Lend Academy's Lending and Fintech Podcast

PODCAST TRANSCRIPTION SESSION NO. 221 –  MARTINS SULTE

This episode, No. 221, of the Lend Academy podcast was recorded at LendIt Fintech Europe 2019. It was recorded live onstage, there is also an accompanying video, but we have what follows the audio from that conversation.

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Peter Renton: Okay, welcome everybody. We are here for a special LendIt Fintech Europe 2019 edition of the Lend Academy podcast, and it’s my pleasure to welcome Martins Sulte from Mintos to the show. Maybe we can get started, Martins, by….why don’t you just give us a little bit of background about yourself and what you’ve done so far in your career.

Martins Sulte: Sure. So, I’m originally from Latvia. Basically, my previous career before Mintos was mostly, if not like….everything was related to finance so I spent my time in investment banking for a good six years. Then after investment banking, I actually decided to pursue my MBA and did MBA at INSEAD in Singapore and in Paris, they have two campuses, and then after INSEAD basically decided to take a plunge in entrepreneurship and start Mintos, that’s very short.

Peter: Okay. So you went straight from university straight to your masters, right, and then straight into starting this company.

Martins:  After my MBA, yeah, so straight from MBA. And then before MBA, basically when I was looking for a loan to finance my studies was my first exposure to P2P.

Peter: Right:

Martins: I actually got the student loan from Prodigy Finance to fund my studies at INSEAD so there was some connection also already before INSEAD to the P2P concept.

Peter: Right, interesting, interesting. So, you came at it from the borrower side originally. So, what was the idea….were you looking to start like something in financial services, or what was the idea that really led to Mintos?

Martins: I think I was looking…after MBA, after my masters, I was looking what to do next and I knew already before INSEAD that I wanted to take a plunge in entrepreneurship and then after INSEAD I was just looking where could add the most value, what kind of interest me and then just combine the two things. So, I had my background in finance, so I spent like time in investment banking, did the CFA, studied undergrad in business and economics, had a kind of finance background and then just like my love for tech. So, I’m not like technical, I cannot actually write a code, but I’ve always been passionate about technology.

And then, I think, after INSEAD, just was looking at the space, what’s happening in financial technology, financial services and that coincided with the advent of peer-to-peer lending at that time which was like early 2014. I still remember coming actually to the first LendIt in 2014 in Europe and then that’s also, of course, other players kind of scaling up and was just looking at the space. I think what made me kind of thinking is the whole concept of having like very many different platforms, each of them kind of originating different loans and then as an investor if I want to invest, I have to go to each and every platform to get kind of exposure to this asset class.

That kind of didn’t make sense to me, I thought there should be a better way actually and that’s how the idea about Mintos came about as a marketplace for investments of loans where there are many different loan originators, and as an investor I can come to one marketplace and find a lot of different loans from many different loan originators.

Peter: Right, right. So then, your platform has become a bit of a phenomenon, I would say, in Europe where you are now originating. I’ve been following your history and just seeing how…..eventually, you started to keep growing and it seems like it’s taken off like a rocket ship. You’re doing more loans than like Zopa and Funding Circle combined, sort of thing.

So, tell us…maybe we just step back, I’m curious to maybe get a sense because you’re based in Latvia, right, so then what is it…I’m curious about what the environment is like in Latvia, like do you have all your developers there, is your whole team there, do you have other offices? Tell us a little bit about that.

Martins: Sure. So, basically, how you should look at that, Latvia is where are based out of so most of the team sits in Latvia and we have offices in Berlin, in Warsaw, in Vilnius, in addition to Latvia but most of the people sit in Latvia, but businesswise, like 95% of the business we do outside of Latvia. That’s basically…when I was looking to set up the company….so we had a clear choice, either to start in London, or start in Latvia.

But at that moment, it definitely felt and I think it was a good decision to start in Latvia because I had all the kind of network available, the capital there and just seemed right to start out of Latvia. Today, it’s definitely like a competitive advantage for us that we are based out of Latvia because the cost base for us is rather low, but it will allow you…..which we can build as the same what you can build from Western Europe.

Peter: That’s part of the Euro zone, is that right (cross talking)

Martins: It doesn’t matter these days where you start from and from day one, it was global ambition. So, my ambition was always, hey, that we’re going to build a global marketplace or then we just don’t do anything.

Peter: Right. So then maybe let us…..you aren’t just focused on Europe today, you’re focused….I saw an announcement, I think, yesterday that you’re starting out in Kenya, I think it was, and I know you’ve got Mexican platforms, so maybe……..how many platforms do you have and how many countries did that come from

Martins: Yeah. I’m just going to step back a bit and explain how we actually operate. The marketplace, it’s a two-sided marketplace. On one side, we have the loan supply and loan supply is brought to the marketplace by loan originators. Those are separate companies like they’ll be focused on alternative lending companies, all of them are balance sheet lenders, or used to be balance sheet lenders and they are using the Mintos marketplace basically to sell the loans they originate so that’s the loan supply side of the marketplace.

Another side of the marketplace is investors and on that side we have retail investors who are then coming to the marketplace and buying the loan parts of the loans which are originated by different lending companies. What it means, we as Mintos, we don’t touch the borrowers so we never see the borrowers so we don’t do the credit scoring of the borrowers, that’s done by the loan originators. If you look at the loan originators, we also call them lending companies, today we have 67 different lending companies from 31 different countries and that’s what we, I think, bring to the table for any investor is like unmatched supply of loans, right.

Investors can invest in different loan types, on consumer loans, on business loans, invoice financing, agricultural loans, car loans, you name it. It’s different countries so today, we have 31 different countries, anything from what you mentioned like Kenya, South Africa, Zambia, Botswana in Africa to Colombia and Mexico in Latin America and then Vietnam, Indonesia and the Philippines in Southeast Asia and then everything in between, in Europe, a lot of countries and also Central Asia, Kazakhstan and Armenia and those countries as well.

Peter: So then, given that, it’s such a broad spectrum of countries, how do you vet these companies. As I imagine, like anything, there’s going to be well established players who are very trustworthy, there will be others that are newer and it’s harder to know whether they’re trustworthy. So, what sort of process do you go through to allow like a lending originator on your platform?

Martins: So, basically, they’re going to go through the due diligence process with us and, obviously, there’s like different loan originators from our marketplace. There are players that have been around since actually 1999, they’ve been lending as a balance sheet lender for like 20 plus years, right. And then there are players which are now just popping up, especially in Southeast Asia where there’s a lot of activity which are just entering the market.

Irrespective of how much experience they have, the process is the same so what we’re going to look at is first and foremost, of course, the loan performance. So, we have to see that the loans are performing, that they understand how to originate like quality asset. That’s going to involve looking at the cohorts like the network, what they have, having minimum portfolios of loan book and so forth so there’s obviously some threshold there.

Then we’re going to go and do our checks on management, for sure we’re going to do checks on the position in the market, we’re going to check regulatory environment, like a whole bunch of things basically before we are comfortable to connect our loan originators to our  marketplace. And that ends up, but, usually, we’re going to connect only the top players in the respective markets to Mintos marketplace. So, depending on the market, it’s going to either among the top five players, among the top ten, maybe top 20 players, depends on how big a market it is and those loans are the ones which we are working with today.

Peter: So, do your people actually physically go and visit these originators in their offices?

Martins: Yeah, yeah, for sure. So, basically, we have the whole sales team show up, that’s the first context. So, we travel a lot to all the countries then we have a risk team, a separate risk team. The only thing that they do is like getting all the loan originators and then following and monitoring them and, of course, like visiting them which is one part of kind of due diligence.

Like now, when we are already a established player, we also can do a lot of reference checks in the market, so if you know the market…..for instance, now we launched Kenya, another, we had already before so we can ask the market players as well like any reference about the players. So, there’s a lot of things which go in before we connect the loan originator to Mintos.

Peter: Right. So, once an originator joins your platform….and, obviously, they have a very good insight, a real time inside into how they’re doing, I mean, have you had instances where an originator comes on to your platform, have not performed like you would expect and you kicked them off?

Martins: Yeah.

Peter: That happens, so what are the parameters there, what would cause that?

Martins: Yeah, so those cases…..there are only very few of the loans which would want to be on the marketplace we accept.

Peter: Right.

Martins: So, in total, we have a relationship with like 1,000 loan originators across the globe. Of those, we have connected only 70, right.

Peter: Right:

Martins: So, maybe it’s still in the process, there’s plenty of those which we have sort of refused and just like a lot of players out there open to lending space. Those which have connected to Mintos and reached….either themselves have decided to stop using Mintos, or we have kind of mutually decided on that, the reason is usually either they are kind of too small, or the loan performance is not up to the kind of quality which we would want to see and originate.

Peter: Right, right, okay, it’s super fascinating, I think. Full disclosure, actually I signed up for an account at Mintos just a couple of weeks ago and I have transferred in $2,500 transferred into Euros so I could invest across the Euro zone and I noticed that you grade every loan, but, certainly, there’s a lot of loans that I graded. So, does that mean you’re adding on your underwriting, or what goes into that loan grade?

Martins: So, the loan grading and credit scoring is done by the loan originator, so each loan originator have their own approach how they actually look at the credit scoring and underwriting, and if they have a loan grade, those are shown on the marketplace for Mintos, so we don’t go into each and every borrower. So, in total investors have funded, so far, 3.5 Billion Euros worth of loans and if you translate to number of loans, it’s 16 million loans.

Peter: 16 million loans.

Martins: 16, 1-6 million loans.

Peter: Wow!

Martins: Some of them, of course, are very small so in Kenya the loan is about 50 Euros and is already considered like a pretty big loan, right. But, when we look at the grading of the specific borrower, that’s not what we touch, that’s what we leave to the loan originator. What we do though is, actually, we go in, we check that the loan originator understands what they do, they understand how to credit score, how to underwrite and how to credit score the borrower.

And then, basically, what we do to help investors make judgment because there’s a lot of kind of moments that we assign Mintos ratings to the loan originators. It shows them how good the quality loans they can originate, how financially stable they are and like general position in the marketplace, so that’s what we do. Based on supply side, we much, much more look at the kind of loan originator as a whole, instead of like a specific loan which is originated by them.

Peter: Okay, okay. So, I imagine, you’ve got these 70 plus originators, what are the different verticals that you’re offering? Obviously, you’ve got consumer, but maybe just run us through the different types of lenders that are coming.

Martins: Basically, you can think of it…..as long as it’s a loan, it can be funded in the marketplace. So, we have everything from very short term consumer loans, installment-based consumer loans, consumer loans which are basically car loans to buy a car, mortgage loans which are basically real estate, then we have on the small business loans invoice financing, we do have agricultural loans, we do have VAT loans.

As long as it’s a loan, it can be funded on the marketplace, and that’s what, I guess, we bring to the table. As an investor, I can’t come to Mintos…. like super diversified loan offerings and I can pick and choose subject to my preference, what I feel I would want to invest in, and we facilitate ten different currencies so, also, investors can come and invest in different currencies.

Peter: Right, right.

Martins: That’s also what is the kind of basically the value of building one marketplace for many, many different loans.

 

Peter: Right, right, yeah, that’s interesting. I notice….just to share with the listeners, I actually invested…I used your Auto Invest tool and I think within like two days it was all invested and it was across, I think, 35 originators and…I only did $2,500 which is like 2,200 or something Euros, but I was in well over 100 loans.

Martins: Investors can start small, the minimum they can invest….they are investing in fractions of loans so the minimum they can invest is 10 Euros, or the equivalent in any other currency which means that even if it’s a few hundreds, or a few thousands of Euros, you can build a pretty diversified portfolio. And the tools like Auto Invest, or Invest and Acess which is an even easier tool allows you to build a diversified portfolio pretty easily so you don’t have to go and pick and choose yourself manually.

