies that you probably have had on your podcast before, Peter, Petal is one the companies.

On the consumer side, we engaged Petal, Brigit, LendUp and Oportun and these are all really dedicated companies to serving market segments who are, generally, more non-traditional. In some cases, these are lenders who were serving Latino Hispanic populations and other cases either lenders who are really going after the thin file/no file population.

In the case of Brigit, they are offering an overdraft alternative, but each of these four companies in the consumer market are leveraging cash flow data to do an evaluation and make decisions about extending credit to those consumers.

We also wanted to evaluate cash flow variables and metrics in the small business context and so there we engaged the companies Kabbage and Accion and they’re serving very different small business populations. That’s actually, we think, quite helpful, I mean, it made the research a little more complicated looking at each of these companies and doing firm by firm evaluations of their cash flow data and metrics.

But on the other hand, the findings become all that more powerful because what you see then are consistent results across each of these different companies that are using these cash flow metrics. It’s telling you something, I think, really about the uniqueness and the power of the cash flow data in the credit evaluation.

Peter: Right, right, Okay, so then you got all this data in and you analyzed it, what did you find out?

Melissa: So, we wanted to evaluate across three questions, questions that, I think, we all realize are important for the market as well as for policy. We wanted to evaluate for just the first base question, is this data predictive or not. We also wanted to evaluate, is the data enabling these lenders to serve populations who otherwise might have been turned down under traditional credit evaluation.

And then from a very policy specific, but market important question, we wanted to evaluate fair lending implications of the use of this data. Each of these, we think, are pretty foundational. We, over the course of basically nine months, we brought in the data from each of the companies and I’m happy to share with you, Peter, and your listeners that our analysis definitively confirmed that these different types of cash flow data and metrics that these different companies are using to underwrite unsecured consumer and small business credit are actually being used. And we found in our independent evaluation compelling evidence indicating that the cash flow variables and scores are predictive of credit risk and loan performance across these heterogeneous sets of providers, the different populations they’re serving and the products that we studied.

Standing alone, this is, I think, really a couple of really important things and you’re going to see a lot of these in detail in the report itself, but, standing alone, the cash flow metrics generally performed as well as traditional credit scores so we were comparing them against FICO and other traditional credit-based scores. That finding suggests that the cash flow variables and scores can provide meaningful predictive power among populations and products that are similar to the products and the populations we evaluated in this research.

But another really important insight that we gained on the predictiveness question, our analysis also indicated that these cash flow data and the metrics provided different insights into the credit risk than what the FICO-based more traditional credit risk metrics would show you. And so when you get a chance to read through the report, we actually have a number of hit maps that are broken up which is done by participant and you will see the level of granularity that the cash flow is able to offer in terms of measuring or assessing credit risk which is actually different than what you can see according to the different FICO bands.

So I think that’s really, really kind of an important outcome or learning from the research that we’ve done.

Peter: And so what about the question about serving new populations, did you find that that was also able to be done?

Melissa: We did. This was actually one of the harder questions that we found. A harder question to evaluate from a quantitative assessment just simply because you have differences in things like how do you define income, but we, definitely, found evidence that participants in the study are serving borrowers who may have historically faced constraints in their ability to access credit.

We, basically, came up with our own method for evaluating whether or not the populations who were being studied were located in predominantly minority communities and we looked at and evaluated according to whether or not the populations were in minority communities or were 50% minority communities, 80% minority communities and you will see in the research there are definitely populations in these different demographic neighborhoods that are being served by these providers.

So, I think the other thing to keep in mind, two of the companies in the research are themselves CDFIs or community development financial institutions and that’s designated by the US Treasury Department to be serving low and moderate income communities and populations. So just by their mere designation as a CDFI we have strong confidence that they are serving underserved communities and populations.

Peter: Right, right. So you didn’t see disparate impacts that came out of this?

Melissa: So, great question. So, we were able to do a component of a disparate impact evaluation with four of the six companies who participated and what we found is that the degree to which the cash flow data was predictive of credit risk, meaning, how independent are these variables in assessing credit risk within sub-population groups or different demographic groups that those cash flow variables are independently evaluating risk.

And so, that’s a really important aspect of a desperate impact valuation and so we’re quite excited and quite pleased to find that rather than acting as a proxy for race or ethnicity or gender, the cash flow variables and the scores that these companies are using were providing independent, predictive value across our groups and so that’s a really encouraging finding.

Now we have to offer the caveats in a company who is evaluating themselves for fair lending questions and companies know they need to be doing this if they’re in the lending space. You know, we’ll go through a range of evaluative questions that they’ll be asking themselves, but this is, I think, one of the sort of core questions that are used in any disparate impact evaluation.

It was really encouraging to see that we were finding these variables and, again, these are inflow/outflow transactions, inflow/outflow indicators, indicators of monthly cushion, economic cushion. These variables that we evaluated are not proxying for protected classes.

Peter: Okay, so the report…and we’re recording this, I know, a week before the report comes out, but by the time this publishes it’ll have been out a few days and we’ll certainly link to the report in the show notes. So the report’s coming out, what do you want to do with this report now? How do you think this research should impact public policy, for example.

Melissa: Absolutely, that is the right question. So, make that up a little bit, part of the ambition of FinRegLab is to ask and refine in a timely fashion to some of these pressing opportunities for using technology and data and to be this, as you heard me say, this honest broker that is able to bring all the stakeholders to the table, both to look and learn, as we undertake this research endeavors. But there’s another really important piece of the work that we do and that is to put together, it’s a very non-sexy term, but, basically, policy working groups to come together reflecting the different important voices in any policy evolution.

So, clearly, market actors from the incumbent banks, to the fintechs, to the data aggregators, to the important voices of the consumers and the consumers’ perspectives so consumer advocates who are part of these conversations to, ultimately, look at what is existing law and what do the existing rules that exist that are relevant for a particular new use of data, what do they say about the existing use of data, where they’re stymieing the potential value of the use of data and what are the potential ways  in which policy and regulation, and eventually potentially laws, could evolve so that we are seeing the safe use of the data being brought into the financial system, and in this case, cash flow data being used in underwriting.

And so, over the past year, we held three policy working group sessions and we had the regulators sitting at the table with us as we, week-by-week, over two and a two and a half month-period, evaluated and considered what are the fair lending implications, what are the fair lending legal implications, what are the policy implications.

Another working group was very focused on the data flow and what do existing laws of Fair Credit Reporting Act, the Gramm-Leach-Bliley Act, what do they say, where do they stymie the potential value and flow of data in these ways and then important question around…from the various roots of consumers-centric perspective, how does the consumer understand the use of the data, how do they give meaningful consent. If there is an adverse action notice required, how is that information conveyed to the consumer in a way that will be meaningful and potentially even actionable by the consumer.

So, this research has learned from, but also helped to inform what FinRegLab will produce in September which is a policy report that really evaluates existing laws that are in place right now and tease out different considerations to potential evolution of both our regulations and our policies in light of what this type of research shows us. And so, my hope is that this is something that will be widely read and considered by policy makers and the regulators as they themselves are having to think about these questions of alternative data.

