Lend Academy's Lending and Fintech Podcast

 

PODCAST TRANSCRIPTION SESSION NO. 177/RANIA SUCCAR

Welcome to the Lend Academy Podcast, Episode No. 177. This is your host, Peter Renton, Founder of Lend Academy and Co-Founder of LendIt Fintech.

Today’s show is sponsored by LendIt Fintech USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8th and 9th, 2019, at Moscone West in San Francisco. We’ve recently opened registration as well as speaker applications. You can find out more by going to lendit.com/usa

Peter Renton: Today on the show, I am delighted to welcome Rania Succar. Her official title is Business Leader, QuickBooks Capital and Payments and that’s part of the Intuit organization. Now most people know about QuickBooks, it’s an accounting software that’s been around for many, many years; I’ve used it myself extensively.

Rania has come in to run their…originally, she came in just to run their lending operation, it’s a relatively new business for them, they launched it not that long ago and she was brought in to really build that up and make it a core piece of the Intuit business. So in this interview, we talk a lot about why she decided to come to Intuit from Google, is where she came from, what she saw was the opportunity, we talk about their approach to underwriting, how they’re able to underwrite these loans very quickly and efficiently, we talk about data and obviously the rich data sources that they have at Intuit.

We talk about funding of the loans, we talk about their new entry into…well their new addition of payments into the QuickBooks Capital umbrella and the thinking behind that. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, Rania!

Rania Succar: Thank you, thanks for having me, Peter.

Peter: My pleasure. Okay, so I like to get these things started by giving the listeners a little bit of background about yourself. You have had a very interesting career to date so maybe you could just give us some of the highlights.

Rania: Absolutely. Well I joined Intuit three years ago to lead our QuickBooks Capital business and I’ve long been interested in economic development and creating jobs and driving economic productivity. I got to do a ton of that when I was at McKinsey early on in my career doing work with various governments. We did some labor market reforms, spent a lot of time thinking about the productivity of different sectors and became fascinated by all of that.

And then I got to spend some time in Silicon Valley with Google and saw the power of technology driven innovation and learned all about the concept of 10x change. If you weren’t driving 10x change with something it wasn’t big enough. And so about three years ago when I was looking for the next thing to do when I heard about the vision of Intuit and the work we wanted to do around small business lending and the leadership role that Intuit had when it came to powering the prosperity of small businesses, I was just blown away by the potential and the opportunity.

So to be able to come over here and play a really unique role in super charging the economy with products like QuickBooks Capital and do it by harnessing data-driven innovation and technology, that was super exciting to me. So those have been some of the themes that I’ve been involved in before Intuit. As I mentioned, I spent time at Google, I spent time at McKinsey and I started my career at Merrill Lynch on the investment banking side.

Peter: Okay, it’s certainly an interesting journey you’ve had so far. So then, you mentioned the potential of QuickBooks Capital, maybe we can just get started by talking a little about the product itself like what is QuickBooks Capital?

Rania: Yeah, QuickBooks Capital is focused on solving one of the biggest challenges that small businesses have and that’s access to capital. So at QuickBooks we are obsessed and we’re constantly thinking about how we change the trajectory of success for small businesses. We all know the statistics that more than 50% of small businesses go out of business in their first five years and most often that’s driven by cash flow challenges.

In fact, I think this week we’re about to release a study that we just did that shows some of the challenges that small businesses face when it comes to cash flow, but close to 70% of small businesses lose sleep at night because of cash flow problems and over 50% are leaving opportunities on the table because they can’t access cash flow and so cash flow is a huge problem.

Access to capital is a big driver of that and we’ve all read about it and understand that there’s a lot of market failures when it comes to small business lending because if you’ve been in business for less than two years, you have less than $100,000 of revenue, it’s nearly impossible for a traditional lender to underwrite a small business efficiently and profitably in a way that can actually get capital to the small businesses.

It’s even a challenge for alternative lenders who’ve been out there tapping into so much advanced data to do this. So despite all the innovation in the industry, especially with alternative lenders over the last ten years, there was still a huge problem that has left small businesses underserved and that’s the problem that QuickBooks Capital came in to work to solve.

Peter: Right, and so it’s primarily or I imagine it’s completely focused on QuickBooks customers, is that correct, the QuickBooks accounting software?

Rania: Today, yes, that’s what the offering is focused on today.

Peter: Right.

Rania: And so basically the way it works is small businesses who use QuickBooks are able to apply for a loan and tap into all the data that sits in QuickBooks. As you can imagine, there’s more financial data in QuickBooks that small businesses can use to apply for a loan than they could anywhere else. So it includes all of their transactional historical data, which is very interesting, but also all of the future forward looking data.

As you may know, over 240 million invoices are sent a year through QuickBooks and so when you can understand future profitability, historical profitability, when it can all be put in context to so many other small businesses because QuickBooks is the largest ecosystem for small businesses out there, that’s translated into being able to offer capital to small businesses who otherwise would never have the opportunity to get a loan. And if they did, the terms they can get through QuickBooks Capital are much better.

Peter: Yeah, right, that makes sense. You know, it’s interesting because….obviously, I’ve been following you guys for a while, I’ve used the QuickBooks Online product. In my old business I used it exclusively so I know the product from multiple perspectives, but it’s interesting because I actually went to visit the Intuit…I think it’s the headquarters in Mountain View, California back in 2015, really we were doing sort of a fact finding trip for LendIt, wanted to meet with some of the people there.

Back then, you had a partnership with OnDeck and a couple of others I think for lending, but I remember being in that meeting and coming out of it talking to my partner, Jason, who I was in the meeting with saying, wow, this company has so much potential and yet they weren’t really leveraging pretty much any of that potential. It seems like now…I mean, you started it seems like a few months or a year after when we had that meeting, but what we talked about is data.

I mean, QuickBooks has the richest database of I think just about anybody because you’ve got granular transactional level data, you see every single expense, every single receipt that comes in so I guess…I’m curious about, like when you started, because this didn’t exist, I mean, QuickBooks Capital wasn’t there when you started. Was that really part of what sort of attracted you? You saw what was there and what it could be because it’s certainly…I see where you are now from the way you were three and a half years ago when I was sitting in your offices in Mountain View and it’s dramatically different.

Rania: Yeah it is exciting, the trajectory we’re on has been incredible. I came from Google, as I mentioned, which was full of innovation and the things that we were pursuing were just beyond exciting. To come here, I have to say, I’m even more excited coming to work every day by what we’re working on and the potential of what we’re working on and so as a company, we have renewed our vision for what QuickBooks is over the past few years and QuickBooks Capital is at the heart of it, but it’s only one of the many things that we’re doing.

So we talk about smart money, smart decisions and smart connections and it’s all powered by data so a small business doesn’t use QuickBooks anymore just for accounting. QuickBooks is meant to help them become a smarter business owner to tip the odds in favor of small businesses, you know, to take away that lonely journey and to tap into all the data that sits in QuickBooks to help them, as I mentioned, with smarter money, smarter decisions, smarter connections.

So on smarter money, we’re tapping into big data, machine learning, artificial intelligence to do things for small businesses based on that data in the ecosystem that couldn’t happen elsewhere. So of course, it’s access to capital, but it’s also help getting paid faster, solving some of those accounts receivable challenges, again, through the power of big data and we can talk about some of the ways we’re doing that.

We’re also working on things on the smart money to help alleviate some of the major challenges when it comes to payroll. Within QuickBooks, we run payrolls for one in twelve employees in the country, we’re a top two payroll provider across the country. And so we’re in a position to launch things like same day payroll and next day payroll to not have small businesses…to allow them to hold on to their money longer as they do payroll. So that’s the smart money side of things.

The smart decision side of things is to tap into all of that data so that small businesses are powered with the insights that they need. We’re able for example to say, it looks like this is about to be a very busy seasonal period for you and we can see that down to the industry, down to the narrow geography and say, have you invested in the additional inventory you’re going to need to make that season a success? And we’re doing that through QuickBooks Assistant, for example, we’re using voice-powered artificial intelligence, etc.

On smart connections, we’re helping create the connections that small businesses need to be successful, whether it’s connecting accountants to small businesses, or small businesses to each other, or small businesses to the self-employed when they need to find work. So there’s many, many things involved in that vision. Some of those exist today, some of them will come online over time, but the opportunity that we see to transform the trajectory for small businesses is really exciting and compelling.

Peter: Sure, as a small business owner my entire career, it’s exciting now that…I feel like it’s a good time to be a small business owner because you have a lot more tools at your disposal and you obviously have access to capital in more efficient ways as well. So I want to go back to just talk about the actual product itself and maybe you can sort of give us some sense just of the type of loans these are, the lengths, how’s the repayment, and what’s the typical interest rate; just give us a range on the loans themselves.

Rania: The loans range anywhere from $1,500 term loan up to $100,000 and so we’re really focused, as I mentioned, on giving capital to the underserved small businesses. So we realized…you know, we started at a $5,000 amount, but we realized that sometimes even smaller amounts can make a big difference to small businesses so we’ve gone down and gone up. These are short-term working capital loans, they range from 3 to 12-month loan paybacks and we also have weekly and monthly payback.

The interest rates are extremely competitive. The important thing about the interest rate here is that we believe with the precision of our data, we’re able to understand risk better than other lenders out there. Again, we’ve talked about the extreme precision and the ability to price based on that and so small businesses will typically…we hear that they feel great about the interest rates, but the APRs range from 8% all the way up, you know, they’ll go into the mid-20’s, for example.

Peter: Right, right, okay, got it. I know you’ve got a massive customer base, what is the profile of a typical QuickBooks Capital customer when they’re taking out a loan?

Rania: It’s really exciting. One thing we’ve seen is that 46% of small businesses who are taking out these loans never applied for a loan before and we are incredibly excited by that statistic because it means that historically, these businesses that have needed capital had felt intimidated or daunted by the process of applying for capital. Whereas in QuickBooks, it’s so simple, it’s just there for them. They have a historical relationship, there’s deep trust with the brand that they go for it so that’s one thing that’s extremely positive for us.

And then the other statistic that’s very exciting is that 90% of people who’ve taken a loan from QuickBooks have used it for growth. So we featured a story of a small business at QuickBooks Connect last week where a business had one floor that they were using for the business, it was for various vendors to come in and sell their goods, like a market. They had one floor built out and they wanted to expand to the second floor, but to do that they needed to retrofit the second floor to fix all the HVAC and the heating and everything and the electrical work and they needed the funding to do that and they weren’t able to get a loan anywhere else.

Through QuickBooks they did it and they were able to double their business and grow their revenue substantially. We also have other businesses who’ve used the capital to expand into other parts of their business that helps them solve their seasonality problems so we’ve had businesses that…for example, there was a ski manufacturer that had just a winter business and with QuickBooks Capital was able to add a beer garden onto their shop and expand into a summer business and solve their seasonality problem.

So whether it’s to buy inventory for an upcoming season, or to buy inventory in bulk and get better rates, or to expand their business with some construction opportunities, we’ve seen these loans power different opportunities for small businesses and that gets us really excited.

Peter: Yeah, for sure. So then do you still have that marketplace…I know it was in existence back in 2015, partnering with companies like OnDeck and Fundbox, is that still in operation, or is everything done through QuickBooks Capital?

Rania: That’s still in operation. QuickBooks is an open platform and that’s core to our strategy. We believe that small businesses come to QuickBooks to run their business, for it to be the hub and center of their business and they connect several different apps and experiences that compliment their business end-to-end. So there’s many different reasons that a small business may need a loan.

QuickBooks Capital, our direct lending offering provides those short term working capital loans, but then they may need a secured loan or a longer term loan and so we believe that the marketplace can add quite an important compliment to what we’re doing and help small businesses solve all of their financing needs. So it still exists and it’s growing quite nicely and we’re excited to see the progress there as well.

Peter: Okay, so let’s talk about data for a little bit, we’ve already touched on it, but obviously you have the transaction level data from all of your customers, but can you tell us your approach when it comes making an underwriting decision? I mean, how do you process all that data and what about other data sources as well; maybe you can just run us through your approach to underwriting.

Rania: Absolutely. We have invested quite a bit in our underwriting models, our credit models, our real-time decision engines, all the infrastructure that can crunch so much of this data very rapidly for small businesses. We built our credit model on top of 27 billion data points and it’s growing constantly so when a small business applies, we’ll take into account all of the data we see in the ecosystem so certainly there is QuickBooks transactional data, their connected bank account data, we look at third party data as well and the richness of the QuickBooks data to give you a sense…

As you may know, we purchased TSheets last year so we can see all the time tracking data or we can see the payroll data which is of course one of the biggest expenses. Small businesses connect Bill Pay through QuickBooks, they’ve got payments providers and processors and of course we’ve got QuickBooks Payments which is one of the largest payments providers in the country. So we have all of that data and then we see future looking data from invoices and all of that so all of that is taken into account in the decision making.

Then of course we’ve built quite a bit of advanced machine learning to understand things like, as I described earlier, what does the seasonality look like of this business, is this business seeing low cash flow today but about to see really strong cash flow because they’re about to hit their strong seasonal period? That took quite a bit of advanced machine learning and modeling work, but that is a great way to look into the future cash flow of a small business.

And then we have done other things like understanding how likely is that invoice to be paid back, not only do we see future revenue, but because we see so much invoice data and understand the payers, how likely is that payer to pay back at all and if they are to pay back, when do we expect them to pay back. So this is very much based on what is the ability of that small business to pay back?

It’s not just a revenue-based model, we do really look at debt service coverage ratios, all of this in real-time to understand, can this business pay back that loan which is extremely important to us given the role we play with small businesses. We want to make sure that these loans are empowering small businesses to grow in strength and to succeed and so we work on pricing it right, making sure we’re lending that small business the amount that their business can sustain.

Peter: Is this a fully automated process? When a business is applying for a loan, obviously you’ve got all the analysis going on for the underwriting, but does a human sort of take a look at every loan, or is it fully automated?

Rania: It’s a mix. We are working to automate more and more and more of the process. When we started much of it was manual and we were reviewing everything so we could learn and make our models better and over time, more and more of it has become automated and different loans, different types of loans and different loan limits will have more automation versus more manual intervention, but as I mentioned, it’s a mix. But it’s very important to us to help small businesses get decisions in real-time and so the automation component is quite critical.

Peter: Right, right. So then, I think you launched…was it 2016 you actually launched? Maybe you could tell us when you launched and sort of what is the scale you’re at today, as far as loan volume goes.

Rania: We officially launched a year ago, we announced it last year at QuickBooks Connect, we were doing a small pilot before that, but the real launch was a year ago. At the end of our fiscal year, which was in July, we announced we’ve done $140 million of loan volume. We believe that that’s one of the fastest ramps of a small business lender out there and we’re continuing to see really strong growth, but that’s the timeline of when we launched and what’s been happening and it’s been fun.

There’s been so much innovation, it’s been incredibly fun to be part of this team to get, you know, all of the…Intuit does this quite well, but all the principles of fast and rapid developments and minimum viable product. We launched early, we saw how our customers reacted, we learned quickly from our customers and there’s been almost a new launch or a new innovation or a new feature that’s material every few weeks and every month. Rapidly innovating on the data and the background, pulling new sources of data constantly, innovating on the product itself, innovating on the customer experience so we really believe we’re just getting started and there’s so much more we’re doing and bringing to our customers.

Peter: And given these are fairly short term loans…I know you haven’t launched that long ago, you would have had some insight into your loan performance I imagine by now given the short term nature, what can you…I know you’re a public company and everything, what can you tell us about loan performance, so far?

Rania: What I can tell you is it’s doing better than we expected. We’ve been able to grow the base so much because our data has proven even more powerful than we expected in predicting risk. And so when we started, we hadn’t opened it up to businesses that were younger than two years and now we require something like six months of transactional data to be able to lend to a small business. And so that’s just demonstrating the power of the data and that the data is able to help us go into younger and younger populations and still see loan performance that we are seeing as better than peers in the industry so the data has been quite powerful.

Peter: Right, and obviously…I believe there is…maybe you can tell me a sense of like how many QuickBooks Online customers are there? I believe this is only available to the QuickBooks Online customer, you can correct me if I’m wrong, because when I did QuickBooks I started off actually on the offline product and I migrated to an online product, but I imagine there’s still people running the offline product.

Rania: That’s right.

Peter: Can you tell us, what are some of the metrics or the numbers on the different types of customers you have?

Rania: Yeah, there’s 3.4 million QuickBooks customers today and the growth is just tremendous, I mean, it’s pretty incredible to see this, but we added a million incremental QuickBooks customers just in the last year. I think the first ten years of QuickBooks, we added a million and in the last year, we added a million and we’re just seeing growth continue at the same pace if not accelerate. So there’s quite a big base of QuickBooks customers and as I mentioned, the ecosystem of everything else that small businesses are doing in QuickBooks makes this central to them.

So there’s the payroll side of the business, there’s the payment side of the business, there’s time tracking, there’s automated sales tax and then of course, there’s the apps ecosystem where small businesses are coming in and connecting up to 15 and sometimes more apps to their ecosystem, and then of course, the accountant community so all of that builds on itself, and then we have the self-employed side of the world.

QuickBooks made a big investment and a big bet around the self-employed four/five years ago and that’s been growing tremendously and we’re really innovating in that space for the self-employed and providing more value than perhaps any other player out there. Just a few weeks ago we announced that we’ve moved into the mid-market segment as well which we’re calling the QuickBooks Advanced Offering.

And so a small business can come in from the earliest days and they can stick with QuickBooks and grow over time. And that’s our vision for the lending side of things too; that they come in when they’re youngest and they can’t tap opportunities anywhere else and then QuickBooks Capital can grow with them and be a constant source of credit to tap into as they need to take advantage of the next opportunity they have in front of them.

Peter: Yeah that’s a really good idea because when we first started LendIt, we actually were on QuickBooks and then we hired a finance person and they said oh no, we’re too big for QuickBooks now, we need to move on to something else. Obviously, we let them run with it, but that’s good that you can see that a small business as it grows can stay with you.

Rania: Absolutely.

Peter: Okay. Then let’s talk about the funding of these loans. From my understanding, you are funding everything from your own balance sheet, obviously you can confirm if that’s correct and are you going to start looking for outside investors to fund these loans, or what’s your plans?

Rania: Absolutely. We did start funding all of these internally on our own balance sheet just to get things going and to start and make the R&D cycle very fast and rapid, and as we’ve mentioned, there is the intention to partner over time with other investors and that’s certainly the direction we plan to take.

Peter: Okay, but as of right now everything is being funded from your own balance sheet?

Rania: Yes.

Peter: Okay.

Rania: Again, with the intention of working with partners.

Peter: Right, right.

Rania: But in the early days, it was very important to move very quickly in this space.

Peter: Yeah, yeah, I understand. And you’re making money…I was just on your website before we started this call and the way you make money, it seems like…there is no origination fee, it looks like. There’s just…on your website you say, no origination fees, no pre-payment penalties, no surprises and it’s just interest that the company pays. Is that correct?

Rania: That’s right and the entire QuickBooks Capital offering is very much founded on transparency and being a white knight for small businesses and leading the way when it comes to regulatory matters and compliance, but really putting the customer first. And so this lack of surprises is a critical thing.

It’s amazing that most existing alternative lending offerings today have a pre-payment penalty. If you pay it early, or you keep it the entire time, you’re still going to pay that interest amount, you know, if the cost is 10% of the loan, that’s what you’re going to pay if you pay it back in one month or nine months and that’s an unfair burden for small businesses to have to shoulder, and so that was very important for us as we launched this.

One of the interesting statistics is that, and this is from the Federal Reserve, more than 50% of small businesses who take a loan, around 50% of small businesses who take a loan with an alternative lender today are dissatisfied with the experience and that’s often because of the incredibly high interest rates and often these surprises and pre-payment penalties. And so as we designed this putting our small businesses first, it was very important that we set QuickBooks Capital up differently.

Another thing is that we always disclose the APR and that is very rare too, you often don’t find that with some of these other offerings. They might say the cost to borrowing is 10%, but the APR could be well into the 30’s and as we all know, even in the high, well above 50%, and so that was a very important thing for us too that we would always show the APR on our website and always lead with that for the small business so their cost of borrowing might be less than 5%, for example, hypothetically, but the APR, we will always be very clear about that.

Peter: Right, I think we’re moving in that direction, I mean obviously there was the State of California, I believe, passed something for more transparency in small business lending.

Rania: Yeah.

Peter: There’s the Business Borrowers’ Bill of Rights and there’s other initiatives that…I mean, we have it in consumer lending where we have The Truth in Lending that really has been around now for decades and is sort of the bedrock of the consumer lending space whether you take a car loan, a student loan, a mortgage loan, you’ve got this one document that is consistent that shows everything pretty clearly and you don’t have that in small business so it’s a little crazy, I think, that there isn’t that same regulatory requirement for a small business owner.

Rania: That’s right, that’s right. We feel that way too.

Peter: And just on regulatory, you mentioned it, I know that you are a partner with Financial Innovation Now, you’ve got some of the biggest hitters in the country, it’s Amazon, Apple, Google, Intuit, PayPal and I even see Stripe is now a member, so tell us a little bit about why you are a founding member of this organization and talk about your engagement in Washington and what you’re trying to achieve with that engagement.

Rania: It builds on some of the discussion we were just having which is that there’s tremendous potential for technology and some of these fintech companies to add tremendous innovation and benefit to small businesses and to open up credit and capital to small businesses in a way that can change the trajectory and yet there’s opportunity for regulation and improved standards for the industry.

And so we were a founding member of FIN, Financial Innovation Now, in order to help educate and inform the DC community about the potential benefits of data-driven innovation for small businesses, but also to share more about our perspective on standards we could set to ensure that we were protecting small businesses in all of this. So it’s to help create clarity about the potential benefits, but also to, you know as I mentioned, inform on some of the opportunities to improve the regulatory environment and to strengthen it.

Peter: Right, okay. Briefly, we are running out of time, but I wanted to just ask about payments because when we first chatted which was about a year ago now, it was just QuickBooks Capital. Now I see when you go to your LinkedIn profile you’ll see it’s QuickBooks Capital and Payments so it seems like you guys have brought payments under your roof. So tell us what was the thinking behind that and tell us how the payments and the capital pieces are connected.

Rania: Great. Well first just context on QuickBooks Payments. Not many people know this, but QuickBooks Payments is one of the largest payments facilitators in the country. We do about $50 billion annually of payments processing for small businesses across credit card and ACH and so it’s a key solution for small businesses who are looking to get paid.

But we thought it would be wonderful to bring the businesses together, QuickBooks Capital and Payments because it would help us solve the true big challenge of small businesses when it comes to both these areas which is cash flow, as we started talking about at the beginning of this discussion.

So our vision is, you know, if you’re a small business and many of the small businesses who are using QuickBooks are invoicers so they get paid later. More than 50% of small businesses get future payments rather than payments here and now and so for them they tend to have a big receivables challenge and that can be…you know, the typical business has over $55,000 of open receivables, and so that can be a big challenge for small businesses. So by bringing these pieces together, payments and capital, we can create a world where whenever you send out your invoices, you’ve got capital available there for you that you can tap into.

And so by bringing these together we can push product innovation that help small businesses no longer chase getting paid, no longer worry about cash so we are just beginning the journey on our side to create whole new categories of products here that can solve some of these challenges for small businesses and you’ll see more and more of that innovation on our part in the coming months and years.

Peter: Right, right, got it. So then speaking of the future, what is your vision? It feels like you’ve got a lot of open fields in front of you. You’re really expanding this space and you’re only just gotten started, I mean, what is your vision for the future of QuickBooks Capital and QuickBooks Payments?

Rania: Several things. There’s quite a bit that we’re innovating on. One thing that we didn’t spend a lot of time talking about is the work we’ve done on QuickBooks Capital around business credit scores. And so that’s one of the areas we’ve just announced this year and that we’ll continue to innovate on, but you know, more than 50% of small businesses don’t have a business credit score and we found a lot of hunger as we launched QuickBooks Capital for small businesses to take a loan just to start building credit because the capital product definitely helps them build credit by reporting back to commercial credit bureaus.

And so what we did, building on that insight, is we recently introduced a new credit score in QuickBooks with Dun & Bradstreet. So it’s the D&B credit score in QuickBooks that we’re offering for free for all small businesses which isn’t available in other places that they’re able to get so we’re working on strengthening education around business credit scores and helping small businesses build those out. That’s one area that we’ll continue to lean into over time.

You can also imagine a world where the QuickBooks Capital credit score becomes stronger and stronger and small businesses can take that with them so small businesses join QuickBooks can take that with them and use it to tap into new funding sources in other places as well so that’s one big theme.

Another theme is certainly around the cash flow side of things. We want to eliminate some of the pain that small businesses feel around cash flow so how do they tap into QuickBooks, see their available QuickBooks Capital balance, have it grow with them over time, just have it to draw down from anytime they need it for the various work that they do.

Also on the cash flow theme, we’re working to build out a cash flow forecaster that helps small businesses understand when it’s safe to spend and to help them make informed decisions around, you know, the season really looks good this season, make that extra investment in inventory, for example, or hire this extra worker. So there’s that piece, for sure.

And then, of course, continuing all the work that we’re doing around data innovation to continue to be able to offer more capital to small businesses and continue to offer better terms so there’s quite a bit of work around data innovation. Despite everything we’ve done in the past year, we know that we’re just getting started there.

Peter: Right, well, it’s exciting times and I really appreciate you coming on the show today, Rania.

Rania: Thanks for having me, Peter.

Peter: Okay, see you

Rania: Alright, bye.

Peter: As I said earlier, this is a really good time to be a small business owner. You have access to tools that simply weren’t available just a few years ago and it’s really interesting to me that there’s many companies competing to be that financial hub for the small business owner. Obviously, QuickBooks have a massive leg up because they have a relationship with millions and millions of small business owners already, interesting that they’re back growing fast again adding new customers, but the thing is, most small business owners don’t really want to sit around managing finances.

They want to run their business, they often have a passion for the industry that they’re in and they don’t want to sit around thinking about money and payments and getting a loan and that sort of thing. I feel like just like in the consumer space, I feel like in the small business space we’re not far away from really having tools that can anticipate your needs, that can really provide intelligence that is actionable, that is useful and business owners will be able to spend less time on the financial side of their business. It’s exciting times and I think we’re going to see it become ever more useful as time goes on.

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 USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8th through 9th, 2019, at Moscone West in San Francisco. Registration is now open and we are also taking speaker applications. You can find out more by going to lendit.com/usa.

PODCAST TRANSCRIPTION SESSION NO. 176/ANIL STOCKER

Welcome to the Lend Academy Podcast, Episode No. 176. This is your host, Peter Renton, Founder of Lend Academy and Co-Founder of LendIt Fintech.

Today’s show is sponsored by LendIt Fintech Europe 2018, Europe’s leading event for innovation in financial services. It’s coming up very shortly on the 19th and 20th of November in London at the Business Design Centre. It’s not too late a get a ticket as we’re recording this. You can go to lendit.com to find out more.

Peter Renton: Today on the show, I’m delighted to welcome Anil Stocker, he is the CEO and Co-Founder of MarketInvoice. Now MarketInvoice has been around for quite a few years, they have really become the leader certainly in the UK, and potentially even globally, in online invoice finance space, but they certainly have aspirations far beyond that.

We get into that in some detail on the show, we talk about their approach to underwriting and we spend quite a bit of time going in depth on their new partnership with Barclays, fascinating conversation there about that, where they’ve got quite a deep partnership with Barclays providing invoice finance to the million small business customers that Barclays retail bank has in the UK. It was a fascinating conversation, I hope you enjoy the show.

Welcome to the podcast, Anil!

Anil Stocker: Hi, Peter.

Peter: Okay, so I like to get these things started by giving the listeners a little bit of background about yourself and sort of what you did before you started MarketInvoice.

Anil: Sure, so my name is Anil, and I came over to the UK, went to school and studied economics and actually met my future co-founders at university. I first started working in a big investment bank, I joined Lehman Brothers back in 2006 working in a private equity fund, investing in companies and that’s where I kind of got to grips a little bit with cash flow and financial requirements from growing businesses and then went to another kind of smaller private equity shop. Started in 2010, to kind of looked around and wanted to start a business and that’s when I kind of started to think about fintech and what I could do as an entrepreneur.

Peter: Okay, so what was sort of the catalyst, what was the idea that led to the founding of MarketInvoice?

Anil: Yeah, look it really came from spending a lot of time with small businesses. I think I had a bunch a ideas. One of them was to kind of start investing in small businesses in particular sectors here and I probably met about 50 businesses and they all kind of were telling me a little bit about their troubles of scaling, the need for cash, the difficulty of doing business with the banks if you were a small business.

So it was really kind of born out of that experience of talking to them and probing around what the problems were that I started to think about what I could do. What’s interesting is many of the businesses wanted access to capital, not necessarily equity investment. They wanted debt finance, they were struggling to understand invoice finance. They had ambitious plans and they wanted to grow, but they just felt frustrated that the lack of funding was holding them back.

At a kind of macro level finance I felt was on the precipice of change, the big banks were being distracted by other regulatory issues, and fixing themselves inside and I felt that technology would change finance just like it has changed many other sectors so that’s when we started writing the business plan of MarketInvoice and trying to make a difference.

Peter: So why specifically invoice finance, why did you start with that? I mean, you could have done…obviously, Funding Circle was already I think just getting going around that time. Why invoice financing, and why not just do regular loans or what was the reason?

Anil: Yeah, look invoice finance was a slightly less well understood segment of the market, it was very manual, there was a lot of paperwork that was quite complex to get set up so we just felt like the pain was being felt a lot by small businesses. We also figured that if we could make this easier to use, a lot of small businesses would find invoice finance extremely powerful because for many businesses their only assets that they have are their invoices, the work that they’ve completed and waiting to collect cash on.

And then from an investor perspective, because, you know, we wanted to do a marketplace where high net worth would fund these invoices, we felt that from an investor perspective it was quite nice to have knowledge that this company was going to receive cash in the future against an invoice so it is secured lending. So that enabled us to de-risk it somewhat from just an unsecured loan so we thought that could be a unique way for us to make a name for ourselves in this space.

Peter: Right. So when you sort of did your due diligence and looked around at the invoice finance space in the UK, I mean, what did see…I mean, who are the major players? Like in the US it’s a very fragmented market, what’s it like in the UK?