Peter: Right, right. So, let’s talk about the investors, maybe you could give us a little bit of a profile. Who are the typical investors that is coming to Mintos?

Martins: So, when you said typical so perhaps you are at the stage when like typical is not a good way to look at it because it’s very diverse, but still if you look at the typical I would say that all of them are retail investors. We have only very few which we might call institutional investors so they are very small so we focus on retail investors.

So, your retail investors can be anybody who is investing, just maybe starting to invest, they’re investing like few tens of Euros up to people who are investing in like a couple of millions of Euros on Mintos. On average investors outstanding have invested…outstanding is about 5,000 Euros which is invested through us. They’re going to be your people in very late 20’s or early 30’s up to like mid-40’s, maybe 50’s.

Basically, they’re digitally savvy people which are starting to accumulate the capital and which are kind of comfortable with managing those digitally, so that’s basically how we see our clients. In total, we have today 190,000 retail investors, still growing around like 8/10% month over month, so I would say that it’s only like now kind of starting that we are really opening up the asset class to retail investors.

Peter: Right, and as far as geography…I mean, obviously, I’m based in the US and was able to invest. Tell us, where in the world can you invest?

Martins: It’s predominantly…..these days it’s from Europe because also the loan supplies are in Euros, we accept also investments from other countries, but then it depends where they have the kind of bank accounts, also from the US we can accept, but……

Peter: Do you have many US investors?

Martins: We are not focusing on these because there’s no US kind of denominated loans, so we’re not focusing on them.

 

Peter: Yeah, yeah, fair enough, and it doesn’t sound like you need to given the volume. We just heard earlier today, someone talked about the cost of acquiring retail investors here in the UK was quite cost prohibitive and so you see a lot of them have moved away from retail and doing more institutional.

Now, you have stayed with retail and you built a sizable business, what I’m really curious about is when you got started and you seem like you went over this hump and started to take off like a rocket ship….when you got started, I presume you were advertising for investors. Tell us how you’ve acquired investors and how that’s evolved.

Martins: It’s actually…initially, it was the other way around, so, initially we did…most investors came through word of mouth , either through referrals or through affiliate networks and so forth, so word of mouth was a big driver and only in the last, I would say, six months or so we have started to invest in investor acquisition. And, I think, actually, back to your point about like typical…good question, what is typical like P2P platform these days, but they definitely shifted from retail to institutional, but the problem was because the originations were going faster than actually they could acquire retail investors.

But, how we solved that is actually….basically, the problem was that it was very hard to get kind of a decent amount of retail investors. It sounds that there would be sufficient retail investors so that you can actually fund a lot of loans and that’s what we have solved today. Any loan originator which connects to Mintos, they get access to 190,000 investors from day one, so basically get like instant liquidity from day one and was kind of, I think, the problem for other players that they actually could not scale up the retail investors side, as far as they would actually originating.

Having said that, I still think that retail is like fantastic, retail investors is definitely fantastic and the funding source and that’s what we see, loan originators very much valuing today, but they actually can connect to us and they get access to 190,000 investors from day one.

Peter: So, you could almost become like the de facto retail arm for all these platforms.

Martins: That’s a very fair point, so what I see is that most of the loan originators build a very diversified funding source. They have warehouse lines, they have whatever direct funds investing, somebody maybe have a public fund or like directly institutional and they also want to have retail investors.

But, for them to build the retail investors side themselves as a platform…actually, in most of the cases, it doesn’t make sense and that was also the initial idea of Mintos that if you look at the loan originator side, it doesn’t make sense that you have your different platforms competing for the same investors and trying to get them on the platform and then as an investor they have to go and actually from one platform to another….and like many different platforms is kind of repeating the same things which doesn’t make sense. So, much better to just come to just one marketplace, see all the same loan originators and invest in one kind of gateway.

Peter: Right. So, how do you balance out the platform? Like any of the peer-to-peer companies, you’ve got your supply of investor capital, you’ve got your borrowers and you have a bit more control over it because don’t just rely on one source of borrowers, but still….I mean, do you find like….what do you have an excess of, is there excess investor money looking for capital, is every loan funded, or some of the loans are not getting funded, how’s the balance?

Martins: I would say, today, actually we would much rather call it as a marketplace for investments and loans because we technically are not p-to-p lenders. So, marketplace for investments and loans, but that’s still the same dynamics which is investor demand and loan supply and as a two-sided marketplace it’s never in balance.

Like today, if you would have asked like three months ago, I would say we lacked on the investor side, investor demand was behind, but, today, actually, loan supply is lagging behind. It’s never in balance all the time, it’s like a balancing act, but the good thing is that all the loans which come on the Mintos marketplace, they are pre-funded by the loan originators, they actually have issued the loan already. So, for them, it’s actually….they have other funding sources as well. If it doesn’t work on Mintos, they can fund it through their own balance sheet themselves so they are not kind of constrained on that side.

Most of the loans these days, actually, when they come on to Mintos…today, for sure, because the loan supply is lagging behind, they’re going to be funded instantly through Auto Invest or Invest and Access product. Most of the investors, actually, I think about 80% of loans get funded through Auto Invest which means that once it appears in the marketplace, it gets funded straightaway.

Peter: Right, right. So, do these platforms have to have like an API connection capability? I imagine, some of these platforms are offline, right, and they don’t really…..they wouldn’t have the capability to directly connect with you. Do you work with them to be able to build an API connection, how does it work?

Martins: So, we have API connections, so it works only through API connections because of the volume. Having them being offline, actually, doesn’t mean that they don’t have like back office digitally kind of developed. So, maybe they have offline operations where they acquire borrowers in an offline way, like the same as Oriente which was on stage just now. Basically, they have most of their borrower acquisitions offline, but as a bank everything is online, right, so everything is actually in their system so we just need API connection to their system.

Once the loan is originated, the borrower goes to the same, Oriente for instance, they take the loan at that moment that appears on their system, the API sends to Mintos marketplace and then it appears for Mintos investors to invest in and they can invest through automated tools and, basically, in many cases that can happen. Say you are seated in your home, with a few clicks you have set up your Auto Invest and when the loan is originated it gets funded like immediately.

Peter: Right, right. So then, what about the interest rates of these loans, and maybe you could talk about the interest rates of the loans. I know it’s got a very ….like a short term invoice financing loan is going to be different from a property-backed three-year loan, or 10-year loan, whatever. So, tell us about the range and the typical returns or the average returns maybe on the platform.

Martins: Average returns, so far, has been around 11% per annum net net for investors in Euro terms, in other currencies it could be higher and then when we look at the kind of borrower…….what borrowers like banks and industries is exactly what you said, it’s going to be a wide, wide range so there’s going to be from very high single digits with a very low default risk up for a very short period.

Short term loans, it could be like much higher interest than what the borrowers are paying, so it really depends on the loan product because we have so diverse offerings so there’s no like good average we could use. It depends on the product, country, loan originator, borrower segment and loan type.

Peter: So, how do you guys make money? Do you make it on both sides, do you take a fee for the platform and a fee from the investor, how do you make money?

Martins: We take a fee from the platform, and then we don’t charge anything to investors. On top of it, we provide some services, so, for instance, currency exchange. They we’re going to charge some fee, but the main revenue is from the fees in the platform for using the marketplace.

Peter: Right, right, okay. So then, I remember you spoke here last year and you talked about adding a debit card and a bank account, did that come to fruition over the last year, or where are you at with that?

Martins: It’s still in progress. Basically, it takes time to get the necessary license and permissions and these days when fintech is fairly kind of up and coming and growing….so, obviously, the regulators also have a lot of work on their table. So, basically, it just takes time for the regulators to look through the applications. As soon as we get the necessary permissions, we will be ready to launch both bank account for European-based investors and also Mintos card for investors.

Peter: And then what about the UK, I read somewhere that you were applying to get authorized in the UK, where are you at on that journey?

Martins: So, the UK for us is just another market. That’s one of the markets which we definitely see there is a potential. We actually applied for the necessary permissions already very early in our journey in 2016. It took a while for, actually, the FCA to review that, but this moment, basically…..at that moment we were perhaps a bit too early in our kind of effort in establishing an international kind of operation.

So, they kind of deemed that we don’t have like enough resources and, basically, said to come back later, right. At this moment, if you ask me, we have a lot of opportunities on the table. Well, I said, the UK is the best market to kind of focus on, there’s a lot of uncertainty out there.

Peter: Right, give it a year or so.

Martins: The FCA, the Brexit and all that, so we keep our eyes open and we definitely have the UK on our agenda, but it’s most likely not in the immediate future.

Peter: Right. So then, I’m curious about where you are on the profit journey. Are you making profits yet, or whereabouts are you?

Martins: We actually are. So, and that’s what I say, it’s been a competitive advantage being based out of Latvia. So, we’ve actually been profitable since early 2017, even with all the growth we have experienced, so now maybe, we are now kind of burning cash because we kind of have more people and expanding much more aggressively in geographies. But, we’ve been slightly profitable for the last few years and remain slightly profitable on a monthly basis.

Peter: Okay. So, we’re almost out of time, but I’m curious….I mean, you’ve got this amazing platform right now that feels like it’s already…..I see the list on p2p-banking.com and you’re always, by far, the…….I think you’ve outdone every single platform on there and wouldn’t come up close to what your total is each month.

So, where do you take this, do you want to be the sort of the way the world invests in lending, I mean, are you focusing on building what you’re already doing? I feel like you’ve got this incredible opportunity in front of you and I’d love to know where you would want to take it.

Martins: I think our vision really is to open up the new asset class to really open investments in loans, basically, loans as an investment for the retail investors, so that when people think where to invest, they can simply say I can invest in stocks, I can invest in real estate, commodities, I don’t know, maybe some in crypto, or somewhere else and then they think, well, I also can invest in loans.

And so, the retail investors actually have this opportunity on the table so that’s what we are working towards. The market is huge, they’re not only limited by alternative lending companies originating the loans, so already today, while we are still……I’m going to focus on the immediate future in the alternative lending space. There’s a lot of things happening, already today we have been talking with, for instance, telecom companies, like telecom companies in Africa or in Pakistan, they are one of the biggest originators of loans because they are the ones who have data which can actually credit score the borrower one way or the other.

So, that’s like clear, the originator as well for us, just an e-commerce company, it’s like e-commerce platforms, they are giving loans to the Americans in the e-commerce site and they also don’t want to keep the loans themselves on their balance sheet. So, for them, they also can serve as a kind of way to offload the loans and basically fund the loans, or the same banks actually.

There are plenty of banks which don’t want to keep small business loans on the balance sheet because they have to manage capital ratios, and, of course, they might want to offload them to the marketplace through the retail investors. So, basically, what I see us actually becoming is a place where retail investors can come and choose from many different loans, be it originated by an alternative lending company, or down the road, by some other players and become basically this marketplace for investments and loans globally.

Peter: Right, one more question I forgot to ask you earlier. How are you regulated, I mean, as I mentioned that’s a very important thing for….you know, investors want to feel like their money is safe. So, tell us how you’re regulated.

Martins: So, regulation is like two-fold, so we have to look at the side of loan origination so, basically, each and every loan originator they have their own permissions and licenses in their respective countries they operate in so that’s where the regulation comes in there. And then, on the other side, it depends on the kind of market we are operating, or we are kind of working in. In most of the countries, actually, in Europe, I would say the regulators are kind of forming their approach, there’s no kind of homogenous approach to how to regulate.

So, today, we are based out of Latvia, that’s where we are operating from so our service is not considered regulated service, basically, because what we do, we facilitate assignment of loans receivables from loan originators in masses so it’s deemed a regulated service today. Having said that, that’s definitely going to change and we are pushing for that to change.

Peter: Right.

Martins: Meanwhile, we are applying for electronic money institutional license and investment brokerage license just to have additional kind of certainty there. It’s still kind of a work in progress, I think, when it comes to the kind of regulating.