I mean, your listeners probably are very familiar with the fact that the GAO has asked the regulators to express an opinion about alternative data and what that may mean. Next week, we’re going to have a congressional hearing that’s focused on alternative data and so we think we’re hitting a really important moment in the policy evolution process where we’re bringing facts to the table that get us beyond the different points of view in advocating of the different points of view.

Peter: Right, so I’m curious that….there are a couple of extra questions here to follow-up with that. As you were talking, I was wondering about privacy, it’s such a huge topic and I’m sure the legislators are going to be, you know, concerned about any negative impacts there because you’re diving into someone’s bank account for cash flow data that’s certainly…..maybe we just start with that, maybe you could comment on privacy implications here.

Melissa: Yeah, we are absolutely thinking about and writing about the privacy implications. For one, just starting with the basic premise that we’re talking about new data being used in underwriting, what is the understanding the consumers need to have in order to give meaningful consent to this type of information to be shared. That’s just sort of the first place to start.

Part of the work that we’re doing and that will come out in the September report is also about what do existing privacy protections say about this new type of data and how it’s being, with consumer consent, flowing from, you know, one bank account to a lender. The Gramm-Leach-Bliley Act speaks to this very specifically. I think there’s also a little bit of a risk that many of us in financial services, I think, are becoming acutely aware of which is how are we as a sector and how are we as policy makers and researchers really thinking through and helping to articulate where and how we define policy protections as it relates to the use of data in financial services and thinking about that carefully and to some extent separately from the bigger consumer data privacy efforts that are underway that we know. California Data Privacy is obviously one moving piece of policy that will have implications that some of these bigger consumer data privacy laws may have bearing on the use of data in the financial sector.

So, I think, there is a lot more work for those of us in financial services to do to make sure that we are able to articulate where data and even new data in the use of underwriting, identity, fraud mitigation, where these new type of data can really be advantageous for protecting consumers, protecting our financial system, also making it very transparent for consumers about the data that would be used, but making sure that we’re not in a way that ultimately harms the value of the data getting caught up in these broader consumer data privacy movements.

Peter: Right, right, okay. So then what about….did you notice in your findings, are there any negatives for this, I mean, we touched on privacy obviously, but is there anything else that you discovered that may negatively impact the consumer because of this new way of using data?

Melissa: There wasn’t anything in the research, frankly, that raised red flags for us. I think stepping back from the empirical work that we’ve done, I think we are all aware that we’ve got to really start to sort out and understand some of these expectations around privacy and how the financial sector is doing it right.

I do think that there are big questions that we’ve got to think about in terms of, you know, how are we allowing this sort of innovative use of data that many lenders, many fintech lenders, in particular, are employing in terms of creating their own metrics and which particular types of transaction data that they, you know, can put together that is very much sort of proprietary in their own secret sauce.

How are we allowing for that level of innovation and flexibility to continue to thrive while also counterbalancing that with, you know, it’s cash flow data and our research suggests that it can be so effective at serving so many millions of people, how do we balance the need for allowing for innovation with the potential around standardization. You know, UltraFICO, you and I have talked about this, Peter, is in many ways quite exciting, but it is definitely starting to create new norms and new standards in terms of the type of data that might be used.

So, I think it is an important question for the financial sector to figure out how do we sort of allow for the proprietary innovative approaches that industry may be taking that ultimately are allowing and enabling them to serve populations who may be harder to serve, but yet realizing there is real value in standards and norms and regulatory-recognized approaches to the data use. So, those are some of the questions that we will all be grappling with over the next half decade.

Peter: Right, right, for sure. So we’re almost out of time, but before I let you go I’d like to sort of turn the page and maybe you can give us some sense…you know, you’re putting this cash flow data work to bed, obviously you’ve got the policy report coming up, but what are you working on? What’s going to be the next project for FinRegLab

Melissa: We actually very intentionally decided to start with data and evaluate data, new types of data and underwriting under more traditional methods for evaluating. So, we retained Cross River Associates, many of your readers will know them well and probably have engaged them in order to do the evaluation of the cash flow data. If you think about our next areas of research, you know, we do continue to think about a lot of the questions that we, frankly, weren’t able to get after in this first go looking at cash flow. Price is important evaluating cash flow in a down cycle would be very important for policy makers and industry overall.

So, those are potential areas that we continue in the evaluation of the data. We are, though, quite interested in building some similar work, meaning, convening stakeholders to look at some of the questions that are arising in terms of the machine learning algorithms and techniques in evaluating data and underwriting. I think there’s a lot of potential, many of us are increasingly realizing how these machine learning techniques can improve in terms of accuracy, but yet we also have really important questions around, you know, how are risks related to bias being managed in these algorithms.

You know, explainability continues to be an important piece of this and so we are beginning to think about building out some work in that particular area, the techniques and the algorithms as opposed to just working with the data.

Peter: Right, right.

Melissa: But I would love to hear from your listeners once they’ve had the chance to hear this podcast where they think we should be spending our time and our resources.

Peter: Okay, we will challenge the listeners to give some feedback there. Anyway, we’re out of time, I really appreciate you coming on the show today, Melissa.

Melissa: Thank you, Peter, it’s really nice to talk to you and I appreciate your giving me the chance to share what we’ve done.

Peter: Okay.

Melissa: And our report will be out next Tuesday so that is July 23rd, so, hopefully, we’ll post with you all and get it out there.

Peter: Yeah, as I said, we’ll be having a link to it and this will actually be published after, obviously, the report comes out. Anyway, thanks again, Melissa, see you.

Melissa: Thank you, take care. Bye.

Peter: So I think it’s really important that the industry has an organization like FinRegLab that can do this independent work. I mean, cash flow data used in underwriting, there are many companies that are doing it, they have been doing it even for some time, but there has not been this independent analysis of this new, relatively new technique in underwriting. I think what lawmakers and legislators in Washington want to see, they want to see independent research, they don’t want to see a company coming and saying this is good, or even a trade organization coming and saying this is good because they all have ulterior motives.

What they want is empirical evidence, independent research and that’s what FinRegLab is able to provide. I’m very much looking forward to their next project and you heard the challenge to the listeners, if you have some ideas, please go to lendacademy com, go to the blog post for this podcast and put a comment in to say what you’re interested in FinRegLab studying.

Anyway on that note, I will sign off. I very much appreciate you listening and I’ll catch you next time. Bye.

Today’s episode was sponsored by LendIt Fintech USA, the world’s largest fintech event dedicated to lending and digital banking. It’s happening on May 13th and 14th, 2020 at the Javits Center in New York. Lending and banking are converging and LendIt Fintech immerses you in the most important trends of the day. Meet the people who matter, learn from the experts and get business done, LendIt Fintech, lending and banking connected. Go to lendit.com/usa to register.