Anil: So in the UK, the big banks control the majority of the market, they have 60 to 70%, there  are also independent factoring companies that account for the rest. The big banks tend to focus more on the larger end of the market which leaves a little bit of a hole at the smaller end and some of the independent factoring companies approach that segment. That’s why we wanted to start at the smaller end and figure out a product that could be used by the smallest of businesses. We felt that if we helped the smallest of businesses as they grow they would come back to us and feel allegiance to us.

Peter: Right, right. And so maybe you can take us through the offerings. I see on your website here you can actually finance individual invoices, you can finance like all of your invoices, you can get funding against contracts, what have you. So tell us what you started with, what was the very first product and how has that evolved over time?

Anil: Our first product was the single invoice finance product. So let’s say you’re a media company, you’re doing work with Sony, you have a hundred thousand pound invoice, you’re waiting 90 days for it to get paid, the business could bring that invoice to MarketInvoice, you could apply online, get a decision within 24 hours and borrow let’s say 80% of that invoice face value up front. They still get the remaining payment at the end when they get paid so this kind of on demand, pay as we go, single invoice product was really perfect for small businesses that were looking to grow, that didn’t have a big enough overdraft, that couldn’t get any debt finance and this was a neat tool for them to top up the amount of money that they could loan with us.

What we found was that when a company starts to use us once, they would then use us repeatedly. So from there, we saw that many businesses were starting to use us repeatedly were growing, were getting larger, they started to have the need for a more permanent solution and that’s when we introduced the invoice finance subscription.

So we built some technology that integrates with a company’s accountancy platform, pulls data and gives them a permanent balance so they can download a certain amount of money against total stock and invoices. That also makes it more secure, makes it a lower APR product so it’s quite nice for businesses to start with single invoice and then graduate on to the subscription.

As we’ve been working and funding companies in different sectors, we also identified that some of the more newer industries like software companies, they had these contracts that were one year/two years in duration that would get a monthly payment so that’s when we developed our contract finance offering where they could accelerate payments of that contract up into one upfront payment. So let’s say you’re a company and you’ve got a database and you’re getting paid every month, you can take 12 months of those payments and get financed against that and that lends itself well to technology businesses.

Peter: So those three products…I mean, what is sort of the volume that you do…how is it sort of split between those three products?

Anil: So we’ve obviously had a lot more years of track record with the single invoice finance product so we’re probably about 60% still single invoice, about 40% subscription and we would count the contract finance within the subscription, but we expect the real vector of growth to come from the subscription finance product because those tend to be larger businesses that have a more permanent need for capital. So what it’s evolving into is that the single invoice is kind of the entry product and then companies graduate on to subscription.

Peter: Right, right, got it. So you must sort of have a pretty tight kind of connection to the accounting software for these small businesses, I expect, because I’m just wondering about… you can’t sort of email in a PDF of an invoice or maybe you can, I don’t know, you tell me, but it’s pretty easy obviously to create a fake invoice. How do you work with that, I mean, how do you sort of verify that everything is correct, do you have to interface into the accounting software for everybody even if it’s just a single invoice?

Anil: No, so if you’re using single invoice you can manually upload invoices and many companies do that. We are doing extensive checks on the borrowers as they apply to us so we look at the business, we calculate the credit score of the business, of the borrower, we take public information as well as financial information, we do fraud checks, we approve the borrower, we’re then performing the verification of invoices through various means. We’re able to verify that invoices have been received by end customers, we look at the quality of the end customers and we are then able to release funding on a risk-based approach so every transaction is placed into a different risk category and we have different advance rates and different fees. Now if you’re using the subscription product, you do need to integrate your accountancy package because that’s a tighter relationship…

Peter: Right.

Anil: These companies are drawing down funding, sometimes every day, every week, so one way that we monitor the business’s performance is through their banking data and their accountancy platform so that enables us to automate a lot of the work that was being done manually with manual reconciliations by banks.

Peter: Right, you’ve got an interesting product, it’s not like….with a small business loan you’re underwriting the borrower. Here, you underwrite the borrower, the vendor and the actual transaction itself because, obviously, there could be…someone could say that it’s…there could be a real invoice out there, but the amounts might be different. So you mentioned just briefly that you validate the transaction, but like how do you do that?

Anil: There’s a number of different ways. Obviously the first transaction is the riskiest one because the company doesn’t have a track record.

Peter: Right.

Anil: So we have various e-mail based ways, online…you know, some companies have online portals that they log into. For large transactions we might even do a telephone based verification as well so the first transaction is the riskiest, then as the company starts to build track record we see payments flowing into their bank account. We’re able to sort of derive patterns and understand what’s the funding need of this company and if there’s anything out of the ordinary we might re-verify so it’s really a risk-based approach we take.

Peter: Okay, fair enough. I know you guys have been around for a while now and you really are one of the leaders in this space, certainly in the online area. How are you finding new deals? Are you finding that you have…you get a lot of referrals, what are the typical sources to find new customers?

Anil: Businesses find us directly so we get a lot of organic referrals from entrepreneurs that have used us and talk about us, we’ve built a little bit of a brand here in the UK, we’ve done some advertising, we go to relevant events and kind of do customer case studies so companies hear about us and apply. We work with other referrals so we work with the accounting community, we work with financial brokers who pass us opportunities to look at to be funded. And now, we’re really trying to start to make deeper connections in certain industries where we know that the underlying customer base is very well suited to our product. And finally, strategic partnerships are a big area of interest for us right now, you know, partnering with banks, partnering with financial institutions, partnering with accountancy, software providers, that’s perhaps the next phase of how we can really scale this.

Peter: Right, right. And then what about moving on to the other side of the equation here on the investors. I know you guys are members of the P2PFA, you have a peer-to-peer element, I’m curious about…you said you started off with high net worth individuals, I presume you have institutions as well, I mean, how’s that mix? Tell us a little bit about the investor side.

Anil: Yes, we started off with high net worth investors, but as we’ve developed, we have moved that funding mix to be more coming from institutions and within those institutions we now have banks deploying funding on the platform, so we have three/four banks, they understand the asset class, they can give us more scalable lines, they have lower return expectations than the high net worth community. So we’ve now pivoted more to having 70% from institutions and 30% from high net worths so yeah, we see the future really coming and scaling through institutional arrangements.

Peter: Right, right, that makes sense. So then what are the interest rates here, like tell us a little bit about the interest rates you’re charging. Obviously, these are pretty short term, the durations, I imagine, 30, 45 days or something. What are the returns that you’re providing and what is the sort of the cost to the customer?

Anil: Yes, so as you say, it’s a great asset class for investors, it’s short durations, it’s secured and it’s yielding, blended across all of the products, probably 5 to 6%, between 4 and 6%, in terms of annual return. It depends a little bit on your mix so if you’re funding single invoices you might get slightly higher yield and if you’re funding the subscriptions which are a lower risk product then you will get slightly less than the range that I mentioned.

So you know, blended, we’re trying to get out 4 to 5% or so for investors which is really quite a good return given the short duration nature of the asset class. You know, funds are not locked up for many years, you know, investors can scale in and out, they can tweak their mandate to exclude certain sectors or certain geographies or they could put limits on total amounts that they would like to have deployed against a single borrower or even against a debtor, right, so if you want a max exposure to Amazon. It makes you not reach that, our system makes it very easy for you to control that. So it’s a pretty attractive proposition for investors.

Peter: Right, right. One of the great things about the UK platforms is you guys put a lot of information online for investors and I’m just on your statistics page right now and I see you’re just under 3 billion pounds of total originations as of this recording. I’m looking through and you’ve really had…2018, you’ve had a great year, so far, as far as loan volume goes, looks like you’re going to be close to double, probably more than double by the end of the year it looks like, so you’ve really ramped things up. I mean, what’s driving your growth this year?

Anil: So that’s really coming from our subscription product so, you know, companies that get on to the subscriptions, they really tend to stick around. When we look at the data from the banks,  invoice finance users stay for on average five years using this product. So when we get a customer and they start to use our subscription, start to download cash every month then it starts to layer. As we get more customers, we get more volume building so that’s why we’re quite excited at the moment that we can really scale this out and become a very big player in this market in the UK which is large. There’s like 20/25 billion outstanding in invoice finance in the UK, it’s one of the biggest markets in the world.

I guess the other reason is that people are gaining more awareness of invoice finance as a product. It used to be viewed as a kind of a niche product, it used to be viewed as like a funding product of last resort, but business owners now, especially the younger generation, really understand that they can unlock this cash on their invoices.

In a recessionary environment or in an uncertain environment, banks and other financial institutions are telling their customers more about asset-backed lending because they don’t want to be in the unsecured space, they want to be lending against assets such as invoices so there’s great awareness, the market is generally growing as well which is adding to it. When people start to shop around they will usually find us and so we’re getting a lot of interest right now.

Peter: Right, right, okay, makes sense. So I want to switch gears and talk a little bit about the big deal that you announced here with Barclays just a couple of months ago so the first question on it is when did you start talking to Barclays? It sounds like from what I’ve read, they approached you so tell us sort of how this all began.

Anil: Yes, so it’s interesting because Barclays here in the UK ring fenced part of their bank, so they separated out their corporate bank from their small business and retail bank. This retail bank called Barclays UK has about 1 million business customers that have bank accounts with them and their product team at Barclays reviewed their product set, reviewed the applications that they were getting and they did not have an invoice financing solution that was fit for purpose. They had an invoice finance product that was very well suited to large corporates, but nothing that really met the mark in terms of experience, speed and support for small businesses like businesses turning over less than 10 million.

And then they went on, I guess, this soul searching, should we build it ourselves, should we partner and I think they kind of realized that, hey, actually, we’re not just looking for bits of software, we’re actually looking for culture, DNA and innovation of trying to make our products more digital and that’s when they did a review of the market and they approached us and we sat down and spoke with them and it was one of these great meetings where we really had a meeting of the minds.

They liked our approach, we said that not only do we have technology, we also have great people who are on the phone helping customers, we have a great brand and so they were not looking…important, they were not just looking for like a software provider, they were looking for a true company they could partner with and for us to be a catalyst for change within their finance products which is why this is such an exciting partnership and they worked extremely fast for a bank.

I think we had an initial meeting, we had two or three months sizing up the opportunity and then when they said they want to go…it took about seven months from beginning to end to get the agreement signed and then we’ve already launched a pilot, already getting leads through the door and I’ve been really impressed with how they work.

I don’t think it’s just Barclays, I think many banks right now are thinking about their future, they’re thinking about their product set, how they’re going to compete, how they’re going to retain customers and it’s a very good time for fintech and banks to be talking.

Peter: Right, right. We’re seeing that globally, certainly in the US there’s a lot of activity between fintechs and banks and I think it’s only going to become more so. So that sounds like it was less than 12 months from first conversation to launch of the pilot, it sounds like.

Anil: Yeah, well I guess from first conversation to launch the pilot was about 12 months.

Peter: Okay.

Anil: From the time that they actually decided we want to do this, it was less than 12 months.

Peter: Right, so then just describe how it works exactly because I read that they’ve taken an equity piece in your company so I presume that’s like a separate piece because what you’re doing, it sounds like, is providing these million small business customers with an opportunity for them to finance their invoices, but did you create like a white label site that sits on Barclays.com, just tell us how it works.

Anil: So the proposition is completely co-branded so it’s not white labeled, it’s a partnership and how the partnership works is that Barclays has thousands of relationship managers and staff that handle queries around finance from their customers and we have been embarking on a program of training around how these relationship managers and call center staff can qualify opportunities for invoice finance.

They then push them into our system, they do this online through a portal and that comes into our system and our sales team or our business specialists get on the phone and explain our product in a little bit more detail and then they come through on to the online application form. So it’s kind of a hand-off from the Barclays point person to a MarketInvoice point person. That’s kind of stage one, that’s kind of the phase that we’re in, we’re also starting to do joint marketing in the next year to kind of educate the base on invoice finance and that this is now an option at Barclays.

We’re also going to be working on a digital journey so as businesses log into their business banking dashboard, they’ll see certain widgets and they’ll see a MarketInvoice widget which should outline how much funding they could potentially unlock by using MarketInvoice and then they would come through an entirely digital journey as well. So these things are all phased right because you want to get to market quickly…

Peter: Sure.

Anil: …you want to test and learn.

The second important piece of the partnership is next year that Barclays are doing a lot of work to rely on our credit models for underwriting. It’s the first time that they would ever do this, that they would rely on a third party credit model and then they would start to fund their customers coming through this origination channel so they would start to fund their own customers on the platform so it would turn into an origination and funding partnership with Barclays.

Peter: Interesting.

Anil: So it’s quite exciting.

Peter: Sure, that’s really interesting. So then when do you actually launch….you said you’re in pilot mode right now, is there going to be like an actual launch where you basically have…it’s all out there to….like is there going to be a big public launch when you sort of move on from the pilot phase?

Anil: Yes, so we announced the partnership in August in the Barclays quarterly results call. It was mentioned by Jes Staley, the CEO of Barclays, and we will then do another big push on the national launch so the pilot is a subset. There’s about 120 people that have been trained up in the pilot, they’re gathering great data, we’re getting our first customers through and then sometime in Q1, date to be confirmed we will do the national launch which we’ll scale up by ten times.

As you can imagine, there’s quite a lot of preparation work that needs to be done both on our side and their side so as soon as we can launch it we will, we’ll kind of do a big splash and tell the world that we’re now going to the national launch.

Peter: It sounds like from the way you’re talking, it really sounds like, you found this to be a good relationship where, as you said, there was a meeting of the minds and I’m just curious because there’s always talk about the culture clash between large banks and fintech companies that have been used to moving fast and being nimble. You can just walk into Canary Wharf and it’s a different feel than it is like walking into your offices so how has that been culturally? It sounds like…just tell me what’s it like, do you feel like you’ve had to really work to fit these cultures or has it been more natural?

Anil: That’s a great question, it’s something that we’ve been aware of and debated openly with Barclays since the beginning and the last thing they want to do is stifle us. They want us to challenge them, they want us to come up with ideas, they want us to kind of push the boundaries, but I think that this is only possible if really the senior people at the bank buy into that and really believe in the strategy of embracing partnering with fintechs and making things digital and improving the experience.

What’s quite unique, I think, at Barclays is that they’ve always been a brand that has wanted to adopt technology fast and be at the forefront of the tech revolution. I think they were the bank that rolled out the first ATM, the first credit card so, you know, they have right from the top great engagement from the top of Barclays, from the CEO of Barclays UK down and the core business people are all on top of it and know there will be bumps in the road, there’ll be instances where people at the bank will say that’s not possible, but so far they’ve been really good at like then saying, we have to make it work. Our experience so far has been great, they’re really putting actions behind their words and we’re making really fast progress.

So I’m not going to say that every bank will be like this, but if at the top the culture is one of, we want to embrace the change and we want to work with fintech partners as true equals and really do something new then I think a huge potential is possible. But I think, it’s also important for fintechs to realize that when they might be working on a project and if it is slowing down and the appetite is not there sometimes it’s better to disengage and not continue it because you don’t want to get bogged down in a relationship that’s not working.

Even though Barclays might well have an equity stake in MarketInvoice, it will not be a controlling stake, you know, we are an independent company, we have our own business, we have our own brand, we’re free to partner with lots of other strategic partners in the future. So we’re still going fast, we’re still nimble and we have a great partner with Barclays.

Peter: Right, so then I can imagine you’ve got a million customers, I mean a million potential customers there and I can see you will do like a billion pounds roughly in 2018. It doesn’t take long to sort of see how that could scale pretty dramatically with Barclays, but you don’t want to have like 75% of your business there so how are you managing that as you scale that up? I’m sure you’re very cognizant of the fact that you can’t have all your eggs in one basket, but just tell us how you’re thinking about that for 2019 and beyond.

Anil: Absolutely, we’re very excited about the work we’re doing with Barclays, but they’re not the only partner, right, we have lots of other types of partners that we can work with, be it accountancy or other software companies, other fintechs, other people who are coming on to the market and we also have our standalone business so we have to work hard on all aspects of our business.

Peter: Right.

Anil: It’s not just one partnership that we’re working on and that’s very much our focus in the next few years.

Peter: Sure, sure. So we’re almost out of time, but before I let you go I’ve got to ask you about…it’s on your website so clearly you’re not being coy about it, but there’s business loans it says available soon and funding up to 100,000 pounds, 12-month term. Obviously, you’ve put in our website so what is deal with business loans, are you launching that soon, or why have you got it there?

Anil: We’re currently testing out a loan proposition and again this is coming from our customers who….many of them have been using invoice finance, but also would like a loan and it really just makes a lot of sense for us to…you know, we know these companies very well, they have a long track record with us, we’re seeing their monthly payments in and out, we’re really the best place to offer them a loan.

Whereas in the past, we’ve had to coexist with other banks who might be giving them a loan or an overdraft, we’d like to more and more become a one-stop shop in trying to offer them all the products that they need to run their working capital.

You know, it’s not just loans that we’re interested in, we’re also potentially interested in trade finance, in asset finance; the products that companies need to grow as they evolve their businesses. So we’re gathering some data, we’re testing it out in 2018. In 2019, we’ll probably do a bit more of a sizable push on it and see how it gets taken up by the market.

Peter: It looks like you’re not going head-to-head necessarily with Funding Circle because these are shorter term loans. Is that the plan?

Anil: Yes, yes, obviously, there’s lots of providers out there, it’s not just Funding Circle, I mean there’s banks. We want to compete in the same space as banks and we’re very much focused on B2B businesses and trading business that get paid on terms so we know the verticals that we like, the companies that use invoice finance and it’s really a cross sell and a way of retaining customers for longer and helping them more on their journey.

Peter: Right, right. Okay, you’ve got a lot on your plate, but when you look to 2019, what are some of the things you’re excited about beyond sort of the Barclays partnership, obviously it’s going to take up a lot of your time personally, I imagine, but what else are you looking at for 2019?

Anil: 2019 is all about scaling up partnerships, working on some more, looking at our product mix and then behind the scene, a lot of tech and automation and data work to make our processes really tech-driven, really smooth, frictionless and automating some of the back end so it’s going to be a very busy year and we’re growing the team as well so we’re hiring and trying to bring in the best talent so, yes, we’ve got a lot of things on our plate.

Peter: Okay, well we’ll have to leave it there. Best of luck to you, Anil, I really appreciate you coming on the show today.

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

Peter: Okay, see you.

Anil: Bye.

Peter: You know, I think there have been so many important partnerships announced between banks and fintech platforms this year, really in the second half of this year it feels like, There’s been a real acceleration of that and I don’t know if any are more important than the ones between Barclays and MarketInvoice, Barclays have taken an equity stake.

Clearly they’re all in and I really appreciated Anil’s comments saying that this is coming from the top down at Barclays, you need to have that buy-in for these partnerships to be successful. They certainly have all of the ingredients to make this a really successful, long term partnership and could be very much something that the whole industry can learn from about how they’ve put this deal together.

Anyway on that note, I will sign off. The Lend Academy podcast is taking next week off for Thanksgiving, we’ll be back in two weeks. I very much appreciate your listening. And I’ll catch you next time. Bye.

Today’s show was sponsored by LendIt Fintech Europe 2018, Europe’s leading event for innovation in financial services. It’s happening November 19th and 20th, just a few days away as we record this, at the Business Design Centre in London. Tickets are available at lendit.com/europe and you can also buy tickets at the door.

Anil will be on stage with the Head of Barclays Business Bank, Ian Rand, talking much more about this partnership. If you’re listening to this after November 20th, you can actually go to lendit.com/europe, click on the videos, the videos are uploaded within a week or two of the event and you’ll be able to watch the video of the conversation between Anil and Ian Rand from Barclays.

 

PODCAST TRANSCRIPTION SESSION NO. 175/JASON BROWN

Welcome to the Lend Academy Podcast, Episode No. 175. This is your host, Peter Renton, Founder of Lend Academy and Co-Founder of LendIt Fintech.

Today’s show is sponsored by LendIt Fintech USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8th and 9th, 2019, at Moscone West in San Francisco. We’ve recently opened registration as well as speaker applications. You can find out more by going to lendit.com/usa

Peter Renton: Today on the show, I’m delighted to welcome Jason Brown, he is the CEO and Co-Founder of Tally. Tally are a very interesting company, they really focus on solving the massive problem of credit card debt in this country, but they’re doing it in a different way to many of the online lenders. It’s an app-based approach and they describe it as, you know, it’s kind of like a robo-advisor for debt where they help you manage your credit card debt. They manage it for you in ways that are optimal for you to really get debt free so we go into that in some detail. We talk about how their product works, their approach to underwriting, we talk about Tally Advisor, sort of their automated debt manager, we talk about the scale they’re at and what the future holds. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, Jason!

Jason Brown: Thanks, glad to be here.

Peter: Okay, so I like to get these things started by giving the listeners a little bit of background about yourself and what you’ve done in your career before you started Tally.

Jason: Well this is my fourth company and I really wanted my fourth company to be something that was personally meaningful to me. And one of the things that has really stuck with me from my childhood was….our family, we had a lot of financial stress. You know, money was always a problem in our life growing up and even though I’m fortunate to have gone a different path than my parents, from at least from a money perspective, that anxiety and that feeling of uncertainty still is there, that relic of childhood.

So when I met my Co-Founder, Jasper, we actually built a previous company together, and he actually was auditing banks for PwC actually in Europe and we were talking about how we could build something that could really help people that have a lot less stress in their life and we realized that if you could build a technology that could automate the way that people relate to their money…so basically not only figure out what’s best for them, but really do the financial work for them, you would have this unbelievable power to make people just enjoy their lives better, just make the little moments be so much more rewarding.

So we decided to found Tally and started working on credit card debt as our first problem that we were going to tackle with automation.

Peter: So tell us about that. What was sort of the aha moment or the force that sort of led to…what was the idea that led to it? Was this something that you saw others doing, I mean, the way you’ve approached it hasn’t really been done before, at least not to my knowledge, and so what was sort of the idea that led to this?

Jason: You know, we were actually thinking 20 years out and what we were thinking is…we just said, imagine the world 20 years from now and our belief is that 20 years from now, everybody will have this invisible and ambient service that is mediating most of their relationship with their money. So it’s figuring out everything for you and is doing all of the work.

What we used as our kind of prototype are rich people, so if you’re ultra wealthy, you know, you might be in France summering there and you’ve got this team of people in some office park somewhere and there’s, you know, the tax specialist and the accountant and the investment advisor and they’re actually doing real work. They’re sitting there in their cubicles, and they’re crunching numbers, they’re moving money around, they’re signing contracts and they’re only bothering the rich person in France when they need some kind of human input like, hey, do you want to buy a house in Vale or something like that, right.

If you think about…software has the power to take that advantage that rich people have and democratize it and provide it to everybody for free and we said, that’s what the future is going to look like so if that’s the future how do you actually build to that because obviously we’re not there at this moment and we realized that if we tackle the really hard financial problem that a lot of people were facing that that would be a solid foundation for then automating the rest.

So when we looked at all the problems to solve, we were staring at a trillion dollars in credit card debt. Just under half of all households have about $15,000 of debt and there’s no real solution there for folks and we said, that’s going to be the problem, that will be our beachhead, we’re going to go in and we’re going to solve that problem and then from there we can start to automate the rest of people’s lives.

Peter: Okay, so then let’s dig in a little bit to what you’ve actually got today and that is, you’re attacking credit card debt, you’re providing people with a line of credit product to help them manage that debt, why don’t you sort of explain how it all works and the principles behind it.

Jason: Perfect. Well it starts at the very beginning, you go to the App Store, you download the app for free, you pull out your credit card, you actually scan them in using your phone’s camera, you pass a quick credit check and from there, we actually give each customer a line of credit. But what’s interesting about the line of credit is it’s exclusively controlled by our algorithm and our algorithms only use it to make you better off.

So the times where the algorithms will use your line of credit is number one, is to protect you from late fees. So there are $12 billion of credit card late fees every year in this country because only about 15% of people use autopay for their credit cards. So the line of credit allows us to step in for people and make payments if for some reason they’re not in a position to, so we can guarantee no late payments.

Second, it moves balances from high interest rate cards over to Tally so it will only move balances over to that line of credit when it saves people money from interest and then finally, the way that our algorithms work is they actually shave 10 to 15 years off of how long it takes somebody to get out of credit card debt because it’s managing everything properly and it’s helping shape the way that customers pay their total revolving debt so that we can get them out of debt faster.

Peter: Okay, so I want to dig into this a little bit so I completely understand it. So let’s just maybe talk through an example, like a typical customer might have four credit cards, interest rates might range from like 24% down to 14% say, and they download the app, they scan the cards and then…they’ve got decent credit, they always pay on time. Let’s just say maybe it’s $12,000 spread over these four credit cards. Firstly, I guess you’ve got to decide how much line of credit you’re going to give. Do you give someone the full $12,000 or do you say that we can only really give them $5,000 so I guess question is, how do you decide how much to give and then what actually happens once you’ve given it to them? Do you takeover paying all of them or some of them or how does it work?

Jason: Yeah, so we have full underwriting and risk management and it’s all automated so one of the things that was…I guess, we underestimated is, we initially thought it would take us about a year to build the technology to make this possible and we were only off by 300%. It took us 3 years (Peter laughs) and we actually had to build an entire bank core from the ledger up so every aspect of Tally’s technology we built from scratch. One of those components is instant underwriting so it takes in all of your information from your cards, your credit file, everything and it figures out, hey, what is a fair APR for you based on your credit risk and what’s the right credit size so varies based on people’s credit worthiness.

Let’s just use the example that you gave us and let’s just simplify it and say that Tally gave you a $10,000 line of credit so what it would do immediately is it would move over $10,000 of balances on day one from the highest APR cards and I think you said they range from like 20 to 14.9% so it’ll clear out balances on the three with the highest APRs and then it will move over $1,000 from the one that had a little lower APR and leave on $2,000, okay. So now you still owe $12,000 of debt, but $10,000 is now to Tally and $2,000 is to your lowest APR card. What happens from here is you pay Tally for everything and then Tally pays your cards so you keep using your cards like normal, you get your points and rewards and then you pay Tally, Tally pays your cards.

So let’s say that you spend an average $2,000 of new spend per month on your cards, Tally is going to recommend that you pay let’s say $3,000 total so you pay $3,000 to Tally, again, Tally pays off the $2,000 in new spending and now it can move over another $1,000 from that card that still has a balance. So it’s always the central hub of the spoke of your cards and Tally is helping you figure out how much you should pay and then it’s always paying your cards and it perpetually goes on and runs algorithms every single day.

Peter: So they don’t have to…I mean, have you worked out with the credit companies? You know, you’ve got to go in, log in, put in your autopay so if Tally is paying it then it’s coming out of Tally’s account, it’s suddenly not coming out of the customer’s account. As you said, most people don’t actually have automated payments set up so I guess that’s a moot point for most people so what you are doing is…are you automatically paying back that credit card, I mean, obviously…you said it’s all automated, right, so how does it…like are you sending money to the bank each month for that credit card?

Jason: So we actually are sending money to the banks potentially multiple times per month so, again, this is all about optimizing. So every single day the algorithms wake up and say, hey, can I move more balances from any of these cards over to Tally if it will save the customer interest. What customers really like is the fact that they go from before Tally, they have on average 48 due dates per year so, again, 48 opportunities to either miss a payment, or 48 times where you have to do math and figure out how much can I pay, how much should I pay and that gets boiled down to we make one recommended payment every single month for you.

Recently this summer, we launched a feature called Tally Advisor and what’s cool about Tally Advisor is it actually lets you collaborate with our algorithms to set a debt free date. So it’s the first robo-advisor for debt and it’s similar to like a retirement date where you say, hey, I want to retire at 62 and this is how much money I need to save.

This is similar, except our algorithms are actually helping you come up with a realistic date for when you can be out of debt based on your income, all of your monthly spending, your existing debt load and then it comes up with a custom recommended payment for you every single month and then you just have to press one button each month which is to say pay the recommended amount, or if you want to customize it you can. So we really like to make sure that customers once a month can come into Tally and they can see everything and then press that button to say, hey, I am going to pay that recommended amount and then they pay Tally.

Peter: Right, so I guess the mere fact that they’ve downloaded your app, and they’ve scanned their credit cards means they really…they’re motivated to get out of debt, I imagine, because…I mean, the temptation is and we’ve seen this with some of the lending platforms where they…you know, someone says they want a debt consolidation loan and when you look at their utilization six months later it’s back to where it was. So I guess maybe you could give me a little bit of a profile, maybe even a psychological profile of your customers and how they’re different to the general population.

Jason: You know, I do believe that people come to Tally wanting a solution to their credit card debt, but I also think that people go to personal loans wanting a solution. It’s just that personal loans get people into more debt, I mean, that’s just the reality and I don’t actually know if it is because the people are different, or because the mechanism is not actually helping solve their problem. The data suggests that people after they take out a personal loan to debt consolidate are, within 12 to 24 months, they are in substantially more debt. Usually, they’ve paid off the cards with that personal loan and the cards are back to where they were.

And it has to do with the fact that it’s not actually solving the underlying problem, it’s not helping them manage their financial life any better whereas Tally is saying, hey, we have one central hub, one view and we’re going to help you set a goal for when you’re going to be out of debt and we’re going to set a recommended payment for you every single month that’s not only based on your debt load, but also based on your new spending so that we can nudge you to make sure that you’re actually making progress collectively, not just moving debt from one pile to another.

Peter: Right, okay. So then I’m interested in the behavior that you’ve seen since you launched, and maybe you can tell us when you launched, I know it hasn’t been that long, but I’m curious because what I wonder about is people want to get out of debt and they sign up for Tally and then someone invites them out for dinner and they go spend $100 on an expensive dinner that they really shouldn’t have and they can’t afford to pay. So tell us a little bit about are people sticking to this kind of…firstly, are you seeing their credit card balances actually go down, or what data have you seen, so far?

Jason: We’ve been really energized by what we’ve seen. So we’ve officially been live for about a year so we launched in October. So it took us about three years to build the technology and we’ve got a year of being live and when we were in the beta phases we played with a lot of different experiments. The thing that we found most powerful is if you recommend people pay more, they pay more and if they pay more, they spend less the next month.