Peter: Okay. So, finally then, last question, how many people across the difference offices do you have, what’s the total workforce size?

Martins: Today, we are about 150 people, we’ve been scaling quite a bit, so we started the year with 60 people. Now, we are 150, most likely we’re going to end up the year with like 200/220 people and I think it’s only now the scaling part is starting for us.

Peter: Right. Well, you’ve created an amazing organization that is….it’s been fascinating to watch how you guys have grown. All the best and thank you very much for coming on the show.

Martins: Thank you, Peter.

Peter: Okay, see you.

PODCAST TRANSCRIPTION SESSION NO. 220 –  LUZ URRUTIA

Welcome to the Lend Academy Podcast, Episode No. 220, this is your host, Peter Renton, Founder of Lend Academy and Co-Founder of the LendIt Fintech Conference.

(music)

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

Peter Renton: Today on the show, I am delighted to welcome Luz Urrutia, she is the CEO of Opportunity Fund, a position she has held for about a couple of years now. I wanted to get Luz on the show because I’ve always been fascinated, for several years now, with Opportunity Fund. They are the largest non-profit small business micro lender in the country and I feel like they have such an interesting story where they’re loaning money to people who are underserved at very reasonable rates and have very reasonable default rates so I wanted to sort of dig into that and find out why.

Luz is actually very generous in sharing a lot of the insights that has really enabled her company to be successful and so we talk about the underwriting, we talk about how they are sort of more than just a lender to these people, they really are a part of their borrowers’ lives. We talk about how they’ve sort of managed their relationship with Lending Club, that’s a big part of what they do, and where their capital comes from and what’s next for 2020. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, Luz!

Luz Urrutia: Thank you, Peter, glad to be here.

Peter: Okay, so I’d like to get this thing started by giving the listeners a little bit of background about yourself and…you’ve had quite a storied career, I would say, so far, with working in the banking system, so just tell some of the highlights of your career to date, before Opportunity Fund.

Luz: Sure. So, I’m originally from Venezuela so I’m an immigrant myself, I’ve been here for a very, very long time, came to this country to learn English and finish my undergraduate and then started working for a bank, at that time was Wachovia Bank, then went and got my MBA.

Then I got this little bug in me driven mostly by my original experience when I started working at Wachovia that I was turned down….I applied for a credit card and they turned me down because I didn’t have any credit. And so I thought that was pretty odd because I could be working for a financial institution, but they wouldn’t give me credit and I promised that one day, in the future, I would go build a bank or a financial services organization to serve the under-banked population with responsible and affordable financial services for people that didn’t have access.

And so, that sort of drilled my, you know, pursuit of working in a number of different organizations that developed knowledge and understanding about this community. So, from that, I built a bank, ran it for about 13 years, sold it, then I came to California, started working for a company called today Oportun, it was Progreso Financiero, and they also worked with small dollar….primarily at that time, immigrants, Hispanic immigrants, that didn’t have credit or had thin files.

And then, you know, I decided that I needed to think about……I’ve been in the for-profit world my whole life and sort of balancing profits with mission is the real difficult tension at times and so that kind of brought me to coming and joining Opportunity Fund…a) because I was passionate about their mission, and two, because I felt that how about if I start with a mission and allow the mission to drive the sustainability of the business. So really, my whole entire career has been focused on financial services in the last 17 pretty much serving underserved populations.

Peter: Right, right, interesting. So, you know, we had Oportun, we had Raul on the show before and, you know, they certainly are focused on an underserved population. So, I’m curious about the crossover between the population, but, let’s just hold that thought because maybe we should start by explaining what Opportunity Fund does. So, why don’t you give us a little bit of a spiel there.

Luz: Sure. So, Opportunity Fund, we are largest non-profit micro lender in the country and our focus is to tackle the widened inequality by investing in underserved and overlooked small business owners and communities across the country, both urban and rural. You know, small businesses are a critical driver of new jobs, they employ 50% of the population and generate 64% of net new jobs and entrepreneurship is a proven pathway to help move people into the middle class.

But, unfortunately, many deserving small business owners don’t have access to the affordable and responsible credit that they need to support and grow their businesses. So, we provide small loans mostly to low to moderate income ethnic minorities, women and immigrants to help them make that permanent and lasting change in their lives. So, you can look at our model as a hand-up not a handout. You know, we’ve seen first hand the ripple effect of the loans that we make in the form of growing businesses, more jobs, more vibrant communities.

The organization has been in existence since 1994 and since that time, we’ve deployed more than $900 Million and helped thousands of entrepreneurs invest in their futures. Right now, we are launching….last year launched our new 5-year strategic plan where we are committed to deploy an additional $1.2 billion to small business owners across the country by 2023. Our focus, as I said, we do about….. 75% of our borrowers are low to moderate income, 30% are women and 85 to 90% are minority-owned businesses.

Peter: Right, right, okay. And in addition to that, I also believe you are also CDFI so you get some of the benefits from that designation, I’m guessing, so maybe just a quick rundown for the listeners, just a short spiel on what the CDFI is.

Luz: Sure. So, CDFI’s are community-based specialized financial institutions that serve low income communities, or people that live in distressed communities and often they are working in market niches that may be underserved by traditional financial institutions. The CDFI is a designation that’s provided by the US Treasury Department for institutions that help low income communities.

So, they are very strict in the measurement on who we serve, they opened a pool of low cost capital to us and actually, on September 23rd of this year marked the 25th anniversary of the CDFI fund, you know, which aims to expand economic opportunity by investing in organizations like Opportunity Fund to provide loans, technical assistance and financial services.

Peter: Okay, so the other thing I want to talk about because it’s not……from my understanding when I was researching Opportunity Fund, it’s not just about the loans, it’s also…..why don’t you tell us about this New Markets Tax Credit, what is that and how does it fit in with what else you’re doing.

Luz: Sure. You know, it’s very much complimentary to what we do. So, the CDFI Plan also administers the New Markets Tax Credit Program which builds and supports high impact development projects like healthcare centers, homeless shelters, services for at risk youth, food banks and other much needed services by low income populations and neighborhoods. You know, I look at that as a prime example of successful public and private partnering.

So, CDFI’s across the country leverage an additional $12 in private capital for every dollar of federal funding received through that New Markets Tax Credit Program. And so, in our case, what we do is our program is designed to increase the flow of capital that’s going to businesses and low income communities and it provides a modest tax incentive to private investors. Over the last ten years, it really has proven that this program is a really effective targeted and cost-efficient financing tool for businesses, communities and investors across the US.

So, we work with a variety of banks who act as the investors and we’re providing those tax credits to those investors. We’ve received, gosh, over $350 Million worth of allocations from the CDFI Fund and have allocated those to, right now, about $330 Million of that has been put to work in this very high impact, as I said, you know, homeless shelters, food banks, education services. I mean, you may have heard some of these in California….you know, the Boys and Girls Clubhouse, Ravenswood Health Clinic, Compass Family Services….so these are the kind of projects that we are helping to finance.

Peter: Right, right, okay. So, I want to get back to the borrowers, I want to actually talk….you guys are a little bit of a demographic of who the borrowers are, but I want to dig a little deeper there. Maybe, you know, what kinds of companies are these small business owners borrowing money for, you know, like just tell us a little bit about who they are.

Luz: Sure. So, you know, our clients really come from nearly every industry that you can imagine across the country and they share a number of things in common. First, many of them are small mom and pops, anywhere between one to three employees and up to about half a dozen or so. We do have very few clients that have a hundred employees, but that’s really not the norm, it’s more the smaller micro businesses.

They’re all incredibly hardworking and resilient, they’re established and successful, they’re looking to grow their businesses so think about the dry cleaners expanding to a second location, or a woman who makes tamales, you know, ready for a cargo van to start taking catering deliveries, or the restaurant in the corner from your house. These are borrowers….when they come to us, many of them, unfortunately, come to us looking to recover because these days we see that many of the small businesses are trapped in debt cycles by not very good actors that are offering short term, high cost financing, you know, with a direct take into their bank account, it’s called merchant cash advance and so they’re drowning in debt.

These are very healthy businesses with great cash flow, but have a need for capital that’s responsible and affordable, and, unfortunately, they go online and they find these very easy to qualify for loans, they take them and then they come to realize that they’re doing more damage to their business than help. Our borrowers also, in many cases, don’t have traditional documentation, you know, over 15 to 20% don’t have credit, or have thin files, so, obviously, they’re not a focus for many of the banks and lending institutions.

You know, many of them have been….their average to give you an idea….the median household income is about $38,000 of our borrowers, so these are really, you know, individuals that are looking to set up their business and support themselves and their families, create jobs in their community and then cause that ripple effect of, you know, people that invest and save and invest in their community.

Peter: Right. So then, you sort of set up a business which made think, are these new businesses as well as established businesses?

Luz: So, our requirement is that we look at borrowers that have been in business at least for one year.

Peter: Okay.

Luz: However, in some cases, if we have a borrower coming to us that have a lot of experience in the trade in which they’re trying to set up…so they’ve been in the food industry, in the restaurant as a cook and they come to us and say, look, we want to buy a mobile food truck to start our own, we will finance that mobile food truck, but it’s because they’ve got experience in the trade and the business that they want to start.

 

Peter: Right, got it. So, what about the loans themselves? Let’s just talk about the terms of these loans, what’s the typical size, interest rate, the loan terms, tell us about the loans themselves.

Luz: Sure. So, we loan anywhere between $2,600 to $250,000 and, obviously, that’s a big range. The average term is about 33 months, our loans go anywhere from 12 months to 72 months, and our rates vary, and, again, it depends on the size of the loan, the profile of the borrower, but our rates go anywhere between 7.5 to 18%.

Peter: Okay. So, 18% is the high that they’re going to pay?

Luz: Yeah.

Peter: It sounds like some of them are really re-financing existing high interest debt like if they’ve got a merchant cash advance that’s really crushing them. You’re finding that a few of them will just need to get out from under that and so they’re coming to you to try and re-finance?

Luz: Yes, as a matter of fact, there is a paper that you can access on our website on affordable and on sustainable which was a research that we did a few years back when we spoke. We got about a hundred clients that came to us to get re-financing and we found that many of them…the average interest rate was 94% on the loans that they were borrowing for their business.

Some of them we saw had rates up to 350% and what we also learned was that most of these businesses were paying twice the amount in debt that had available for their own cash flow. We were able to help about 50% of those borrowers, Peter, unfortunately, the other 50% were so deep in the hole that we could not help them, but our focus is to get them into a responsible loan before they even have to go out and find a loan of that magnitude and that rate. If they go there and find them before they find us then trying to re-finance them into a better loan that’s going to help their business.

Peter: Right, right. So, I’m curious about the loan performance because you’ve got…..I mean, these are very reasonable rates, there’s no question about it. These are from a small business to an underserved community…these rates are very reasonable. Are there any metrics you can share on how the loans have been performing?

Luz: Sure. So, you know, we have a 95% repayment rate which is one of those huge misconceptions that these borrowers are very high risk. If you apply the principles of responsible lending which is underwriting every borrower for ability to pay making sure that they have sufficient cash flow so that they can afford the loan, reporting credit to the credit bureaus, providing, you know, reasonable pricing, what you’re going to find is that you have not only very responsible borrowers that pay back 95% of the time, but also very loyal.

And so that is one of our sort of biggest rewards, if you will, to see that these borrowers can take money, can do so much, invest and grow their business and yet, you know, we get a 95% repayment rate.

The other piece is the survival rate of the businesses. Our business is after having taken and paid the loan after a few years, they show a 94% business survival rate and that is twice that of the national average. So that’s another statistic that we measure that we’re very, very proud about.

Peter: So then, what is it about your underwriting, you think, that is being able to have….I mean, obviously, it’s more than underwriting. It sounds like you really got this sort of bond with your borrowers, but I want to just talk about the underwriting briefly, you know, what kind of data do you use, how do you approach it and what’s your approval rate on these borrowers?