PODCAST TRANSCRIPTION SESSION NO. 207  –  JOHN DANCU

Welcome to the Lend Academy Podcast, Episode No. 207. This is your host, Peter Renton, Founder of Lend Academy and Co-Founder of the LendIt Fintech Conference.

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Today’s show is sponsored by LendIt Fintech Europe 2019, Europe’s leading event for innovation in financial services. It’s coming up on the 26th and 27th of September in London at the Business Design Centre. We’ve recently opened registration as well as speaker applications. You can find out more by going to lendit.com/europe.

Peter Renton: Today on the show, I am delighted to welcome John Dancu, he is the CEO of IDology. Now IDology are a fascinating company, they have been around longer than just about anybody else in the identity verification space. So I wanted to get John on the show and talk about what the world was like when they started, this was like 15 years ago or thereabouts, so we talk about that, we talk about how it’s changed and how their product has evolved with it.

John talks about their friction free approach, in fact, we go into some depth on that, we talk about how they’re using machine learning and they also have an annual digital identity study which we discuss and then we talk about the fraudsters and how they’re getting better and how companies like IDology are really trying to stay one step ahead. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, John!

John Dancu: Thank you, Peter.

Peter: So I like to get these things started by focusing on your background, maybe you could tell the listeners what you did before you got to IDology, what sort of…what you did in your career.

John: Sure, so I’ve been an entrepreneur for a period of time. I started my career as an accountant and then also as an investment banker for roughly ten years which is a profession I really enjoyed and left banking to basically to start help companies raise capital and build them substantially. IDology is the longest one I’ve done, I’ve done four of them, and I’ve been at IDology for roughly 14 years, I would say I’m a classic entrepreneur.

Peter: Okay, so tell us sort of the story of IDology because, you know, you weren’t one of the founders, I believe, you came in as CEO in 2005, so what was it that you saw back then that really convinced you that this company had potential?

John: Sure, so when I found IDology, you know, it had a couple of employees and a V1 level product and what really excited me about it was…remember, this was 14 years ago.

Peter: Right.

John: So things have changed since then, but it’s a big market. At that point in time, consumer- not-present type transactions where you were conducting transactions where people didn’t see you, whether that be on a phone or on the Internet, were growing and growing rapidly and I saw that there was a really substantial opportunity relative to that market and the growth that it was going to have and the need for really a unique solution. I also believed that it was a market that was going to continue to grow and have continual wind behind our backs and that’s still the case today.

I mean, the market is still very vibrant and it’s really growing, but the other point that we saw was there were certain markets that were underserved and that was mostly kind of underbanked, thin file type individuals that wanted to conduct business on a consumer-not- present environment. The vendors that were out there in the market, at that point in time, didn’t really do a very good job of supporting on-boarding of those customers. So we felt that we could build a niche and that’s what we did and then, of course, we expanded the niche beyond that.

Peter: Sure, so it feels like in the ID verification space 15 years or 14 years is an eternity, tell us about what the product was like back when you first got involved and contrasting that with what you’re offering today.

John: Yeah, that’s a funny question because, I can remember, years ago I was working late nights and coming up with innovations that we just thought were the next best thing and now I look at those innovations and I kind of giggle about them because now they’ve just become requirements relative to the market, but the market has certainly grown dramatically, right, from a standpoint of needs for the market.

Our philosophy and…IDology is very much a product company that basically just happens to access data and help solve this identity issue. Our philosophy has always been to build, break and then build again, but one of the things that we realized about a decade ago was breached data really lent itself to what we call “perfect identities.” So a fraudster would come in and basically steal identities or purchase identities on the dark web and then have the ability to come in and basically mimic you, right, they’d have your name, your address, your social, your birth and be an impostor and basically utilize your identity.

One of the real innovations that IDology built back then was to address that issue and the way that we did it was we looked at…you know, not only do we have to consider that John’s data is correct, but is John really the correct person submitting the information on their computer or on their mobile phone. And that’s what’s really made IDology a very successful company is being able to solve those two problems as opposed to just saying, hey, your data matches.

Peter: Right, right. So when you first got involved in this company, I mean, data breaches were pretty rare from my understanding. Obviously, there were probably some, but now it feels like today everyone just assumes their identity is…their personal information is out there and available with, obviously, we had the Equifax breach a while back and there has been many, many other massive data breaches in recent years. It feels like that’s becoming more and more rapid so how should we think about, you know, identity verification then in the age of these massive data breaches?

John: Well, I think there were a lot of breaches back then, but they just weren’t as public and publicized and…

Peter: Okay.

John: …certainly since the regs have changed and so forth and the obligations of people for disclosure on that, it’s becoming pretty much a daily occurrence, right, relative to, there was one I think just yesterday on Quest Diagnostics. So the breaches have always been there, I just don’t think they’ve been as announced relative to it. But again, from our standpoint, the fact that data has been breached is something that you have to take into consideration when you let someone buy something on the Internet or whether you on-board it.

You need to take an approach that you’re protecting that consumer, right, you want to make sure that when you validate a transaction and an identity, that you’re validating the correct person and it’s really a duty of us and a duty of other companies out there to help protect consumers.

We just put out a consumer study and that was one of the things that consumers said to us is that they really expect companies to go above and beyond in protecting their identities so these breaches that basically, I think, created a requirement, a bar that basically we make sure that we’re doing proper identity verification on the people that we’re conducting business with.

Peter: Okay, we’ll get into the study in a little bit, but let’s just maybe switch to sort of talking about what is it you’re offering today? What is the product suite and who is the target market, tell us a bit about your offerings.

John: Sure so we sell to businesses, we’re a cloud-based solution that’s B2B. We solve a very horizontal problem of validating that someone is who they say they are in the consumer-not-present environment that lends itself to be heavy financial today because that’s where a significant part of those transactions are; health care, life insurance, gaming for lotteries and sports betting. There’s a whole listing of things that we basically do and sometimes we’re kind of quite surprised at use cases that come to us where people have needs, for instance, a good one is organ donation.

We wouldn’t think that we would be doing that, but we are validating people basically giving the permission to donate their organs on their licenses. But the product today is a very comprehensive solution, you asked the question before about, you know, what was it like back 14/15 years ago. Basically, what we’ve done is we’ve built a solution over time where based on our customers and their needs and the market that we’ve tried to address the issues that they have.

Really the issue that we’re addressing is validating an individual with nominal friction, with no friction and having confidence that they are who they say are and we do that through a product that we call “Expect ID” that has multiple ways of basically looking at your identity. We call it “smart layers,” right, when we think about validating someone. The more kind of layers that you go through gaining confidence on that identity, that their data matches, that there aren’t issues relative to the strength of their identity, doesn’t look like a breached identity, there’s proper addresses, their email looks appropriate, their phone hasn’t had recent changes.

These are all kind of smart layers that we’re looking at, in essence, and we’re correlating that data to make sure that we have confidence that the person that’s presenting their data is the right person, is the legitimate person. How we have really helped…how IDology has been successful in the market is we’re helping our customers basically on-board legitimate users. We happen to do that through identity verification, and the product is basically focused on trying to validate folks with no friction and then dynamically we’ll evaluate attributes on an identity.