It’s actually really interesting because they feel like they’ve “spent” so if I pay let’s say an extra $300 towards my collective revolving and new spending then the next month they feel a little poorer so they seem to be more disciplined and by just getting people to pay more every single month we see them spending less the next month. On average, our customers are on track to be out of debt 10 to 15 years faster than they were before they came to Tally. So we’re really energized by the fact that by helping people have one view and one recommended payment, we’re actually shaping their behavior in a positive way. Our mission is to make people first, less stressed and then second, better off financially so this is really core to our mission.

Peter: Okay, so I want to switch gears and talk about technology a little bit because you mentioned it took you a lot longer to build this platform. Obviously, there’s lots of data points here, tell us how you’re approaching the underwriting. I’m particularly curious about artificial intelligence that’s behind some of the models that you’re building, maybe you could give us a little bit of color on that.

Jason: Well let’s see, maybe it would be helpful so the listeners know what our business model is. So the way that we make money is by charging interest. So it’s free to use the app, we don’t charge anything, we don’t charge any fees, no late fees, no overdrafts, no penalties so we don’t make any money off of any fees. The only time we make money is when we charge somebody interest and the only time we charge somebody interest is when our rates are lower than the card rates which is in most cases…the exception being sometimes people have promotional offers for let’s say six or 12 months and Tally is really smart and it leaves those balances on the card until that promo rate expires.

So what Tally is…our interests are completely aligned with the customer and making sure that we are getting them lower rates than what’s on their cards. The way that we provide lower rates is we’re actually borrowing money from banks in bulk and then passing on those savings on to customers and what we found is the way to get the cheapest money from banks is to actually have a more traditional underwriting model since banks are more likely to trust an institution that is using an approach to underwriting that they understand…

Peter: Right.

Jason: …then it actually turns out It is better for the customers to have a more traditional model so that’s the approach that we’ve taken and we’ve actually seen in the last…I’m sure you as well have seen in the last couple of years. There’s been more of a move to more traditional underwriting. There were a couple of years when everybody was talking about all of this alternative data and I think it has turned out to be that a lot of folks have come more to the center and have a more traditional approach.

Peter: Okay, so then that’s the underwriting piece. So I guess, one thing on that, I mean, what percentage of the time….I imagine there are some people even without like removing the promotional offer…I mean, you must get some cases where your rates are going to be… either they’ve got a fantastic deal on a credit card or they’re loaded up on relatively low interest credits cards, like what percentage of the time can you provide lower interest rates than what the customers are doing right now?

Jason: You know, in the vast majority of cases, Tally is lower than what the rates are on the cards, but there are certainly instances where somebody has either a promotional rate or a card that’s just a really low APR card. What’s great about Tally is that it’s smart so it actually still pays that card, but it will only pay the minimum and then when you pay Tally, Tally will allocate the right amount of money to the right card.

So if you still have outstanding debt, that low APR card will be the very last one to get paid off. So we’ll actually pay off Tally before that card because it makes more sense to get rid of the higher Tally APR than let’s say this, you know, really low APR that you have on the card. So Tally always does mathematically what’s in your best interest, even if it’s not necessarily in Tally’s best interest to do it.

Peter: Okay, and so when you’ve got…you said you’ve been live for a year and you were obviously in beta for some time before that, are you finding this is really a set it and forget it, are people really…I’m just wondering how much they’re actually fiddling with things, whether they’re trusting…are you seeing at the start people fiddling with kind of the way things are, like what your recommendations and you said you’ve got this Tally Advisor now which really becomes like a robo-advisor for debt. I guess what I’m most curious about is the trust because this feels like it’s an exercise in trust. How quickly do people trust what Tally is doing?

Jason: I mean, using Tally requires…you nailed it, it requires trust. You think of most finance apps, the home screens have lots of charts and graphs and data, maybe they’ll have recommended credit cards together, ads or things like that, whereas Tally’s home screen is literally just a picture of a person with their feet on the table with a cup of coffee (Peter laughs). That’s it, there’s not a lot of interface because we’ve automated everything on the backend and what we’ve seen, the most surprising statistics that we’ve seen, is that we have 99% monthly retention of our customers. So once they set everything up with Tally and they get it off of their back, it’s not like they want that work back. They’re like, oh, I’m really glad that I don’t have to deal with that and so they are trusting Tally to do it.

One of the things that we’ve seen is important is in the home screen you can scroll down, you cap tap on this rocket and it fires up and then it shows you how much money you’ve saved and since we’re controlling all of the money we can quantify exactly how much money they’ve saved so far, and on average we’re saving customers about $7,000 so we’ve really focused our brand around showing results, like showing that we are actually doing this work for you, the payments are showing up on your cards on time, you’re seeing savings and from there people check it about once a week.

So they like to see the central view because they can also see all the new spend on their cards and we’ve just observed that people like taking a look about once a week and then obviously once a month you at least have to tap the button to pay Tally so that we can keep everything running for you.

Peter: Right, right, okay, interesting, interesting. So then how many states are you operating in today?

Jason: We’re in about 20 states and we cover about 75% of the population. This actually relates back to a critical early decision because at the time most fintechs were partnering with banks.

Peter: Right.

Jason: So they would effectively borrow a bank charter that would allow them access to the whole US right away. We’ve deemed for ourselves, since we’re trying to create this truly new customer centric experience, that if we had to work through an existing bank that had old technology that we really wouldn’t be able to deliver the experience that we wanted.

So we actually decided to have the rather painful and slow route of going state by state to get licensed in every state so we literally have been at it for three years and we finally got to 75% of the population and we’ll finish off the rest of the US next year, but it’s crazy how just like…again, if your goal is to have a screen with not a lot interface then there’s all this immense financial regulatory work you have to do as well as technology work to make that experience possible for the customer.

Peter: Right, right. So you’re literally going through one by one and getting your own license for each state, it sounds like.

Jason: Yeah.

Peter: So the first time I actually heard about you guys was in an article by Ron Lieber in The New York Times and the timing was interesting because…I don’t know whether this was a PR push that you did, or if this is just something that came up and it was obviously mentioned in the article, it came out just like…I think it was a week or two after the LendingClub issues of May 2016, so I’m curious about…I mean, obviously getting in The New York Times with Ron Lieber is a massive win because huge readership, was that a net positive and how sort of did that kind of impact sort of the way you kind of ramped up?

Jason: That was a huge win for us, I mean having The New York Times. We were actually on B1 on the print edition which my Mom thought was pretty cool (Peter laughs) so print still matters at least to parents. What we liked about that is the first generation of fintech was more about filling in the gaps that had been left by the big banks after the financial crisis.

Peter: Right.

Jason: All these big banks had pulled back and then fintechs came in and said, hey, banks aren’t lending there, I’m going to lend there. And so they jumped in and there wasn’t really any technical innovation, it was just, hey, there’s a gap in the market, I’m going to fill that gap. The second generation is about true technology innovation and about doing things that banks just are not good at. They’re not great at automation, they’re not great at doing things that cross the entire financial industry; they’re great at doing things individually in their own bank, but not across institutions, and so this second wave is about automating people’s financial lives.

There’s a lot of folks that started on the investment and the savings side and there’s folks that have done some great work there, obviously, we chose to start on the debt side, but we’ve seen investors and customers really gravitate towards companies that are trying to innovate on the technology and the experience side of things. You know, we just announced our Series B this summer which was $25 million led by Kleiner Perkins so it brings our total raise up to $42 million. We’ve definitely seen investors be pulled towards companies that are trying to do hard things on the tech side of things.

Peter: Right, okay. So I’m curious about…you’ve mentioned that you borrow this in bulk from banks so can you just describe exactly how you’re funding obviously…I presume you’re not using equity to fund any of these lines of credit, where are you getting your financing from?

Jason: One of the things that makes this business model harder than it would be otherwise is the fact that there is this algorithmically controlled line of credit that’s revolving and it makes it a lot harder to fund. So we actually…I don’t know if you had seen the announcement, but Erica Dorfman, she was previously the Co-Head of Capital Markets for SoFi and last year, she literally did billions of dollars of transactions for SoFi so we had her join our team to help build out the finance side of our business and to have a more sophisticated approach to doing the capital markets than we were already. And so we’ve taken an approach where we’re working with small regional banks and we’re working with Bulge Bracket banks simultaneously to have them lend us money so that we can provide savings to our customers.

Peter: Okay, I’m curious about the…what is sort of the…I mean these are lines of credit so it’s an open-ended term, but what is sort of a blended average interest rate that you’re charging your customers?

Jason: You know it depends based on every single person’s credit so Tally is pricing every single person based on the likelihood that they will default. What’s different, compared to the cards, is most credit cards just charge a really high interest rate so the average APR for people with 720 FICOs and above in the US is over 18% so they just charge really high rates whereas we’re actually saying, hey, we want to give you a fair rate based on your individual credit worthiness so every person has a different rate with the average savings being about $7,000 per customer. So we obviously can only make money when we save people money on their credit cards so it really keeps our interests aligned with theirs.

Peter: Right, got it. Okay so then I guess you’re really here in the debt space and you’re really focusing on that, so who do you actually see as your competitors because you’ve talked about this is sort of just an entry point and I really don’t know anyone who’s approaching this problem quite the same way as you, but who do you view as your competitors?

Jason: You know in the short term, we don’t have competitors, we actually view credit cards as our competitors. It’s kind of interesting because Tally really separates the benefits of credit cards from the burden. So you keep using your cards, you get all the points and rewards; we’re just making it so you don’t have to worry about high interest and late fees, but it’s just so easy for people just to, even though it’s bad for them, just to stay with the status quo.

So there’s over a trillion dollars of credit card debt, as I mentioned before, because it’s just really easy to leave it there and downloading an app, you know, it takes some energy and obviously you have to trust Tally so just getting people over that initial hump is really the thing that’s holding people back. We’ve grown primarily through organic word-of-mouth so since we have such high satisfaction, people tell their friends about Tally and we grow that way.

In the long run though, we think there’s a lot of competition. We believe that many companies are working towards this end goal of a fully automated financial experience and different companies have just selected a different beachhead and so the folks that are doing automated savings or investing, we think that they’re racing towards this fully automated point, as are we, so in the long run, we feel like there’s a lot of competition there. It’s just right now, it’s not exactly clear because everybody has selected different strategies, but the strategies aren’t transparent yet.

Peter: Right, I had Ken Lin from Credit Karma on a few weeks ago and he spent a good chunk of the interview talking about autonomous finance which is similar to what you’re talking about as well where if we can do autonomous driving, you know, managing finances is a lot simpler than managing driving a car and so we really should be able to do that. Anyway, so I can see that it’s exciting times for consumers, that’s for sure, because I can really see that there are going to be choices here to really get significant help in managing all areas of your business.

So I guess, we’re almost out of time, but one last question, what’s next for you guys? I mean, you’ve talked about…you’ve obviously got the credit card piece which is a huge piece and there’s a huge amount of runway there really until the credit card revolving numbers come down from below $1 trillion there is a lot of help that you’ll be able to provide people, but do you have like a logical next step that sort of fits in with that, or what is next for Tally?

Jason: Yeah, so with the Series B that I had mentioned, one of the key things is needing to hire a bunch more engineers, I mean, we started this year with I think 15 people and now we’re almost at 60 so a lot of this has to do with just hiring a lot more engineers to be able to build the technology so we can expand outside of credit cards. We’re focused right now on laying that next foundation to be able to broaden our product offering and that’s what we’re focusing on next year now that we’re building out our team to be much more robust.

Peter: So no hints on what that’s going to be yet…

Jason: Yeah, we’ll have to get my Co-Founder, Jasper, he’s our Head of Product, we’ll have to get him on here. He likes to play it close to the vest on that front.

Peter: Okay, understood. Well on that note, we’ll have to sign off. I really appreciate you coming on the show today, Jason.

Jason: It was a pleasure to be here, thank you so much, Peter.

Peter: Okay, see you.

Jason: Bye.

Peter: You know, we have this massive $1 trillion revolving credit card balance that keeps going up despite the fact that we originate billions of dollars in personal loans every year to help pay off some of this credit card debt. I think one of the things that I really like about Tally is that they’re addressing the problem head on and they’re doing it in an automated way so it doesn’t take…it sort of takes less willpower from the consumer.

I think that’s really key and Jason talked about that a little bit, but until we see that credit card debt go down…in fact we were joking, after we stopped recording we were joking afterwards it’s like we really should be…I told him you could just focus on credit card debt until it comes down to like $800 billion or $700 billion because it’s such a big problem and I think this sort of approach is novel and it’s a “win-win” and I think it prevents those people from….you know, some people take out a personal loan and go back into debt. I think Tally will help stop that kind of behavior and I think that will be a great thing for the consumer,

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 USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8th through 9th 2019 at Moscone West in San Francisco. Registration is now open and we’re also taking speaker applications. You can find out more by going to lendit.com/usa.

 

PODCAST TRANSCRIPTION SESSION NO. 174/KATHRYN PETRALIA

Welcome to the Lend Academy Podcast, Episode No. 174. This is your host, Peter Renton, Founder of Lend Academy and Co-Founder of LendIt Fintech.

Today’s show is sponsored by LendIt Fintech USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8th and 9th, 2019, at Moscone West in San Francisco. We’ve recently opened registration as well as speaker applications. You can find out more by going to lendit.com/usa

Peter Renton: Today on the show we have somebody who, if you’ve been following the fintech industry for any length of time, this is somebody who needs no introduction. Kathryn Petralia is the Co-Founder and President of Kabbage and we’ve had her on the show before, back in July of 2015. In fact, her episode was the most downloaded episode of 2015 so I wanted to get her back on the show to give us an update about what’s going on with Kabbage and we cover a whole range of topics here.

We talk about their core line of credit product, we talk about their approach to data analytics and underwriting; we talk about the need to diversify beyond monoline businesses, we talk about their bank partnership product, we talk about their movement into payments processing which is going to be a new business line for them coming up shortly.

We also talk about women in fintech and what Kabbage is doing to really encourage more gender parody there and much more. It was a fascinating interview. I hope you enjoy the show.

Welcome back to the podcast, Kathryn!

Kathryn Petralia: Hi, Peter, thanks so much for having me.

Peter: The fintech community knows you pretty well so I won’t sort of go into all the details about your background, but maybe we could just get started by telling us something that we don’t know about you.

Kathryn: (laughs) That’s fine, I mean, there’s a million things probably that you don’t know about me. Something that most people don’t know about me, at least except for those with whom I work or my family members, is that I am an avid practitioner of yoga. I have been practicing for 15 years and have probably had thousands of classes.

What’s really neat about yoga is that every single class, I feel like I learn something new even if it’s a pose that I’ve been in 1,500 times. Suddenly, I’ll see exactly how I should be doing something, just something that somebody says tweaks something in my mind and I love that application to life that you never know everything.

Peter: We had you on three years ago and obviously, I’ll link the old show back in the show notes so maybe we could just get started by talking about how Kabbage has changed. You’ve grown from really a startup…I looked on your LinkedIn profile and next month is ten years, it seems like, since you started this which is a lifetime. So tell us how Kabbage has changed, particularly over the last three years as you’ve sort of grown into a much more established company.

Kathryn: Well it’s a really interesting process that you go through with respect to hiring so you are exactly right, next month will be ten years since Rob and I sat at a Starbucks and talked about what it would take to launch this business. By the way, we were super wrong. We thought that we were going to need $2 million and 60 people to get us where we are. Clearly, (laughs) we’re a little bit beyond that, but I think, you know, we didn’t really know then what this business could be. We continually look ahead to, you know, identify and evaluate opportunities for expansion, hence, the now 500 people and a lot more money that we’ve raised from there.

So you know, I think the last three years we’ve spent a lot of time hiring and planning for how we can build everything that we want to build and I think we’ve really honed our vision for how we can become a really critical part of every small business’ life when it comes to how they manage and project cash flow.

I think the biggest challenge is always around people so you know, when you’re really young you need a bunch of generalists that can just do anything. And then you start to grow and refine your business, you need to hire a bunch of specialists and then if you want to expand you find that you need more generalists again and so figuring out how and when people can grow into some of these roles and when you need to hire them and when some people may have reached the end of their ability to grow. Those are really hard things to do.

Peter: Right, right. So maybe you could just take us through the core product offerings that you have today. We see them on your website here, but why don’t you just…you know, you’ve obviously been providing working capital now for many years, but why don’t you just sort of give us a bit of a description about that.

Kathryn: So our original business model was making loans to eBay sellers in real time. We were doing that because eBay was one of the first to launch an API that third parties could use to get access to seller and transaction level data and Rob had the idea for using that data to make a loan. And so we did that for a couple of years, including other e-commerce businesses as those APIs came online and then in 2014, began to serve all small businesses.

Today, you know, online businesses/e-commerce businesses represent probably 10% of our customer population and so that’s been a big change in our business over the last few years. Also, since we last talked, we launched our platform business so a couple of large international banks use our platform to deliver the customer experience that we deliver in the US, to their customers abroad.

So we work with ING and Santander and we operate in six countries around the world through those partnerships and that business is also continuing to grow.

We recently announced that we’re getting into the payment acceptance business so allowing our customers to accept credit card payments via our platform and sort of an integrated solution that will be part of this cash flow management tool that we’re building.

Peter: Right, okay. We’ll get into that in a little bit in more depth…

Kathryn: Great.

Peter: …so the line of credit is still the core product, what is it, it’s six and 12 month terms, I believe, and what’s the typical size of how much people use of the line of credit?

Kathryn: I like telling this, when we first launched, we offered lines of credit between $500 and $12,000, it was only a six month repayment term. We’ve always offered a line of credit, that’s a unique product to us so that our customers only borrow what they need, when they need it and that helps them manage the fees they’re paying on funds potentially they don’t need to borrow if they only are borrowing one time from somebody.

But then now, we have all the way up to 18 months, our customers can select the duration of their loan up to $250,000. That product has certainly expanded a lot and a lot of that is driven by the customers that we’re serving.

Peter: Right, right, okay, so then when I had you on before…I’ve always been impressed with your approach to data analytics and just data sources, the different things you use. One of the things I look at is you’re doing this online in an automated way and small businesses are just not very homogenous. Consumers are much more homogenous than small business when it comes to financial behavior.

So maybe let’s just talk about…let’s just go straight into the data analytics and talk about how you’ve really evolved in that because the first time, I remember, it was actually at the very first LendIt back in 2013 when you talked about UPS box size data. It just blew me away as an idea that we could use that as a predictive data point. So maybe you could just talk about what are the things that you’re seeing today, what are the new data sources you’re using and how is your approach to data analytics evolving?

Kathryn: Thank you for bringing that up. We do love to talk about the unique way that we use data. So our customers are able to get access to their line of credit from the time they first land on our site until they have access to capital and in some cases, capital actually in their account in seven minutes. People ask us all the time, are your customers that desperate for money that they need to have it in seven minutes. The answer is, I hope not, (laughs) and what it really is, is they’re desperate for time.

So it’s a very opaque process, applying for traditional business credit. It’s hard to know what all the words mean, how long is it going to take, when am I going to know if I’m approved, if I am, for what might I possibly be approved and what does it mean that I have to give you a financial statement, do I need to go to my accountant for that. It’s just a really complicated process. So what they’re excited about is that we make it really easy for them, we basically do all the work on their behalf, building a financial statement for them to predict what future revenue is likely to be.

We do that by connecting in real time to these data sources, to which our customers give us access in real time and what’s important is to which we stay connected and that’s why we’re able to deliver a unique product, this line of credit, and to manage the ongoing risk of access to that line because we stay connected to data. I think we’ve been continuing to refine the data sources to which we are connected.

Early on, it was just e-commerce data and then we folded in checking account data and we folded in accounting data, payment acceptance data, social data. We’re doing a lot of unique things with shipping data right now and I’m trying to think of…this is a unique one, we’re partnered with a company that provides fuel cards to small businesses that have fleets and we’re able to use fuel consumption data as a proxy for business performance.

Peter: Interesting. Does it mean that the more fuel they’re using, the better their business is going?

Kathryn:  That’s exactly right and you also want to see the trend. You know, obviously, a lot of businesses have really lumpy behavior and that happens somewhat in the shipping and fleet business, but you do want to see year over year an improving trend.

Peter: Right, got it. Okay, so then you’ve got all of this data coming in and you’re analyzing it, what happens when you see that there’s….you can probably get a very good indication that things are not going as well as expected and something has happened and you can see it in the checking account data, the fuel data, whatever it is, what do you then? They may still be paying just fine, but you can see that there’s a problem brewing, what do you do?

Kathryn: So one of the things that’s really important when you think about a downward trend in a business is you want to make sure you have enough data to understand…is it really a downward trend or is there simply seasonality or volatility in this particular business because it’s this business, because they’re in this geography, because they’re in this industry, because of macro trends that may be impacting that business so it’s important that you layer on all of that data so you don’t make a knee jerk reaction. So that’s important data point number one.

Number two is you can’t have a draconian response to that information unless there’s some sort of fraud or lack of access to data so every day when a customer logs in, they don’t see a different line of credit, they don’t see different fees or pricing, they don’t see different availability because that would be a terrible customer experience.

Peter: Right.

Kathryn: So we do have the ability to limit access to a line in the event that we see something terrible, most likely we contact the business because a lot of times what happens is you may not see activity in one account, you may see a declining activity in one account, but you also have ramping activity in another account to which we may not have access because a customer didn’t know that they needed to share it with us.

So that’s why it’s important to have a partnership with your customers so that you can contact them and say, hey, we noticed that your sales are going down, is that really what’s going on and 9 times out of 10, it’s not.

Peter: Okay, interesting, interesting. So then you’ve got an app now that people can download. I think they can access their line of credit through the app. How popular is that, I mean, I just feel like are people going to download the app before they apply for a line of credit, or are they…I would imagine that’s a commitment to go and download an app where you can just go to the website, fill in a few forms, I mean, how do you think about the app?

Kathryn: I think views on that are changing and perhaps I’m an anomaly and I don’t want to be a focus group of one, but I have no problem downloading an app. To me that’s not a commitment if it is going to be a better experience and I almost never open my laptop so most of the things I do, I do on my mobile device and if I’m going to have a better experience with a native app, 100% of the time I will download the app.

Because it’s free and Apple, well I use Apple products, you know, they’ve already vetted these developers, I mean, I already trust Apple with all the rest of my data so why would I not trust them to give me an app. I feel like the obstacle, the hurdle for downloading an app is nothing like it was even a year ago, but certainly a couple of years ago. People are happy because it’s a better experience.

Peter: Okay, so even new customers who have never interacted with you before will download an app and interact there.

Kathryn: Absolutely, I find it really bizarre that our rating on the App Store is as high as it is because I think we have five stars which is not a thing you would expect for a company that, you know, is charging you a fee to borrow money.

Peter: (laughs) Right, is there anything else the app does other than just the line of credit and the application? Is there any other tools that they can use?

Kathryn: We are in the process of launching some new tools for our customers that are going to, again be about cash flow, but today, you can apply, you can borrow, you can make a payment, you can see how much you have available, all of the typical things that our customers do with us today.

Peter: So your customers, these small businesses, are they choosing the mobile experience over…is it more popular than the desktop these days?

Kathryn: It’s not more popular, but we’re starting to reach parity on desktop versus mobile and some of it depends on whether it’s an application or whether it’s just borrowing. What we’re also seeing though from getting off the desktop perspective is our customers now have cards they can use at the point of sale and swipe the Kabbage card to access their line of credit and we’re seeing growth in that area as well which is, again, taking things off the desktop and soon enough they’ll be able to use their phones to use mobile payments in the mobile wallet.

Peter: Interesting, interesting. So you have a debit card right now that they can go in and they can go and buy like a piece of machinery or something that’s within their line of credit and they’ll just pay on a Visa card or something that will trigger the loan kind of thing.

Kathryn: That’s exactly right.

Peter: Okay, okay, cool. So you’re moving along to something that your partner Rob said at LendIt earlier this year and it certainly caused a bit of a stir and a lot of people talked about it. He was talking about monoline lenders are going the way of the dinosaur and obviously, you’ve already talked about different product lines you’re doing, but when you’re looking at adding a new product line, what’s your approach here. How do you decide that this is something that is going to be a good idea?

Kathryn: So what we hear from our customers all the time is, I really need help managing cash flow and so you sort of have to unpackage what that means to them. For your typical, you know, HBS graduate with an MBA in finance, that means something totally different than to the local baker. So to the local baker it means, I need to make sure I have enough money to do the stuff I want to do, not just to satisfy the obligations I may have to, you know, all of the folks I may owe money as part of running my business, but also to take advantage of the opportunities that I have that I couldn’t do with my current capital flow.

So I think when we think about how we want to help them with that we look at what are all the components to cash flow and obviously lending is sort of, as Rob says, the speckle (laughs) that fills everything in and it’s really important to have a great understanding of how to do that which we started with lending. But, it’s all about how our customers move money so it includes payment processing for those who accept credit cards, it includes bill payment and account payable/receivable management, invoicing for those who move funds in that way; it includes banking because everybody has a bank account and everybody needs to put money somewhere.

So we’re not necessarily building all of these things from scratch, but being able to tie these features together allows us to really do a much better job at helping our customers manage cash flow in a way that takes a lot of the effort out of it. So many of our customers spend day to day anywhere between 20 and 50% of their time just worrying about that, instead of running the business.

Peter: Right, right, got it. So now let’s talk about the payments processing thing. You know, I was at my local farmer’s market this past weekend and I was just going through the different little stalls they had and I noticed that pretty much everyone accepted Square so they’re a real behemoth, shall we say, when it comes to these small businesses with payment processing and I’m curious how you’re positioning that, your payment processing product compared to Square, or compared to other competitors, obviously there are others out there as well. What are you doing that’s going to different, that’s going to be better, how are you approaching it?

Kathryn: Well a big part of it, from our perspective, is making sure that we are serving the specific customers that we do today with Kabbage and we spend a lot of time talking to our customers about payment acceptance. Certainly Square has a lot of customers and a lot of small customers. I would say, you know, our customers range from…you know, again, the eBay business to construction companies generating tens of millions of dollars in revenue annually.

So it really is a broad swath, you know, Square got their start in micro merchants and I think that represents a large part of their customer population, I think they want to expand of course from there. Because we’re approaching it in a totally different way looking at, I guess, all customers in all industries, in all geographies. We have a different view and our customers have different needs and many of our customers are really excited about the prospect of having an integrated product, just like PayPal and Square have with processing and lending. I think we’re just able to serve a broader market, we’re not fishing just in our own pond, so to speak.

Peter: But initially are you rolling this out just to Kabbage clients, I mean, your line of credit clients? I presume that’s going to be the first step, right?

Kathryn: Absolutely, that’ll be the first step.

Peter: But your vision is that someone can come along to Kabbage, you know, whether it’s a year’s time or whatever, and just really take you up on your payment processing product without  having any need for a credit product.

Kathryn: That’s exactly right and we’re going to have a standalone product that is going to be customized to a couple of very specific industry verticals that are currently not being well served by the payment processing space. And I would love to tell you more (Peter laughs), but I can’t…

Peter: Well can you give me at least some sort of timeline. I presume this is 2019 as an initiative?

Kathryn: I think it’ll scale in 2019, but we’ll have customers using our products by the end of the year.

Peter: Okay, I look forward to hearing more about that. Okay, so then you talked about your bank products and you’ve done a few partnerships, you’ve already mentioned some of them. This particular piece, I noticed that it’s mainly international banks that you’re working with, do you have…why is that because you’re only really lending money inside the US, to my knowledge anyway. Correct me if I’m wrong, but how come this has sort of come up internationally rather than domestically?

Kathryn: Well I think there are a couple of reasons for that and I’ll start with why we haven’t pursued direct lending outside of the US. I think it’s fun because we had a bad experience. We actually launched in the UK as a direct lender, it took us six weeks to get a lending license in the UK and it took us three years to get a bank account. (Peter laughs) So just the…I know, it was really insane.

Just the sheer burden, whether it’s regulatory burden, money movement burden, customer acquisition burden; all of those things made it so hard to get off the ground in another country without hiring people on the ground and creating sort of a bloated, bulky infrastructure that we felt would be hard for us to manage as well as grow the core business in the US as fast as we wanted to so we realized that a great way to do that would be via partnership.

We actually launched our first partnership in Australia with a fintech company that unfortunately is no longer operating, but that really led us to the ability to operate our platform as a global platform. And we were actually approached by the great folks at ING saying, hey, we saw what you were doing in Australia, we’d really love to be able to partner with you in Europe. I think probably global banks are a little less hamstrung by regulations than US banks and I think they’re probably a little less gun shy because, you know, they weren’t the cause of the GFC, so to speak, certainly they were contributory, but they didn’t…(laughs) it didn’t start there.

So I feel like the US banks probably are operating a little more slowly, but I will tell you that the US banks have been very interested and many of them have asked for dog and pony shows from all of the fintech companies. They ask us to come in and talk to them about how we would partner and many of them have subsequently launched their own product after that discovery process with all of the fintechs. So I think they are trying to figure out how to do it themselves and I think that’s slow going, as you might expect, just because they’re slow moving beasts.

Peter: So when you look at it competitively, I mean, obviously you look at the banks and…I mean, let’s be honest, there’s not really many banks right now doing a great job particularly when it comes to customer experience that you guys have been known for, but they are certainly competitors to you. We’ve already talked about Square and PayPal, and there’s Amazon that we haven’t talked about who are…you know, they obviously have a small business lending operation for a huge number of the merchants that they have so when you look at the competitive environment, where do you think it’s most threatening for Kabbage?

Kathryn: Well certainly, there are companies that are fishing from their own pond, so to speak, so whether it’s Square or PayPal or Intuit or Stripe or Shopify or Amazon or the list goes on and on, you know, you might say, well that covers everybody because that’s like most of the businesses, but the difference is they only know how to serve their customers using their data and their experience.

They don’t actually see the rest of that business, they only see their interaction with that business so I think it makes it really challenging for them to offer, you know, complimentary products and services that take into account the rest of their business. Just because you’re a business that sells on Amazon, you probably are a business that does a lot of other things too. Just because you’re a business that accepts payments using Stripe, you probably are a business that does a lot of other things too. We’re uniquely positioned because we are operating an open network, so to speak, to see the full business, not just part of it.

Peter: Right, that makes sense. So then, just one other thing before we move on from that topic, I loved your study. It was a few months ago now I saw it where you guys came out with this stat that you have loaned out $1 billion outside of banking hours, like people have applied outside of banking hours. You know, I feel like…one thing that struck me when I was reading that, it’s amazing to me that there is no bank that’s taking you head on.