Luz: Yeah. So, you know, it’s a combination of things, right. The first thing is, you know, we underwrite every single borrower for ability to pay so that’s at the top of the list. If you think about what are the first things you do, those are the first things we do. We believe that it doesn’t make any sense to put a borrower in a loan that they cannot afford, particularly because we report credit to the bureau, so that’s number one.

The number two is, you know, we look beyond the numbers. We underwrite loans taking into consideration the borrower’s experience, as I mentioned earlier, as well as the character. So, you know, when we talk about collateral, for us, we look at collateral in terms of assets, but we look at moral collateral which is very, very high within the community that we serve.

As I mentioned, we report all loan payments to the credit bureaus because we believe that helping someone build or improve a credit score is helping borrowers build an asset that is critical for any business or individual that’s looking to grow and be able to do some of the very most basic financial transactions in this country, right.

So, running a place, connecting utilities, you know, getting a cell phone, so that’s very important to us. The other thing that we do that I think is critical in the success of our lending is that we build in businesses advising and feedback throughout the underwriting process and the life of the loan. We believe that a little bit of the seed money with the right kind of financial advice, those two combined, are a real powerful combination to ensure the success of that loan and that borrower.

Peter: Right.

Luz: The other thing that we do which is also very unique is we, you know, have a very empathetic collections programs. So, from time to time, we know that our borrowers get into trouble and many cases for reasons that are beyond their control and so rather than sending that loan to collection immediately and charging against the customer, we take an approach to understand what are the challenges they’re having, how can we help them restructure the loan, extend the payment terms. And so what we find is that in 80% of the cases those loans that go delinquent get that current, okay.

And then, finally, you know, we make the process of paying us back as easy as possible and I think that makes a huge difference and then if you take that further down to dealing with immigrant population, I think one of the most important things is making sure that you have cultural competence in our team and that we understand the market, in other words, our people serving our people.

When you build that trust with the borrower and they know that they’re going to see Adela not just closing a loan, but they’re going to see her in the school with her kids, in the soccer field, in the grocery store, there is a trust bond that’s established between the lender and the borrower that really lasts for a very long time. If they get in trouble, they’re going to pick up the phone and call you.

Peter: Right, right, that makes sense. So then, I know you can apply online to these loans, but you can also, I believe, apply in person. So, are most of your loans coming from the online channel, or how do borrowers get in touch?

Luz: Yeah. So, we have a combination of outreach and customer acquisition so, you know, we have boots on the ground for the very small micro businesses and we work with a network, a significant network of community partners in California, about 50. These are other CDFI’s that are providing either technical assistance, business advising, tax, legal and accounting services, but need somebody to provide the capital and that’s where we come in so we get, you know, a significant number of borrowers coming through our community partnership network.

We also work with mobile food truck manufacturers, we work with trucking dealerships, we work with other banks that may decline customers for credit and they send them to us, and then we have our online channel. Our online channel is mostly with the Lending Club partnership that I know you covered when we launched that expanded partnership back in April and so that partnership is in 45 states now; California and 44 states outside of California. I say that our online channel generates about a third of the volume that we do, a third to 40% of the volume that we do and the other channels that I talked about generate the remaining.

Peter: Right, right. So, just maybe tell us about this relationship with Lending Club. I think most listeners would remember that Lending Club decided to stop originating loans and they’re sending them off to you guys and to Funding Circle, so maybe….like is this sort of…that’s where most of your online is coming from, is this a partnership that you’re hoping to deepen? What are your expectations for this partnership going forward?

Luz: Sure. So, you covered this, again as I mentioned earlier, which was a very exciting time for us. So, Opportunity Fund established a partnership with Lending Club back in 2016 and at that time it was….thank you to a grant made by the J.P. Morgan Chase organization where they wanted to see how a marketplace lender, the largest marketplace lender, could partner with a non-profit to help borrowers that were declined by the online lenders.

So, if a borrower came to Lending Club and they were declined for credit reasons then we interfaced our systems with theirs through API’s and they, in the background, would run that borrower against our own credit box. And then if we approve them, the borrower would get an immediate notification, congratulations, you have been approved, pre-qualified by one of our partners and so we would take the borrower relationship from there and we would underwrite the loan and, you know, close the loan, service the loan, etc.

We had that partnership in 13 states for a couple of years, a lot of success, we were able to help a lot of borrowers reduce their pricing from other options that they had if they had been turned down by Lending Club and by us and so we felt that it was time to expand it. And so what we did is we said, look, we want to go nationwide with them, leverage your technology, integrate more and then start to provide pre-qualified offers, not just to second look customers throughout the country, but to what we’re calling near prime customers.

Near prime customers are customers that are not yet being approved by banks, or other responsible lenders and are still going to, you know, higher cost online lenders. With that partnership and the expansion of that partnership back in April, we also recognize that, you know, there’s a lot of prime borrowers coming in through the Lending Club channel, but those are not necessarily Opportunity Fund’s target market. Those are more the target market of organizations like Funding Circle. So, Opportunity Fund is getting the second look in the near-prime and Funding Circle is getting all the prime-based customers.

Peter: Right, right. So then, is this relationship unique? Are you looking to like duplicate this with other potential online lenders, or what are you…how do you view it as a channel you can expand?

Luz: Sure. So, you know, we obviously just launched this in April. We have met all of our goals in terms of loan originations which has been wonderful. We believe that the combination of, you know, our credit technology, their capabilities, our mission-based high touch lending model that we can continue to dramatically expand access to affordable capital to more underserved business owners across the country. If you think about our partnership, you know, we’re taking care of about 80% of the market that we believe 80% of the market of underserved small businesses.

So, we still have a lot of work to do with Lending Club to expand the partnership, we’re in the final stages of building the more integrated technology solution and so we’re expecting to work on that for the next six to 12 months and then decide, you know, where do we go from here. Is there opportunity for us to extend to other partnerships which is a key element of our strategic plan that I mentioned earlier, to deploy $1.2 Billion. It is to partner with other organizations, both online, other CDFIs, you know, other referral partnerships in order to extend our capability and be able to help more underserved populations across the country.

Peter: Yeah, so what about like an organization like Oportun where you used to work. Obviously, they’re more focused on the consumer, consumer and personal loans, but is that the sort of company that you would consider partnering with?

Luz: Well, you know, we’re not a consumer lender. We are a small business lender and while they are sort of….you know, when you get to the lower end of the pyramid, as I call it, there is a real blurry line between what’s a consumer loan and what’s a business loan because a lot of consumers will borrow under their personal credit and they’re investing and they have other jobs, right, during the day, but they have a side business, whether they’re at landscaping, or restaurant, etc. So, we don’t have plans to become a consumer lender, at least for the foreseeable future, so our partnerships are going to be more focused with organizations that are applying through underserved small businesses.

Peter: Right, okay, that makes sense. So then, what about the capital that you’re lending out? I mean, obviously, you’ve got the CDFI Fund that you talked about and banks, I believe, can get CRA credit for the loans they’re putting up there, but maybe you could tell us what other sources of capital that you’re working with.

Luz: Sure, absolutely. So, the CDFI Fund is crucial for us and, you know, we’ve…..I think we’ve gotten like $16.5 Million worth of allocations since the fund has been in existence which has been great. The bulk of our funding comes from traditional banks, financial institutions that are lending us through their Community Re-Investment Act. So, you know, it’s highly critical, highly impossible because it’s low cost capital and as you probably know, banks are required to invest capital into communities in which they take deposits from and where they operate and a lot of financial institutions don’t necessarily have the expertise, the know how, or the desire to lend to the kind of businesses that we lend to.

So, what they do, in turn, is they give us those loans and we lend to those local communities and so that has been incredible capital for us. You know, right now, we have over $110 million worth of lines of credit, the bulk of that comes from CRA banks, we also have an impact investment note. Two years ago, we issued the largest impact investment note that has even been issued by a non-profit small business lender, CDFI.

We raised about $11.5 Million from that, we’re expanding that and that had, you know, investors foundation, a lot of accredited individual investors and so that provides another important source of capital for us, and then we have a number of foundations that provide program-related investments, banks provide EQ2’s and other low cost capital which is, obviously, so critical for us because the rates you were talking about that are reasonable. The reason we can provide those kinds of rates is because we get very low cost of capital that help support the lending at those rates.

Peter: Right, right, for sure. Okay, we’re just about out of time, Luz, maybe we could end with talking about what’s next for you guys. You’ve talked about your 5-year strategic plan, but maybe give us a bit of a window into next year and what do you hope to achieve in 2020.

Luz: Yeah. So, as I said, you know, we’re marching towards a $1.2 Billion deployed by 2023. You know, next year, we’re looking at deploying close to 140 million worth of capital, we are launching our Women of Opportunity initiative. As you can imagine, I am keenly focused on helping women on businesses achieve their true potential and that’s one segment of the population that, unfortunately, gets a minimum amount of debt capital when they ask for it.

We’re working, obviously, with Lending Club to expand that partnership and make it as productive as it can be. We also established a partnership with Key Bank to open new markets with our trucking lending starting in New York and, hopefully, expanding into other markets. We’re looking to expand our impact investment fund to attract more institutional and individual accredited investors.

We will continue….. one of the key areas of our business is to advocate and help influence policy, both at the state, but, you know, national and regional level and that’s a big part, especially in these days where, you know, every time we turn around, we see that one of the programs that is benefitting these low income communities is at risk of being eliminated. So, our policy and advocacy work is going to take a very intense approach in 2020. I’m going to be spending time, you know, talking at the CFPB next month about the need for us to collect data from small business owners under Section 1071 that they’re evaluating.

We’re going to continue hiring, seeing our staff grow, you know, hopefully, by 200 people by the time we’re done with this strategic plan, and just you know, relentlessly trying to manage risk, adopt new technology which is key. You know, technology and data analytics are key for us to deliver the kind of growth and impact that we want to deliver, and just helping more borrowers, say more yeses to borrowers that as we can so that we can continue to close that income and equality and support the communities in which we all work and serve.

Peter: Okay, it is a noble cause and I think your organization, I think…I hear about it talked all the time, about what great work you guys are doing. So, I really appreciate your coming on the show today, Luz.

Luz: Peter, thank you so much for your time. As always, it’s a pleasure.

Peter: Okay, see you.

Luz: Talk to you soon, bye.

Peter: Bye.

You know, you can really tell talking with Luz right there that her company has developed a bond with their borrowers that is real, and, obviously, they have….you know, they’re serving underserved population and these people are very grateful for receiving this money, but it’s more than that because they develop this loyalty, I mean, this 95% repayment rate for what is essentially, let’s face it, a near prime or subprime population.

That to me is astounding and not just in a consumer, but in a small business setting where these businesses are potentially…..many businesses fail, as we know, and they’ve got a better success rate than average there as well. So, they’ve worked out how to really attach themselves into the lives of these people where they consider paying off their Opportunity Fund loan a very high priority and that’s, I think, the story here. They’ve, obviously done a great job in attracting these customers and underwriting them, but what they’ve done best at, as far as I can tell, is they have got loyalty. Loyalty, I think, that many other small business lenders would be quite envious of.

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

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

PODCAST TRANSCRIPTION SESSION NO. 219 –  DANIEL CHU

Welcome to the Lend Academy Podcast, Episode No. 219, this is your host, Peter Renton, Founder of Lend Academy and Co-Founder of the LendIt Fintech Conference.

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

Peter Renton: Today on the show, I’m delighted to welcome Daniel Chu, he is the CEO and Founder of the Tricolor Auto Group. Now, we’re talking auto financing today and a specific niche within that, auto financing for the Hispanic market. So, most of the customers that come to the dealerships of the Tricolor Auto Group, and they have dealerships in Texas and throughout Southern California, most of the people are thin file or no file and yet they approve pretty much everybody who walks in the door.