If it sees inconsistencies, or you want a higher level of identity verification then we have means of basically stepping up that verification through asking a series of multiple choice questions what’s called knowledge based authentication, scanning your license, sending a secure link to your phone, etc. so it’s all under control by our clients/our customers. They basically can determine exactly how they want the process to go.

Peter: Okay, so I want to just delve into that a little bit because you said a couple of times there, you know, a no-friction solution. I’m just curious about…maybe you could take us through a use case where…you know, if it’s a financial transaction, maybe it’s an online lending platform, or an online bank, or someone and they’re using your product. I’m curious about how you’re able to have confidence that the identitiy is correct without having any friction, or maybe you could expand on…just expand on that.

John: Yeah, that’s part of the secret sauce, right, of how we do this, but in general, the way I would view it is the more unique data points that you can check on an identity, the higher confidence you have in that identity in conducting business with them and then it gets back to what I mentioned about smart layers, right.

Think about…we do a lot of compliance, right, it’s a fundamental part of our solution, making sure that financial institutions are meeting their KYC compliance from a regulatory standpoint, but that’s just one point and that’s a very small sliver of it. We also want to make sure we check the depths of that identity and the quality of that identity and you do that by looking at differing notes relative to that identity that gets created by algorithms that we have at looking at the information, and then by also looking at differing data points.

When you think about someone committing fraud, they can steal your identity because of all of this breached data, but that fraudster needs to have a phone, they need to have an email, they need to come from an IP address. By looking at what we call the vice location and activity-based attributes, we can gain confidence that that person that’s provided that information is really the correct person.

Peter: Okay, so then your clients then, I mean, don’t necessarily…your client’s clients, I guess, so your business clients who are offering this to consumers, or whatever,  the consumer may never know that there is really an identity verification going on because, obviously, there are some companies that are out there today that are making you get out your driver’s license, I had to do one the other day.

You take a photograph of your driver’s license, you take a selfie and, you know, you’re clear that there’s something serious going on there where they’re really checking you out. So what you’re saying is you can have a high degree of confidence and obviously, I imagine it’s up to your clients that you don’t need to go through that process, is that what you’re saying?

John: That’s correct and, you know, we’re doing it day in and day out. When you think about consumers, consumers don’t really care that the company has fraud, right, they want to have a really….because they’re legitimate, they’re not worried about the fact that ABC company may have fraud that they have to deal with…I’m legitimate, I want to on-board and I want to on-board quickly and easily.

Now clearly, if they go and read the terms of service, they would see that they’re subject to identity verification, but the process of being able to validate people on a frictionless basis is really important relative to the velocity and speed and making sure that consumers don’t fall off in the process which is a really, really big issue.

Peter: Right, right, for sure. And then what about when like…the world is switching to mobile and, I imagine, I don’t know what percent, but there are certainly many companies now have a majority of customers coming to them through mobile. Does that make it easier or harder for you to really do this frictionless verification?

John: Well, it’s a different form factor, right, so mobile does a couple of things. One is, there’s more transactions coming, right, because now I can basically conduct commerce anywhere and that’s good for our customers and that’s good for us. The second is I’ve got a different form factor that I’m doing this on and it’s a form factor that doesn’t really promote lengthy information so when people are on their phones, they want things to be clean and crisp and to be able to put in less information. When they do that, that means you have less data to basically validate people with.

So you have to look at different data points relative to that as opposed to if you’re on a laptop and you could ask for more information and people are willing to kind of type it in so, you know, there’s less data, there’s a different form factor, there’s also the ability to switch my phone quickly, right, that’s why we want to look at mobile SIM swaps and port changes, and things like that.

So I would say that it’s a different fraud problem than on your laptop and it has different complexities, but the fraudsters are committing fraud on phones, laptops and iPads and everything so for them they’re going to try to use the form factor that gives them the highest probability of being successful.

Peter:  So from what I hear you saying, you really rely so much on, it sounds like, on data sources so you’re pulling in a variety of different data sources. I know you’re probably not going to get into the secret sauce, but can you just give us some sense of the different data sources that you’re pulling in that gives you this confidence?

John: I mean, there are lots of sources that we pull in, some of these are referred to as public records, they’re not public per se, right, but they give you the ability to look at information relating to your driver’s license or your voting record or creditor information, utility bills and factors like that. So that’s the type of information that you can access relative to comparing data that exists in the public records compared to the data that you’ve submitted.

We’re also looking at mobile data, e-mail type data and IDology has something that’s really very unique and that is, we have the largest identity consortium in the US and with that, all of our customers are, in essence, contributing transaction data to consortium and that gives us the ability to enable our customers to basically see repeated activity across the network. So when someone is committing fraud, they may commit fraud in the pre-paid market and then go to the tax market and then move to the financial institution market.

By having velocity data, transaction activity that goes across all of our customers, we’re actually able to see that fraud move from entity to entity and this has been a very important part of the success of IDology. We treat data in a very confidential manner, you see data; I don’t really want to go into specifics on how velocity works, but we’re very cognizant of privacy issues there. Our customers tell us it’s the most powerful tool they have relative to catching fraudulent transactions and that’s our own consortium data.

Peter: Right. I know, I think I read something about that you’ve got a range of different companies, some of the other online lenders, so that consortium, that’s got to be billions of transactions that you’re getting access to, right?

John: Yes, it’s a lot.

Peter: Right, right. Okay, so then what about…you know, we haven’t talked yet about artificial intelligence or machine learning and that’s…you know, you’re dealing with massive amounts of data and clearly, that’s the situation where this comes in very handy. Can you just talk a little bit about how you’re using AI in your systems?

John: Sure, our velocity tool is somewhat machine learning-based. You ask people what machine learning means and you get lots of different definitions, but we’re definitely using transactions on an active basis that help make decisions right so the machine is, in essence, learning. We also do a fair amount of machine learning on our back end relative to reviewing transactions and that’s an important part of what we do so we’re doing a fair amount of AI after the transaction today with the viewpoint of proving it out, and we’ve had a lot of success with that.

Over time, we’ll be adding supplemental machine learning into the products so we think it’s an important area and we have lots of interesting data and lots of fraud that we can use to basically train the engine, but I think, what people sometimes forget about machine learning is you need to tell the machine what to do. It has to basically learn from factors that you see and we’re in the process of refining that today and we’re pretty excited about that. In the next year or so, you’ll see us move that into a product.

Peter: Okay, so then I’m interested about banks today and you know, banks have relied on the physical world to sort of verify customers. These banks are moving more and more to the online world, so where do you think banks still need to improve and…I’m talking mainly about those in the online world because that is where you operate, but where are the gaps today and where do they need to improve?