The banks traditionally have been the largest lenders to small business for decades, centuries probably in many cases, so when you look at the banks and you look at what…obviously, that was a little bit of a dig at them that you did that. I mean, are you surprised that you’ve been going for almost ten years now and the banks are still, for the most part, they haven’t gone head-to-head with you?

Kathryn: I’m not exactly surprised only because I think there are two components to that.  One of them is you have to be nimble. Technology and real time data have to be part of your DNA and it’s simply not part of a bank’s DNA. You walk into the innovation lab at any bank and you see an abandoned pool table and four beers in a cooler and that’s their innovation lab. It’s not part of the way everybody operates and so I think it’s a really important distinction for the difference.

The other thing is you have to have the will to do it. A hundred percent of our customers bank with banks, they just don’t get loans from them and it’s because they’re smaller than a bank can economically serve. And so unless they have technology and automation, it’s just too expensive for them to provide loans to those customers so we’re still not really competing with banks because banks have a hard time serving this segment. I mean, I think they will for a long time because it’s so hard for them to get their heads around automation.

I mean almost every time we talk with a bank we’ll say, okay, this is great, you know, we’d love to work with you, but tell us a little bit about how you feel about a digital experience. What are your plans for digital and tell us what automation means to you and almost invariably they will say, yes, we love automation as long as there’s a person who’s ultimately making the decision about risk. Well that’s not automated (Peter and Kathryn laugh) so I think it’s just like how do you define what it means and is it part of who you are.

Peter: Yeah okay, that makes sense. So then switching gears, I want to talk a little bit about an acquisition you guys made earlier this year, you bought the Orchard Platform. It didn’t seem like a logical fit for those of us who have been in the industry for a while. Tell us about your thinking behind that acquisition.

Kathryn: Well we were already a customer of Orchard and we really loved the platform that they had. We were using that platform to pledge assets into our facilities that we use for securitization and so it really made a lot of sense for us to be able to continue using that. And because, you know, we’re not a P2P lender, we’re not a marketplace lender, we securitize 100% of the receivables that are generated on our platform, that is an important aspect to us and because we have a lot of different products that are a little bit unique in this space. We have spent so much time and energy getting things working on that platform, we hated to lose that because the technology was great.

I think the second thing was the people. They had a lot of fantastic data engineers and software engineers who knew our space and would be able to, you know, integrate into the company and make us more productive overall, not just with their software, and allow us to put all of our data into their platform that would make us more productive. And I think, lastly, they had a lot of data that was very useful to us and, you know, building out and forecasting various scenarios.

Peter: Okay, so how has it been? It’s been a few months now, I mean, are you leveraging some of this data into your own business?

Kathryn: We are. They made themselves almost immediately invaluable, not only did they integrate into our system very, very quickly, but also they were able to teach us a few things and generate real time dynamic reporting for some of our partners that we hadn’t done on our own. So it’s been really a fantastic experience and I’m delighted that we are one family.

Peter: Okay, we’re almost out of time, but before I let you go, I want to talk about an op-ed you just did in American Banker. You wrote a piece, I think it was published this last week from memory, that you talk about the need for more gender balance in fintech so maybe you could just give us your thoughts on…you’ve been a woman in fintech for a long time now and first thing maybe, what is Kabbage doing specifically to foster more gender balance in fintech?

Kathryn: From our perspective, we take great pains to make sure that we have good balance in our organization, whether it’s at the leadership level or, you know, throughout the rest of the organization. I mean, that’s obvious as you walk through our halls or go to any meetings, you’ll see a lot of women at all levels around the company. Certainly we try to, you know, walk the talk even if you look at our customer population. We have twice as many women in minority owned businesses in our customer population as exists in the business owning population in the US.

Peter: So how did that happen?

Kathryn: Well, it’s not because we target it. Of course, we do some things that…you know, we support female entrepreneurs and we appear and sponsor things where there are female entrepreneurs, but so does everybody else. I think the biggest thing is the anonymity of applying online creates positive selection for minorities, including women, not that we’re a minority, there’s more of us than men, in the business world, I would say, we might be considered such and it’s because there’s a lack of judgment.

You can go to a website, there’s not an old white banker looking you in the eye trying to make a decision about your business. So not only is the application process conducive to that population, but actually the decisioning is too because there’s not a human who’s bringing their own biases to that decision and it is impossible to avoid human bias.

Peter: Right. So then obviously an algorithm has been created that really just gives…it’s all data based. I get that, I can see how that would create a bias. So when you look at fintech now…at LendIt we have lots of initiatives, we’re trying very hard to sort of create more gender balance as well with having female speakers and what have you, but it still feels like sometimes just looking around the facts of the female founders or co-founders of fintech companies, females are a significant minority there.

How are we going to change that, I mean, how are we going to change the reality in having more women involved, more women getting VC funding and obviously that’s a major problem as well, but I sometimes look at this and it feels like such a…we’ve got so far to go. How do you see this playing out?

Kathryn: You know, certainly I think we’ll reach critical mass, some inflection point where all of a sudden we won’t realize that it happened, but you know, all of a sudden half of the fintech entrepreneurs are women and you won’t…like I said, it will be unremarkable because it’ll just be something that we’re used to at that point. I think for now, it’s really hard for people to do something when they don’t see themselves or someone like them doing it and you find that all over the place.

There are things…we look inside at Kabbage to see what are the things that we’re doing where we don’t even realize that we are driving women away or driving minorities away from certain functions just because of the words we use in the job description. It turned out we were using words like ninja and superhero in our descriptions for software engineers and that doesn’t resonate with women.

So it’s not just about being excited about bringing women on and trying to find them and actively recruit them; it’s about making sure that all the language that we’re using makes people feel comfortable and they see themselves doing that job because for most people it’s really hard to be the only one doing something, it’s uncomfortable.

Peter: Yeah, understood. So we’re just about out of time. Last question, when are we going to see a Kabbage IPO?

Kathryn: We don’t have any plans for a public offering. I think, you know, the reality is we see so much opportunities it would not make sense for us to do something like that right now because we believe the delta between where we are and where we’re going to be is so great that we don’t want to until we’re closer to that goal. So I think that’s why we’re not talking about it or planning it or anything else in the near future.

Peter: Okay, well on that note, we’ll leave it there, Kathryn. It’s always a pleasure chatting with you. Thanks a lot for coming on the show.

Kathryn: Thank you for having me.

Peter: Okay, see you.

You know, I just want to go back to something that Kathryn said there a few minutes ago talking about competing with the likes of Amazon, PayPal and Square. I’ve always thought that those companies had tremendous advantages when it comes to small business lending because they have obviously a captive audience for their offering and they really have very low cost of customer acquisition, but what Kathryn says, and it just struck me as I’ve been thinking about this since we hung up the phone that you know, they only see a portion of the business activity, that might be a large portion to some, it might be close to 100%, for others it may be 20%, but they only see a portion of their small business customers’ actual revenue streams. I really get the point in what Kathryn is saying, Kabbage tries to take a really holistic view of the entirety of all of the revenue streams that are coming in and really applying their rigorous approach to data on making decisions based on that. So it was just a fascinating little tidbit there that I thought I would focus on.

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 USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8^th through 9^th  2019 at Moscone West in San Francisco. Registration is now open and we’re also taking speaker applications. You can find out more by going to lendit.com/usa.

 

PODCAST TRANSCRIPTION SESSION NO. 173/STEPHANIE KLEIN

Welcome to the Lend Academy Podcast, Episode No. 173. This is your host, Peter Renton, Founder of Lend Academy and Co-Founder of LendIt Fintech.

Today’s show is sponsored by LendIt Fintech USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8th and 9th, 2019, at Moscone West in San Francisco. We’ve recently opened registration as well as speaker applications. You can find out more by going to lendit.com/usa.

Peter Renton: Today on the show, I am delighted to welcome Stephanie Klein, she is the CEO and Chairman of Braviant Holdings. Now Braviant is an interesting company, they haven’t been around that long, but they’re starting to get some really good traction in the non-prime lending space, non-prime consumer lending, and this is an area that Stephanie knows very well.

She spent a better part, or more than a decade in this space so we talk about what attracts her to the non-prime lending space, we talk about how they use technology, what channels they use to attract customers, we talk about their underwriting, we talk about the different brands that they have and how they are trying to graduate people from non-prime up into prime. It was a fascinating interview, hope you enjoy the show.

Welcome to the podcast, Stephanie!

Stephanie Klein: Thank you so much for having me, Peter.

Peter: Okay, so I like to get these things started by giving the listeners a bit of insight into your background. Maybe you can tell us what you’ve done in your career before you started at Braviant.

Stephanie: Yeah, absolutely. So going back to sort of school, I studied finance and business administration at the University of Illinois and more recently, I went to Chicago Booth for my MBA, but coming out of school I actually interned in investment banking at Goldman. I was in the Financial Institutions Group and I remember just thinking, if I ever do banking full time, it’s going to be post MBA. I think the post MBA associates just look maybe a little bit more well rested (Peter laughs) than some of the second and third year analysts so I didn’t make it into banking full time.

I did go into consulting which when you graduate U of I…you know, from the business school in 2006, kind of banking and consulting were the two big careers. So I ended up working at a boutique healthcare consulting firm straight out of college and my second full time job was also a corporate finance role in healthcare.

And so it wasn’t until about 18 months out of undergrad that I found my way into fintech. So this was back in 2007, you know, before most people had really heard of LendingClub or Prosper. People weren’t talking about marketplace lending or even more broadly non-bank lending, but at the time I was lucky to interview with the founding team of a little known online lender called CashNetUSA.

That name may not ring a bell for most today, but CashNet is actually a division of a billion dollar public company that is now called Enova International. So I think a lot more people are probably familiar with the Enova brand name, but back in 2007, the company was still pretty small, growing really fast. I interviewed for an entry level financial analyst role and my interview was with three C-level execs, the CEO, the CFO and the COO so imagine 18 months out of school, it was kind of crazy. Now again, most of these guys were in their 20s.

Peter: Right, I know some of them.

Stephanie:  You do, you do, so the CEO was, the Co-Founder, Al Goldstein. So obviously Al is in many ways a visionary, one of the very early pioneers in online lending and of course, you know, has gone on to become a serial fintech entrepreneur with Avant and other businesses. So needless to say, I got the offer, I accepted and it was a really exciting time to join Enova and to get started in fintech back in 2007, working side by side and learning from the original founding team was amazing.

They were still there for a couple of years working towards the earn out from the 2006 Cash America acquisition, really talented group of people, insane year over year growth numbers and it really, just this feeling of forward momentum. It felt like we were building something that really mattered and something for a segment of customers which is non-prime consumers who had essentially been left behind by the big banks and excluded from traditional credit products.

So that’s really where I spent most of my career prior to Braviant, about seven years at Enova starting as an entry level financial analyst and when I left had actually spearheaded the launch of the NetCredit business and was in a P&L management role overseeing the early growth phase of that business. Actually, I saw you also recently spoke to Matt Hollender, who was one of my colleagues back at Enova now running the NetCredit business and kind of taking it on to the next level. So that’s really where I got my start in fintech.

Peter: So then this is obviously the non-prime space…you know, we know about Enova. So what specifically attracts you to this particular space, the non-prime space?

Stephanie: Yeah, so when I think back to 2007, if I’m being totally honest, I didn’t know anything about it, I didn’t know what a payday loan was, I didn’t really understand the dynamics of being prime or non-prime in the US. You know, so back in the day, I just saw a bunch of really smart young people working downtown in Chicago with a casual dress code that seemed like they were building something they were pretty proud of. Obviously since then, it’s changed a lot and I think during my time at Enova and in things I have done since, I really developed kind of an appreciation for this space and there’s probably three reasons that I stayed in non-prime credit for over ten years now.

So the first is need. A lot of people with prime credit kind of think that sub-prime is a small sliver of people at the very bottom of the credit spectrum and the reality is that much of middle America today is considered non-prime. So 43% of the population has a FICO score below 700, 50 million adults are labeled underbanked by the FDIC, you know, CFSI which is a fantastic non-profit that does a lot of research said, look, it’s not really 50 million, it’s 150 million Americans that are financially underserved by the traditional big banks. And so I think that’s the first thing. It’s just a really huge problem and it’s kind of cool to be trying to solve a real problem for people who need access to credit, people who don’t take that access for granted like a lot of us do.

I guess the second reason is just that there’s a lot of work still to be done so I look back at sort of what’s been accomplished over the past ten years. And I think there’s been a lot of progress moving from single pay kind of payday products which were, more or less, the only product you could get back in the day at a storefront and then eventually online from someone like Enova to installment products, longer term products. Now even a lot of people are bringing credit cards to market for this customer base.

So I think there’s been a lot of progress, but there’s still a lot to do even today. You know, four out of ten Americans can’t come up with $400 to cover an unexpected expense and so that’s, I think what keeps me motivated. I feel like with the pace that technology is evolving and analytics is evolving, there’s so much more that we can do in the next ten years relative to what we did in the prior ten years. So those are two of the big reasons.

The third one is probably a little more pragmatic. I firmly believe that the non-prime space is quite frankly just less likely to be taken back by the big banks than prime. I think in prime, sort of non-bank lending…there’s a real risk of the disruptor kind of becoming the disrupted with players like Goldman Sachs through its Marcus brand and others entering this space. At the end of the day, everybody wants to lend to someone with good credit, you know when you’ve got good credit, a basic kind of FICO score and income matrix and a little bit of verification takes you pretty far.

The non-prime space is a little bit more difficult, a little bit more challenging. It’s hard for a traditional bank to serve because they’ve got deposits and FDIC insurance and things like that to think about so I think, pragmatically, non-prime is a space where people like my current company, Braviant, are just quite frankly going to keep leading the way on innovative scalable credit solutions.

Peter: Okay, why don’t you give the listeners a little bit of background about Braviant. I know it hasn’t been around that long and I believe that while you’re the CEO, you weren’t there at the very beginning of the founding of the company, was my understanding. So tell us a little bit about the Braviant story.

Stephanie: So Braviant was founded in 2014 and as you said, I joined a bit later. Our first loan was issued in December 2014 and I joined almost a year later in November 2015 so pretty early on, but certainly the company looks quite different today than it did when I started.

I think originally, Braviant was founded to essentially take advantage of all of the advancements in online technology, data sources and analytics over the past several years. So you think of some of the online players, especially in the non-prime space, who really got started in the early 2000s and a lot changed over the years. And so getting started in 2014, there was an opportunity that our founder saw to sort of start over and take everything that had been learned and figure out how can we create a next generation lender for underbanked consumers, you know, for the next ten years.

What I’ve done since I joined is obviously focused on some of the basics, you know, how do we scale profitably, making sure the unit economics make sense, all of those things, but a big thing I’ve also focused on is what is our mission, why do we exist. So one of the things we’re rolling out this year that I’m pretty excited about is the new mission which is “A Path to Prime.”

A Path to Prime means not only solving the immediate credit need, but trying to design products that can help non-prime consumers build credit history, build savings and achieve overall better financial health as they work their way toward prime credit. And so that’s really the mission and the goal of Braviant, you know, how can we help people graduate to better rates over time which we’re doing today.

Our previous customer rates are about 40% lower than new customers, but going forward, there’s so much more we can do and we’re trying to figure out how to help customers build savings and improve their traditional credit scores so they have access to other products in the future.

Peter: Okay, so with that…I mean, you’ve got two brands, it seems like right now. You have the Balance Credit brand and the Chorus Credit brand. Because I don’t believe you market yourself as Braviant to consumers, that’s my understanding, so correct me if I’m wrong, but talk us through the two different brands that you’ve got.

Stephanie:  Yeah, that’s correct. So Braviant is sort of the corporate…you know, the name that everyone who works out of Chicago thinks of themselves as part of the team so we’ve got close to 60 people in Chicago heavily centered in technology and analytics roles and that’s what we really think of as Braviant. Our two consumer facing brands, as you alluded, are Balance Credit and Chorus Credit.

So Balance Credit is our small dollar installment product, it’s really a payday alternative product. Balance Credit is fulfilling that emergency need, that kind of $400 need that we talked about, for somebody who’s living paycheck to paycheck. With Balance Credit, customers can borrow anywhere from a couple of hundred bucks up to close to $2,500 or $3,000 on the high end, but really an average loan is about $1,000 and it’s paid back very quickly in about six months. So we don’t offer any single pay products, but the installment products are still relatively short term on the Balance Credit side.

And then flipping over to our second brand, Chorus Credit, Chorus is our near-prime offering, on average…instead of $1,000, we’re lending closer to $5,000 with a 3-year duration. So a Chorus loan is an unsecured personal loan, it can be used for any purpose, you know, it could be used for emergency expenses just like Balance, but what we see from the data is that close to 75% of Balance customers are using that product for an emergency expense, you know, a car repair, a medical bill, something like that, whereas less than 20% of Chorus customers are looking for emergency credit.

So on the Chorus Credit side, the vast majority of customers are really using the product to either consolidate other debts or to fund a major purchase. I guess with that said, it sort of leads into well why we have two brands. We feel like the products and the target customers are actually pretty different and that’s why we decided to separate the brands. It basically helps us focus on the right messaging, the right products, the right customer acquisition strategy for each type of consumer, sub-prime versus near-prime, and it also helps us seek out separate debt facilities, strategic partnerships, you know, things like that that make more sense for one brand versus the other.

Peter: Right, but you would get, I imagine, some people who come to Chorus Credit who really don’t belong there, maybe even vice versa, going and coming to Balance Credit. Do you sort of send customers between the two brands?

Stephanie: Yeah absolutely, you bring up a good point. Chorus Credit, just as a side note, just launched in December of last year so it’s been live for less than a year, still more or less in a pilot mode. So what we envision for the future is we want to serve that full non-prime spectrum and essentially, we think of it as a risk-based pricing approach day 1 to figure out what’s the right, you know, loan offer, price, term for a customer when they come to us as a new customer and then no matter where you start in the spectrum graduating people down to a better product over time.

So because Chorus is so new, to date we really focus on graduating people within the Balance Credit business, but certainly in the future we think about what should the Braviant Path to Prime mean, it needs to cross both brands, whether that’s somebody who doesn’t quite qualify for Chorus being referred to a more appropriate product from Balance Credit, or somebody who’s reached the top of the Balance credit spectrum being able to graduate into a much lower cost loan via Chorus Credit.

Peter: Okay, so then can you give me some sense on…obviously, you talked about the duration, but what about the interest rates of these particular loans, what are we looking at here? What’s the typical Balance Credit and Chorus Credit type terms?

Stephanie: Yeah, absolutely. So Chorus Credit which again, is that sort of $5,000 average 3-year personal loan is a sub 36% APR. Balance Credit generally starts in the triple digits so a new customer at Balance would generally pay about half the cost of a payday loan or an overdraft fee and then that rate is going to decrease over time as customers prove out their ability and willingness to repay.

And really the higher cost of credit for Balance reflects a couple of things. First, obviously the higher default risk being more of a sub-prime consumer versus near-prime, but the second piece is just the higher proportional cost of originating and servicing such a small dollar loan. So if you think about a prime lender, you know, they might spend $350 let’s say to originate a $15,000 loan; a sub-prime lender might still spend $250 to $300 to originate a $1,000 to $2,000 loan so the principal funded is close to 90% lower, but the cost to originate is only 15% to 30% lower.

Peter: Right.

Stephanie:  So I think it’s fairly well understood in the industry. Unfortunately, less credit worthy consumers tend to pay significantly more for credit and quite frankly the economics wouldn’t work if they didn’t. But I think that’s why it’s important for lenders like Braviant to incorporate more of a mission-focused work toward the Path to Prime and figure out, regardless of where that starting point is, how can we help people graduate to a better place over time because you’ve got a pretty high charge off rate on sub-prime, but you also have people who pay back successfully. And once you know who those people are, they deserve a path to better products.

Peter: Right, okay. Obviously, you’re operating online, but are you nationwide or what states are you operating in?

Stephanie: Sure, today we’re operating in 12 states so the largest by population are California, Texas and Ohio. We do have plans to scale nationwide in 2019 so I’m not able to share the name or too many details quite yet, but we’re essentially in the due diligence process and working out the program details for a bank sponsor program.

Peter: Right.

Stephanie: So I’m hopeful that I’ll be able to announce that in the next four to six months. It would be a partnership with a state chartered community bank who would actually originate loans nationwide and Braviant would serve as a vendor to that bank.

Peter: Interesting, okay, that sounds great. So then I look at your website here and it says that you combine breakthrough technology and machine learning to empower consumers with better credit solutions. So there’s quite a bit in that statement there, but I’m most interested in the breakthrough technology and the machine learning. Can you sort of talk about what that actually means, what you are doing to really enable more people to be underwritten more effectively?

Stephanie: Happy to, so over the past year, and this is kind of a project tied into the launch of our Chorus Credit platform. When we launched that new business it really gave the current team an opportunity to sort of assess the lay of the land from a technology perspective, figure out where we had pain points and how we could address those. And so one of the initiatives that we undertook was completely rebuilding our decision engine technology infrastructure and we rebuilt that infrastructure to support two main goals.

So first, we wanted to be able to seamlessly deploy R and Python code into production. Generally, that’s what our analytics team is coding models in and a lot of companies have, you know, different types of decision engine structures where you need to essentially take that code that your analytics person is building the model in and then translate it to a different language to deploy it into production.

As you can imagine, that’s inefficient, it’s time consuming and it also increases the execution risk of having a bug or an error so we wanted to be able to eliminate that friction which helps us move a lot faster. You know, we build models, we can roll them out closer to real time instead of a lengthy technology process.

The second piece is that we wanted to be able to support machine learning models. You know, again, going back to the types of models that you can build in R and Python, there’s a lot of cool things, you can do to random forest, gradient boosting and we wanted to be able to deploy that machine learning technology and test it in a very sort of disciplined champion/challenger way against our linear models.

Of course if there’s lift, we want to be able to scale those models up. So a key requirement there, especially on the underwriting side, we’re also using machine learning for marketing acquisition, but on the underwriting side, it’s very important from a compliance perspective to be able to explain to a consumer why they were declined to be able to provide essentially the reasons for the notice of adverse action.

So those were our two goals, we wanted to rebuild our infrastructure to be able to seamlessly deploy models in the language they were written in and then be able to also use machine learning models not just logistic regression models and, you know, have that explanation for a customer still of why they were declined if we weren’t able to approve. And so that’s really where we focused a lot of our technology.

I think you’re well aware…I mean, for a balance sheet lender like us, the two largest operating expenses are basically loan losses and marketing, and traditionally, those sort of move in opposite directions (Peter laughs) so…if acquisition cost is too high, you loosen your underwriting, but then your defaults go up; if defaults are too high, you tighten your underwriting, but then your acquisition cost goes up.

And so our goal and what we’ve actually been able to prove out through some of our new machine learning models is that we can find those “win-win” scenarios so how can we increase approval rates, expand access for underbanked consumers without increasing our default risk and the better we are at that, the more efficient we get at marketing and underwriting our customers, the better we can execute on our mission to lower the cost of borrowing as well as to invest in new products and services such as savings.

Peter: Right, got it. So then what about…I’m really interested in data particularly when you look at your Balance Credit type customers. A lot of these are people who don’t have a large credit file, sometimes they’ll have, I imagine, a thin or no file so what is the data you’re actually getting from this population that really enables you to make an appropriate underwriting decision?

Stephanie: Yeah, we use a variety of data sources to underwrite non-prime. It certainly is not as straightforward as, you know, just buying a FICO score from one of the big three bureaus. That said, I will say that some of the big three bureau data can still be predictive and so what we try to do is take the raw attributes that you can buy from those bureaus and then build our own scores and we’ve been able to build scores that differentiate a lot better for the sub-prime population than an official FICO or VantageScore. So that is one input into our models.

We’re also looking at non-traditional bureau data so there’s a lot of alternative bureaus out there. Interestingly enough, a couple of them, Clarity and FactorTrust were both just recently acquired in the past year or so by the big bureaus so the big guys are really focused on this alternative data space, but those bureaus have been around for a long time, a lot of rich data there for the types of products that never were reported to the big three.

You know, going back to kind of the online payday loans where the whole industry started 15 years ago, that wasn’t a product that the bureaus even wanted data on, let alone if a lender wanted to give that data. You know, the way they viewed it is a one time payment of $500, that’s not really relevant to my customer at the credit bureau which is a big bank who’s writing a multi year, you know, mortgage or auto loan or credit card product.

So it’s really interesting though how those two worlds have sort of merged with traditional bureaus and alternative and then we’re also looking at other types of data, you know, bank transaction history, looking at the cash flow data there. Obviously, as an online operator, we need to build a really robust fraud prevention model and have really good tools and methods there so looking at things like the IP address, looking at information we can find about the email or the phone number that was applied, trying to make sure that we’re mitigating not only our credit risk but also our fraud risk and protecting consumers who may unknowingly be the victim of identity theft.

Peter: Got it. So these consumers…I mean, where are you going to find them? Obviously, this is an online endeavor, I presume it is, you tell me, what are the channels or how are you finding these customers?

Stephanie: Yeah so I mean, as you said, you know, we’re only operating online and so both of our consumer facing brands…neither of them has a storefront. You’ve got to apply online and it’s interesting because we’re actually one of the largest direct mail providers in our markets which sounds a little maybe, you know, non-intuitive, right. You’re acquiring customers online, why are you sending them a piece of paper mail. That sounds even maybe a little bit kind of old school, but the reality is that direct mail works really, really well for our segment of the population.

You know, first of all, you’re talking about people that generally are getting declined over and over so being able to send somebody a pre-approved firm offer of credit is really huge in our space because that’s really the number one fear that these customers have is why even waste time applying for credit just to hear a no again. And the other thing that’s interesting about mail is, you know, opening a piece of paper from an envelope in your mailbox, again, feels a little bit dated, but the actual data driven process behind direct mail targeting is really, really sophisticated.

So we currently work with four different bureaus to generate lists for our mail, we’ve built more than 30 different proprietary models, they predict things like likelihood to respond to an offer, likelihood to convert after responding, default risk, expected income, all different dependent variables. Half of these 30 models are machine learning, half are more traditional linear models and so it’s really amazing to have a channel like that. You know, we send millions of pre-approved offers per month and then as we see who responds and how these customers that we approve perform, we can fine tune our models and build new models to get better and better over time.

So I think that’s, you know, something that we’re really proud of, kind of our direct mail programs; we feel like we definitely have some secret sauce there. Outside of direct mail, we use of course, some digital marketing techniques, things like retargeting if someone was on the website and bounced off making sure that they have ads, email marketing, but we are starting to also ramp up some additional digital channels. Online affiliate partners I think will be a big channel for us in 2019. 

Peter: Interesting. I know that direct mail has been very successful for the prime segment. I didn’t realize that that was going to be a core piece of what you guys do because you’re still talking about a direct mail piece for a $1,000 loan. Obviously, it’s got a relatively high APR, but you can make money by having a $1,000…all the costs that obviously goes with the direct mail piece, I mean obviously you know exactly how much it costs. But, that to me is surprising that you can still have a loan that is relatively small, there’s not a whole lot of room there to recoup your costs and that can still be a profitable channel for you.

Stephanie: Yeah, it is interesting and I think there’s some lenders in the non-prime space who are quite good at direct mail, we’re definitely one of them. I think there’s others who have tried and failed, or are sort of still trying to figure it out. Certainly, you know the cost of the mail piece, right, I mean a mail piece might cost something like $.35 to $.40, including the data to actually generate the name, but there’s a lot of risk that then comes into play once you send that mail out. You know, that $.35 is going to easily turn into a couple of hundred bucks and if you don’t know what you’re doing that acquisition cost can just go higher and higher.

If people don’t respond, or if they respond to the dollar amount, but then they see the APR and they don’t convert, you know, they respond, they convert, you fund them and they default, etc., but we’ve done, I think, a really good job there and built that out as truly a core competency of Braviant.

One of the things that I think is also unique about how we approach direct mail and really how we approach any channel, we’re very disciplined. So our goal is to be profitable on the first loan. Certainly, we have a fairly, you know, a high percentage of customers that like the product and if they have a need again a few months down the road they will come back, but I’ve seen other lenders who are really counting on, sort of banking on that lifetime value from the subsequent loans even saying, hey, I can operate at a loss for the first loan, kind of weed out the defaults and then whoever comes back I will make money on those guys.

But for us, we just wanted to take a more disciplined approach, I guess, to some extent within fintech we feel like the “fin” piece is just as important as the “tech” piece and so with our direct mail campaign we’re actually, you know, covering all that variable cost of mail, the underwriting data and the servicing on the first loan. What that does is it gives us flexibility to reward our customers on the subsequent loan.

Peter: Right.

Stephanie: So when I talked about taking the APR down 40% on the second loan, if you can’t figure out how to acquire customers profitably on a first loan for a small dollar loan like $1,000 then you really don’t have the flexibility to lower the rate on the second loan because maybe only 30% of people or something like that will take a second loan and you’re going to be looking to that subsequent loan, that previous customer who might charge off half as much as a new customer to make all your profit.

So that’s something that I…again, it just goes back to a really sophisticated data driven approach trying to slice and dice the data however we can and figure out which segments have a higher expected first loan profitability relative to acquisition cost and which segments don’t. If they don’t, we will forego that revenue and we won’t mail and, you know, we kind of stay true to that disciplined approach.

Peter: Right, right. Okay, so I want to ask you about competition and it’s sort of a two part question. The first part is I want to talk about US Bank because it’s the first time…I’m sure you saw the news recently, they are launching a non-prime product, I think it’s very similar to what you have, like a thousand dollar typical loan, six month duration type thing and so interested to get your take on how you view the banks as a potential competitor because I imagine before that the banks were pretty much…they were not in this space pretty much at all.

Also, there are obviously others in the non-bank space who are going after these same customers and how you view the competition with them so if you could sort of give us your perspective on the competitive landscape.

Stephanie: Yeah, sure and definitely, really interesting news with US Bank, certainly a different product, but it kind of brings me back to gosh, maybe seven/eight years ago before Direct Deposit Advance went away. So DDA was another product kind of back in the day that, you know, quite a few of the big banks were offering that in a lot of ways competed with short term credit from a non-bank like us and so I think it’s almost coming full circle with US Bank stepping back in to offer a product like that and obviously kind of driven by the administration right now and the administration looking favorably on trying to serve this segment of the population.