And we talk about how they’re able to do that, the terms of the loans and sort of the state of the auto finance market for the Hispanic population. We also talk about securitization and how they’ve done many successful securitizations to date. We talk about how they’re trying to graduate their customers into the traditional financial system, we talk about a new product they’ve got going and what their vision is for the future. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, Daniel!

Daniel Chu: Thank you, thank you, Peter.

Peter: So, I like to get these things started by giving the listeners some background. You have an interesting background in that you started off in basketball, not many of my guests start off in sports. So why don’t you give us a little bit of a rundown of the highlights of your background.

Daniel: Sure. So, oddly enough, I do have a background in sports but really I think my experience in basketball really in many ways captured my interest and developed for me a passion in wanting to build something and maybe beyond that building something with really a clear purpose.

Actually, as both a player and a coach, I was involved in two college basketball programs where the sport was reinstated after 10 or 12 years of inactivity. So just being exposed to the process of starting something new where you had to mobilize all of the different constituencies from players, to fans, to media, to all of the different support groups around a vision to create something that was going to, hopefully, be successful was really a great experience for me and in many ways was maybe the best preparation for business possible.

It really trained me to understand how to get alignment, to present a clear and compelling vision and get buy in around that vision, very similar to the challenges really of an entrepreneur today.

Peter: So, it’s interesting, it seems like you’ve kind of moved from basketball into the automotive space and you’ve spent, it seems like, most of your career there. So, tell us a little bit about Tricolor and sort of the founding story. What was the idea that kind of led to it?

Daniel: So I think at the beginning there was a recognition that the Hispanic market was highly underserved, and I think that opportunity led to really the notion that if we could figure out a way to address that segment…it was a differentiated enough segment where there truly was a purpose to providing a better product and a better service that could really be compelling.

My parents were both immigrants and in many respects, Asians and Hispanics share similar cultural values. There’s definitely an importance around family, there’s definitely a commitment to working hard to build a better future and I think that gave me an appreciation for the Hispanic culture. As I spent time understanding that market, I think there were continued discoveries that led me to believe that there was really great potential in being able to serve that very, again, underserved segment.

One that I often think about is how intensely brand loyal that segment is to the extent you provide them with compelling value, I think you have a customer for life. We’ve really built our business at Tricolor on providing for that customer superior value to anything that they really could find and access in the marketplace and I think it served to help the company build really a sustainable business.

Peter: Okay, so why don’t you just give the listeners a little bit of a description of that business, you know, how it operates because I know you really are in the physical world, more possibly than the digital world. Maybe you can tell us a little bit about that, but sort of explain how the business operates.

Daniel: Sure. So, we do operate in a segment that’s known as “buy here, pay here” within retail auto. So, in the continuum of retail auto dealers, you have obviously franchise dealers and independent dealers. We operate in that subset of independent dealers, really, the only subset within the entire continuum that has to finance the sale in order to actually transact it.

That said, we look at our business on a much higher level. The real fundamental mission driving our business genuinely is a desire to enhance the quality of our customers’ life and we believe we achieve that by providing them with a vehicle of very high quality and with financing that is affordable and suitable to their specific needs.

Peter: Okay, so just maybe quickly…what percentage of people coming into your dealerships need financing for their vehicle?

Daniel: Over 99% of the sales that we transact are financed by us and so, clearly, we’re positioned in the market as a lender and as a retailer who can meet the specific needs of a consumer who really has a very, very low ceiling in the types of financial services they can access.

They’re really excluded from anything that would be considered mainstream, but at the same time, it’s a segment of consumer that we’ve been able to observe as being not only appreciative of the opportunity to get financing, but works very hard to meet their obligation to the extent they’re extended credit.

Peter: So, then who are you kind of…let’s just maybe step back and talk about the Hispanic market. They’re going out to buy a car today, and they don’t have the capital to do that, what are their options?

Daniel: Generally, their options would be with a dealer that would be operating in this “buy here, pay here” category and really we would say we’re the only operator serving that specific segment at scale. You will find…you know, virtually in any of the geographies that we operate in, you will find operators that have had positive experiences and have been able to accommodate a Hispanic consumer that may or may not exist in the credit bureau.

We are really the only lender that has been able to address that segment at scale and we believe we have a platform that leverages technology that enables us to do that better than anybody else with more affordable terms and really an opportunity beyond that to build credit and ultimately break through that ceiling that enables those customers to ultimately access traditional financing.

Peter: Right, right. So then maybe you could help us just give a little profile of your typical customer. Are these people…you know, are they thin file, or they have no file, are they really in the cash-based economy, do they have bank accounts, maybe just give us a little bit of a profile.

Daniel: Sure, so the majority of our customers would fall into the category of being no file, or thin file so either they have no bureau data, or they have such limited bureau data that they become effectively unscorable. That said, the average borrower that we finance, even though they are thin file, or no file, have resided in the United States for over 15 years and that’s really consistent with the research that we see in the market.

There’s a very good resource called the Pew Research Center and Pew says that 60% of the undocumented immigrants in America have resided in America for in excess of ten years. That’s very congruent with what we’re seeing in the marketplace. So, even though these customers that we are financing or these consumers do not necessarily exist in the bureau, they are established in the ecosystem in the US.

In Texas, we average over 15 years in the US; in California, actually 18 years. In fact, a reasonably high percentage of our borrowers in California actually own their own business, even though they may be undocumented residents.

Peter: Interesting. So, they have thin file and no file, how do you underwrite these people? I mean, obviously it’s a secured loan, you have the car as the asset securing the loan, but you obviously don’t want to have to go and repossess it. So, tell us a little bit about how you go about underwriting when there is such little information formally on these people?

Daniel: Sure. So, our underwriting process both utilizes alternative data, bureau data as well as what we would call application data. Even on no file/thin file consumers, there are a number of alternative data sources that we use that provide us with insights that we can utilize in the underwriting process for those no file/thin file consumers. At the same time, we do rely on application data which are data points that we are collecting from the customer face-to-face with them when they are in one of our retail dealerships.

We’re collecting, Peter, probably a hundred different data points from that customer in the application process and what we’ve been able to do and what has really been augmented very effectively with the use of artificial intelligence is we’ve been able to identify patterns in both the application data we collect as well as the alternative data and bureau data that give us the ability to segment this consumer even though they may have no credit score that we can rely on.

Peter: Do they need to have a bank account to take out this loan?

Daniel: So, we don’t require a bank account. It would surprise most people that about 80% of our borrowers do have a bank account so even though they are a no file/thin file, or in some cases undocumented, there are several banks, two major banks, Wells Fargo and Bank of America, that will provide that profile with a checking account.

So, the majority of our customers do have bank accounts and actually, we rely on an alternative data source called DecisionLogic which verifies that banking information and that’s an integral part of our process. For us, at the end of the day, with our underwriting model, we’re measuring stability and there is a correlation between a consumer that has been able to secure and maintain a checking account and their overall stability.

Peter: Sure, so then during the application process….this is happening face-to-face in one of your dealerships, is this a paper-based experience, or is it digital, or is it some sort of combination?

Daniel: So, the information is gathered face-to face. It is entered during that interaction with the customer, it is entered into an interface that we’ve built which then feeds our credit decisioning engine. So, once all of that information is actually gathered, collected and input, the process from there becomes purely digital. It’s an automated underwriting process that’s going to feed back to the dealership a grade and we grade in six different tiers, A+, A, B, C, D and the lowest tier, E. And so, the process, again, once we input that data into our, call it “decisioning engine” is fully automated.

Peter: Okay, so then what percentage of the people pass the underwriting, and what percentage do you turn away?

Daniel: There are a couple of conditions that would lead to an automatic disqualification, but for the most part, every customer that applies is going to be approved at some level. They’re going to be graded somewhere on that continuum between an A+ and an E.

What we’re going to do is use that grade to drive the financing terms that we would offer the customer so we’re going to offer the highly stable, high grade customers very attractive financing terms, low down payments, longer terms, lower installment payments and conversely, we’re going to offer the lower grade customers…we’re going to require from those lower grade customers higher down payments, we’re going to finance less over a shorter term.

Peter: Okay, so let’s talk about the loans themselves. Give us a sense of the terms of these loans, the interest rates, the duration, that kind of thing.

Daniel: Sure. I think it might be helpful to provide some context first.

Peter: Okay.

Daniel: Within the “buy here, pay here” industry when we look at the industry, we think about it being comprised of roughly 10,000 pure play operators generally concentrated in Texas and the southeastern United States. If you look at that segment overall, that group is originating loans with an average interest rate of between 22% and 26% with LTV’s of somewhere between 170% and 250% at terms between 36 and probably 60 months.

There are a couple of “buy here, pay here” firms that have been active in the capital markets, DriveTime being the most prominent, and they are originating loans to borrowers with FICO scores in the mid-500 range. And there have been two capital markets transactions from two other “buy here, pay here” firms in the southeastern United States with average FICO scores closer to 500. By contrast, what we’ve been able to do really by applying and leveraging our risk model is originate much lower LTV loans.

Our LTV’s average around 125%. We believe our financing terms are more affordable so our average interest rates are around 16% ranging from 9.9%, a very high grade borrower up to about 19% or 20% for our lowest grade borrowers and we’re financing those customers over a term of between 48 and about 55 months.

If you look at how that translates into performance, I would say among all the “buy here, pay here” operators that currently enjoy capital markets access, our net credit losses are significantly lower, really going hand-in-hand with FICO scores so to the extent our customer has a FICO score…it’s probably averaging around 580 so we’re seeing net credit losses being incrementally or correspondingly lower across, you know, our industry group.

Peter: Okay. So, speaking of the capital markets, I know that you’ve sort of been active in securitization with…I think the last deal that you did was rated and obviously sub-prime auto is not…hasn’t got a great reputation, in some ways that’s been deserved, but just tell us a little bit about your approach to the capital markets.

Daniel: Sure. So, we probably would say first and foremost that our ability to access the capital markets is a pretty strong validation of our ability to actually segment risk with a borrower who, again, is a no file, or thin file and so has very little bureau data that we can rely on.

What we’ve been able to do, and we’ve done now 5 term securitizations, the last one was a rated one that Credit Suisse underwrote…what we’ve been able to do, I believe, is prove that not only can we fairly precisely segment this no file/thin file borrower, but we can fairly precisely predict their loan performance. And so, as a result, I think through 5 term securitizations, we’ve always been comfortably under those loss assumptions and we’ve seen continued success in terms of increasing the advance rates and the execution in those term deals.

Peter: Okay, so then I presume that you are submitting these payments to the credit bureaus and so I imagine that this 580 FICO that your customers applied with…I presume and maybe you can correct me, but I presume that continues to grow, their FICO score keeps going up as they’re now becoming less of a thin file when they have a payment track record with you. I know you mentioned this earlier on, are you trying to move these people, I think you said into the mainstream, into mainstream finance, maybe talk a little bit about how you’re trying to do that.

Daniel: Sure. So we absolutely are trying to graduate this customer. When we started our business, we made it very obvious that our intention was to ultimately provide a path for this consumer to access traditional financing. A lot of people were critical of that approach saying that not engaging in the practice of really trying to build a repeat customer in our portfolio was ultimately going to impair our ability to grow.

We actually believed in the contrary. We believe that to the extent we could provide a customer with affordable financing that allowed them to be successful and ultimately graduate to a lower cost of funds and more mainstream financing, we believe that that would ultimately enable us to attract more and more customers and I think that’s been the case.

So, when a customer builds credit for us, and his friends and family see that he has been able to…on his next purchase, perhaps acquire a new pickup truck that is beyond anything he ever imagined he could access, purchase and finance, we believe that business comes back to us really in a multiple and I think that’s been our observation.