John: Yeah, the banks have lots of gaps (laughs) relative to doing truly online business so when you think about IDology, we’ve been digital since day one for close to 14 years and we’ve helped build these markets, the pre-paid market, the P2P market, the fintech market so we have a lot of expertise relative to doing digital transactions. When you talk with banking executives, I think the best quote I got from a very large bank was, digital to us is you apply on the web or your phone, we deny you and you go into a branch and show your license.

When you look at the large banks, some of them are making progress and we’re helping many of those. Most of them have systems that are nowhere near what a fintech company or an online bank that has been online from day one have and they really need to get there right. When you think about the big banks, they’ve given up markets, right, the pre-paid market they didn’t participate in, the P2P market they didn’t initially, then they got in through Zelle obviously getting good traction there now, but they have to address being truly digital.

I think they’ll get there, some of them are there and doing pretty well, but most still have a long way to go. They need to do kind of basic things of utilizing IDology, creating a whole stack of products that can basically help them being truly digital.

Peter: Sure, so then there are obviously other players other than IDology in this space, I actually had a couple of different players on this podcast so I’m curious about how you view yourself as differentiated from the other players in this space.

John: Sure, we’ve been doing this for a long time, we’ve been highly successful, if you looked at our customer base there would be a whole bunch of names there that you know very, very well, that are leaders in doing online type transactions and that’s really important relative to the consortium. We want to have strong players basically being part of that and, you know, we have a solution that is highly configurable, dynamic relative to the process of being able to decide how you want to do things.

That’s really important relative to also dealing with fraudsters because fraudsters are hourly deciding what their new attack vectors are going to be and how they can try to beat you. If you have a system that’s fixed and you can’t react to that, you’re not going to be successful. One of our competitive advantages in the marketplace is that our system has more configurations than stars in the galaxy, right, configuration options and when we see new attack vectors, we’re actually able to go in and on-demand change the rules and they automatically get deployed.

So it’s really very, very flexible and then you combine that with our consortium power that we have and I think the leading product in the market and continued innovation and that’s pretty much how we separate ourselves.

As I said, our goal of why we exist is we want to help companies drive legitimate customer acquisition and I think comparing us to competitors, you know, we on the margin, approve more people, approve more legitimate people, and that’s really what companies want. They want to be able to deal…make sure their marketing dollars and their time and effort is being used effectively to drive their revenue.

Peter: Right. Okay, so I want to switch gears now to the annual study you do. You have this Annual Consumer Digital Identity Study that came out just a few weeks ago, maybe you can just tell us what are some of the new findings that came out of the study this year?

John: Yeah, there was a couple that I thought were really interesting. One is that people consider phone and email now to be a significant parts of their identity. Historically, you ask people what’s the number one identity factor and they would say my social security number or my license or my date of birth, but this past year, your mobile phone number and your e-mail address also ranked very high relative to what people consider to be part of their identity. That makes sense, right, from a standpoint that they are…none of us let our phone get more than ten feet away from us.

The other factor that I think is also interesting is that…we talked a little bit about it, is that consumers don’t like friction and they want to make sure that their process is easy to apply and that it is also safe. They want to make sure that enterprises are, in essence, taking care of their identities and making sure that their identities are not being misused and I think that’s a reasonable expectation of consumers. They should have confidence that the people that are getting their identity information are using it safely.

The other one that I’ll mention briefly is that this is the first time where we’ve actually seen a higher level of transactions being completed on mobile devices as opposed to fixed devices like laptops and so forth. This is the year that it crossed and clearly that’s important relative to how we build our product and how our clients also build their product relative to ease of use and making it simple for people to basically conduct commerce on their phones.

Peter: Right, and it’s never going back, is it (laughs). I mean, there might be another form factor in a couple of decades or more, but it’s not going back to laptops or desktops, that’s for sure.

John: Yeah.

Peter: So we’re almost out of time, but just a couple more things here. I saw earlier this year you were acquired by a company called GBG, tell us a little bit about that and what changes that’s going to bring to IDology.

John: We’re really excited about that because we think it’s an excellent strategic combination. When you look at IDology, we’re clearly a dominant player in identity in the United States and have established a really significant position and a leading product. We’re not a data company, we’re a solution company.

When you look at GBG, they had nominal presence in the US. They basically had secured data sources in most of the world, I think in over 120 countries. When we go and talk to our larger customers, they want one provider, they want one vendor to basically service their ID requirements and fraud requirements in the US, in Europe, in Asia, and in Latin America, and that was really the driving force behind putting our two companies together is that we have the ability, given our strengths and given their strengths, to build a worldwide identity provider. That’s something that we’re really excited about and the world is in need of it and we want to provide it.

Peter: So I also want to ask about the fraudsters themselves because obviously, you’re getting better, the products are getting better, the technology is getting better, but so are the fraudsters. How do you stay one step ahead of them and do you think you will be able to, say one day, be so far ahead that identity fraud will be a thing of the past?

John: Well, I don’t think that’s going to happen (laughs). You think about how did people commit fraud in the 1800’s, you know, with a gun and they’re committing fraud now, they will figure out ways of how to commit fraud a hundred years from now. That was one of the reasons why I got involved in this business, the need for our solutions, I don’t think ever goes away. So why is that?

Fraudsters are conducting a fraud business, right, what they are really doing is they are…day in and day out, they’re trying to determine how they can beat companies for money. It’s a business for them so how do you counter that?

One, you have to think like one, right, you have to think about fraud…we go on the dark web and we read forums and we see what they’re doing, we look at our own data on an everyday basis to see new attack vectors that are happening and then we’re adjusting our product relative to that. So it’s an old thing, but it’s kind of a cat and mouse game relative to this.

What you need to be able to do relative to fraud is you need to be able to react to it and modify what you’re doing and then you also need to think ahead of building solutions that don’t give them opportunities to commit fraud. Of course, that’s what makes our business fun and challenging is that we’re doing that while we’re trying to provide a friction-free experience for the consumer because those people are legitimate and that’s how companies want to run their business. They want to run their business taking care of the people that want to conduct commerce with them that are legitimate and then on the side, we have to figure how to stop all of this fraud.

Peter: Okay then, so last question, what are you working on now at IDology, what’s exciting, I mean, what’s next for you guys?

John: Well, yeah, that’s a great question. So we’re constantly innovating and I think…clearly in the machine learning and artificial intelligence area, the items that we’re working on today, I’m really excited about that, that will make our solution that much stronger relative to giving more definitive decisions to people on transactions, right, that this is truly fraud, this is…for sure someone who is legitimate and so forth.

Again, adding another layer, right, relative to AI, I think is really important for that and then just what we talked about a few minutes ago, the worldwide approach that we have now given that we have access to data pretty much throughout the world solving the needs of our customers to be able to use the same system to validate somebody in the US, in India, in China, in Mexico, is I think just an exciting challenge for us and we’ll be spending a lot of time and effort on that.

Peter: Okay, we’ll have to leave it there. I very much appreciate you coming on the show today, John.

John: Oh my pleasure, thank you for the opportunity.

Peter: Okay, see you.

John: Bye.