But when I think about sort of the overall competitive landscape, I think what strikes me the most is that it’s very fragmented. You’ve got a couple of big online lenders and even those guys from their own data will say that they make up maybe 2% of the market share if that, in the US and so it’s really fragmented. There’s been a huge shift from storefront to online over time and that’s been well documented.

You know, over the past ten years there’s been a huge shift from single pay to installment loan products so I think everything Braviant is doing with online products and installment products is sort of reflective of where the market has gone, is going and will continue to go, but it’s certainly a really fragmented space. I actually to some extent welcome the competition and the reason I say that is I think, you know, people have a lot of different sort of perspectives on serving the sub-prime customer; how should they be served, what should the product look like, should they even have access to credit. You know, I firmly believe that access to credit is sort of essential in terms of building financial health and obviously it needs to be responsible credit and high quality products.

And so with that said it’s a good thing, in my opinion, that more people are trying to serve this space and what I’ve seen over the past ten years is that certainly there have been regulatory changes at either the state level and in some cases the federal level that have shaped the industry, but a big shaper, I think, even more so has been competition and I’ve seen people come out and say, you know what, the online payday loan doesn’t cut it anymore. You know, the industry has moved to installment, line of credit and again, at times there might have been regulatory drivers for that, but I think it’s also been really good for consumers.

You know, you can imagine, for example, if we’re still sending that $1,000 offer at a higher APR five years from now and the rest of the market has moved on to figuring out how to underwrite these same types of customers for $5,000 at a lower APR, we’re going to be out of business.

Peter: Right.

Stephanie: So I think the competition overall is really good for the consumer. I think it’s…you know, it kind of forces everybody to stay nimble, to never get complacent, to always think about what new technology is out there, what new data sources are out there, what new modeling techniques are out there that I can use to make sure that I still carve out a nice business, you know, for myself. I think again, it’s such a big market that Braviant and a few other key players can all build a really nice sized business and can all sort of compete and innovate against each other to create better solutions for the customer at the end of the day.

Peter: Right, right, got it. So we’re almost out of time, but a couple more questions before you go. You’re a balance sheet lender, but who is providing the capital for your balance sheet to lend to these consumers?

Stephanie: So we’re primarily funding our portfolio today through a couple of senior debt facilities and then cash flow from operations to essentially cover, you know, the debt haircut, the variable acquisition costs and then kind of our fixed overhead.

So about a year ago, we closed a $40 million facility with Redpoint Capital Group, they’ve since rebranded to Park Cities Asset Management; they’ve been a fantastic partner for us. And then we just recently closed a $50 million facility with Keystone National Group. That facility is specifically for our near-prime Chorus Credit business which is still in pilot mode. And so we’re in I think a unique position, you know, with these two debt facilities in place, we really don’t need to go out and raise equity to sustain our current growth rates which is great.

Now with that being said, we’re certainly evaluating if an institutional equity raise would make sense because we do continue to push into larger, longer term loans at lower rates and obviously that is more capital intensive. So as we get better at sort of growing that larger side of the portfolio and graduating people from the starting product to a product more like Chorus Credit, we’ll potentially look at raising outside equity to help fund the business.

Peter: Okay, that makes sense. So what about the future, what are you…obviously, you’re talking about rolling out Chorus Credit, what’s exciting for you as you look down the track?

Stephanie: Yeah I mean, I think, honestly, we’re just trying to build a business that has long term scalability, profitability and sustainability and we want to do that while staying true to our mission and true to our values. So if I could flash-forward, let’s say five years, you know, I’d love to be able to look back and say that one, we’ve achieved meaningful scale with our core lending products. We’re originating close to $100 million this year, I think that number should be over a billion dollars in five years while maintaining profitable unit economics and while maintaining that disciplined approach.

And then, I think, the flip side of it is I’d like to look back and say, you know what, we really did successfully create a Path to Prime for millions of consumers. I talked a lot about being data driven and so I view the Path to Prime the same way. Today, we’re building that path, but in the future I want to be able to look back and point to some hard data, some tangible proof points, you know, stats like higher credit scores, less money spent on interest, more homeowners because our customers disproportionately are renters relative to the median population, fewer customers living paycheck to paycheck, things like that. And so I think if we can accomplish that, it will be a pretty good outcome for Braviant.

Peter: Well, I wish you the best of luck. It certainly is a noble cause and the more people who can move forward from sub-prime or non-prime into prime is going to be…you know, it’s better for the economy, it’s better to everybody. I wish you all the best, thank you very much for coming on the show, Stephanie.

Stephanie: Thanks so much for having me.

Peter: Okay, see you.

You know, I’m really glad that Stephanie mentioned there that she is welcoming the competition. I think this is really what’s going to move the needle. If we get a competitive environment within the banks including, I expect, other banks…US Bank won’t be the only bank that will come out with a product like that, but there will be bank options, there will be non-bank options. People can compete on rates and user experience and really the winner is going to be the non-prime customer. Those who are responsible who really have the capability to move beyond non-prime, they will find themselves with lots of opportunities to do so and I think that’s a great thing. It’s going to be interesting to see how it evolves, but the non-prime space is one that really has so much opportunity to improve the lives of everyday Americans.

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 USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8^th through 9^th  2019 at Moscone West in San Francisco. Registration is now open and we’re also taking speaker applications. You can find out more by going to lendit.com/usa.

 

PODCAST TRANSCRIPTION SESSION NO. 172/GARY BEASLEY

Welcome to the Lend Academy Podcast, Episode No. 172. This is your host, Peter Renton, Founder of Lend Academy and Co-Founder of LendIt Fintech.

Today’s show is sponsored by LendIt Fintech USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8th and 9th, 2019, at Moscone West in San Francisco. We’ve recently opened registration as well as speaker applications. You can find out more by going to lendit.com/usa.

Peter Renton: Today on the show, I am delighted to welcome Gary Beasley, he is the CEO and Co-Founder of Roofstock. Roofstock is a fascinating company, they’re relatively new, they’ve only been around a few years. They’re basically a marketplace for buying and selling tenant-occupied investment homes and they’re able to do this in an online fashion. We get into sort of the mechanics of this in some depth on the show, we talk about the type of yields investors can expect, we talk about their approach to data because this is very much a data-driven business. We talk about the financing process and what the future holds. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, Gary!

Gary Beasley: Thanks, Peter, great to be here.

Peter: So I like to get these things started by giving the listeners some context and a little bit of background about yourself and what you’ve done in your career before you started Roofstock.

Gary: Sure, originally I grew up in the Midwest and came out to the Bay Area for business school and sort of caught the entrepreneurial bug there and really have spent the majority of my career at the intersection of real estate and technology.

So I’ve done everything from running acquisitions for a luxury resort company for many years to running a boutique hotel company that was based here in San Francisco and then also was CFO of a company called ZipRealty and took that public back in 2004 as the CFO. So I’ve done sort of some traditional real estate, I’ve done some…ZipRealty was the first online residential brokerage and so sort of cut my teeth on a tech-driven residential model there.

My second real estate startup was Waypoint Homes which we actually took public 2014 as a REIT called Starwood Waypoint so this is I guess technically my third real estate startup here at Roofstock so combines a lot of my background in both real estate from a vertical perspective and technology.

Peter: What was the idea that led to the founding of Roofstock?

Gary: Well, as I mentioned, I was running a public company at the time and we had many thousands of homes we were trying to sell, a couple of hundred and it was difficult to find the right channel to do it. It was frustrating trying to sell leased homes through the Multiple Listing Service because typically the MLS is setup to sell vacant homes to consumers not leased homes to investors and my Co-Founder, Gregor Watson, was having a similar issue.

He was trying to sell 500 homes from one of his funds in Dallas and they were all leased and he just started calling real estate agents and the first agent he called said, you know, I don’t have 500 signs (Peter laughs). I wouldn’t have the first idea how to sell 500 homes. The next person he called said, well gee, when can you get the tenants out so I could sell them. So I have to give credit to Gregor who was actually…the genesis of the idea was his and then he approached me about it. He said, hey why don’t we figure out how to sell homes with tenants in them?

We could do it directly to investors, get retail investors or institutions and not disturb the tenants, not have to go through with all the typical friction of a real estate transaction. So that was really the genesis of it, it was coming out the pain point of both of us trying to sell homes efficiently that we owned with tenants in them. The more we thought about it and started sort of whiteboarding it out, we realized that there was actually an opportunity for a really interesting marketplace idea that could cater to investors of all shapes and sizes and really break down the geographic barriers of real estate investing by building a technology platform.

Peter: So as someone not involved directly in this space, it’s staggering to me. This is a very simple idea, you want to be able to sell a home with a tenant already in it and real estate is a very mature asset class. You’ve got all kinds of different vehicles for selling and buying real estate and yet this hadn’t been done before, I mean, why do you think that’s the case?

Gary: Correct, well, it’s a great question. I think there were two sort of catalysts for the single family rental sector which it’s called…which is all the homes that have long term tenants in them, there’s about 16 million of them in the United States, it’s about $3 trillion of assets. But up until the downturn in kind of 2007, started in 2007, no institutional capital had invested in this space so what ended up happening is during the downturn the prices got so low there was a great entry point for investors, professional investors, to come in and take a look at the asset class and start investing capital at scale. That’s what I did with my last company and Gregor did as well so the catalyst was an entry point.

The second key factor is technology so without cloud and mobile computing, investors could not manage these homes at scale efficiently so it’s kind of a confluence, if you will, of the kind of the right timing in the market as well as the right technologies being available to where you could actually manage these rental homes very much like a distributed apartment building; whether you have four of these or 4,000 it’s just like four different apartment units and the operating margins are actually quite similar to apartments when you break it down. So that’s I think why it has taken a while for this to actually to come together.

Peter: So I was actually chatting with my wife this morning, I was telling her that I was going to be interviewing you today about your company and she said, well how can you convince investors to buy a house they’ve never seen. Investing in real estate is something that you do physically, you go visit, you walk through the house, you check out the neighborhood and yet here you are with an online platform. Obviously, you offer some sort of virtual kind of ways of doing that, but to me that seems like it would be a major sticking point, is that correct?

Gary: That was the giant leap of faith that we had to make when we launched the platform. I can’t think of another marketplace that sells $150,000 items, when you really think about it. So we threw a party and we weren’t sure if people were going to show up or not, (Peter & Gary laugh) fortunately, they did, but basically when we were trying to assess what it would take for people to buy homes sight unseen, we thought about it as investors ourselves.

Why do we physically need to see a home, why do we need to walk through it and it really came down to two things that we needed. One is to see the condition of the property to see how much work, if any, it needed and how much that would cost and two was to assess the viability of the floor plan as a rental property and ultimately, something that could be sold in the future. Once we got comfortable with both of those things, everything else can be done from a desktop.

So what we did was we figured out how to do a virtual tour and put that online that strips out all of the furniture so if you go on to our site you can take virtual tours. They’re 3D animated tours because these homes are occupied, but it strips out all of the furniture and you can kind of see what the finishes look like and it generates a 3D floor plan so you can see what the floor plan is like. We also have inspection reports that have been done by inspectors who have walked through the homes and prepared detailed reports with cost estimates. That all gets factored into your bid and factored into our underwriting so that was the premise.

I think that the main reason this has worked is this is not an emotional transaction, it’s an investment so if you and your wife are looking to buy a home in Atlanta to live in, you would certainly go see it, you want to see the exact color of the cabinets and the flooring and kind of see everything. When you’re buying a home as an investment, you’re thinking about it relative to other uses of your capital and you’re much more interested in the cash yield than the color of the cabinets and that’s what we have discovered. You can really do a lot today remotely.

You know, I would say the latest stats I saw, over 90% of our buyers live over 250 miles away from where they’re buying homes so very few people are actually even driving by the homes. The other thing that we’ve done is instituted a 30-day money back guarantee, sort of no questions asked if you buy something through our site and for whatever reason you’re unhappy, we will resell it for free and make you whole if we have to sell it for less, if it doesn’t sell, we’ll buy it. So that has helped, it hasn’t been something many people have even inquired about because we’ve had some pretty good customer satisfaction, but it does happen.

Occasionally, people get buyer’s remorse and we want to be there to make sure we can handle that. So that has actually helped a lot with a new marketplace. You have to build trust. The hardest thing is starting from zero and kind of going to one. So I think a combination of making sure that the inventory is curated and that we kind of do a number of things to help reduce the risk of the investment. We could talk about our certified property managers and all that kind of stuff, but then also having this money back guarantee has been helpful to get people to participate.

Peter: Right, right. Okay, so I’m on your website right now, you’ve got 326 properties, it looks like, available.

Gary: Yeah.

Peter: And they’re ranging in price, looks like the low is like $40,000 up to $150,000. I think $174,000 is the highest I can see on your home page, on the first page. Obviously, these are not Bay Area, you know, 3 bedroom houses that are a million dollars.

Gary: They’re not even Bay Area garages Peter (Peter laughs), it’s one of the reasons so many of our investors are actually kind of…they live on the coasts and live in incredibly expensive real estate markets and they look at what they could get in a market like Memphis, or in Atlanta or Indianapolis or Pittsburgh and it’s incredible that the value and the yields that you can get relative to what you get in these expensive markets, so yeah, I would say that the typical homes on our site are probably $75,000 to $150,000.

We’ve had homes over $1 million on our site, we’ve had plenty in the kind of $250,000 range, but that’s kind of the sweet spot, kind of $150,000 plus or minus and we find that that works quite well because what’s interesting about investing in housing is the yields or let’s just say the rents don’t scale with the home prices. So $100,000 home, the rent on that…or the rent on a $1 million home is not 10 times the rent of that on a $100,000 home so your yields go down generally as your prices go up. So the less expensive the property, generally, the higher the yield and that’s why some of these properties that are sub $100,000 get so much interest on our site because the yields are quite attractive.

Peter: So tell us a sense of what are those yields because obviously you’ve got lots of costs involved. You’ve got to pay property taxes, you’ve got to pay management companies so tell us what can investors expect.

Gary: Sure, so when you buy a property, you get your rent from your tenant, you pay a local property manager unless you want to self-manage. People generally buying through our site pick one of the property managers we’ve certified in the different markets. So they generally charge 7 to 8% of rent to handle the repair & maintenance oversight, collecting rent, doing the leasing, making sure it’s occupied, those kinds of things. So you’ve got that, you’ve got property taxes, you’ve got insurance and you’ve got the ongoing sort of maintenance and repairs of the home.

Typically, if you look at it broadly, expenses might be about 40% of your revenues, kind of 40 to 45% of your revenues would be your expenses so if you had $1,000 of rent, you might expect $500 to $600 of cash flow a month from that property. So if that’s a $100,000 property and you’re getting say $6,000 a year as cash flow that would be sort of a 6% current yield if just look at it on an asset basis and that’s pretty typical. Some of our homes in more expensive markets might be in the 4.5% range, plus or minus, but those are more appreciation plays and so we have people buying homes in more expensive markets that might…the yields might be in the 4’s, but they like the long term appreciation prospects.

And then you have homes that might be less expensive with 7%+ yields that may or may not have the same sort of appreciation characteristics, but have a really nice kind of current coupon and everything in between. When we calculate our returns on our site, we do a number of things, but we look at the current rent that the tenant is paying, we compare that to market rent, which could be higher or lower, we put in an estimate of what real estate tax assessments should be post purchase based on what you’re paying, we estimate insurance costs and repair & maintenance based on the age and sort of vintage and condition of the home and put together a 5-year financial projection.

And we have a pretty robust set of tools so you can say, you know what, I want to increase this expense or I don’t think home price appreciation is going to be 3%, I want to dial it down to 2% and see what that does to my return. So we have kind of a whole series of adjustments that people can make and we encourage people to do that in their underwriting to kind of stress test it and see which investments meet their criteria the best.

Peter: So we haven’t talked about yet financing, I imagine, I mean you tell me, but I imagine most of these houses are financed and that’s not a simple process even today. I mean, I know there’s lots of fintech companies out there trying to make it a simple process, but as of right now, it’s still somewhat of a cumbersome process. Tell us a little bit about how you kind of go through that challenge.

Gary: Sure. So today the actual purchase of the home, we’ve gotten to a fully paperless transaction so we use DocuSign and so investors, if they’re buying for cash, don’t have to deal with paper. The challenge does come in, as you correctly point out, when financing is introduced. That is currently, as you say, is a big opportunity for someone to reinvent.

We work with several lenders and we try to simplify the process the best we can, we encourage people to get pre-approved which can then allow the process to be a bit more streamlined so they really know sort of their buying power and we can just help coordinate and hold people’s hands through the financing process, but yes, you are still getting a loan so you do still have to produce a lot of documentation and there are a lot of things to sign. I think this will be very different a few years down the road, but today it’s still being reinvented.

We are working on some ideas which I hope to implement over the next couple of years which would, you know, allow sort of staple financing where perhaps the valuation could be done upfront so there is no need for an appraisal, for example, so you could know exactly how much you could borrow on a particular property that could really turn a 30-day closing into a 10-day closing, a 10 or 12-day closing, so we’re working on some of those things. It will change over time, but today you are right, that is the long pole in the tent with our closings.

We just closed a transaction yesterday in 11 days which from when somebody hit buy so we can do it pretty quickly, that was a cash buyer, but it’s typically when someone’s getting a loan, you know, 30 days, plus or minus, for the process to go through. A big part of that is the appraisal piece.

Peter: Right, right. So are all the houses on your site, do they all have tenants in them right now? Obviously, what’s the process like because that’s a really critical piece. You’ve got this asset, you really need to have…you don’t want to go a month or two without tenants so what percentage of them have tenants in right now?

Gary: Yeah. So the vast majority of them have tenants. The ones that don’t have tenants, we offer a rent guarantee program so it’s really a lease up guarantee so the idea is you either buy a house with a tenant in it, or you know with certainty it will be leased in a reasonable period of time and if it’s not, Roofstock will cover the rent. What our rent guarantee…the way it works is we’ll pay 90% of market rent until it leases after a 45-day period. So if it doesn’t lease up within 45 days of you buying it, our rent guarantee will kick in and we will cover 90% of the rent until it does.

It’s a pretty rare circumstance that that happens which is why we’re happy to do it and stand in that position.  You have to be using one of our certified property managers who, obviously we have confidence in and the reason it’s 90% is that is essentially which you would get anyway after paying your property management fees. You’re sort of being made whole there and we’re happy to offer that on homes that are vacant so that’s another way we help people get comfortable with the asset class.

Peter: Right, right. Okay, so let’s talk about the investor, I mean, obviously this is real estate, you do not need to be an accredited investor to buy an investment home so I imagine you work with all kinds of investors. Maybe give us some sense of the typical investor on your platform, like how much they put in, how many homes do they have; just tell us a little bit about them.

Gary: Yeah, so the demographic skews a little bit younger obviously because we’re an online model. I would say 35 to 55 is kind of the sweet spot of our investors, they do come from all over the country, certainly all over the world actually and the average retail investor is buying about 1.7 homes, so far, so not quite 2, but I think a lot of people are buying one home now and are looking to maybe buy a home a year as part of a retirement program.

There are a lot of advantages to buying real estate, as you know, it’s tax efficient and all that, leverage is readily available so that is something that our advisors can kind of work with people to help them figure out…okay, if you have long term objectives, we can help you figure out how can you get there over time.

And then we have institutional investors as well who are large institutions and they come from all over as well, they tend to be cash buyers and don’t necessarily need our property management services or anything like that. But as a marketplace, both on the buying and selling side, we encourage participants of all sizes.

Really at the founding of the company, part of the premise was we would like the average investor to have access to the same homes and the same tools at the same prices as the largest institutional investors do and that’s what we’re doing. You could call it sort of democratizing the asset class is one of the terms we use here internally. There are barriers for people to be able to really invest in the asset class if you’re not a professional investor.

So we’re trying to take a lot of the knowledge and tools that we had at our prior large institutional platforms and make them available to everyone and as you say, you don’t need to be an accredited investor, the majority of our retail investors are not accredited, some are, but the majority are not.

We are actually going to be launching a new product shortly that is for accredited investors so I’d be happy to…if any of your listeners are interested in that product, we’d be happy to…if they want to email me just at gary@roofstock.com I’d be happy to put them on the list and we could get them some information on that, but that will be for accredited. That’s a pretty revolutionary product and approach to investing in real estate that we’re excited to talk about.

Peter: Okay, so we’re getting close to our time and I really want to dig into this piece because it strikes me that this is a very data-driven business. I see two things; one, you’ve got to decide…you go in here and obviously you’re in Akron, Ohio or Indianapolis, St. Paul, Minnesota, Memphis, Tennessee so you’ve got to go into a city where…you firstly have to choose a city out of all of the cities in this country, you’ve got to choose the cities that are going to be right and then within that city you’ve got to choose the houses that are most appropriate. So tell us a little bit about that selection process, how you go through that.

Gary: So what we do is we have a pretty good size data science team here and we look at all sorts of data, as you might imagine. We rate neighborhoods, we look at trends, we look at yields, we look at home price appreciation forecasts and try to identify markets and sub-markets that look interesting. But what’s an important point to make is also as a marketplace people are free to make their own decisions on whether Atlanta is a good market or a bad market. Just because it’s on Roofstock doesn’t necessarily mean it’s a good market, it means that it’s a market that has buyers and sellers and obviously there’s two sides of every trade.

When a home trades somebody feels like they’re getting a good deal buying it and somebody feels like they’re getting a good deal selling it. So we’re not going to go into areas that we feel are dangerous or really, really bad areas to invest in so there’s sort of a minimum bar where we feel that these are good rental markets that have good rental demands and should perform reasonably well over time. But there are people who look at the same market and say, well geez, I’d never invest in that area and others look at it and say, well, that’s exactly what I’m looking for.

So how do we do that? We put a lot of data out there and we have ratings of neighborhoods that are a proxy for risk so you could invest in a 4-star neighborhood that has very high school scores and high levels of owner occupant residency and very low levels of crime, birds chirping, etc., pretty low yield, but probably pretty stable.

And you could go into areas that might be in our neighborhood rating…maybe it’s a 2-star neighborhood where the home prices are a bit lower, there might be a bit higher turnover, but the yields are quite high so it’s almost…are you an investor that wants a triple A bond, or a government treasury and you’re going to get a low yield with certainty of repayment, or do want to buy a junk bond and get paid for the risk.

So real estate is very similar and to my knowledge there really aren’t other platforms out there that are trying to really assess and give people an ability to associate sort of risk with return. That’s what we’re doing and so we’re continuing to have our data science team improve those models and, you know, we’re looking to add more and more kind of features there to create more and more sort of transparency and more ability for people to decide what is good for them. That also being said, we’re working on some pretty interesting algorithms that are individual recommendation engines.

For example, based on you and your profile and your objectives, we could recommend a very specific investment strategy or portfolio that is right for you and that’s in beta right now. We’re working on some of those tools that can help separate and synthesize the…you know, out those 300 and some odd homes that are out there, what might be the three to five homes that are ideal for you. Right now, the way we do it is people sort of do it themselves or they talk with one of our advisors here who could held them think through those strategies and that works well too. But as we’re gathering more and more data, we’re going to be able to do that more in an automated way and allow people to do it for themselves.

Peter: So then how do you choose…obviously, if you go into a city you’ve got to have inspectors in place, you’ve got to have management companies in place. You’ve got to have a whole bunch of infrastructure I imagine in place and I presume you’re not in all the cities you want to be, I mean, like how are you thinking about expanding and when will you be in all the cities you want to be in?

Gary: Yeah, so we’re in roughly 30 cities around the country now. We’ve sort of probably doubled in the last year, we’re rolling out about a city a month. So with our model, we’ve gotten entering into a city down a bit to a science where we go and identity the best local property managers, we find great local inspectors, they use our app to do the inspections so we can roll into cities pretty easily. I would say as we look out over the next year, my guess is we’ll add another dozen to 15 cities.

I know there’s at least a hundred that are on our long term target list where we’d like be and we’ll just kind of methodically roll out to them, but what we found is, it’s interesting, unlike some models that do have a lot of infrastructure requirements, ours is actually pretty light so we can go broad as opposed to necessarily going deep in expansion and there’s some network effects that we’re finding. By going to multiple markets, we can service sellers who have properties across lots of markets.

Actually, some of our sellers have encouraged us to go into certain markets before we had planned on doing it because they may have a few hundred high quality houses they wanted to sell and we could use that as a catalyst to go into a market. We went into Charlotte that way, for example, for one of our larger clients and we were live in Charlotte and that’s been a great market for us.

Peter: So then are you constrained by growth on the supply side of inventory of homes or the investor side or are they both matching perfectly?

Gary: (laughs) That’s the one thing I can tell you (Peter laughs) it’s never matching perfectly as a marketplace.

Peter: I know. (laughs)

Gary: We kind of joke that it’s sort of like you’ve got scaffolding on two sides of a wall, you build up one side and then you look and you’re like, whoa, I need to build up the other side. So, depending on what day it is, Peter, I’ll tell you, I’m either more focused on supply or demand which…I would say, generally with this product supply is probably a bigger challenge than demand. I don’t want to say there’s limitless demand, but our product is unique, the way we acquire and curate the inventory is unique and what we find is when it’s the right inventory and it’s presented properly, it sells very quickly.

And we have, you know, lots and lots of customers who are online waiting to get notifications of properties that meet their buy box. We know what those buy boxes are because people fill it out and we go try to find that inventory to fill those orders. I would say, if I had to pick, it’s more kind of a supply challenge long term. We’ve done some interesting things, speaking of data science, we’ve mapped all 16 million rental homes in the country and we know who owns them and we have a view on their value and their rents and we know how to contact them.

Peter: Interesting.

Gary: So that was a big data science project, took us about a year, but now we can reach out specifically to owners of properties that we think are excellent candidates for our marketplace and help kind of secure inventory for our clients who are saying, hey, I want these types of homes. So that’s kind of a way to help fill that supply bucket in a very targeted way using our data science.

Peter: So can you give us a sense of the scale you guys are at, I mean, how many closings are you doing a month these days?

Gary: Yeah, I’ll just sort of give you a sense, so in 2016, we sold about 320 houses, that was our first year of operation. It was about $40 million of property value. Last year, 2017, we sold just under a billion dollars worth of property through the marketplace, it was about $970 million, that was about 4,300 homes. But keep in mind, there are about a million investor transactions a year nationally and we did 4,300 so we feel like we’re literally scratching the surface, but that’s one of the reasons that I think real estate, fintech or proptech is so interesting, is the market is so big. It dwarfs pretty much any other industry out there, real estate does, especially residential.

So we look at that and we say, well gosh, 4,300, why shouldn’t it be 43,000, right, that’s still tiny compared to the overall market so there’s a lot of headroom there, but that just kind of gives you a little bit of an idea of the scale and the trajectory.

Peter: Right, so then leading into my last question, what’s your vision for Roofstock? Do you want this to be…you know, 50% of that market, what is your long term vision?

Gary: Well if we could get to five I’d be very happy (Peter laughs). So we have kind of near term and then longer term visions. So clearly building out this marketplace and single family rental domestically is a big part of our current plan, but ultimately we want Roofstock to be a global exchange for real estate across property types.

So when you think about the opportunity to do what we’re doing in single family rental which is a $3 trillion addressable market. Across small multi-family, for example, which is another $3 trillion market just domestically…when you think about doing this in other markets around the world, there’s…and building an exchange where these properties or fractional interests in these properties could be traded really efficiently, that’s the long term vision.

So you’ll see when we launch our new product, which I referenced earlier, that is a product that ultimately can unlock value in a very, very efficient way and can be fractionalized. So ultimately, I’d like Roofstock to be viewed as sort of the NASDAQ, if you will, of real estate and we’ve got a long term multi-year plan to do that. It’s a pretty bold vision, it’s not going to happen overnight, but we like to say around here…oftentimes, we have 20 years of ideas (Peter laughs), we’re trying to do them faster than that, but there’s no shortage of ideas. I’m looking at our whiteboard right now in our main conference room, there’s a lot, but there’s a lot of opportunity.

Peter: Okay. Great, well we’ll have to leave it there. Fascinating having you on the show today, Gary, I really appreciate it.

Gary:  Alright Peter, enjoyed it. Thanks.

Peter: Thanks. See you.

Gary: Okay.

Peter: You know, one of the things that I really love about the Roofstock model that they have pioneered here is it enables individual investors, obviously non-accredited or accredited, to create a real estate portfolio in a way that is hand-curated. You can have a diversified portfolio across different kinds of geographies, across different kinds of neighborhoods across geographies. What struck me after we hung up the phone is that a lot of people own their own home or they have significant equity in that home, but that is one home in one location, and obviously that is not diversified.

It is far better when you look at your real estate bucket of your portfolio to be a lot more diversified. I really believe, whether it’s Roofstock or other platforms like it, I think people who will want to make an investment in real estate, this is going to be the way they’ll do it; it’s simple, it’s effective and it’s a way to build a portfolio that is truly diverse.

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 USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8th through 9th, 2019, at Moscone West in San Francisco. Registration is now open and we are also taking speaker applications. You can find out more by going to lendit.com/usa.

 

PODCAST TRANSCRIPTION SESSION NO. 171/ANJU PATWARDHAN

Welcome to the Lend Academy Podcast, Episode No. 171. This is your host, Peter Renton, Founder of Lend Academy and Co-Founder of LendIt Fintech.

Today’s show is sponsored by LendIt Fintech USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8th and 9th, 2019, at Moscone West in San Francisco. We’ve recently opened registration as well as speaker applications. You can find out more by going to lendit.com/usa.

Peter Renton: Today on the show, I’m delighted to welcome Anju Patwardhan, she is a Managing Director at the CreditEase Fintech Fund. She has also been a Fulbright Fellow and Visiting Scholar at Stanford; she’s had a very distinguished career in banking, she’s worked with the World Economic Forum and much more. So I wanted to get Anju on the show, she’s got a very unique perspective and the reality is that the CreditEase Fintech Fund has become one of the most prolific VC investors in the fintech space, particularly when it comes to the US and China, and they’ve got a unique perspective.

As I said, they haven’t been around that long and they’ve already made dozens of investments. I wanted to get Anju to talk about their investment philosophy, what they look for in fintech companies when it comes to investing. We talk about CreditEase, the company a little bit and how the money is raised for this fund, we talk about the state of fintech today and where the biggest opportunities lie. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, Anju!