Peter: Sure, so I presume the vehicles that you’re dealing with…I mean, these are all primarily used cars, I imagine. Maybe you could tell us about the average selling price and hence the average loans for these cars.

Daniel: Sure. So, our average sale price is right at $20,000. Most of the expensive vehicles we sell are large trucks and SUV’s which in Texas are, by and large, the preference of the customer we serve. We’re trying to sell across the board a much higher quality vehicle than what we’re seeing overall, particularly in the “buy here, pay here” segment. We’re selling a passenger car that is a one or two-year old vehicle and then a large truck or SUV that’s maybe a five or six-year old vehicle. But, on the average we’re financing between $16,000 and $17,000, again, at an interest rate of approximately 16% and a loan term of around 54 to 55 months on the average.

Peter: Right, okay. Can you give us some sense of the scale? You mentioned Texas and California, how many locations do you have, what sort of volume are you guys doing?

Daniel: Sure. So, we currently operate 36 dealerships, 28 of them are in Texas where we really started the business. We’ve been in California for three years now and operate eight dealerships in Southern California. The California dealerships are a little larger scale than the Texas ones simply because the magnitude of the market in Southern California is so vast and so enormous, we believe there is a tremendous market opportunity there so we try to serve that market with larger locations.

But, we currently are originating around $250 million loans a year and we would anticipate growing about a little over 20% year over year. I think if you look at the last six or seven years, we’ve grown at an average compounded annual growth rate of a little over 20% and we anticipate most of our growth to be in California going forward.

Our value proposition in California is very distinct, there aren’t a lot of opportunities for our customer to secure financing that’s affordable on a vehicle that’s reliable, dependable and sound. And so, we really believe that our value proposition in the platform we’ve built that allows these customers to secure financing has become very compelling in that part of the country.

We are opening in Las Vegas at the end of this year and we will probably fill in gradually through the western part of the United States. Certainly, Arizona is a market that has some appeal, New Mexico, Colorado, and so as we continue to fill out in Southern California and potentially migrate through the Central Valley up to the northern part of the state, San Jose, Oakland, the Bay Area. We also will probably fill in between Texas and California into markets like Phoenix and Tucson and potentially Albuquerque and Denver.

Peter: Okay, so we’re almost out of time, but a couple of more things I really want to get to here. Firstly is, you very recently launched an auto insurance product which I just read about recently so maybe you could tell us a little bit about that product and why branch out into something…obviously, it’s quite a different product to a loan.

Daniel: Sure. So, in many respects, we saw auto insurance as it’s marketed to our customers to be very similar to our observations in the “buy here, pay here” industry. We saw pricing that lacked transparency that was inundated with high fees and really did not provide the customer with the value that we believe they deserved.

And so, we did some research in the industry, we hired a couple of veterans of the agency business that served the segment of the population that resembled our consumer and we really concluded there was an opportunity to build an insurance business that relied on transparency and its pricing and that eliminated all of the brokerage origination fees that really made insurance so costly for our consumer.

So we just actually launched this strategy this year in Texas, we’re getting ready to roll it out across all the markets in Texas as well as California and we really believe that it will be an opportunity again to leverage our platform, to leverage our customer base, our brand, a lot of the infrastructure we’ve built and offer service to the customer that has, again, really compelling value.

Peter: Okay, so final question then, what about other lending products like beyond car loan? Have you thought about it, are you thinking about expanding in the other areas?

Daniel: So, we have done our share of research into other products that we believe would allow us to offer a broader platform of services to our customers. We’ve looked at unsecured loan products, we’ve looked at really all the opportunities across the continuum. We really believe, right now, that our biggest opportunity is to continue to evolve our core business and then compliment that with insurance.

That’s going to be our focus, but we have a bigger picture vision that I think, ultimately as we scale, will become much more efficient for us to leverage the existing infrastructure and add on to and we certainly are optimistic that we’ll be able to do that.

Peter: Okay, we’ll have to leave it there, Daniel. Good luck, I really appreciate you coming on the show today.

Daniel: I appreciate the opportunity, Peter, thank you.

Peter: Okay, see you.

You know, I love hearing these stories of companies operating on the periphery of the traditional financial markets and doing so in an honorable and respectable way and helping their customers not just getting a loan and being able to, you know, really provide them with a vehicle that can probably really help their livelihood considerably, but doing it in a way that actually helps them in the future, helps them graduate into more mainstream products. I think that is an honorable mission and something that I think is going to really help bring…expand the sort of middle class of America.

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

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

PODCAST TRANSCRIPTION SESSION NO. 218 –  CHRIS HARGROVE

Welcome to the Lend Academy Podcast, Episode No. 218, this is your host, Peter Renton, Founder of Lend Academy and Co-Founder of the LendIt Fintech Conference.

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

Peter Renton: So, we’re doing something a little bit different on the show today. We are talking about bank M&A, in particular, a potential fintech company acquiring a bank so I brought in an expert here. I’m delighted to welcome, Chris Hargrove, he is the CEO and Chairman of ProBank Austin. Now, ProBank Austin are a very broadly diversified consulting firm focusing on the financial industry. They provide financial institution consulting and education, they also do advisory services and Chris specifically focuses on their M&A practice and he has worked in bank M&A for several decades.

So, I wanted to get him on the show to talk about..we go through an entire example of what it would look like if a fintech company goes and acquires a bank. We go through all the different steps from the regulators to the lawyers, to valuation and due diligence and many other things. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, Chris!

Chris Hargrove: Thank you, glad to be here.

Peter: Okay, so I like to get these things started by giving the listeners a little bit of a background, so maybe you can give us some of the highlights of your career to date.

Chris: Awesome. I am the Chairman and Chief Executive Officer of ProBank Austin, been there…had those titles for a couple of decades, but my day job is primarily working with financial institutions in the merger and acquisition area, been involved in that since 1982.

I’ve represented approximately 400 financial institutions as their financial advisor and also working a lot with board of directors on strategic planning, whether they want to sell, or do they want to buy, do they need to raise capital, and things like that. But, that’s in a nutshell kind of what I’ve been doing for the last three and a half decades.

Peter: Okay, so then maybe you could tell us a little bit about the ProBank Austin business. I know you’ve got a number of different things you do there and I know you guys have been coming to LendIt for a long time, but I wanted to get just…maybe you could give us a broad picture of all the different parts of the ProBank Austin business.

Chris: If you want a broad brush, it would be easier to say what we don’t do. (Peter laughs) We do a lot of different things. I guess from the fintech perspective, our biggest offerings to that industry would be in the compliance area. We work for many hundreds of financial institutions and fintech companies going in and making sure that they are in compliance with the tens of thousands of pages of bank and financial institution regulation.

In addition to that, we’re probably the largest, not probably, we are the largest compliance training organization in the country. We do anywhere from 700 to 800 seminars or in-house training programs to anywhere from 18,000 to 20,000 bankers every year. We have two new products, bankED, which is our online training which is becoming very popular right now and also Bank Advisor where banks and financial institutions can call in and get a quick and efficient answer to their many, many compliance questions.

Now, outside that, we do many other things; asset liability consulting, profitability, we have a loan pricing software, loan review, internal audit, HR, IT, but again, what we’re talking about today, mergers & acquisitions, which if you look over the last ten/twelve years and you look at the total number of deals, bank deals in the country, we would be ranked in the top five.

Peter: Okay, so let’s dig into that a little bit then. So, we are now ten years almost removed from the financial crisis where the federal government stepped in to support many of the large banks, but I’m curious, if you could sort of go back to that time period and then maybe just sort of take us through the last ten years. What’s the state of M&A in the banking industry today?

Chris: As you might imagine, during the financial crisis, M&A activity dried up to almost nothing. With all the large publicly traded banks who were having problems themselves, we saw activity decrease by almost 75 to 80%. Plus, you know, you had 500 to 550 institutions fail during that period of time, so the healthy institutions were, of course, looking at those bargains as opposed to looking at some of the other deals that came along. And it’s been a slow and gradual process since then to where we are today because the fuel that runs the merger and acquisition industry are the bank stock prices.

So, you could imagine, the bank stocks were trading at terribly low levels during the crisis and really, it’s taken almost ten years for the bank stocks to come back to the level that they traded for pre-crisis. If you look at the SNL index, we’re just now back to that level that we were ten years ago and since then, now, especially in the last few months, because the bank stocks have improved, we’re seeing a significant amount of activity and a significant amount of talking going on right now. I think we’re going to see…as long as the banks’ stocks hold up, I think we’ll see quite a bit of activity, probably 300/350 deals a year over the next three or four years.

Peter: So then maybe you could tell us a little bit about the kinds of deals that you work on personally, you know, like are we talking small banks, medium-sized banks and what sort of geographies are you looking at? Is it nationwide, tell us a little bit about the ProBank Austin’s sort of M&A practice.

Chris: Yeah, we specialize in community banks and when I say community banks that’s probably banks that are $5 billion in assets and less and when you get north of there, you know, you’re dealing with a lot of the publicly traded larger institutions and that’s kind of…and we have represented banks that were larger, but our sweet spot is that $500 billion and down.

As far as geographic, we do nationwide, we are involved in transactions, but our sweet spot there is primarily in the Midwest and the Southeast. I guess if you’re picking up on my accent, you’re guessing the area of the country that I specialize in.

Peter: (laughs) Right, right, got it. Okay so, I know you’ve been paying close attention to sort of the changes in the chartering process. We’ve got the OCC Fintech Charter is in a holding pattern, we’ve got the ILC Charters that are taking forever, no digital bank yet has received a full bank charter, I know Varo is getting close, I believe…so it seems like for the fintech companies, there actually have been a few, OnDeck and LendingClub have both indicated they’re interested in getting a bank charter, but I what I wanted to talk to you today about was really an alternative to that.

So maybe for a fintech company listening to this podcast and they’re thinking about going down the chartering process, why don’t you tell us about a different alternative to doing that and that is obviously acquiring a bank, possibly even a failed institution. So tell us a little bit about that.

Chris: Yeah, as you might imagine, being in this business, I’m very pro acquiring a bank than I am trying to start from scratch.

Peter: Right.

Chris: Because if that were true, you wouldn’t have all of this acquisition activity. It’s much more efficient to acquire an existing charter with the operations and the back room, the computer systems and all that you would need, instead of starting from scratch. I encourage them to look at that alternative as opposed to starting brand new.

One, you mentioned the fact of looking at a failed institution, I don’t know if I were doing a strategic plan for a fintech company, I probably wouldn’t put that very high on the list because what we said earlier, the banking industry is in pretty good shape right now. Of course, that could change day to day, but as we stand here today, the banking industry has been in fine shape and we don’t have that many troubled institutions.

I think the number of troubled institutions right now only amounts to like 30 or 40 banks as opposed to where we were right before or in the beginning of the financial crisis, there were over 800.

So, I don’t think there are going to be a lot of banks that are going to fail over the next 18 months or so. So, there probably won’t be any opportunities of any significance there. The other thing, if you’re going to look at a failed bank, you have to be pre-approved by the FDIC so you got to go in and meet with them and convince them that you have the financial resources and expertise to bid on a failed bank and there’s going to be a lot of competition for that.

But, I do encourage them to look at a community bank that’s already active, that’s clean, that’s in really good shape and that way you have a base of operation that’s functioning and doing well and you don’t have to do everything from scratch.

Peter: Right, so tell us what would that process look like? You know, how do you sort of approach these and how do you discover which community banks would be open to, you know, to an acquisition.

Chris: Yeah, I think what I’ll do is I would kind of put my mindset on, if I were doing a strategic plan for a fintech, what would I be asking them and what kind of road would I lead them down.

The first thing I would want to do is to sit down with them and go, one, of course, how much money do you have, you know, how much capital can you raise because in banking, capital is everything. That’s one reason we had the financial crisis because the banks did not have enough capital. So I’d sit down with them and determine how much capital they have in place, how much they thought they could raise in order to get an idea of what size bank that they could afford to acquire. So we would sit down and determine what size bank could they afford.