Peter: You know, as I said we’ve had a few of these identity verification companies on the show in recent months and I’ve done that because I find this space personally fascinating and I think it is one of those areas that is so dynamic, there’s so much interesting work being done, work that is really making a huge difference into the success of fintech.

I think this is a piece that is so critical that we get right, so critical that we have robust systems in place because without it, I mean, really the online or the fintech space would just disintegrate because we have to be able to identify good people in as frictionless way as possible. That’s why I feel like this is a space that I think, obviously is going to be around probably forever, but certainly for a long, long time.

Anyway on that note, I will sign off. I very much appreciate you listening and I’ll catch you next time. Bye.

Today’s show was sponsored by LendIt Fintech Europe 2019, Europe’s leading event for innovation and financial services. It’s happening September 26th and 27th at the Business Design Centre in London. Registration is now open as well as speaker applications. Find out more by going to lendit.com/europe.

PODCAST TRANSCRIPTION SESSION NO. 206  –  RISHI KHOSLA

Welcome to the Lend Academy Podcast, Episode No. 206. This is your host, Peter Renton, Founder of Lend Academy and Co-Founder of the LendIt Fintech Conference.

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Today’s show is sponsored by LendIt Fintech Europe 2019, Europe’s leading event for innovation and financial services. It’s coming up on the 26th and 27th of September in London at the Business Design Centre. We’ve recently opened registration as well as speaker applications. You can find out more by going to lendit.com/europe.

Peter Renton: Today on the show, I’m delighted to welcome Rishi Khosla, he is the CEO and Co-Founder of OakNorth. Now OakNorth only started in 2015, so they’re just over four years old, but already they are the most valuable fintech company in the UK, they raised the largest ever funding round for a European fintech and they’ve been able to do this, they’ve been able to grow very rapidly, at the same time, in a profitable way.

They’re one of the few fintech companies that actually make a profit, but having said that, they are also expanding aggressively internationally and we talk about that in some depth in the show. They’re putting a lot of effort into the US market, we talk about the differences between the US and the UK, how they’re growing their US presence, how they are approaching their international expansion in a very different way than the way they approached the growth in the UK. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, Rishi!

Rishi Kosla: Thank you.

Peter: Okay, so I like to get these things started by giving the listeners a little bit of background about yourself. I know OakNorth is not your first rodeo so why don’t you tell us a little bit about what you did before OakNorth.

Rishi: Sure. In 2002, my business partner and myself set up a company called Copal, it’s basically a financial research company, we set it up with a view of servicing major financial institutions, initially the large investment banks, then private equity funds, asset managers, etc. We actually made good on that vision so fast forward 12 years on we were a 3,000 person organization which we built using a total of $50,000 in terms of capital.

It was very capital efficient in terms of how we got there, our client base included pretty much all the top ten global investment banks, a number of major private equity firms and asset managers and then we sold that business to Moody’s Corporation and 3,000 people were distributed around I think it was 12 offices in [inaudible] countries.

Peter: Okay, so then you sold that. What was the impetus to start OakNorth, what did you see that really led you to attack this which is something that really hadn’t been done before in a digital way. So what was the opportunity you saw?

Rishi: Sure, so the real opportunity…the seed of the idea came through a particular experience that we had. Back in 2005, when we were building Copal, we went to a commercial bank for a line of credit because, as I said, we sort of used a total of $50,000 to build that business so we were balancing pretty finely from a working capital perspective so we went to a commercial bank. They told us very politely where to go and we went to another commercial bank and we had exactly the same experience.

A few months later, we went to an institutional desk at one of the large banks and that institutional desk gave us a credit facility which was for a hundred times the amount we were asking for from the commercial bank (Peter laughs) and they had no issue with it. And we were like, wow, this just shows something is broken somewhere and you could argue that the institutional desk was a little bit too aggressive, but the answer was surely somewhere in between rather than the answer the commercial banks gave us, ie of zero.

So that sort of caused the seed of the idea and as we played out the business of Copal and we were coming out towards exiting it, we kept on coming back to that particular issue we had and saying, you know, is this a structural problem, is it something which applies across markets, is it cycle related, etc. etc.

We became very convicted that, actually, there was a very strong opportunity because this is an underserved segment. It’s been underserved for very specific reasons and therefore, actually a very strong opportunity to build a business within and also building a business which fundamentally has a lot of net positives for communities within the markets that we would be playing in.

Because fundamentally, we’ll be helping put capital into the hands of companies which are growth companies, small, mid-sized businesses which tend to be the drivers of GDP and employment growth in many countries. So we felt like both from the perspective of solving a real problem, solving a problem which is actually a good problem to solve for countries and communities and also clearly building a good business, it sort of ticked the right boxes.

Peter: Before you launched, I mean, obviously you would have done some market research so you said you went out looking in like 2005, did you find out ten years later that it hadn’t changed at all? I’m just curious about the target market you’re after, these fast growth companies, they’re not really being served by the Funding Circles’ of the world because they need more capital than Funding Circle’s max, so what are their options today?

Rishi: Their options are to go into a commercial bank and get a very standardized loan package which is fundamentally based on backward looking data from the borrowers, from the value of the data you provide and backward looking analysis is great if you’re not a growth company because, you know, your next 12 months looks pretty similar to your last 12 months.

But if you’re a growth company, your next 12 months may look nothing like your previous and therefore, actually having a lending institution which is only going to look at your historics so it does not get you very far in terms of meeting your needs so it gets you with a very sub-optimal loan package.

Peter: Okay, so what are we talking about here? Can you tell us the range of loan sizes and the terms, the interest rates sort of thing you’re talking about and what’s the median?

Rishi: Sure I mean, so in terms of the range of loan sizes we’re talking about roughly from half a million up to…depends on which market, let’s say plus/minus $30 million. In the UK it would be plus that, in the US, it would probably be just a little minus that, in some Asian countries it may only be up to $5/10 million, in terms of where the unmet need is. Average term, roughly three years, average loan size $5/6 million, those type of numbers so within that type of range.

Peter: Okay, and what’s the typical interest rate?

Rishi: The typical interest rate is appropriate for the risk which we’re taking on.

Peter: Is there a range, obviously you’re not approving everybody, is there a range that you work within?

Rishi: Sure, I mean the range is anywhere from 4% to 8%, that type of range.

Peter: Okay, okay. And so I know that you’re not just doing loans, obviously, that’s kind of how you’ve built your business primarily to date, but I know you’ve really got two divisions of the company. Maybe my first question is, with this sort of software-as-a-service or banking-as-a-service type of product that you have, was that the intention…first, describe the product and was that the intention always from the get-go to have these two divisions?

Rishi: Sure, so the first thing I’d say is we don’t actually look at it as two divisions. What we were very clear on is that to provide this type of customized loan packages that we felt were needed within this market segment, you needed to be able to do much more detailed analysis on the particular companies that you were looking to lend to and that detailed analysis looks much more like what you would do on a large corporate loan, i.e. if you were doing a loan of a few hundred million.