Anju Patwardhan: Thank you, Peter, glad to be here.

Peter: So you’ve had a very interesting career to date so why don’t we get started by giving the listeners a little bit of background about yourself and what you’ve done in your career.

Anju: Sure, I currently work with CreditEase, which is a fintech company from China and I’m based in the Bay Area. Prior to that, I spent most of my working life in banking; I worked with Citibank and with Standard Chartered Bank. I lived in Singapore for about 20 years and then moved to the Bay Area two and a half years ago, did a variety of roles when I was at these two banks, some years in India and then several years in roles covering Asia Pacific and also global roles.

I grew up in India and studied in India as well. I did my engineering degree from Indian Institute of Technology and then I did my MBA from Indian Institute of Management. I actually joined Citibank right after my MBA as a management associate and was there for several years after that. Peter, I also want to add that I do listen to your podcast regularly and I enjoy it.

Peter: Oh, thank you.

Anju: I do learn about companies that were not on my radar then I find out about them through your podcast.

Peter: Oh, that’s good to hear.

Anju: Thank you for doing this.

Peter: Of course, of course, I enjoy it immensely.

Okay, so then how did you get connected to CreditEase, I mean, we know CreditEase. They’ve been at our LendIt events for many years, but I’m curious to know how you got connected.

Anju: Yeah, it was a little unusual and great in some ways. In my last job at Standard Chartered Bank, I was the Global Chief Innovation Officer, and one time I was speaking at a panel at the World Economic Forum, at the summit I was. The panel was on crowdfunding, and I was the banker on the panel and Ning who has built this great company in China, he was there as a founder and then there were two other people. It was one of those CCTV panels which was later going to be broadcast on national television in China and that was the first time that I met Ning Tang, who’s the CEO, Founder and Chairman of CreditEase.

We kept in touch after that and I think met again at the World Economic Forum and a couple of years later when I was in the process of leaving Standard Chartered Bank, I was about to come to Stanford and move to the Bay Area, I was on my notice period and Ning was in Singapore for some business meetings. We ended up meeting for breakfast and I realized that the company had grown significantly from when I first knew of CreditEase.

It had started as a marketplace lender, but in the previous years it had also expanded into wealth management, asset management and insurance. It had started several funds and Ning asked me if I would like to join CreditEase. You know, during that one week that he was in Singapore, I think we met for breakfast three times, three really long breakfast meetings, about two to three hours each time, and by the end of the week, I had decided to join CreditEase and it’s been a wonderful journey since then.

Peter: Right, so you joined with the intention of setting up this VC fund? Was that how it kind of played out?

Anju: Not exactly, I joined because I think the real need Ning had was all of the different things that I had done in banking. He wanted people who could help with the CreditEase business in China in different aspects. So there were no clear mandates, but it was more like join us and see how you can help the company, but he also mentioned to me that they had just started a fintech fund, they had started a VC, PE fund of funds a couple of years before that. There was a real estate fund of funds so I started getting involved in some of these things and I joined the investment committee for the fintech fund. And then over time, it became more of like where could I add value living in the US because the company’s core business, as you very well know, is in China.

There are over 40,000 employees in China focused on core lending, wealth and asset management business so I was the first person to be in the US and then I started spending more and more time on the investment and on the VC fund. I think the fund had been set up in March of 2016 and by the time I joined, I think two investments had already been made.

Peter: Okay, so then what is the fund’s mandate, who are you trying to focus on when you’re investing money? Also, maybe tell us the size of the fund, because I know it’s one of the largest funds in the world when it comes to fintech so can you tell us a little bit about the fund.

Anju: Yeah, in terms of size, it’s a billion dollar fund, half of it is in US dollars and half in RMB. The mandate of the fund is basically to invest in and partner with entrepreneurs who have a unique approach to core challenges in the financial services space. It’s a fintech fund, but it’s a broad definition of fintech so we invest in companies that are in lending and the related ecosystem; we also invest in wealth and financial planning companies, insurtech, payments, enterprise software solutions. We invest in companies that are in B2B, B2C, B2B2C so, you know, also Regtech so yeah, it’s a broad definition of fintech.

Peter: Right, okay. So then what do you look for…is there something specific that will cause a startup to get on your radar, is it growth, is it a big market opportunity? What are you looking for when you’re considering a company for investment?

Anju: We primarily invest in growth stage companies so that’s companies which are raising…generally raising Series B onwards. Now we have all kinds of exceptions to various things, but I would say the broad mandate is Series B onwards. Again, the broad mandate, in terms of geographic focus, is investing in the US and China and also in the UK and EU.

We look for strong founding teams, we look for management teams which have an exceptional execution capability and given that it’s a fintech fund, we definitely look for the management team which has deep domain expertise in both finance and technology. So that’s our main focus.

Peter: Okay, and so I noticed recently…I mean, pretty much all the listeners will know Renaud Laplanche, the former CEO of Lending Club, now the CEO of Upgrade, and this was actually a company that I believe you led the recent funding round in Upgrade. So tell us what attracted you to that business.

Anju: Yeah, so you know, as I mentioned, we look for exceptional founders with very strong execution capability and a strong management team and Upgrade ticks all of the boxes. Renaud is an amazing founder, he has an amazing management team, strong expertise in finance and he attracts very good people and we like the company because of the business that it focuses on and also the additional focus that they have on credit health and financial literacy in Upgrade.

The company started with personal loans, it’s already launched a personal line of credit and intends to go into other products as well. CreditEase, as you know, is also in marketplace lending. We started in China 12 years ago as a peer-to-peer lender and we are probably the largest marketplace lender in the world, but we operate only in China.

CreditEase started at almost the same time that Lending Club and Prosper started in the US and therefore, the founders have also known each other for a very long time, have tracked their respective companies and we have a huge amount of respect for what Renaud has built. In the past, we have not been leading rounds, we generally do follow on investments partly because our fund was new. We didn’t have the resources or the bandwidth to do these things and as we got more settled and well resourced in the US, we may be doing more of this.

Peter: Right.

Anju: So far from our fund we’ve made about 45 investments, we are now the second most active fintech fund globally, according to a report from CB Insights and out of those 45 investments, I would say about 25 are in the US, maybe 12 or 14 are in China, five are in the UK and then I think two in Africa and one in Singapore. So we’ve now realigned our resources, we have team members now in China and in the Bay Area so that we can continue to do more in these two markets and we also have a couple of people in London. So now our team distribution and composition is more aligned towards the strategy that we want to follow.

Peter: Right, got it. So I’m curious, you said you spent 20 years in banking and now you’re evaluating fintech investments, how has your experience in banking helped you in making good decisions for investing in fintech?

Anju: Peter, that’s a good question. When I first started doing this and when Ning asked me to start getting involved in this, to be very honest, I did not think that I would know how to do this. I think I kind of underestimated my own experience and knowledge, but in the last two and a half years that I’ve been doing it, I realized how helpful that experience has been.

So when I joined Citibank in India, I was part of the initial team that launched most of the consumer lending products in India. I was there when the bank launched mortgage loans, auto loans, share financing, credit cards; we were the first credit card in the country, and also SME lending. It was like being in a very fast growing startup, right, the businesses were growing so fast that we were constantly trying to figure out, okay, now I need to set up a collections team or now I need to add more underwriters or now I need to upgrade the system or I need to outsource to external partners to be able to deliver the growth.

So it’s a great experience being part of that journey and then I moved to Singapore where I was then in various regional roles. I was the first Digital Banking Business Head for Asia. In those days it wasn’t called digital banking, we just called it internet banking and mobile banking, right, so it was the first time that Citi was launching internet banking and mobile banking and e-statements and sms alerts in different Asian countries.

It was great to be part of the team which was working on the strategy…I worked on the strategy, we did the rollout and then we were involved in selecting partners and also trying out different marketing tactics in different countries to increase consumer awareness and engagement and that…you know, while I was doing that job, I covered all of Asia, all the way from Japan to Australia and different countries in between and that was a wonderful experience in terms of looking at how financial institutions select partners, you know, so when you’re working with B2B fintech companies.

It was also a very good experience because we made some mistakes. In some cases, we worked with companies which were at a very early stage and then didn’t exist two or three years down the line. Again, you know, that whole notion of looking for stable funding, certain level of growth, who their backers are, who are the investors; all of those became quite important.

Peter: Got it.

Anju: And then after that I became the Consumer Finance Credit Head for Asia and we were involved in launching these products that I mentioned earlier in different countries. Some countries we already had the products, in some countries we were rapidly growing them, and in some other countries, during the time I was there, both at Citibank and at Standard Chartered Bank…you know, I’ve also been in various roles during the Asian financial crisis, during the global financial crisis, during the [inaudible] crisis and saw periods of amazing growth in many countries, in some countries we also had to shut the products down.

Peter: Right.

Anju: And that also was an important lesson on what are the things to look out for, or what prevents you from getting to scale or how to be very mindful of the regulatory environment. So I think all of these experiences have significantly shaped our fund in the way we look at fintech companies. So when we look at B2B companies, my own experience of having been in a management team, at Standard Chartered I was part of the Global Operations and Technology Management Group and we used to partner with a lot of companies so that helps us a lot when we’re looking at B2B fintech companies.

When it comes to B2C companies, we are then looking for how they operate and what could potentially be their strategic advantage when they are trying to compete with large banks and financial institutions, or maybe the other way around is what are the barriers within large banks and therefore they provide opportunities for these companies to be able to compete and grow. And then our fintech funds team…the other team members also have very rich backgrounds.

Most of the team members have previously worked in private equity firms or in the M&A teams in investment banking, most of them have either lived or studied in the US and then gone back to China so they’re very familiar with the environment, both in the US and in China and that helps us move very fast. You know, a lot of people say, how did you guys make so many investments in two and a half years?

Peter: Right.

Anju: And I just say, partly because we have an amazing team with really big domain expertise.  So when we meet the companies, most of the time after the first meeting, we have a good sense of whether we want to move forward or not, right, because we’ve all been in this for a very long period of time. And I think, being a distributed team in the US and China allows us to work at double the speed, like the team here does external meetings, we do calls, you know, we have a lot of contacts in the industry and usually after 4 p.m. we start having calls with our team in China, like 4 to 7 is typically our China/US call time.

Peter: Right.

Anju: And then the people here go to sleep and the team there gets to work and by the time you wake up, a lot more has already been accomplished so I think it allows us to move much, much faster.

Peter: Right, right. I have met several members of your team and I’ve always been very impressed with the quality of people that you’ve attracted.  So then do you feel like given that…I mean, you are unique insofar as you are a very international team. I don’t think anyone was born in America in your team so do you feel like you’re very different, that gives you a different perspective from other VCs who are entrenched Silicon Valley VCs that a lot of people know, but they’ve got a different sort of team to you guys. Do you feel like you’re different because of that?

Anju: I think we’re different in several ways. First of all, you know, we are very unique in terms of the way we’re structured. We are not a typical VC fund, we are also not a corporate VC, we are not investing balance sheet money where we have to have a strategic angle, we are not that. If I go back to the CreditEase lines of businesses, I mentioned that we have wealth management, asset management and marketplace lending. So as part of our wealth business in China, we offer robo advisory for mass affluent clients and then we have a private banking business for our high net worth and ultra high net worth clients.

We have over 3,000 relationship managers, we have very high end branches for such clients and we offer several proprietary funds to our private banking clients, right, and that includes our VC/PE fund of funds, real estate fund of funds, we have a credit fund that buys whole loan portfolios, we have an [inaudible] fund, we have a fintech fund so these funds are not balance sheet money. These are the funds that we are offering to our high net worth clients and they are offered with the primary objective of generating financial returns so there is no strategic angle. I think that’s one area where we are very different.

The second angle there I would say we are very different is because of the entire ecosystem, right. So we have a fintech fund which makes direct equity investments because we feel like that’s the only thing we know really well. We don’t know biotech or pharma or other things, but we do know fintech, but then through our VC/PE fund of funds, we are limited partners in over 20 funds and very large private equity firms in the US, China and elsewhere in the world. Through that, we have access to a lot of knowledge that they share with us, or sometimes the deal flow which comes through the funds that we are LPs in. That makes a difference.

Peter: Right.

Anju: And then we have a credit fund, right, which can offer debt. Most VCs can’t offer debt and equity, but we can offer debt through our debt fund as well. And then we have a real estate fund, fund of funds, which invests in REITs and real estate projects.

So through the ecosystem, we’ve built a very, very strong network, both in China and in the US which helps our funds….I think the third angle where I would say we are unique, is that our US dollar fund invests in both US and China, right. We meet a lot of people, even in the US, who are looking for exposure to China, but China is one of those markets where you have to be on the ground to be able to assess opportunities and make good decisions.

Peter: For sure.

Anju: Yeah, so our USD fund allows our investors to get some exposure to China and also to other countries.

And then the last thing I would say is that while the reason for our investment is not a strategic investment we can be very helpful to our portfolio companies if they have plans to be in China, or quite often they go to China for fundraising and we can help them in terms of introductions to other funds or to other potential LPs.

If they want to do business in China, we can introduce them to partners, help them understand the regulatory or legal environment, or introduce them to people who can explain all of that. In some cases, if there is a possibility for CreditEase to be their client in China then that’s great, but that’s not a necessary condition.

Peter: Right, right. Okay, so then if there is an entrepreneur listening to this show who’s looking for funding, how easy is it and what do they have to do to get on your radar?

Anju: A lot of people reach out to us directly. You know, initially like two years ago, most people did not know of CreditEase in the US, but I think now a lot of them, especially the fintech companies, know us. There’s a very high chance that we may have already met them, but if not, they reach out to us either through LinkedIn or you know, we are very active at various conferences and they can find us there or they can just get an introduction to us through other VCs, other founders.

Yeah, there are so many ways and then people can find out more about us on our website which is cefintechfund.com. There is also a CreditEase.com website, but that’s the parent company, that site, and a lot of it is in Chinese and English, but for the fund it’s cefintechfund.com.

Peter: I will link to that, I will link to that in the show notes so everyone can go there. It’s an English language site and it’s great. So, we’re getting close to time here and there are a couple of things I really want to get your take on here. You’ve invested across fintech, obviously you know the marketplace lending space intimately well, but I’m curious to get your take on…when you look at fintech today, where do you see the biggest opportunities?

Anju: I would say that we are just about getting started in fintech, right, the whole fintech landscape. Initially, until about three years ago, 75/80% of the investments were just going into payments and lending and now we’re starting to see a whole range of opportunities coming up in the B2B space, whether it’s B2B payments or it’s capital markets or it’s trade finance, the SME ecosystem, on the wealth management side, micro savings, micro earnings. So I’m very excited about this space. I think we’ve just barely scratched the surface and we’re going to see a lot more.

In fact, last year in the US, 65% of all VC investments were in B2B fintech companies so we are going to start seeing more and more collaboration and partnership with banks. And then, I’m also very excited about what the big tech companies like Amazon and Google and Facebook are doing. That’s also something that they’re very mindful of.

Both Google and Facebook are experimenting with P2P payments in India which I’m sure they intend to take to other countries. And as I talked about getting into insurance and other areas, I think it’s very exciting, it’s going to be great to see how it pans out over the next five, ten, fifteen years and I’m really looking forward to it.

Peter: Right, yeah, that makes sense. We were chatting before we hit record and you were talking about…you were a Fulbright Fellow at Stanford focusing on fintech and financial inclusion, can you just explain some of the work you were doing there at Stanford and maybe what you’re doing today at Stanford?

Anju: Yeah, sure. So you know, when I was with Citi, I mentioned earlier that I was the Consumer Finance Risk Head for Asia, the Chief Credit Officer. We often had this problem that the customer segment, the near prime customer segment that we were trying to reach out to…the underwriting cost was too high and a lot of these countries did not have a bureau or those consumers didn’t have a bureau score, distribution was always a challenge, CAC was high and therefore, the economics didn’t make sense in several of these countries.

In some cases, the bank had to scale back or exit the market because of these challenges and then when I moved to a different role, when I became the Global Chief Innovation Officer at Standard Chartered and I started meeting a lot of these companies which were doing marketplace lending or which were using technology to make better credit decisions, whether it was using data science or AI or machine learning, I got really excited about it. To me it was like, okay, here is a solution to all of those things that we could not solve for in those days, right, and especially with increasing use of smartphones, it also solves the distribution problem.

With online access, you don’t need physical branches to be able to reach people so my research at the time when I came….so when you apply for the Fulbright Visiting Scholar Program, you have to pick a topic and write a short paper on why that topic. So the topic I picked was the use of technology to support financial inclusion for lending and in a for profit way, right. The reason I chose that was because even in my own organizations I felt that either people were not aware of financial inclusion, or even if they were aware of it, they often thought of financial inclusion that was either done at CSR or it was done as philanthropy by foundations.

Basically, the notion was you could not make money in this, right, and that’s why many large financial institutions stay away from it and what I wanted to do was to somehow learn more about it and then be able to showcase to large institutions that you can do it in a scalable way using technology and you can make money.

As I got more and more into my research, this program was for five months, I realized that it was indeed true. In fact, earlier this year, we published a paper, more like a report, jointly with Stanford Business School and with IFC, it’s called “Financial Inclusion in the Digital Age.”

Again, in that paper we talked about the various frictions, the biggest problems that consumers face and how fintech companies can help solve for those problems and make money at the same time. We featured 100 companies that are doing this all over the world. In fact, we picked companies which are already Series B funded or more, right, VC funded because that kind of makes the point that they’ve got VC funding, they’ve gone beyond Series B, they are mission-focused, but at the same time also focused on the bottom line.

We’ve covered companies in lending, in payments, in financial planning and also in insurance because the other misconception people often have is when it comes to financial inclusion the only thing offered is access to credit, but you know, it’s just not access to credit. The problem is also inability to save or lack of access to insurance or lack of access to low cost payment options so we’ve tried to talk about all of those things.

Also, last year, Stanford Business School, I think it was the first business school in all of the US…it launched a program on fintech and I worked closely with Professor Ken Singleton as the program was being finalized in terms of what should be covered and eventually the title of the course became “Innovating for Financial Inclusion” and Ken was wonderful in the way he structured the course.

I helped a little bit in terms of getting a few guest speakers and I also taught some of the classes jointly with him and we found a huge amount of interest and passion amongst the students to take this forward so that’s how I did that. I am still affiliated with Stanford, but now it’s more as a Fellow at the Distinguished Careers Institute and I occasionally teach some guest classes, or you know, I’m looking for like what paper should we write next, but it’s a very limited engagement but it’s just great to be part of the Stanford community.

Peter: Right, right. I will also link to that paper that you did with the IFC. I feel like that’s…this is something that I feel personally strongly about, you know, we really should be attacking financial inclusion in a bigger way in fintech. It’s great that you are sort of leading the way here when it comes to putting that message out there.

So we’re out of time, but last question. Given your perspective, you do have a very unique perspective here given…you’ve worked in the developing world for large banks, you’re looking at a lot of startups now and you mentioned Amazon, Facebook, Google are big tech companies, but where do you think the future of fintech is going to kind of…or who’s going to dominate the future of fintech? Is it going to be the banks, is it going to be the technology companies, or do you think that entrepreneurs are going to continue to create great new ideas, or is it going to be like a combination of all three?

Anju: I would say that it is going to be a combination. I think it’s going to be more of a symbiotic relationship between banks and fintech companies and the ultimate winner is going to be the consumer. In some areas, in some B2C areas, I think no one should underestimate the role that the big tech companies are going to play, especially when it comes to B2C payments, but you know, in a lot of other areas the banks and fintech companies will continue to have a very significant role to play.

I’m a member of the steering committee on Disruptive Innovation in Financial Services with the World Economic Forum and I’ve been involved with the forum in some of the reports that got published. There was one on fintech, in general, there was one of digital identity, AI, blockchain. You know, when it comes to a lot of emerging technologies like using artificial intelligence and machine learning, banks are usually much slower to move forward, whereas the fintech companies are much more nimble, more agile; they’re able to innovate faster.

And then, sooner or later comes the time where they can either collaborate or the banks can adopt new technology so I see a strong role for both; banks with their access to low cost of funding, with regulatory knowledge, with licenses, with the capital markets infrastructure and then the fintech companies which are nimble, faster, innovative, very digitally savvy and I think the combination is what is going to help us move forward much faster.

Peter: Yeah, I agree. We’ll have to leave it there, Anju, I really appreciate you coming on the show today. 

Anju: Thank you, Peter, really enjoyed it. Thanks.

Peter: See you.

First, let me apologize for the sound quality of my voice during that episode. I made a mistake in inadvertently had the wrong audio source dialed into the computer here so apologize for that. I will be sure it doesn’t happen again.

Anyway, just wanted to follow up on some of the things that Anju was talking about there, the future of fintech. You know, I think entrepreneurs have a history of looking for gaps in the market and filling them with new and better and quicker ways of doing things and I think…I really feel that while banks are going to be a huge part of fintech going forward for decades to come, there will always be entrepreneurs coming in and working with the banks potentially, maybe even working with the Amazons’ and Googles’ of the world. But there will always be entrepreneurs coming in and making the experience better for the customer, making it cheaper and making it faster. I feel like that is going to continue forever because I think humans have a tremendous ability to think outside the box and innovate.

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 USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8th through 9th, 2019, at Moscone West in San Francisco. Registration is now open and we are also taking speaker applications. You can find out more by going to lendit.com/usa.

 

PODCAST TRANSCRIPTION SESSION NO. 170/DAN QUAN

Welcome to the Lend Academy Podcast, Episode No. 170. This is your host, Peter Renton, Founder of Lend Academy and Co-Founder of LendIt Fintech.

Today’s show is sponsored by LendIt Fintech USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8th and 9th, 2019, at Moscone West in San Francisco. We’ve recently opened registration as well as speaker applications. You can find out more by going to lendit.com/usa.

Peter Renton: Today on the show, I’m delighted to welcome Dan Quan, he is the former head of Project Catalyst at the CFPB. That’s their division that is focused on innovation and so I’ve been wanting to get Dan on the show for a long time, but while he was at the Bureau it was just not really possible.

Now he has left, he has actually just recently written an op-ed in American Banker which we talk about in some depth. We also talk about what the role of government should be in encouraging innovation, we talk about some of the wins that Dan had at the CFPB with Project Catalyst, why the work they’re doing is important and really what it should look like going forward and how the government can really encourage financial innovation. It was a fascinating episode, I hope you enjoy the show.

Welcome to the podcast, Dan!

Dan Quan: Thank you, Peter, for inviting me.

Peter: Okay, so let’s get started by giving the listeners a little bit of background about yourself and what you’ve done in your career to date.

Dan: Sure, again, thank you Peter for inviting me. This is a great opportunity to introduce myself to you and to your audience. Of course, we have known each other for quite some time. So I started my professional career as a management consultant helping Fortune 500 companies and large private firms to manage their financial risks posed by their pension plans.

Then since I always had an itch for politics and policies, I ended up going to Harvard Kennedy School and spent two years there and that’s where I developed a strong interest in consumer finance. So after Kennedy School, I worked for Professor Peter Tufano at Harvard Business School who is a guru on consumer finance. Around the same time, he left Harvard for Saïd Business School so he is now the Dean at Saïd Business School at Oxford.

I also came down from Boston to Washington DC and joined the Consumer Financial Protection Bureau or CFPB. At the CFPB, I started working in their policy shop called Research, Markets and Regulations, I was in the markets group, specifically on the payments team, managing emerging payments, mobile payments, cryptocurrencies, that kind of stuff. Then after about two years, I joined Project Catalyst and that was in the summer of 2013 actually, that was six months after the initiative was launched and had been leading office ever since.

Peter: So you were at the CFPB pretty much at the beginning then, I take it, right after it was founded, right. It says here, was it 2011 that you started there?

Dan: Yeah, that was July 2011 so I think two weeks after I started, maybe a week after I started, the CFPB officially opened its doors.

Peter: (laughs) Okay, so that was the very beginning. Tell us about Project Catalyst, that’s sort of how I’ve gotten to know you over the years, running that effort inside the CFPB. Tell us about why it was started and what its mandate was.

Dan: Right, the mandate actually is very simple, has been very simple. I even think even with this new Office of Innovation when it was announced in the summer, the mandate hasn’t really changed per se. So the mandate has always been to promote consumer friendly innovation, but honestly, back then, Peter, fintech was just a term. I don’t think fintech, the term fintech, was as popular as it is now, as it is today.

Peter: Oh, for sure.

Dan: We literally, frankly, as a new agency, we sometimes call us a startup, we had no idea what we were going to do, but we just felt that this was the right thing to do. We see so many innovations coming up from Silicon Valley, from New York, from all parts over the country and the world that Washington DC just was not ready to really handle, to really…not to handle, not to understand to start with.

So we believed the first thing we should do is really try to understand them better and see what these people are trying to do and what sort of implications there are for policies, for regulations. So we had a flashy PowerPoint slides back then, but frankly we did not know what to do (Peter laughs) other than…yeah, more outreach or maybe running some pilots, maybe get some work data, maybe start developing the trial disclosure policy. I think that was just early on. So when I joined this initiative, I frankly didn’t have a very full idea how we should make this office work.

The first thing I did was I told my staff, I want to be the first, and what that means is I want to be the first….we will not be the first to develop these innovative products and services. These are the jobs for the VCs, for the entrepreneurs, but I want to be the first. The Bureau wants to be the first to really identify these new things, the new trends and we want to be the first to think about policies, long term and short term.

So, naturally, we were…I think my idea actually worked and we were the first one, I believe, to look into cryptos, back then it was only bitcoin, that was even before ether was created. That was bitcoin and I spent a week in San Francisco, in the Bay area, meeting with Coinbase, with other financial VCs, entrepreneurs who were trying to think about how to take advantage of this new development which was really, really…even today, was still quite stunning for many of us in the financial services space.

I think I missed the first LendIt because I was in San Francisco with a very small private conference, I couldn’t go, but I think I’ve attended LendIt ever since, every LendIt, I’ve never missed one and I think the Project Catalyst office was the first one that actually recognized the sort of the emerging trend in marketplace lending, in peer to peer lending. Even today, after…many of the companies in the peer to peer space have become so big they are sort of out of the normal portfolio of Project Catalyst. These founders and CEOs, they all tend to call me, email me when they have questions which shows how strong the relationship was built with these firms when they were still young and just coming up.

That was also very…not a surprise to a lot of people that Upstart, being a marketplace lending platform, was the first one that received a no-action letter from the CFPB. So those were the relationships that we were able to build over time, over the years, with these companies such that we understand what they are trying to do, we understand their pains, we understand the problems they’re faced with and we’re also trying to take that perspective back to the CFPB and to Washington DC and have a much bigger, larger conversation about these issues.

Hopefully, we can use the authority that we have to remove some of the uncertainties they are faced with, not to mention, alternative data, machine learning, consumer permission, and data access. I think the Project Catalyst office has done a fantastic job in really bringing these topics from thousands of miles away on the West Coast to Washington DC and have an open dialogue about these issues. So I’m very proud of the work that we have been doing.

Peter: So you mentioned Upstart there and I definitely want to bring that up because that was a pretty seminal moment in the industry when you…Upstart was issued that no-action letter from the CFPB. There had been question marks about it over the years because they’re using alternative data and they’ve proudly kind of said that their underwriting is different to everybody else’s. So, tell us a little bit about that particular process and how you were able to get comfortable with what they were doing and issue that no-action letter.

Dan: Well, all I can say is it’s not easy (Peter laughs) and I have grown a lot of gray hair (laughs) during that process and after that process for sure, but honestly, I think the company, since I’m no longer a public official so I can talk about things more candidly, I’m very proud of the things that we have accomplished together on this no-action letter.

I think the company has done a lot of good work, I give Dave and his team, Allison and Paul a lot of credit for their bravery. So, speaking to a federal regular, in many people’s minds is a huge risk and to give them everything that you…they must still have to, of course, you want to apply for something and get something in return, is also a huge risk for a lot of people. I think that the team has done a fantastic job in sort of trusting the Bureau, trusting the Catalyst office and trusting the Fair Lending office at the CFPB to really share information in a very candid manner.

We actually went through the process, we looked at the things they have done, the algorithm they have developed and frequently changed, adapted as they got more experience, got more data, got more loans on their books. And frankly, we finally got very comfortable that number one, there is a potential for this underwriting model to expand access to credit in a responsible way; number two, there’s always fair lending risk and fair lending risk is not a static issue, it’s evolving. You may not have a fair lending problem today, that doesn’t mean you didn’t have it yesterday or you won’t have it tomorrow, but the key is really having a right process in place to monitor, to ensure when a problem emerges you have a way to handle that, to tackle that and I think that’s really sort of the goal of a no-action letter to Upstart.

So I can tell you sort of three things, three takeaways, from this Upstart no-action letter.

Number one, I think this no-action letter shows machine learning and the use of non-traditional data, as controversial as they might seem on surface, they do have the potential to expand access to credit.

Number two, disparate impact, as a legal issue…there’s a debate how this will be done, whether this should be done or not, but I think, I’m a very realistic person, I believe every institution, every lender should take its best effort not to discriminate against protected classes and I don’t think anyone wants to do that, if you’re a responsible lender, of course. So disparate impact…or fair lending is very important that every lender should think about day in and day out.

Number three, with these new innovative methods such as machine learning, such as the use of non-traditional data, or the combination of both, there is still a pathway to compliance. So just because you’re using machine learning on non-traditional data that doesn’t mean you are automatically violating the spirit or the matter of the law. In fact, there is a way for you to move forward, to comply. Of course, a lot of the things that we have done with Upstart during the process and also as part of the compliance agreement, that information is still confidential.

Peter: Sure.

Dan: But I hope through this experiment and hopefully, when the CFPB is thinking about launching its sandbox I hope there will be more firms that can get into the sandbox and work with the CFPB to test the new things. I think with Upstart we only covered an important, but also still a very limited area. I think there are a lot of areas that the CFPB can really help remove the regulatory uncertainty, or the mystery around these issues such that…not just firms like Upstart, the newcomers, but also incumbent financial institutions can also have a chance to really test these new things.