Two, I would want to know, are you interested in a certain geographic area, you know, are you interested in the Midwest, the Southeast, the Great Plains states, you know, or does it really matter? But, it’s funny that even though these are nationwide companies willing and able to do business just about anywhere in the country, when you sit down with these folks, they really want something, they have an idea of what part of the world they may want their bank to be located.

So then, at that point, and it’s really interesting, when you find just these very few parameters, what size, what part of the country, one that’s in good shape, you know, financially, does not have any problems…when you focus in on that, you’ll be shocked to learn that there usually aren’t that many. So, one, we identify, are there institutions out there that would meet their criteria, both from a size, profitability, location.

Then at that point….we all have to remember and I say this almost every day to people, that just because you want to acquire an institution doesn’t mean there’s one out there for sale, or that would meet your criteria. So, one, we want to see how many banks are out there that would meet your criteria. Now, at that point in time, if it’s somewhere that, you know, our firm is strong, or we know some other firm that may be better connected in that market, what I tell people is to do one of two things.

One, is we look and say we’ve identified 15 or 20 banks that would meet that criteria. You know, it’s more cost-effective, and sometimes better instead of the hired guns, like myself, contacting those bankers, contact them yourself and tell them what you’re planning to do and tell them what you’re thinking about just so, you know, they know that if they want to sell down the road that there’s someone out there that might want to take a look at them, especially for the smaller banks because a lot of times the demand for those banks is pretty limited.

The other thing is to let all the professionals in that area know. If there’s an investment banker that’s strong in downstate Illinois, make sure that that person knows that you’re looking for a bank in that part of the world. And, again, we all have these, if somebody contacted me, I can give them a list of the bankers there, also the law firms that are active in M&A in that part of the world, the accounting firms, the main thing is to let all these professionals out there know what you’re looking for. Hopefully, with a little diligence and effort, you can find an institution that when they’re ready to sell, or you spark an interest would be willing to sit down and talk to you.

Peter: So then, how small can we go here, I mean, are there many banks to choose that have like $100 million in assets, or less? I mean, how small can…because a fintech company is probably not going to be able to buy a large bank, or even a larger community bank. How small can they go?

Chris: Well, that’s…the interest that we’re seeing from the fintech world is actually in the smallest of the small.

Peter: Right.

Chris: And when you go into the western part of the Midwest, or into the Great Plains, there are a significant number of extremely small banks in that part of the world and I’m talking, as you said, less than $100 million and that’s where we’re seeing a lot of the looking and conversations  taking place are in that part of the world, what do you call them, the “flyover states.”

Peter: Right, right, And then what about sort of…I mean, what are the multiples there? Say a bank is doing $10 million in revenue and a million dollars in profit…I don’t know what the typical revenues of these small banks are, what kind of multiples would you expect to pay to acquire one of these?

Chris: Oh, the nice thing is the multiples in those parts of the world for the smaller institutions are significantly less in what we’re seeing, you know, in the more metropolitan areas. I mean, you could…the going number for a small bank in the western Midwest, the Great Plains is probably like 1.2, 1.25 times equity, you know, 12 to 14 times after tax earnings, or tax adjusted earnings.

Peter: Right.

Chris: So, that’s why I would be a big proponent of buying these institutions because for just a small premium over their equity account, especially on a small one, you get a shop that’s operating and working perfectly and hopefully, perfectly, and it will put you, you know, years ahead on your timeline on making things happen.

Peter: Right, right. Okay, so let’s assume that a fintech company has talked to a bank, they’re interested, what happens then? I mean, what do you do, obviously there’s a regulatory perspective here, I’m sure communication needs to happen with the regulators, but tell us a little bit about how that process progresses.

Chris: Alright, there’s two hurdles they have to get by to be successful. Well, after you’ve made the contact and they’re interested in talking to you…and even if you, kind of generally, understand the price terms, the first hurdle you have to get over is dealing with somebody like me. When a bank hires me to sell them, what’s my job. My job is to get them the best price and to deliver that price and I have to tell you there, when I deal with individuals, or a fintech company, or a mortgage company, finance company, anything outside the norm of what we’re used to dealing with, you know, my first concern is, one, where are you going to get the money.

And then at that point, you know, the company on the other side of me that I’m dealing with, you know, I want to know that they’ve done their homework ahead of time because a lot of these institutions that want to buy a small community bank, and we’re probably going to get into probably too much of the weeds here, but they’re going to have to form, probably form a holding company which is regulated by the Federal Reserve because most of these institutions, or people, or individuals are going to want to borrow a portion of that purchase price.

So, let’s talk about the $100 million bank that has $10 million in equity and assume we’re going to pay them 1.5 times book or $15 million. You know, what I’m going to want to see from them is…you know, I would expect to see at least half that amount, $7.5 million, being hard equity, equity that they deliver, not borrowed money. The other half I would be comfortable with if that were borrowed.

So the first thing is, if you’re going to do a deal, you have to convince me that you have at least $7.5 million of cash and the ability to borrow the other $7.5 million. That’s to make sure they got the money, right, first part of my job. The second thing that I want to know is will they get regulatory approval. Alright, so, what I would be asking them then, because I work in this all the time and you’re going to hear this a lot the rest of this conversation, I want to see their business plan.

You know, what are they going to do with this bank? They’re buying it to change it so they would have to convince me that the things they’re going to want to do with this bank and the changes they’re going to want to make and the business that they’re going to want to bring in is going to pass regulatory muster or pass through the regulators because the regulators are going to be very skeptical. If you go back, even before the last financial crisis…remember the savings and loan crisis which was a couple of decades ago, a lot of that crisis happened because developers and people outside the industry bought these little sleepy savings and loans and did things with them; started to invest in developments, and getting hot deposits, and growing too fast and things like that and the regulators haven’t forgotten that.

So anytime someone outside the norm comes in and wants to buy a bank, you have to have a business plan that convinces them and shows them that what you’re going to do is not going to jeopardize the fund, meaning the FDIC, deposit insurance fund. So, they would have to convince me first that their business plan is going to be sellable to the regulators. So, that’s kind of what would get you through the first hurdle.

Peter: Okay, so then what do you think the regulators want to see because obviously, these fintech companies that would be buying these banks, as you say, to change them, these are online companies buying obviously banks are physically located in a, presumably, in a relatively small town and maybe have only one or two branches so, they’re going to want to change it dramatically. Is there something that they can do to kind of position themselves to increase their likelihood of approval from the regulators?

Chris: Sure, and that’s to get the regulators comfortable with it, like you wouldn’t want to show them a business plan that you’re going to saturate the market looking for deposits, or CDs, or anything that are 50/75 basis points above everyone else and then all of a sudden you blink your eye and that little sleepy $100 million bank is all of a sudden a half a billion dollar bank because of this flood of deposits.

So, you know, you would have to show them that one, you’re not going to outdistance your capital because we have to remember, the key in banking, everything is capital. So, if I have a $100 million bank and it has $10 million in equity…let’s say that’s what the regulators want to see is the capital ratio or equity to asset ratio of around 10%, we have to remember that for every $10 that we increase the size of this institution, we have to have a $1 of equity backing it up.

So if we’re going to show a dramatic growth in deposits and assets then we have to show them that we have the capital that’s going to be coming in to support that growth and again, that’s one of the things that got us in the financial crisis. You’ve probably heard people say, the leveraging of the industry.

Peter: Right.

Chris: So, they don’t want us to leverage too much. You know, they’re going to want to be comfortable with the type of lending that you do and I think the regulators are becoming more tuned in to that kind of lending, but you’ve got to show them that you have the loan policies and procedures and systems, you know, where you can do this kind of business and run it through the bank and fund that with insured deposits by the FDIC.

That’s the key that the bank won’t fail, that you won’t put on the books assets that will eventually be trouble so you’ve got to look at all the aspects of the bank. You’ve got to convince them from an operations perspective that…can I take this $100 million bank and over two or three years turn it into a billion dollar bank? Do I have the expertise and management and systems in place to do that? So, this business plan, this business plan is the key to anything and everything for a fintech company to come in and buy a commercial bank.

Peter: Right, right. Okay, so maybe you could give us a sense of timelines here. Once you feel like you’ve got a good business plan, you’re talking with a bank, you want to pull the trigger, I mean, I’m talking about…obviously, regulators have to be involved, the other party has to get comfortable and lawyers, and everything, but what is the typical timeline from start to finish of a transaction like this?

Chris: Well, one, the start to finish of when you decide you want to acquire a bank to even getting it under contract can be month or never. (Peter laughs) I mean, it can be. I have banks, I have entities out there that decided two years ago and I guess that’s what I want to stress is how difficult it is to find one.

Peter: Right.

Chris: I have clients that decided two years ago they wanted to acquire another bank and they’re still looking. I met with some guys in New York not long ago, they quit their jobs and their whole business plan personally is finding a bank to acquire and they still haven’t, you know. So, I wouldn’t quit my day job until I had something lined up, but anyway, so if you find a bank and you have a good business plan and you have the money, you guys shake hands on a deal.

Then it’s usually…the next step would be, you know, finalizing the merger contract, the definitive agreement that spell…that’s when the lawyers get involved, when they spell out, you know, the financial terms and conditions of the deal. I mean, these are big monster contracts, you know, 70/80 pages long, that covers every different crazy scenario that you can think of. So, that process…and, oh, more important than that, if you’re looking at acquiring an institution, you have to do your own due diligence.

You don’t want to buy something that has problems, so you’ve got to get your accountants or consultants, your loan review people, your outside folks to come in and help you look at that institution to make sure that there’s nothing in there that’s going to bite you after you close. So, once you shake hands on a deal, you’ll want to do your due diligence, which usually takes a couple of weeks to make sure that you look and see what you’re buying. During that period, or shortly after that, the attorneys would get involved working on the definitive agreement which usually, again, takes a couple of weeks to formalize that.

Once you do that, you’re going to have the announcement then would come regulatory process. You have to file your regulatory application, it may take a little bit longer to prepare that for a fintech or other companies because, again…say I’m a $2 billion bank with $200 million in equity and I want to buy a little $100 million bank, the regulators are going to look at that deal almost…and I hate to say to word rubber stamp, but, you know, this is a proven bank that has been around for 75 years, the regulators know them, they’ve examined them, they’re very comfortable allowing them to buy this other institution.

Now, anyone other than that is going to get a lot of scrutiny so we come back to that business plan. That business plan has to be bullet proof when we give that to the regulatory agencies. In addition, we’ve got to have projections and proformas that show that if we’re borrowing money, we have the ability to pay that back, we’ve got to do projections that show that when we implement this business plan that we won’t outgrow our capital.

If we’re saying that we’re going to be $300 million in three years, then we’ve got to show them that the capital levels will be sufficient to support that level, we’ve got to give them proformas showing what we anticipate the income stream to be from that. So, it’s a very detailed, complicated application but, you know, basically what we’re doing, we’re selling the regulators on our concept of what we want to do. The regulatory process takes anywhere from three to four months.

Peter: Right.

Chris: So, they’re going to have that application and they’re going to look, they’re going to do background checks on all the principals. They’re going to make sure that we’re not violating any type of anti-trust laws, they’re going to look at the capital levels, they’re going to come in and want to interview you guys, those folks to make sure they know what they’re doing. They will want to know how much we’re relying on the existing management of the bank we’re buying, but it’s a long drawn out process and it takes quite a while.

Peter: Okay, so then what about…once the transaction has closed, the fintech now has a bank, they have a banking license that they can use, but what happens then because keep in mind, most of these fintechs that are looking at this, they already have a relationship with a partner bank, they’ve had examinations from the FDIC and others so they do have some connection with the regulators, but post transaction, what do you think the fintech should be looking out for?