And we knew how to do that pretty well from our last business because that’s the type of stuff we did day in, day out and we were clear that we needed to bring technology into the equation to be able to apply that same methodology down to smaller ticket sizes. So we actually started by actually saying, we need to build a platform which will enable us to take that corporate approach to be able to provide customized bespoke lending to smaller businesses and mid-sized businesses.

That’s where we started and we were very clear that we needed to prove the market opportunity as well as the functionality of that platform in one market and therefore, the bank is very much…in the UK, where we started actually building that proof and obviously have built a pretty strong loan book here in the UK on the back of it. But as a core theme, it is all about providing customized lending to small and mid-sized companies and globally, we’re doing that through obviously providing our platform to existing banks rather than creating our own bank in other markets.

Peter: Right.

Rishi: So we’ll continue to obviously build our own bank in the UK and continue to use that to test and evolve our own platform that fundamentally, as I like to say, we think of this as a horizontal play around solving this problem on a global basis, rather than a vertical play of building a bank in one country.

Peter: Right, right, got it. Okay, so then I want to just dig in a little bit into the technology you use because you’re making these decisions much more rapidly, I believe, obviously than a traditional bank so how are you using this technology? What’s sort of involved in the underwriting process and what have you automated? How does it work?

Rishi: Sure, here’s the fun part. So not only are we doing things quicker, but we’re doing things quicker on the basis of actually having done significantly more work so if you go back to what I said, most banks in this space actually take a backward looking view based purely on borrower data. Whereas, what we’re doing is we’re taking the borrower data, we’re obviously looking at historics, but then we’re using lots of different data sources to be able to create a forward looking view for that particular business. And that’s something which other lending institutions in this part of the market, i.e. small and medium-sized businesses, tend not to do.

So we’re doing significantly more work in much less time, and ultimately, that’s enabled through the platform. So what does the platform do? The platform effectively helps pull in both the borrowers’ data, but also locks up said third party data sources and when I say lock, on any particular case, it may be 5,10,15, 20, but if I look across the platform, it’s thousands of data sources which the platform will go out to across different cases.

So you pull in all of that data and then you use that data, fundamentally, to create benchmarks on a forward looking view so you can have conviction that your forward looking view has been stressed appropriately to be able then to formulate a loan package which is both appropriate for the borrower and more suitable for their business, but at the same time also clearly meets the risk appetite of the lending institution.

Peter: Right.

Rishi: So that at its core is what the platform does.

Peter: So these companies that are coming for a loan, obviously they have their own forward looking projections and I am sure you look at those, but from what I hear you saying, you’re saying you create your own based on the data that you’ve seen so obviously you’re not going to rely just on what they say and you’re creating your own forward looking projections, is that how it works?

Rishi: Exactly, so we take obviously what the borrower says, but then we formulate our own perspective.

Peter: Right, right. Okay, so back to the bank for a second, I mean, you’ve been famously quoted saying you’ve experienced zero defaults to date. The unfortunate thing about being famously quoted for that is there’s only one way to go from there (laughs) because you can’t do better than zero.

Rishi:  I one hundred percent agree (Peter laughs), and let’s be clear that there is only one way to go and it’s inevitable that you’ll go there, right?

Peter: Right.

Rishi: So I think what we’re very clear on is that we will perform, both in the current market environment but also in a downturn, at a level which is significantly better than the market in the segment that we play in. So we clearly, as a lending institution, at some point you’re going to have defaults, but we have a very strong conviction that the default rate that we will have and therefore, the loss ratio that we will have will be significantly below market.

Peter: Right, that’s fair enough, that’s fair enough. So one more question about the bank before we get on to your international expansion. Are you funding all of these loans through deposits in the UK, I mean, I know you’re offering some of the best deposit rates. You’ve got a deal with Monzo now I read about, is that how you’re funding the loan book?

Rishi: In the UK, that’s exactly right.

Peter: Right. Okay, so then let’s move along to…I know you’ve opened up a US office recently and obviously most of the listeners of this podcast are based in the US, although we do have a substantial international following, so you’re opening up in the US and I am curious about the…I get the problem is very, very similar.

I’ve heard that this segment of the market is very much underserved in this country as well, but isn’t the approach going to be very…I mean, every country is going to be different, I mean, the data sources are going to be different, I mean certainly the software is different, the accounting software or whatever, so how do you approach that with taking what the core of what you’ve built and applying it into a country that has…it’s got different infrastructure.

Rishi: So the first thing to note is that we’re already live in I think about eight different countries at least, so the challenge of being live in a new country with different data sources, etc. isn’t actually a big challenge for us. Some of the countries which we’re live in are significantly tougher countries than the US to get data. The US is relatively data rich and, I have to say, data quality is relatively strong.

Peter: Right.

Rishi: So the US, for us, is absolutely a core market that we’re looking to delve into. We’ve already started originating in the US as well as actually licensing our platform so we have clients who are live in the US on our platform today, we’re also originating loans for those clients so the client can choose just to take a platform, or they can take the platform and loans as well from us so we’re not putting those loans on our own balance sheet.

The amount of demand in the US for the type of lending we’re doing, I would say if anything, is stronger than even in the UK and I say that fundamentally because the US is a larger market and we’re just seeing larger volumes in a very short period of time than what we had seen on a comparative basis in the UK. So the transportability of the model is very high and actually our ability to execute it as I said, is much simpler in the US than some of the other markets where you have both language, data quality and data availability issues.

Peter: Right, right. So are you just focused on the US banks, is that the market you’re going after for this solution?

Rishi: So we’re licensing the platform to US banks, but we’re also offering the platform and loans to other institutional investors outside banks. So we’re both, fundamentally, appealing to banks and non-banks.

Peter: Okay, interesting. And so I haven’t heard an announcement so obviously there is nothing public yet, as far as who have signed up for your platform, is that correct?

Rishi: That is correct.

Peter: You can make an announcement right now, if you want. (laughs)

Rishi: I’m sure I can. (both laugh)

Peter: Okay.

Rishi: Thank you for that.

Peter: So then are you like …when you look at the US market, I mean, do you see this as…obviously the market is much bigger than the UK, we know that, but where are these people being served in the US right now? Is it still the same, are they going along to banks right now and having the same experience that a similar company in the UK would have?

Rishi: Exactly right. Regional banks and having the same experience.

Peter: Right, right, okay. So then the platform, the website anyway is oaknorth.ai and ai, it doesn’t stand for artificial intelligence from what I gather it stands for analytical intelligence. Is that the platform that you’re going out globally with for this offering?

Rishi: Exactly right, the reason is very specifically that we call it analytical intelligence, but clearly it is a play on artificial intelligence which obviously is already embedded within the platform, but fundamentally, it’s an analytical platform so that’s why…the origins of the name. Actually, we used an algorithm to come up with the name (Peter laughs) just for the fun of it.

Peter: Okay.

Rishi: So, yeah that is absolutely the platform which we’re referring to.

Peter: Okay, so what geographies are you live in today and what geographies are you expanding into?