Because these are really, really powerful tools that it can not only, as I said, from the policy perspective, expand access to credit helping people like new immigrants, people like women, people like young people, 12:32 people who actually were called fallen angel who had good credit, but they fell, then they try to pick up and get back to the credit mainstream. I think these methods can be really, really useful to do that so that’s a good public policy outcome.

From the business side, these methods can make the underwriting models more robust, can reduce defaults and what that translates into….you know, if you are big institution that’s millions or billions of dollars in savings.

Peter: Right, right, for sure. So then I want to take a step back and you sort of touched on it, but I want to sort of talk about the role of government a little bit holistically. I mean you were in the CFPB for more than seven years, you know, you had a sort of a front seat role to the innovations happening in financial services and the CFPB obviously it’s about consumer protection so you’ve got this, you know, protecting the consumer on the one hand and all of this exciting innovation happening on the other hand.  So when you think about those two things holistically, how is the government supposed to balance those two things?

Dan: Yeah, it’s a very important question. Frankly, I don’t think anyone has sort of a perfect answer for that, I mean, there’s no perfect answer so oftentimes, I use sort of the 5 percent rule of thumb. What I mean by that is an agency such as the CFPB or take any agency, the OCC, the FDIC, the Fed or SEC or CFTC, any of those regulatory agencies, they should spend maybe 95% of their resources and time thinking about or helping institutions that they supervise to comply with the nation’s laws and rules such that people are not harmed, institutions are secure and safe, but there should be also another 5, maybe 10%…I don’t know what the number is, this is just a very sort of…it’s more of an idea.

They should spend some time not just within one office, maybe starting with just one office such as the Innovation Office or Project Catalyst at the CFPB, but ideally across all of the offices or divisions within the agency to really think about what’s next, what’s coming and the goal is not really about oh, I’m going to police all of these new things or any new thing is scary, new things can be very scary, I can tell you but they don’t have to be, or at least the people who are actually thinking about these questions, shouldn’t take a very adversarial position towards the new things. They should really think about, okay, so technology is going to change our lives, no matter what the government does or doesn’t do, right, it’s the fact. Now we can not really stop what technology will bring to our lives so a more collaborative attitude is that’s really first, not take an adversarial position.

The second, try to understand, try to understand what these things are going to do to consumers, to the financial institutions of these products, to our financial system, if there are any safety and soundness issues that we should be concerned about. And number three, is there a way for us to allow these things to be further developed, to be tested. Maybe you’ll think about a, you know, sort of sandboxing can come up, allow these things to be piloted and the reason is when you don’t have a good amount of information about these new things, it is very dangerous for you as a regulator or policy maker to set guardrails to regulate these new things. I think nine out of ten times, whatever you were trying to do may end up in a not perfect place and you either over regulate or you, I should say, not regulate enough.

So I think there needs to be some kind of a balance between innovation and the consumer protection. And also, I want to say, one of the very famous VCs and entrepreneurs in Silicon Valley once told us, I am not going to mention the name, what this person told us was pretty much since the financial meltdown from ten years ago with all the firms that he has seen and, you know, companies that have pitched to him, all the VCs, in general at large, who were actually reviewing these sort of deals/opportunities, by and large, there’s nothing 100%, but by and large, 99% of these companies are really trying to do the right thing.

Peter: Right.

Dan: None of the companies are trying to harm people. Along the way, they may do stupid things, of course, but technology by and large, is trying to be developed by these people to help consumers, to really make the products and services more efficient, more effective. I think this is something that as regulators we should feel comfortable with. Frankly, maybe I have a very limited sample size, but frankly, most of the companies that I have dealt with, that I have spoken to, that I have met with and some of the CEOs/founders I have become personal friends with, I think they truly believe what they are trying to do; not trying to scam people or trying to harm people, they’re trying to develop better products to make people’s financial lives better.

Peter: Yeah, okay, that makes sense. So, you left the CFPB in July and we reconnected. You wrote an op-ed in American Banker just last week, as we’re recording this in mid-September, and in it you laid out a pretty clear plan of what you think the CFPB sandbox should look like. I don’t want you to sort of recite the entire article, but maybe for those that haven’t read it just tell us some of the summarized…like the points, what you do think it should look like.

Dan: Sure. So, unfortunately the op-ed, you know, there is a word limit…

Peter: (laughs) Right.

Dan: …it’s only 800 to 1,000 words and the editor was very nice with me and she told me if you exceed the word count it’s fine as long as it’s not too lengthy…so, anyway, it’s not a policy paper so I can not really put everything and give very detailed information for everything that I was trying to make, the points I wanted to pack into the op-ed. But maybe I can just break this thing down into maybe two parts; one is the long term, the other one is the short term.

So in the longer term, I think in a way this is probably the most important message. Unfortunately, this probably is not really appreciated by many readers because I think naturally, readers will think about…given the title of the op-ed is about the sandbox, but what I’m trying to say…maybe I’ll write another op-ed in the near future about my views on the sandbox. I think the real hard work and what I call unsexy work is really think about the long term policies and rule making.

These are the things that are not sexy or tend to be controversial…or really does not attract much attention from the media, but the longer term goal for any agency, in this case this op-ed is about the CFPB, is really think about you have to run these experiments through the sandbox, you’ll learn a lot, but what are you doing with the rules on the book that are sort of outdated, that are sort of impeding customer-friendly innovation. Are you willing to…do you have the will to change the rules and that’s an important task to do.

In my view, in an ideal world and to use the analogy of driving…if you have proper insurance and a valid driver’s license, you don’t need to get the permission from the DMV every time you get on the road, that would be absurd.  The same thing here, companies should have the comfort from their regulators that as long as they are doing everything in compliance, they shouldn’t need to get permission from the regulator, but you know that’s in an ideal world, we’re not there yet. Hopefully, we’ll get there someday, hopefully in my lifetime (laughs), but that’s the much longer term goal. That’s something that the Bureau should spend more time thinking about doing.

The short term, obviously, is all about the sandbox. I think the most important thing for the agency to really realize is, what exactly is the sandbox about so the first thing you have to do is really layout to the public, tell the public in a speech or in some kind of op-ed or blog post, tell the public what the sandbox…what kind of issues or problems does the sandbox try to address.

I think there’s two things that I sort of layout for the public, for the Bureau and to the public, that is, regulatory uncertainty and regulatory fear. Uncertainty is something that has been talked about and written about for a long time, a lot of people are familiar with what that means. Regulatory fear is a term that I coined and this is from my experience when I was running the Innovation Office at the CFPB.

So many times companies would come to me and say, here’s my product, it’s new, never offered by anyone before and I’ve checked with my lawyers and they have told me that I’m doing everything in compliance with the rules that the CFPB is in charge of, can you give us a approval? I said, no, that’s not my job because if you are in compliance with everything that you are doing then why would you worry about the CFPB? The answer is, well, my partner, especially my partner, if the partner is a bank, will say, what does the CFPB think because I’m not going to do something that has never been done before and get slapped with an enforcement action or supervisory action by the CFPB for doing this because I want to make sure they understand what we are trying to do here.

So I think this is a very sad reality because, as I said, if the rules are clear, you are doing everything in compliance, you don’t need the CFPB to give you approval. I think in this case the rules probably are pretty clear, it’s just that the novelty of the product they’re very uncomfortable with. So longer term, again, I think you shouldn’t come to the Bureau or any agency to do this, but in the short term a sandbox can be useful for the CFPB to take more initiative to encourage more trials, more pilots, more testing of new products and services, whether they need some kind of safe harbor or not. I think that’s a very important thing for the CFPB to do.

Now I mentioned the approval authority in my op-ed, later on I’ll also post a LinkedIn… because some people were asking me, where are the approval authorities in the three statutes that you referenced in the op-ed which are TLA, ECOA and EFTA. So I put out these provisions in my LinkedIn post so a lot of people have seen that which is good I think. So this an authority that has been rarely used in the past, if memory serves, it was only used once or twice probably by the Bureau. I don’t think the Federal Reserve ever used this before, but it’s a very powerful authority, in essence what it is is the CFPB can basically deem someone or some product in compliance with regard to, of course, these three statutes.

If it’s beyond the three statutes, the CFPB does not have the authority to approve something and this product can be just one product or it can be a category of products. So the nice thing about this approval authority is really about…it’s really that this kind of a certainty that the approval gives to the institution or institutions because unlike the no-action letter which is a staff recommendation, which is non-binding, the approval authority is binding, it’s an agency action.

Of course, the downside is if somebody sues the CFPB, you know, you have to go to court to defend, but by and large, this has never been done before, has never happened before, but by and large, the courts in such cases, will most likely defer to the Bureaus because this is the statutory authority that Congress gives to the CFPB. Now, I’m not saying the no-action letter or the trial disclosure waiver policies are not important, but for sure, compared to the approval, they’re less important, but they do have other usages that the approval authorities doesn’t have.

So again, one is the three statutes, right…beyond that, if you want to do something, you probably will need the CFPB to issue you a no-action letter. The waiver authority or trial disclosure is also a very interesting thing and that’s the first thing that the new Innovation Office rolled out for public comment. I do think disclosures are very important, but I think, you know, importance is also a relative thing so compared to the no-action letter and the approval, I do think disclosure testing is less important, mostly because from my experience, again, this is about innovation, right. I’ve never heard anyone actually telling me that because of the disclosure rules here, I can not create or offer this new product, it’s never been an obstacle for innovation, but there are legitimate complaints about the effectiveness or whether the disclosure rules, certain rules are too burdensome. I think these are very fair comments and I do encourage the Bureau to look into these things and figure out ways to improve disclosures, but if the office or if the Bureau in the sandbox is focused on innovation, if you spend more time on disclosures that is not the right use of resources.

So the Bureau should, in my mind, really focus on the approval and the no-action letter; these are the two powerful tools that the Bureau can further develop. Of course, the approval has not been developed yet, there needs to be processes in place to make it work. The no-action letter policy obviously, the scope and also develop things in the policy and a lot of people have written about it, I don’t need to repeat them, very good points to further enhance the effectiveness of the policy.

Peter: Right.

Dan: So these are the things that I’m trying to argue in the op-ed, but I do hope and I think this is a very important message. The Bureau should put focus on the long term goals of all of these exercises. There is a danger that when agencies roll out these sandboxes they think it will make them look innovative, make them look very forward leaning, make them look very good, but sandboxes are merely tools, they are not the end. The end is really making sure you have the right rules in place such that everyone can comply with and they don’t have to come to you for any kind of permissions or one-time permissions or approvals.

Peter: Right, that’s a very good point. I think the example you gave about someone working with a bank partner and the bank partner says, oh, that’s never been done before, I don’t want to be the first…it would be so great to have a framework in place where…for big banks or people to get comfortable so they don’t mind being the first if they’ve got this kind of framework in place. I want to get your perspective on…because we live in obviously a very globally connected world and we know that there’s plenty of different regulators around the world doing different things with sandboxes, particularly I’m thinking about the UK and Singapore specifically. How is your view of the whole sandbox concept being informed by what other countries are doing?

Dan : Right, so I have been in touch with the FCA, the Financial Conduct Authority in the UK, since probably four/five years ago. They actually came to the US, came to the Bureau to sort of learn from us, our experience with Project Catalyst and they later launched Project Innovate and they have progressed so fast as they are the true…what I think a true leader in…not just in sandbox…sandbox again, I don’t want to talk too much about the sandbox. Two things they are the true leader in promoting innovation, in promoting fintech to benefit consumers and to benefit the economy at large.

Peter: Right.

Dan: In terms of my views being informed by them, the first thing we have to recognize is we have a very different regulatory structure in the United States and whatever the FCA or Singapore MAS has been doing, you can not really transplant what they have been doing to here, that’s just not going to work. A large part of what they can do is really about licensing which the Bureau doesn’t have any authority in issuing licenses. Chartering is the job of the OCC in the States and we don’t have the charter authority and specific licensing is done to non-banking institutions are done at the state level and again, the CFPB doesn’t have that authority.

So the specific policies in the sandbox at the CFPB are going to be very, very different and they are. Based on the blueprint that I devised for the Bureau before I left and based on what I argue in the op-ed, very, very different from the FCA or the MAS in Singapore, but I think the common theme here is this, and I think I’ve learned quite a lot from my friends and colleagues at the FCA, which is really their mentality and their long term thinking.

They have a very clear strategy, they are not just doing Project Innovate for the sake of being cool, being sexy, they’re not doing sandbox…they were the first one, by the way, to launch a regulatory sandbox and they have done I think four cohorts so far. They are not doing this just to show that, hey, we are good. Actually, they are thinking very carefully about what exactly these tools that they’re using, they’re developing, they are fine tuning to achieve and I think along the way they have done a fantastic job in really changing the culture of the agency.

I think in this case, I wanted to give Tom Curry, the previous Comptroller of the Currency, the OCC, a lot of credit for, first of all, acknowledging the culture issue within their agency and I think that issue is not just with their agency, but I think it’s across the board, every agency. This is the sort of 5% thing that I talked about previously; it is about a lot of agencies, most agencies, probably when they see these new things their knee-jerk reaction is, oh my gosh, I don’t understand this so I don’t want to deal with it so that is not really helpful.

I think the OCC, when it was under Tom, in the first white paper in response to innovation they acknowledged the issue and they wanted to figure out ways to tackle that and I think this is the issue that every agency has been struggling with. I think frankly, the FCA, my understanding is they also have a similar growth pain and they also wanted to address the issue, but I think they are probably the most successful in doing that and there is a lot for us to learn from them, us, meaning not just the Bureau but also all of the agencies, the regulatory agencies in the United States to learn from them, their experience.

You know, I truly think agencies need to be a bit bolder, be more brave to really embrace new things and to figure out the way to really balance the innovation and consumer protection. I’m not saying that the FCA is perfect, I am sure they have made mistakes, but I think they are really, in my mind, the most powerful leader in this space and I think there is a lot for the regulators in the United States to learn from.

Peter: Right, I completely agree. So we’re running out of time, but before I let you go…you left the Bureau a couple of months ago now so what are you doing and what’s next for Dan Quan?

Dan: (laughs) Probably writing more op-eds. (Peter laughs) So listen, Peter, I have…as I said, I have strong (inaudible) in the fintech space for quite some time, I’ve built a very strong network, I have made a lot of friends in the space and I truly, truly am very passionate about what I’m doing here, what I’ve been doing and the issues that I’ve been advocating for and the fantastic business models that I have witnessed. Some of them starting from the very, very beginning, really ideas on a piece of paper and those firms have become very prominent, very big in doing what they have been doing.

So really it’s too early for me to say where I will ultimately land. I can say I’ll continue to be active in the fintech space and when the right time comes, I’ll let you know.

Peter: Okay, that’s good news, I mean, we certainly would love to have you still actively involved in our space. You have done a tremendous job over the last several years of really encouraging innovation in fintech and also for fintech companies to proactively engage with regulators. I think that’s been a real gift to the industry. Anyway, we’ll have to leave it there, Dan, I really appreciate you coming on the show.

Dan: Thank you very much, Peter, for having me.

Peter: Okay, see you.

Dan: Bye.

Peter: You know, it’s not easy thing for government to really balance this consumer protection and encouraging innovation. I think Dan sort of lays it out pretty well here in what his vision is to be able to do that. I think, from my perspective, we certainly do not want to stifle innovation. This country has had some amazing technological breakthroughs, not just in finance, but in other areas over the last several decades and some of the American companies are some of the largest companies in the world because they were able to produce innovation that was better than what others were doing.

It’s not a guarantee that that will stay going forward, there’s lots of other countries and foreign companies that are looking to really beat the US in the innovation area, particularly when it comes to financial services. So I hope Dan stays in the industry, it sounds like he is. I think his sort of expertise is something that we really need in this industry as we try and bring more innovation, more responsible innovation into finance.

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 USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8th through 9th, 2019, at Moscone West in San Francisco. Registration is now open and we’re also taking speaker applications. You can find out more by going to lendit.com/usa.

 

PODCAST TRANSCRIPTION SESSION NO. 169/JENNIFER TESCHER

Welcome to the Lend Academy podcast, Episode No. 169. This is your host, Peter Renton, Founder of Lend Academy and Co-Founder of LendIt Fintech.

(music)

Today’s show is sponsored by LendIt Fintech USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8th and 9th, 2019, at Moscone West In San Francisco. We’ve recently opened registration as well as speaker applications. You can find out more by going to lendit.com/usa.

Peter Renton: Today on the show, I’m delighted to welcome Jennifer Tescher, she is the President and CEO of the Center for Financial Services Innovation, otherwise known as CFSI. Now the focus of this organization is really about improving financial health, we talk about that in great detail in this podcast, we talk about how, firstly, they initially got started really focusing on access to financial services and now, a few years ago, they switched to financial health.

We talk about how is the financial health of Americans today, what are biggest challenges facing them, what are the fintech companies doing to actually address these needs, and we talk about the different components of their organization as well as her vision for the future. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, Jennifer!

Jennifer Tescher: Thanks Peter for inviting me.

Peter: Okay, so I like to get these things started by giving the listeners a little bit of background about yourself, what you’ve done in your career, particularly before you started at CFSI.

Jennifer: Sure, running an organization like CFSI and being deeply engaged in financial services is about the last thing on earth I imagined I’d be doing. I expected to be a journalist, a newspaper reporter, in fact I have an undergraduate and a graduate degree in journalism and was a reporter 20 plus years ago and realized that what really motivated me wasn’t just writing about the issues, but doing something about them.

And so I went and got a public policy degree and tried to think about what was the one root cause I could work on, the one thing I could focus my attention on that was going to really help improve life for low and moderate income people and somewhere along the way I ended up at a community development bank. Actually, the very first community development bank in this country, ShoreBank, and worked there in a number of different parts of the institution and in a number of different capacities and CFSI was really born out of that institution and that experience.

So I’ve worked in a bank, I would never consider myself a banker, (Peter laughs) but I know enough to be dangerous and I think that a lot of my journalism skills still hold me in good stead today. I ask a lot of questions, I am a generalist, I know a little about a lot of different things and I can communicate effectively and I think that, frankly, anybody should have those skills to be successful today.

Peter: Right, sure. So then what was the actual impetus to the founding of CFSI. I mean, it’s going back a few years now, but can you remember just to share with the listeners what you were thinking when you decided to go off on this adventure of creating a new organization?

Jennifer: Yes, because it wasn’t actually my idea (laughs). I was at this point working in the consulting arm of ShoreBank and had been hired by the Ford Foundation. The internet had just been invented by Al Gore, they say, (Peter laughs) and Ford had just commissioned a paper that said, wow, the internet represents a huge opportunity to reach and serve low and moderate income people with financial services, with bank accounts, in ways that we hadn’t been able to think about before, and boy, Jennifer, we want to do something about this opportunity. We want to deploy our capital against the opportunity, but we have no idea what that looks like on the ground so help us develop our strategy.

And I went off and came back and said, well, you should create a center to do the following things and they said that’s a great idea, here, here’s a check, why don’t you go do that. So that was really how CFSI was born, that was back in 2003, right before…I remember it because it literally right before I gave birth to my first child…

Peter: Oh, boy.

Jennifer: …like in the weeks before (Peter laughs) and when I came back, I had just birthed one baby and I had to now birth another and I had a commitment for three years worth of funding and the money for the first 18 months in hand and it wasn’t even a legal entity at the beginning. It was really a project housed out of ShoreBank and once we saw that there was traction, we went ahead setting up a, you know, a legitimate separate organization.

Peter: Okay, are you set up as a 501(c)(3), are you a non-profit?

Jennifer: We are, we are.

Peter: Okay, so then what was the mission then…you said you had this check from the Ford Foundation, but what was the mission that you were trying to accomplish back then and how has that evolved over time?

Jennifer: Yeah, so back then we were founded to answer the question of…how can changes in technology in the financial services industry really benefit those who need it most. And we became quickly known as the un and underbanked people because we were the ones who put those words and that issue on the map. Back then, this is the early to mid 2000’s, the federal government had just decided it wanted to try to pay everyone’s federal benefits electronically only to realize that 10 million people, benefit recipients didn’t have a bank account and that was sort of fresh in people’s conscience.

If you went to a banking conference back then, you would see a bar chart showing the cost of a teller transaction and a smaller bar for the cost of an ATM transaction and an even smaller bar for the cost of an online banking transaction. So it was both a moment of understanding that there were a lot of people who lacked access, basic access to banking and back then it really was still just banking.

We didn’t have so many of the new competitors that we have today and there was this understanding that somehow technology was going to both dramatically reduce the cost to serve these consumers and that it was going to enable us to reach them where they were in a more effective way. So that’s where we started and, you know, fast forward ten years, and we’re at our ten-year anniversary. This was around 2014, and we were taking stock and a lot had changed in that period of time.

Peter: Sure.

Jennifer: The iPhone was invented in 2007, like we were well ahead of our time from a fintech perspective, fintech wasn’t even a word when we launched in 2004. So the iPhone had been invented and in a way the notion of access being the problem went away, right, because if you have a phone and in this country a pre-paid card…you know, access became almost ubiquitous, particularly to the payment system.

And we had a financial crisis which made it clear that even if you had a bank account or say a mortgage, if you were well banked, it didn’t necessarily mean that you were immune from financial challenge. And then we had a Great Recession which laid bare this idea that really this wasn’t just a niche problem of the un and underbanked; this was a problem for the majority of Americans who were financially struggling and we just didn’t see it because of the over indebtedness that had built up over the previous couple of decades.

And so we said to ourselves, what are we doing, you know, what is our purpose, what are we trying to accomplish and right around this time, we came out of the field with data from our Financial Diaries Project where we followed over 200 families for a year documenting every dollar that flowed in and out of their households and the decisions that they were making and the context in which they were making it.

And my colleague, Rachel Schneider, who co-authored that study used to say, you know, when you sit down with somebody and you ask them to talk about their financial lives they really just start talking about their lives because those two things are so intertwined. It became very clear to us that what we were really wanting to do was help improve people’s lives by helping improve their financial lives and that that was really about ultimately improving peoples’ financial health.

And so over the last four or five years, we shifted the frame of our work from being about access and the un and underbanked to really being about financial health for all, especially those who don’t have it and we’ve spent a lot of time building a financial health methodology, a framework, a measurement methodology and it’s been exciting to see the traction of that over the last few years.

Peter: So is the implication in that access to financial services has now been solved, because obviously we still hear about people who are unbanked so where do you sit on that question today?

Jennifer: So I should first say that we really focus our work in the United States.

Peter: Right.

Jennifer: So obviously there are still billions of people around the globe who lack access although as you know that gap has been dramatically narrowed over time. The other thing I would say is I don’t think we’ve ever had as much low or no cost access ever to basic transaction and payment accounts.

Peter: Right.

Jennifer: I think credit access is still an issue, but I also think that we’re seeing all kinds of interesting innovations around how to attack that challenge. I mean, look, US banks, just earlier this week rolled out a new small dollar credit product which isn’t going to solve every need and every problem, but when did you think a top ten bank was going to say that they were going to charge 70+% APR and make a loan that’s just three months long and make loans to people much further down the credit spectrum than they would ever make in any other kind of loan product.

That to me suggests that there’s significant change there so my take on the topic is that there are still some people in this country who do not have a bank account. At least half, if not more of them, have had one in the past and they’re just churning through the system. And so we’re talking about a very small number of people who actually are completely without access and then I think some of those people likely have far bigger challenges; homelessness, poverty, other kinds of issues that I would submit are far more important than having a bank account.

Peter: Right, right. Okay, so then let’s talk about financial health for a minute. You look at the country today and you know, we’ve come through the financial crisis and the economy is chugging along, unemployment is low, but yet you still hear that the average person has very little in emergency savings, so what’s your take on the financial health of Americans today?

Jennifer: So in about a couple of months, we will release data from our newest national study, the product of our new US financial health pulse. We’re actually going to be producing, on an annual basis now, a national benchmark around financial health and we’re just out of the field with that work and just as you say, the headlines suggest we’re in an incredibly rosy time in the recovery and boy, doesn’t it all look great, but as we learned from the US Financial Diaries work, numbers that are focused on annuals and averages really mask what’s going on with people day-to-day at the micro level.

The problem is the macro level data that we use to gauge the health of the country is not terribly effective at gauging sort of the micro economic health of households and families and so, yeah, a lot of people are working, but they are working multiple jobs, they’re not being paid very well in those jobs. A huge percentage of this country are, you know, making less than $12 an hour and if you do the math that’s, you know, about $30,000 a year. So we look at the stock market gains, but you know, an increasingly smaller percentage of Americans actually own any stock in the first place, so they’re not necessarily benefitting from those gains.

And so I know it’s not a popular message, but I think it’s an important message that people are still really struggling, they’re also struggling under mountains of student loan debt and they’re really struggling with health care expenses and medical debt. So you know, the things that we think are the most important, basic expenses, getting healthcare, sending your kids to college, frankly, renting an apartment or buying a house are all incredibly expensive and people’s wages and working conditions haven’t kept up.

Peter: Interesting, interesting. So you’ve had a great view here on the evolution of fintech starting in 2004 and really you can see that there’s been an explosion in, I would say, innovation over the last…it seems like it is exponential over the last several years, but it sounds like there’s still a lot of work to be done and I’m curious to get your thoughts on what should fintech companies be doing to really address the needs of these middle class Americans that you talk about.

Jennifer: Great question. I agree with you that there’s been tremendous innovation, but only some of it has really been aimed either at solving consumer financial health challenges at large or on reaching and working with consumers whose financial health is most challenged. And so, you know, doing a fintech business, as you know, is very different than a lot of other businesses. You can’t sit in a room all weekend and code something and stick it up on the internet and be ready to go. It’s much more complicated, it takes much longer, there are more rules to follow and if you’re going to spend all that time and effort, you might as well spend it on something that’s actually going to matter, that’s really going to move the needle.

So I think there are tons of interesting sort of day-to-day financial challenges that folks face that are worthy of fintech focus where technology can really make a big difference. I think one of those arenas is decision making, optimizing decision making for people. People’s financial lives are incredibly complicated, they have multiple streams of income, those streams are not always predictable, both in their timing and their amount, they’re juggling multiple types of bills payable at different times and they have very little cushion, they have very little slack. And so the decisions that they make about their cash flow are extremely critical because small mistakes that many of us take for granted are catastrophic for them. So I’m really excited about a lot of the tools I’m seeing that are attempting to solve for those kinds of challenges.

Technology should make it easier to help people make these decisions. It’s not easy because people’s lives are complicated, but you know, I think a lot of progress is being made there, as an example.

I think the other thing I’m seeing that I’m excited about is innovations being delivered through the workplace, both because it’s a really sort of momentous time to be engaging with somebody, it’s where they’re receiving their paycheck, it’s often where they’re receiving benefits. It’s a place where they’re used to having to make those kinds of decisions and I’m excited about it because I see employers increasingly interested in the broader financial health of their employees, not just their physical health, but also their financial health.

And so we’re seeing innovation from fintechs, but we’re also seeing innovations from incumbents on the retirement side because their plan sponsor, employers are saying my employees need more than just a retirement calculator, and they need more help on more topics than just retirement, how about like today. So I’m very excited about all the energy in that space.

Peter: Right, right. You know it’s interesting, I had the CEO of Credit Karma, Ken Lin, on just a few episodes ago and he talked about this concept of autonomous finance where…you know, when you think about it…a lot of this stuff, it’s highly complex, but there’s a lot of data out there and he used the example of, you know, you’ve got a car loan or a personal loan or a credit card, whatever and there’s a deal out there that you will qualify for that is going to save you $100 a month. That’s super meaningful and he says we should be in a world where that information gets to the consumer and say, hey, do want to save $100 a month, I’ve pre-filled out this application for you, you just have to okay it and boom, you’re saving $100 a month.

So that’s the sort of thing that I get excited about because, as you say, and I’ve written about this several times where I feel like the promise of fintech isn’t necessarily to save the upper middle class a little bit of money on their credit card bill or their credit card debt, but it’s really to move the needle for people who really need it.

It feels like to me and you’ve been in this for a long time and I feel like it’s only really been in the last year or two that fintech companies are really now focusing on this massive middle class or lower middle class, shall we say, and doing and creating products specifically for them. It has to be done by the for profit sector, I mean, I love the work you’re doing, but to move the needle for millions and millions of people there has to be a profit incentive. Would you agree with that?

Jennifer: Oh entirely, and we happen to be a non-profit, but our entire sort of theory of how we’re trying to make change in the world is by helping providers understand that there’s a business opportunity to be had in promoting the financial health of your customers, and frankly, making money as a result of improving their financial health as opposed to in spite of your customers’ financial health.

I mean, that’s really an important lesson from the financial crisis that in the short run there may be more money to be made by working against the better interests of your customers, but that’s not a long term recipe for success and it’s certainly not how you build trust, especially in the digital age and the social media age so I think this is true both for fintechs, but also very much for incumbents.

You know, I mentioned earlier that when we started back in 2004, this was largely about banks, I mean, the only kind of non-banks that were in this space in a serious way were starting to innovate were H&R Block and Walmart. In fact, back in the day, we used to hold them up to try to scare the banks and say, you really should be focusing on this because there’s other people who are looking to eat your lunch.

And so because we’ve seen this evolution for such a long period of time, we were pretty early in talking about the idea that it’s not who’s going to win, fintech or incumbents. It’s the mash-up between them that’s where the most interesting things are happening and I think that’s now sort of the…it’s more of an agreed upon idea. So as much as I want to do everything I can to help the startups that are in our portfolio through our Financial Solutions Lab be successful on their own terms…for some of them, frankly, for many of them, the ultimate success is going to be them being bought by or them partnering with an incumbent.

Peter: Right, that makes sense. So you just touched on it, but I want to get an overall view of your organization and you just talked about the Financial Solutions Lab, you do research as well so can you just take us through the different components of CFSI real quick?

Jennifer: Absolutely. So our goal is to improve financial health in America and we do that by working with providers to help them build strategies, businesses, products that will make them money while they are improving the financial health of their customers and so we work with providers in a variety of ways.

The primary way is through our financial health network. We have, I think, 160+ members at this point, very diverse, most of the largest brands in financial services, a range of credit unions, mostly the biggest credit unions, vendors, technology partners, fintech companies, some non-profit providers notably in the credit counseling arena, as an example, some of the largest providers in that arena. And we bring those network members together, both to engage with each other and I like to describe it as a snow globe, right, put all of these different people and different institutions together, shake it up and see what comes out the other end; that’s where the interesting stuff happens.