Rishi: So in terms of where we’re live, obviously the US, obviously the UK, Germany, Austria, the Netherlands, Italy, Singapore, Taiwan, China; that’s where we’re live. And where are we expanding to, I mean, you know, I think that’s already a reasonable amount of breadth, I think what we’re looking to do is gain increased depth within each market. Yeah, I think we’ve got, again, our estimate of total loan stock in this space is around $7 trillion and we think the market is under penetrated so, you know, I think we’ve got a reasonable way to go.

Peter: Right, right, for sure. And the fact is there really is no global brand doing this right now. I mean, it feels like…

Rishi: Except for one.

Peter: (laughs) Right, right, there is one up and coming global brand, yes indeed. So your intention then is not to get a banking license in any of these countries, is that correct, and why not do that, why not get a banking license?

Rishi: That’s correct. Why not, because we fundamentally believe that working with existing lenders in existing markets is a much more scalable way for us to actually take our platform and propagate it across markets, rather than trying to build our own regulatory infrastructure in each of these countries and then dealing with, you know, the challenges of running multiple regulated entities.

And clearly, from a capital perspective, the amount of capital it would take to run a bank in each of these different markets would require us maybe tens of billions and, therefore, it’s just not the most efficient way to either bring in capital, use capital, also not the most efficient way to [inaudible].

Peter: Right, right. So this sort of SME growth business segment is obviously huge, but I noticed recently that you’ve also expanded your product offering in the UK to mortgages for the entrepreneurs, the business owners of these companies. So tell us a little bit about that product, was that driven by your customers, or why launch that product?

Rishi: If you look at what we’ve done within the core, it is very much about how do you create a tech platform to be able to provide customized lending into a segment which isn’t used to receiving customized lending.

Now when you look at what we’re doing in the mortgages space, we’re not doing standard mortgages. We’re doing complex mortgages where we need to be able to look beyond the types of basic parameters that a standard clearing bank would look at. Therefore, the approach which we take has (inaudible) and the underwriting is actually very similar for these types of assets as well as we do in our core.

Now clearly the end customer, instead of being a business in this scenario is a company, but it’s clearly one in the same in the way that a lot of these clients are going to be business owners and therefore, we’re servicing them on their personal requirements, rather than on their commercial requirements. So we felt like it very much leverages the core of our approach and our platform, number one.

Number two, although it’s not technically the same client segment, it’s technically the same client.

Peter: Right.

Rishi: Right, so therefore, it’s actually very much in keeping with the mission that we have.

Peter: So is that something that you intend to roll out across the other markets eventually?

Rishi: Exactly right.

Peter: Okay, so then like I’m just curious then, you’re live in the US and how many people do you have in your US office now?

Rishi: Plus/minus 20.

Peter: Okay, do you think that’s going to be your…what’s the plan for growing that? I was in your office just last month in London and it’s quite a sizable workforce there. Are you intending for the US to grow into that kind of size?

Rishi: Yeah, very much so, very much so.

Peter: Okay. So then talking about the funding round, there was a lot of noise or a lot of a…not noise, but publicity, shall we say, around the funding round that you did. It was the largest ever funding round for a European fintech, $440 million from SoftBank. I’m curious…obviously SoftBank, they’re relatively active in the fintech space, but how are they helping you, or are they helping you beyond just providing capital?

Rishi: Sure, so a couple of things. First of all, you’re right about the $440 million round, SoftBank was the primary investor, but Clermont Group was the secondary investor so it was a combination of the two of them.

To answer your question on SoftBank, SoftBank are helping us and actually I have to say that they’re proving to be a very strong partner for us and they’re helping us in a multitude of ways. One is removing the constraints from your thinking about capital so effectively saying capital isn’t a constraint; how fast can you go, how large can you go whilst still obviously maintaining some level of prudence one needs to to make sure we don’t go off the rails, right, that’s number one.

Number two, they are directly helping in terms of bringing in talent and identifying actually where we may need talent as we scale which is proving very useful.

The third aspect is, you know, they know a few banks who could be clients and they’re being helpful in that regard so fundamentally, strategically, channel acquisition and actually from a client perspective, on all areas they are being helpful and therefore for us are proving to be a very strong partner.

Peter: Right, right. We’re almost out of time, but I want to get a couple of more questions in. You mentioned China and…China is notoriously difficult to crack. I spend a lot of time in China personally with our event, we have a conference in Shanghai. How are you approaching that market, I mean, do you have like….are you partnering with a local business, are you setting up from scratch? How are you attacking the Chinese market?

Rishi: So the first thing to note is in our previous business we did operate in China, we had about 300 people in Beijing.

Peter: Okay.

Rishi: So we’ve operated there and that was an independent operation, i.e. standalone, and therefore operating in China isn’t new to us. We have a small team in China today and we intend to, again, build that, not necessarily at a very high growth rate today, but build it and put all the right foundations in place.

The market which we’re obviously looking at scaling quickly is the US market and what we want to do is take our time in creating the right foundations in China because we do understand how much tougher it is to actually build and penetrate so that’s our approach to China.

Peter:  Right, okay. So you know, I’m thinking as you’re talking, you’ve got a lot on your plate. Like this is the last question then, so tell us how you spend your time? Do you spend half your time focused on the US market, are you focusing on building the team, maintaining the culture; how do you spend your time?

Rishi: All of the above so obviously the US is a key focus. I am the CEO of the regulated bank in the UK so clearly, that continues to be my main focus, but bringing in the right talent across the business in the right places is fundamentally the only way that one can scale. Therefore, that’s inevitably a meaningful focus for us and then, you know, there’s 24 hours in a day and seven days in a week so you can actually stretch the week pretty effectively.

Peter: Okay, well on that note, we’ll have to leave it there, Rishi, I wish you all the best. You’ve built a fantastic business in a short amount of time and I can see that you’re only just getting started. Thanks for coming on the show.

Rishi: Thank you so much, appreciate it.

Peter: Okay, see you.

Rishi: Bye.

Peter: This whole banking-as-a-service segment is truly fascinating to me. It’s one that is really still in it’s infancy. While we’ve seen some companies in the consumer lending space, even in the small business space move beyond their own offering and offering it to other companies in the space, we’ve never seen anyone like OakNorth that are just going out across the globe fairly aggressively, taking their core technology, not just expanding it to one other country, but to multiple other countries at the same time.

If they can pull this off and they certainly have the resources to do it, they’re extremely well funded so if they can execute this, they will be the dominant brand in this space and it’s going to be fascinating to see how all this plays out.

Rishi is actually going to be a keynote speaker at our LendIt Fintech Europe event in September so you can find out more and listen to him at that event.

Anyway on that note, I will sign off. I very much appreciate you listening and I’ll catch you next time. Bye.

Today’s show was sponsored by LendIt Fintech Europe 2019, Europe’s leading event for innovation and financial services. It’s happening September 26th and 27th at the Business Design Centre in London. Registration is now open as well as speaker applications. Find out more by going to lendit.com/europe.