The other thing that we do with this network is we provide them a lot of information and research. We have deep expertise and research on consumer behavior, consumer preference and then we do a bunch of research on specific opportunity areas. We recently just put out a paper on insurance ownership in America, we’re about to put out something on retirement so we’ve done product specific work, we’ve done sector specific work.

We also have a consulting business so we do proprietary work for companies who need a partner alongside to roll up their sleeves and help with product or business development, strategy development, understanding their customers, understanding the competition.

And then, finally, we try to seed innovation in the marketplace and we do that in a variety of ways. We do that through our Financial Solutions Lab which is a partnership with J.P. Morgan Chase, we essentially run an accelerator for early stage fintech companies that are focused on solving financial health challenges. We’re on our fourth cohort now, we have 30 some odd companies in our portfolio and we’re also, you know, doing a lot of work with incumbents and others to help them innovate within their four walls. So that’s really sort of CFSI as a whole.

We often get asked about if we play a policy role. We do have a new Vice President of Innovation and Policy, Garry Reeder, and we do have a presence in Washington, we spend a lot of time talking with regulators and policy makers helping them understand the real financial lives of Americans, but we are not primarily a policy think tank. We’re focused on policy from the perspective of making sure that there’s a supportive environment and ecosystem in which financial services providers can innovate.

Peter: Okay, that’s quite a lot. So then how do you measure your impact?

Jennifer: That is a great question and it continues to change as our model evolves. So we are just now coming to the end of a four year plan and our goals from that plan were to grow our network so reach more providers and make sure that that it is a diverse group of providers. You know, one could say that choosing to pay money to be part of a financial health network demonstrates that the idea of financial health is gaining traction.

Remember, a few years ago we didn’t have a network at all, we worked with a handful of companies, but we weren’t formally engaged with companies as members and today we have over 160 in just a few years. We measure how engaged those companies are in developing new products, services, policies that we think are meant to promote financial health so we track and monitor that.

We also, through our Compass Principles, track and monitor quality in the marketplace because it’s always good to have more, but not if it’s not high quality. So we’re also, you know, benchmarking quality in a variety of places in the industry and monitoring whether quality is ever improving.

And then, finally, we’re really focused on influencing both the broader industry and the broader zeitgeist, but also the firms we work with by encouraging them to measure the financial health of their customers and start to use that data as a KPI for how they run their business. Back when we started this, financial health barely existed, we didn’t even have a measurement system and we set a goal of having 25% of our network members actively measuring and I’m really excited to say that we actually hit that goal.

So we’re working with, at this point, about 40 companies and organizations who in some cases are using our methodology and in some cases using their own to measure and track the financial health of their customers and understand what moves the needle year-on-year.

We’re actually at the point where we’ve got a few companies who are now either in their second or third year of starting to measure so they have some year-on-year data. If you couple that with this new financial health pulse which is going to give us regular national benchmarking data and we also have a new sentiment survey.

We’ve surveyed 650 financial services executives about their sentiments around financial health and it’s importance as a strategy and a business priority. We’re going to have a whole set of new tools to be measuring industry engagement on this topic. And ultimately, we think we should be able to measure year-on-year change in financial health among Americans.

Peter: Interesting. So I’m curious, how big is your organization? I know you’re based in Chicago, I believe you have a number of offices around the country, I mean, how many people work at CFSI?

Jennifer: We’re a group of about 55 and we have offices in Chicago, New York, DC and San Francisco and it’s just a terrific group of people, very varied backgrounds; some people out of industry or out of business; others out of non-profit or out of international development, but all really passionate, motivated, innovative and really comfortable, you know, pushing the boundaries.

Peter: Right.

Jennifer: Most of what we’re doing we’re inventing every day and what’s really exciting is to be working, not just with other innovators who are used to doing something new every day, but really having some success in convincing incumbents in a very conservative industry to actually start to think differently about the business they’re in. So there’s tons more work for us to do, but I’m really excited about the traction.

Peter: Right. So it sounds like you’ve got a lot of revenue generators, but given that you’re a non-profit, I imagine you’re still getting donations as well. What is the split between donations or grants that you receive versus your revenue generating activities?

Jennifer: Yeah, it’s about half and half, maybe slightly more grants, it goes in waves and I think it’s also intentional in the sense that one of the reasons why we’ve been successful is that we’re viewed as having independence. Even though we work with industry and individual companies, we ultimately are in this to improve things for consumers.

Peter: Right.

Jennifer: And so having outside grant funding, and not just from corporate donors, but also from private foundations, enables us to control our agenda, particularly on issues or products or policies where we need to actually drum up interest or help set a new point of view before we can convince others to pay for it if you will, and see it as being in their interest.

So for instance, this national US financial health pulse I mentioned, this national data collection is a very significant and expensive undertaking and we have support from Omidyar Network, MetLife Foundation and AARP, but over the course of time we expect to be able to monetize it sufficiently so that it becomes sustainable and isn’t going to need grant funding forever.

So that’s how we tend to think about our grant funding, it’s either sort of capital to take on new things that market isn’t ready to pay for yet, or to take on issues and topics that we want to have independence around.

Peter: Okay, so we’re just about out of time, where are you taking this, what’s your vision for the future of CFSI?

Jennifer: So I think our vision is to really equip financial services providers with the tools, technology and infrastructure that they need to execute on financial health strategies. We’ve done a tremendous amount of work to raise awareness, to get people interested, to help them understand the idea, to even help them begin to understand sort of the baseline of where they’re starting from, in terms of the financial health of their own customers. And now, everyone wants to know how do I do that?

And so I think an important role that CFSI can play is really bringing data, analytics and benchmarking to bear because as this becomes a more standard way of operating, right, there’s going need to be more information about how one compares to others and what strategies work. I think there’s some other work that we need to cause to happen outside of our four walls, right.

A lot of financial institutions are now looking for technology partners who can offer the platforms and infrastructure that they need, either to offer their customers a financial health experience directly, or to provide advice in a different form or fashion and so we really want to help create a more robust marketplace of vendors and partners who can provide the kinds of financial health solutions that providers are going to be looking for, they are already looking for it.

So as an example, a couple of years ago we worked closely with Envestnet Yodlee to help them build their new Fin Health Check app and so banks, on a white label basis, can leverage this tool if they want to enable their customers to generate a financial health score and then to provide them with some advice about improving it and we’re starting to see others try similar things in the marketplace.

I think there’s room for more of that and other kinds of platforms that will also enable firms to aggregate the data that they have on their customers to paint a better picture so it’s not just serving your customers, but using transactional data to help give them a picture. So I think that through our innovation work, we’re really excited about trying to help fill in that marketplace because ultimately, what we really want is financial services companies to see themselves as being in the financial health business.

That’s what their customers want from them and that net promoter score is a very valuable KPI for making sure that that the experience they have is pleasant and positive, but our research shows that plenty of people have pleasant and positive experiences, but still feel very negatively about their financial condition.

Peter: Right.

Jennifer: So we want to see more firms using financial health as a way to measure their own impact as an enterprise. I would say that’s probably our ultimate goal.

Peter: Right. Well that is a noble goal and one that I will also try and work towards personally. I feel like improving financial health really is the promise of fintech and I feel like we are nowhere near realizing that promise. It’s organizations like yours that are really helping to drive this forward. I really appreciate you being on the show today, Jen.

Jennifer: Thank you for having me, I really enjoyed the discussion.

Peter: Okay, see you.

Jennifer: Alright, take care. Bye.

Peter: Many companies in this space are focused directly on improving financial health and I think there are many companies doing tremendous work here, but I also think there are those that should be doing better, that really should be focused on really improving the health of their customers more so than what they are. I think it’s a trend that I see moving in this direction.

I think with technology, with artificial intelligence, with all kinds of other tools, we now have the capability to profitably serve a much bigger population than was possible just a few years ago. I really commend the work CFSI is doing and I think more companies should be really turning their attention towards directly improving the financial health of their customers. I think we’re moving in that direction. I hope that we will see tremendous gains over the coming years.

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 USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8th through 9th, 2019, at Moscone West in San Francisco. Registration is now open and we’re also taking speaker applications. You can find out more by going to lendit.com/usa.

 

PODCAST TRANSCRIPTION SESSION NO. 168 / MATT HUMPHREY

Welcome to the Lend Academy podcast, Episode No. 168. This is your host, Peter Renton, Founder of Lend Academy and Co-Founder of LendIt Fintech.

(music)

Today’s show is sponsored by LendIt Fintech USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8th and 9th, 2019, at Moscone West In San Francisco. We’ve recently opened registration as well as speaker applications. You can find out more by going to lendit.com/usa.

Peter Renton: Today on the show, I’m delighted to welcome Matt Humphrey, he is the CEO and Co-Founder of LendingHome. Now LendingHome are a fascinating company, they have in a very short amount of time become the largest fix & flip lender. They’ve done over $3 billion as of this recording and we talk about how they were able to do that, how they were able to go into this space that was really dominated by, you know, small hard money lenders and create an online process that’s efficient.

We talk quite a bit about the technology they’ve been able to develop, we talk a lot about how they differentiate themselves from the other players in this space, we talk about the loans themselves, we talk about the investing side of the business and much more. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, Matt!

Matt Humphrey: Thanks for having me, Peter.

Peter: Okay, so I like to get these things started by giving the listeners a little bit of background about yourself. Maybe you can tell us what you did before you started LendingHome.

Matt: Sure, so I guess you can say I’m a multi-time tech entrepreneur. This is depending on how you count, I think company number 8 (Peter laughs) since 2004, every time in different spaces, everything from 3D virtual world to content delivery to social games, e-commerce, lending and more. You know, I’m classically trained as an engineer, I love attacking problems no matter where they may be where tech can really truly create an advantage; that was my upbringing.

I was Carnegie Mellon computer science…long story short, actually started there when I was 13 years old, I was that guy and basically finished my core computer science requirements by 18 and then I didn’t have a minor so I went and got an MBA, caught the startup bug and then started building companies.

So I moved out west from Pittsburgh where I grew up and went to school in 2007, and then built a variety of things from there. So my last company was a company called HomeRun, it was an e-commerce platform that we built back in 2010 and actually we sold it for a very strong outcome only about 18 months after founding and we basically powered an e-commerce platform where we sold things to consumers and we also powered rewards and loyalty and commerce solutions for large card companies and banks like JP Morgan Chase and American Express and others. So next up after that, after selling it and working with the acquirer for a number of years, started LendingHome.

Peter: It sounds like…looking at your LinkedIn profile, LendingHome is your longest running startup, it sounds like. It’s where you’ve spent the most time in your career, just on pure timewise.

Matt: Well for some of those early ones I’ve got to admit it wasn’t a high bar to spend more than, you know, 12 to 18 months. (Peter laughs) I really think that I took a philosophy of just start things, learn, rapid pace, rapid prototype, get products to market and if we’re going to succeed, great and if we’re going to fail, let’s fail fast, learn and iterate. And so, you know, through those early days of some faster start and stops, learned a lot I think, you know, a lot of life lessons as an entrepreneur.

HomeRun was a good three year and change run and LendingHome has been now between four and five years. You know, I have to say though, it is…I am more proud of what we’ve built here than probably all of the past 7+ combined. Just in the scale and scope of what we’re taking on, the technology that we brought to market and we’ve built a real business which is cool and exciting.

Peter: Right, right. So let’s just talk about the early days at LendingHome, what were you thinking when you thought you needed to start an online mortgage origination platform? What was the problem you were trying to solve?

Matt: Yeah, so going back to middle of 2013, I, having sold HomeRun in 2011, I actually was angel investing in a lot of technology startups and caught the bug to also want to think about investing in real estate and it didn’t seem like there was a simple, scalable, online, transparent way for investors to access investments in real estate or specifically mortgage, and I was intrigued when other companies like LendingClub, Prosper and beyond had brought such a straightforward way for an individual investor to invest in personal loans that didn’t exist in mortgage.

So I was actually looking at it from more of that side and actually got approached to be an LP in a few private mortgage funds covering areas of lending and credit for homes where banks did not so the fix & flip space that we now find ourselves in…single family rental, foreign nationals, those that are self-employed; lots of verticals that banks didn’t cover. So I actually took a step back and said, would I rather be an LP in a few of these funds or can we actually build technology to do this even better.

And then you combine that with some of my close friends and family, even ones with great credit that were having just the hardest time even refinancing loans with their existing bank, taking months if not quarters, asking them multiple times for their documents over and over again and consistently getting surprised in the process. So it led me to be pretty introspective and say, whoa, if this asset class of mortgage is so big and both the borrowers and investors have trouble accessing it in a simple, fast, reliable way, what if we did it better with tech and that’s how LendingHome was born.

Peter: Right, right. Obviously, you started just a few years ago and you’ve built it up into a pretty sizable scale. I saw just recently your press release that came out, you crossed $3 billion in total originations, so can you just give us some context to that, like how many homes is that, how many loans have you done, that kind of thing.

Matt: For sure. So yes, about a month ago, we reported that we had crossed about $3 billion in cumulative originations. Each billion has come considerably faster than the last; it was around 30 months for the first billion, 11 for the next and then about eight for the third and so we’re very excited that the business is accelerating and growing so quickly.

You know, that breaks down if you just do some simple math, the average mortgage in the US is slightly over $200K and so it should be no surprise that that actually equates to…now, as of the day of this call we’re over 15,000 individual homes that we’ve lent to so that’s about $200,000 and a little bit per loan. We have focused our tech, our process, how we go to market to be able to lend to the average homeowner across the US.

Whereas, I think there’s lots of platforms that are focused on small balance commercial or office buildings or hotels, we’re focusing on those single family homes, townhomes, condos in the Phoenix, Arizonas’, the Las Vegas, Nevadas’. The repeatable part of this asset class is that standard average home across the US so it’s been great and I think as we focused, the majority of that volume has been focused towards the asset class of fix & flip where our borrowers are buying, oftentimes rehabilitating and reselling homes in their area.

We think this is awesome because this is how communities all across the country stay fresh with this type of financing to enable older, more rundown homes to become new, fresh, come back on market and to be available for homeowners to buy. So that’s what we’ve done and at the same time, not only have we helped to rehabilitate the housing stock, we’ve actually had a lot of borrowers that have gone from hobbyists of this to actually building businesses, turning homes of the sort so it’s been really rewarding to see.

Peter: Right, so let’s just touch on that a bit because how much of your business is this sort of one person doing it as a hobby versus someone who has taken out five loans every year kind of thing. What is the typical borrower, like who are they?

Matt: Yeah, so that’s a great question. Across the US, when we look at all of the data that we keep a pretty close eye on, we see that about half of this market for buying, rehabilitating and reselling homes and the financing thereof occurs to folks that are more of repeat borrowers and that’s what we say internally. Just as a note that somebody is doing multiple loans in a given year or two year span. Sometimes they’ve made this their job, sometimes this has literally become their livelihood and they build strong businesses on this and our lending and our loans enable them to do so.

About half of the space is your one-off or two-off borrower that maybe this is a hobby and so what we’ve seen is we’ve actually seen our business grow on both sides. About three quarters of our business today is more of the what we would call pro or repeat audience that has done this many times and about a quarter of it is that one-off individual loan to a borrower that may be more one and done, more of the hobbyist, but we’ve seen strong growth across both and now across well over half of the states in the US that we’re actively licensed and lending into.

Peter: Okay, so then I saw, I think it was last year you announced you were going to get into traditional mortgages. I haven’t heard you mention that yet, is that sort of initiative on hold or are you in a pilot phase, where are you at with that?

Matt: Yeah over the last year we basically have been in a protractive pilot phase. You know, we decided earlier this year to really double down and focus on the bridge loans and the fix & flip, bridge is our internal term for fix & flip because we’ve gone from zero to number one in that market and we’ve really decided to double down there. So earlier this year, we paused the originations of the 30-year mortgages to focus on that bridge space.

We still have the technology platform built, we’re still actually making progress in that space, just with rates going up in Q1/Q2 and how much volume in business there is on the bridge side where the average traditional mortgage company is losing money today. Even if we could do better with tech, we still have such margins, such scale potential and so many customers coming to us asking for help on the bridge side, we decided to kind of truly double down our focus there.

Peter: Okay, okay, that makes sense, So then what about…this is a primarily or has been traditionally an offline process, very paper-based and it sounds like you’re often working with just individuals, tell us about how you’ve sort of implemented technology to make this process more efficient. What have you done to really make this a repeatable process?

Matt: Yeah, so we have a little bit of a running joke internally of fintech companies, sometimes they’re more “fin fin” or more “tech tech.” I think we’ve struck a really nice balance of both the fin and the tech. Look, technology is at our core and we say, at the end of the day, we win on service, you know, we’re here to be a customer company that wins on service, enabled and growing through technology and that is our ethos and that’s our essence and that is our edge.

So we internally break down how the tech can add advantage into three camps. We say experience, platform and marketplace, and I’ll start with the first, so experience. Can somebody who has never gotten a mortgage before find out about us, walk up and answer a few simple questions, see if they qualify, select the perfect product for them and then finish their application in just minutes where it could take days or weeks with a traditional paper-based lender.

There’s a lot of technology that has to be built to acquire those customers, to make sure we’re asking the right questions, to really run our credit engine in real time to be able to, frankly, decision customers literally as they’re on our website answering questions without a human ever having to step in.

I’m pleased to report that actually about 80% of our customers are submitting loans, loan inquiries and then their full applications before they ever talk to a human on LendingHome’s side and that’s validation to us that…you know, where other lenders have to talk to maybe 10 or 20 customers for every one that closes, we do much better than that and we put the power and control in the customers’ hands so they can run their process the way they want to. So that’s part of how we’re differentiating on the experience side.

When it comes to platform, the average…I don’t know if you track this stat, it’s truthfully a little bit crazy. The average cost to close a residential mortgage loan has gone up just about every quarter for the last 20 and is now around $9,000 a loan.

Peter: Wow!

Matt: So if we pause on that for a second. Average loan in the US is $200,000, average cost to close it $9,000. That borrower is charged about 4.5% in higher fees, rates, hidden charges by traditional lenders just to pay their expenses, to pay their bills, that’s before their profit. That’s actually why in Q1, the Mortgage Bankers Association released the stat that the average independent mortgage company was losing money per transaction, that’s crazy.

And so we’ve been able to actually create, through significant amount of automation of the underwriting process, we’ve been able to create a process that we make thousands of dollars per transaction and have a really, really, really good business on a per unit basis, make strong margins. That then puts both money in our pockets that we can reinvest back into more tech to keep accelerating that lead, or it actually allows us to charge less fees to our borrowers and save them money.

Peter: Right:

Matt: So that platform is all about automation of the process, pulling in data automatically and not having to have 20 or 30 humans triple, quadruple, quintuple checking each other. That’s our edge with tech.

And the third is marketplace. You know, we have a wide array of investors who buy our loans and so our marketplace allows us to find, within days of closing that mortgage, allows us to find the perfect place to sell that loan, whether that’s large institutions and banks, whether that’s a credit fund that we’ve launched, whether that’s our peer-to-peer platform. And so that efficiency lets us not have to accrue loans for months or quarters or years, but actually sell them off within days of close and it lets us be hyper efficient with our capital. So really tech, it’s from end-to-end experience, platform, marketplace and that’s what we build every single day here at LendingHome.

Peter: I’m curious about mobile because…what percentage are coming to your site through the mobile device and how are you optimizing for that?

Matt: Yeah, I believe the last time we checked new customers that were coming at the top of the funnel was about 50/50…

Peter: Wow!

Matt: …which even let’s say four years ago when we started lending, those numbers have increased steadily. You might think, hey, this is a mortgage, this is the most important financial transaction that most customers are ever going to make and it’s stressful and people are dug in for a hard process, but people are still…they want to inquire on the phone, they want to see if they qualify. That’s where they’re figuring out the first steps of the process.

Basically, we haven’t launched an app as you would traditionally think of an iPhone app or an Android app. What we’ve done is every part of our site from learning about us, to seeing if they qualify to that entire experience with their application, when they’re on their phone it’s optimized for mobile so they can go through the entire experience right there and even with some of their documents.

For instance, if they’re going through their application on their phone, they can take a picture of them, have them in their photo album and seamlessly upload them right through their mobile web browser right into our hands so we can verify those docs. So we don’t have apps, so to speak, but we take advantage of it and it’s super important, it’s a high percentage today.

Peter: Right, right, makes sense. So now you’ve got the scale, you’ve got the technology, but is there…like when you look at the marketplace there’s obviously many people doing fix & flips, there’s many successful offline lenders that are doing fix & flips and you now have, you know, quite a few in the online space. So how do you differentiate yourself, is it really your tech and your scale or is there something else?

Matt: Yeah, so when we look at the competition, I would say there’s a number of ways we look different and there’s a number of ways that we have an edge. So I would say that the first is compared to most of our more offline or traditional counterparts, borrowers think of us as effectively having a national presence, right. We don’t have to have local sales people in every city that we operate in, borrowers literally anywhere can walk up and apply for a loan at any given time and we do most of our customer acquisition through online channels and so this actually just vastly reduces the overhead and the physical people in each location that we need to scale our business. So that’s thing one.

I would say thing two is really, really driving down those operational costs, right. You know, when a borrower is let’s say on their second, third, fourth, fifth loan that application is only taking minutes, we’re able to approve within days and sometimes those borrowers are able to close the same week. That’s really impressive level of service, but even though they might, you know, be traditionally going to their local country club lender who makes the process really easy for them because it’s done over a handshake, they get the certainty and scale of working with a national scale player like us, but they get that same efficiency.

We even have some of our largest borrowers that used to have in-house staff just to manage disparate loan processes with lots of different lenders that were using paper and faxes etc. and when they found LendingHome they realized, wow, I don’t even need that, all of my information is saved, this is super easy and especially once I’m repeating, it’s a breeze and so I think the service aspect is hugely important to it.

And I would say between the operational automation that drives down our costs and our low cost of capital out in the capital markets because we’ve had such strong loan performance…you know, this is not 2013/2014 all over again where the country club loan is at 12 to 15% and 2 to 5 points. This is, you know, 9/10% and maybe 1.5, 2 points up front and rates and fees and terms that really work for borrowers and really perform for our investors.

So cost of capital, cost of operation, national scale presence and tech-enabled service. Multiple things in there that we think our competition is not set up to really compete with.

Peter: Right, right, okay. So I just want to ask again about the loans themselves. You mentioned you’re 9/10% or whatever, but what is the range of the loans that you offer and then let’s talk about LTV and the length of the loan term. Just tell us about the loans.

Matt: Yeah, so the loans are going to end up being…most of these bridge loans are one year loans so this is generally the right duration to cover the acquisition of the property, the rehabilitation and the resale. Oftentimes, the loans tend to last between seven and ten months. The borrowers can actually pay them off with no pre-payment penalty, but they’re one year base loans to begin with.

We lend anywhere between as low as $75,000 and as high as $2 million, they’re interest only and the ranges of those rates will be anywhere from 7.5% on the low end up to 12 or 13% on the high end and so they are compared to some of the anecdotes that I just gave you of where the market has been…they’re nicely and competitively priced to borrowers.

Now you also touched upon restrictions like LTV and leverage and things of that sort. You know, we take a view, and this is informed by now having 15,000 units and lots of credit cycles to look at of full repayment of loans where we want to make sure that both…given their level of experience, does the borrower have enough skin in the game upfront and do they have enough cushion on the backend with what this home is going to be worth when they go to resell it.

The typical loan for us will look like let’s say between 80 to 90% of the purchase price of the home, but then we also want to check to make sure that it’s maybe 65 to 75% of the after-repair value. So if we’re going to disburse some money upfront to help them buy the home and then give them some of the dollars to rehab the home itself, we want to make sure that those combined proceeds are still only let’s say, at most, three quarters of the value of the home when they go to resell that.

That’s going to give us comfort that the upfront loan as well as all the way through that project we have significant coverage were anything to go wrong and look, a very small percentage of the time things do, but we’ve had fantastic performance because I think we’ve kept our parameters really thoughtful and make our borrowers…we make loans that perform.

Peter: Right, when they do go wrong obviously, you really have this asset backing the loan like how…maybe just give us some idea, any principal loss or how has this played out. Obviously this is a one year loan, you’ve been doing this for four and a half years, you’ve had many cycles of the loan book and what have you seen when it comes to those non-performing loans?

Matt: Yeah, so high level stats to start you out there, we’ve returned about $1.6 billion in principal to investors and about $133 million of interest so we’ve had about $1.8 billion overall in full repayment. Again, as you mentioned, we’ve seen…not our first rodeo doing this and we start to get a pretty good feel for how these loans work and perform. Basically, when we feel that even a loan is at risk of potentially not repaying or the home not being resold, we actually proactively are reaching out to that borrower well before maturity.

We realized early on that we could originate amazing loans and have this great platform and help borrowers on the front end, but if we didn’t actually also launch a servicing platform, we weren’t going to be truly best in class and win this space and that’s our goal.

So a couple of years ago, we actually brought servicing in-house which allows us to do these proactive reach outs like, you know, at month 9, 10, 11 reaching out to the borrowers. If they need, let’s say an extension, but the home is listed, it’s just not fully sold yet, we can make those within certain bounds and then should the borrower actually not pay and not be able to exit the loan, our data and analytics team, in concert with our risk teams are running all the analysis of the market, the home, the state it’s in, other purchase and sales that have occurred recently to give us the best analytics of what to do with it.

That investor who technically holds the risk is generally coming back to us saying, hey, what do you recommend we do with this asset and in almost every case, we’re able to get full principal and interest repaid. We don’t talk specifics on those credit performance numbers, but our investors have been extremely pleased with that performance to date and it’s exciting to see.

Peter: Okay, so on the investor side then…my understanding is you fund these loans off your own balance sheet and then sort of sell them to the marketplace just for the ease of use for the user experience more than anything I guess, but tell us about the typical investors you have. I know you started off you were 100% institutional and you opened up to retail, it was one or two years ago now so tell us a little bit about that. What’s the breakdown between the two and the kinds of investors you have.

Matt: Yeah, so three main camps of our investors we would say are marketplace platform or basically, the p2p platform; second is our institutional investors and third is we actually launched a second iteration in October 2017, was when we announced it, of a mortgage opportunity fund, it’s a credit fund that we actually launched and managed in-house dedicated to buying our loans.

So today, the platform looks about 15% peer-to-peer; about 30% towards the fund and about 55% institutional and that’s a good balance of where we actually enjoy keeping that mix with all of those channels growing proportionally as we scale. And so going one by one there, the marketplace platform is essentially any accredited peer-to-peer investor can walk up, can prove they’re accredited, can connect their bank account and launch assets on to our platform and then either select individual loans they would like to invest in or use our simple auto invest algorithm that dials up or down their risk reward ratio that they want to get them the return that they’d like.

So at this point, hundreds of millions of capital on that platform and we’re seeing great retention that…you know, some investors as soon as they start to get those first repayments, they put in more and many at that 6, 9, 12-month mark when those first loans start to fully repay, they get it, they see the fruits of our great credit work and they re-up with a sizable reinvestment. So that platform is growing and we’re very excited about it.

The fund which was again a dedicated opportunity fund for mortgage was launched in October 2017, we raised about $100 million of equity and we have a credit facility against it of up to $300 million of debt and so that fund earns our LPs in that fund strong returns north of 10% and can hold up to $400 million in assets at any given time.

And then the last is institutions and I think you hit the nail on the head there. When we started, we were pretty much asking just about anybody who will buy our loans. You know, if you go all the way back to 2014, starting off much more in fast money: hedge funds, private equity, folks that really needed a north of 10% unlevered return and as we’ve proven that credit and proven that scale, we’ve really normalized this asset class and we’ve been able to expand that to asset managers, specialty mortgage funds and in conversations with pensions and insurers now to even broaden that mix further. So diversified channels, diversified investor base and very exciting overall.

Peter: Right, okay, we’re just about out of time, but I can hear the passion in your voice and you really are excited about what you’re doing here so what is your vision, what is the future for LendingHome? Are you going to be the largest mortgage lender in the country, or what are your plans?

Matt: Yeah, so in the near term we are focused heads down growing and scaling the business. If you just look at our first product in fix & flip, we’ve become number one in that market from a standing start in between three and four years and we can have just on that first product, we can have a highly profitable, highly scalable business and the near term focus is to go even deeper towards that.

I think as we do that we’re going to continue building out the best mortgage platform in the world and that could be a platform that supports, you know, bridge loans, loans of adjacent products or all the way to 30-year mortgages and that platform is diverse enough to really allow us to go into any market that we want to, when we want to go into it and be truly the best way to get that mortgage product.

And last, you know, it really comes down to just that, what is the right expansion of our products over time where we can scale and be one of the most significant mortgage players in the country.

So if you’ve got that experience, that platform, that marketplace and you really unlock the business with winning on service, there’s not a lot we can’t do so focused on that and you know, as we look out to other lenders that we have admiration for like the GreenSky’s of the world who went public earlier this year, the Funding Circle’s of the world who are going to go public, folks that can leverage tech, efficiently use capital and help customers where banks aren’t or partner with banks to do that, can build multi-billion dollar businesses and that’s what we’re excited to do.

Peter: Alright, well good luck to you, Matt, we’ll have to leave it there. I really appreciate you coming on the show today.

Matt: Thank you so much, always a pleasure.

Peter: Okay, thanks, see you.

Matt: Bye.

Peter: You know, it’s interesting to me that LendingHome has decided to double down on one product, the fix & flip product. Obviously, they announced mortgage as we talked about, but they haven’t really done much with it. They’re doubling down on fix & flip and in some ways it goes against conventional wisdom in the fintech space today that companies need to offer multiple products.

So I think clearly, it’s not a one size fits all mentality for having a diversified product, they’ve decided that they can really build a profitable business in this single vertical and I think part of the reason is they have these borrowers that come and do two, three, four, five, six loans a year so the customer acquisition cost, it’s not like a personal loan where someone might do them once every two or three years. They are able to generate this repeat business in a much quicker fashion so maybe that’s it. I think there’s a lot to be said for focusing on one product if you can build a profitable business around it and it sounds like that’s what they’re doing.

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 is sponsored by LendIt Fintech USA 2019, the world’s leading event in financial services innovation. It’s coming up on April 8th and 9th, 2019, at Moscone West In San Francisco. We’ve recently opened registration as well as speaker applications. You can find out more by going to lendit.com/usa.