Chris: Well, I’ll tell you what they should be concerned about from a regulatory perspective. It’s going to be the other side of the balance sheet, the deposit side because, you know, because that’s where the abuses have been in the past and the regulators are really going to pay a lot of attention to, you know, what type of deposits are they bringing in, how hot are they, are they just hot deposits, meaning you get them off the internet, which is where most of their deposits are going to come from.

But that they’re not considered deposits that are going to leave very quickly. They’re really going to focus in on that and that’s the piece of the puzzle that they haven’t dealt with before because, I believe, they just upstream those loans to the bigger institutions and it’s just like a conduit. Now they’re going to be holding on to those loans and they’re going to be funding them with their own deposits.

Peter: Sure, and then do you provide guidance? Obviously, your company has all kinds of compliance capabilities, do you provide guidance post transactions?

Chris: This company was built for that. Just like I told you when we started, it’s easier to say what we don’t do.

Peter: Right.

Chris: I mean, anything that any type of bank or company would need in dealing with a bank. We handle the compliance piece, the internal audit piece, the loan review piece, we do those business plans that we’ve talked about, any type of operational issue that could ever come up. We’ve got the experienced folks to come in there and help them. Building that relationship is how built this company since 1978.

Peter: Right, right, So we’re running out of time, but last question then. I’d be interested to get your perspective on the potential for this particular…what we’ve been talking about here for a fintech to come along and buy a bank. We saw it happen in Europe, I think it was in Germany with Raisin buying a bank in Germany, what do you think is going to happen here? In three years time, if we reconnect, are we going to see half a dozen or a dozen of these type of transactions. What’s your prediction?

Chris: Well, as the father of six millennials (Peter laughs) what I’m learning is I think this is the wave of the future, and I think that a fintech acquiring a community bank and getting the other side of the balance sheet that they don’t have is the key and the answer and I’m very bullish on this.

I think over the next four, or five years, you’re going to see a dozen, or more of these announced, if not more, and again, because one, this is the future, this is where we’re headed, and also there are…you know, there’s 5,000 plus community banks out there in the United States and there’s going to be supply.

Peter: Right.

Chris: There are going to be community banks out there to acquire and I think it’s probably the most efficient way for a fintech to go that route.

Peter: Okay, it will be interesting to see. I’ll have to leave it there, Chris, but I really appreciate you coming on the show today.

Chris: Thank you, I had a great time.

Peter: Okay, see you.

Chris: Bye, bye.

Peter: Well obviously, I’m no expert here. It does make perfect, logical sense to me that any fintech company that is looking at getting a bank license with the lack of clarity in the Fintech Charter and, you know, the very slow process involved in getting approved for a new license, I think it makes perfect sense that this should be an avenue that fintech companies should explore. It will be very interesting to see who goes first and how many we actually see over the next couple of years, but I’ll be very surprised if that number is zero.

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

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

PODCAST TRANSCRIPTION SESSION NO. 217  –  JASON WILK

Welcome to the Lend Academy Podcast, Episode No. 217, this is your host, Peter Renton, Founder of Lend Academy and Co-Founder of the LendIt Fintech Conference.

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

Peter Renton: Today on the show, I am delighted to welcome Jason Wilk, he is the CEO and Co-Founder of Dave. Dave bills themselves as banking for humans and they have a very friendly approach which we talk about in the episode here. We firstly talk about why the company is called Dave and why they decided to pay a lot of money for Dave.com, we talk about their approach to overdrafts and how they’re able to really be proactive and predict when their customer’s bank account balance is going to fall below zero.

We talk about some of the other ways that people use in the app particularly when it comes to budgeting, but also on the income side and their side hustle feature and several other things as well. We talk about the typical customer of Dave and what they look like, we talk about how they make money, their business model, and much more. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, Jason!

Jason Wilk: Thanks Peter, great to be here.

Peter: Okay, great to have you. So, you know, I like to get these things started by giving the listeners a little bit of background. You’ve had an interesting career to date, this is not your first rodeo so why don’t you tell us a little bit about your background before Dave.

Jason: Yeah, sure. So, I’ve been an entrepreneur since I was…since I can ever remember, never really had a regular job. My first company was in the daily deals space, I was always trying to figure out different problems for myself. This instance, I wasn’t a wealthy kid growing up, I always wanted the latest and greatest golf stuff, but generally couldn’t afford it and I created a website called 1DaySports which would offer people last year’s clubs at the lowest price in the country and that business took off from my dorm room and I ended up selling the company when I graduated college.

Peter: Okay, so you still actually graduated, unlike many other entrepreneurs that start stuff in college.

Jason: Yeah, absolutely, and that was a tremendous life event for me, I didn’t make a ton of money off the deal, but it gave me enough to kind of make it to my next venture, ended up getting introduced to the guys from Y Combinator back in 2009.

Started a company with my then Co-Founder of Dave, we built an advertising business called AllScreen TV which we ended up selling in 2015, and got together again to start Dave and really this time with the goal of solving a pain point that we felt was affecting the majority of Americans, not just certain niche industries or certain markets.

Peter: So then was there like an “aha” moment, or something that triggered the idea for Dave?

Jason: Yeah, it wasn’t necessarily an “aha” moment. I obviously had personal gripes with overdraft fees. It really was the persistence of seeing a story pop up on social media on sites like Reddit with people consistently talking about overdraft fees being punitive, being criminal. I figured there’s got to be a way with today’s technology to solve for that. Just knowing particularly why I overdrafted, I knew that there was a way you could build a cool application that could really remediate those two fundamental problems.

Peter: Okay, so then why did you decide to call your company Dave, I mean, it is Dave.com, so clearly you spent a little bit of money on the domain name. Tell us a little bit about that thought process.

Jason: We really wanted Dave to be this financial friend in your pocket and NPS at big banks were at an all time low, brand affinity with big banks was also low, we really wanted something that was friendly, that was trustworthy and that was really going to help you out. So, Dave…the first thing we do is we help you manage all your bills and upcoming expenses and that was something that no other budgeting app had ever tried to accomplish.

We looked at things in the market like Mint which was more focused on sort of middle to upper income earners that were spending too much money and really needed to know where all the dollars were flowing versus the majority of Americans don’t have $400 for an emergency. They need to know where their paycheck is going each week and there was not an app out there to help people do that. Dave is now the number one budgeting app in the country.

The second piece was we realized that, you know, sometimes you just…as a kid or even going through your 20’s…sometimes you just need 20/30/40/50 dollars and you always have to turn to friends or family to borrow that. That can be an embarrassing situation and given the product is named Dave, he is this helpful bear, we want to be kind of be that friend disruptor that…hey, I know when you’re getting paid, let me advance a small amount of it for you so you can go buy things like gas, groceries, at no interest, just like a friend would do, and we’ve replaced that entire experience for people.

Peter: Okay, so then how…tell us how it works exactly. So, you actually predict when people are going to overdraw their account and you proactively offer them this advance, so how are you able to do that?

Jason: Well, the way Dave works is someone comes in, they connect any checking account. We support 14,000 banks in the US, within seconds we are able to create a prediction for you and let you know where you typically spend your money each pay period and then off of that same type of data we’re able to make an instant underwriting decision to allow you to access a small portion of your upcoming paycheck. There’s no interest to avoid, an overdraft fee; just have an extra cushion before a paycheck date.

Peter: And so I’m looking on your website right now and it says you’ll be alerted ahead of time if you can’t afford a bill. So you say it simply, there are no overdraft fees for Dave banking members. What happens if someone has a medical bill that you really couldn’t predict…like when you say no overdraft fees, what does that actually mean?

Jason: Well, we don’t charge any fees if someone needs to go into the negative. So, the way we’ve really built overdraft is to empower the user to say, hey, instead of you going to swipe your card and having it get rejected, we’re proactively going to give an extra $100 on that account so you have a little buffer to go for that medical expense or gas or groceries.

Typically in the past, we’ve seen neo banks go for this no overdraft model, but we really wanted to be the first ones to reinvent that and say, well overdraft actually is a useful and worthwhile concept, the predatory $30 or $40 fees associated with it are not. But, what people can’t have is a situation where they hit zero and their card gets rejected because that could lead to a late fee on a credit card bill, it could lead to, like you said, not being able to fulfill a medical expense and now what?

So, really banking for humans in this instance is we are empowering you to go beyond zero if you need it, we’re not there to kick you when you’re down, and this is something that’s going to truly be helpful for you.

Peter: Right, so my understanding is that you don’t…I think I read this somewhere that you don’t do any credit checks on this, this is available to all Dave members, so, I imagine like anyone, there’s going to be certain people that are responsible and there’ll be others that simply won’t. So, firstly, maybe confirm that, yes, you are right, it is available to everybody and then how are you sort of handling kind of repayment of that sort of up to $100 you’re advancing.

Jason: Yeah, we do offer it to everyone…our approval rating is almost every single user and as far as repayment goes, you know, that’s why we have this kind of tip-based model where the users that like to contribute to Dave help cover those that don’t pay it back. And given we are really in the business right now of building a brand and loyalty with our consumers…the fact that if we can come out slightly ahead on that, we are doing everything we hope to and more to really build a lifelong relationship with that customer.

Peter: So, just tell us a little bit…I mean, you said…I think I read somewhere it’s like a dollar a month to be a Dave member, but there’s also a tipping process on top of that, just tell us a little bit about why you did that and how it works.

Jason: That’s right. Well, just like a GoFundMe or Twitch or any of these gaming companies or even apps like an Uber or a Square Checkout, tipping is a concept that people have become quite comfortable with and unlike others who have tried this in the industry, Dave being a business of helping you avoid overdraft fees, a tip seems like the most valuable way to…most valuable exchange with our customer in that we help save you from a $30/$40 fee, is that worth anything to you and is it worth 0% of the amount we gave you, is it worth 5%. That exchange works out quite well for both people involved.

Peter: Right, okay. Obviously, that’s how you’re able to offset losses, I take it, which there must be some. Can you share anything about the losses that are coming up on your portfolio now?

Jason: I can’t really.

Peter: Okay, fair enough.

Jason: Another way we’ve really helped our users avoid overdraft fees is…we introduced this about six months ago, it’s a product called Side Hustle and that’s actually what…we partner with a dozen different gig economy and side income providers and our users have actually made millions of dollars to help them avoid overdraft fees through that as well. We’ll say, hey, Peter, here are some last minute income creation opportunities for you. That’s been an incredibly successful program for us and our users.

Peter: Right, I know Steady does something similar to that, and you’re basically subtly pushing people into, hey, you need to earn more money if you really want to spend this extra $100.

Jason: That’s right.

Peter: Yeah, okay. Okay, so then what else do you offer, I mean, you’ve got the Side Hustle, you’ve got the overdraft protection, you talked about budgeting tools, I mean, how are people actually…I mean, they’ve downloaded the app, I know you’ve got millions of customers downloading the app so you have a pretty big sample size of data for behavior. How are people using it…are they logging in every day, how do they use the app, do they just wait for notifications? Tell us a little bit more about that.

Jason: It’s pretty frequent, so we’ve really built and designed Dave to be a replacement for your existing bank. So whether you bank with Dave, or you come and connect with your existing checking account, Dave is there to help you understand your upcoming bills. You can look at your past transactions, we’re going to tell you your monthly cash flow and we’re going to tell you your low balance till paycheck date.

So, we are seeing extremely high daily usage of the product. As people are coming in, they start to trust this more than their own institution and that’s why we’ve seen such a strong aversion towards our existing users opting in into our own bank account because of how close it is to their existing bank relationship and we can prove how much better it is to be with Dave.

Peter: Right, so tell us a little bit about that bank account. I mean, you don’t have a banking license, I take it, so you’re obviously partnering with an existing bank. What do they get when they open up an account with Dave, like a bank account?

Jason: Yeah, so they get a bank account, they get a Dave debit card, they have all the same features we’ve built, remote deposit capture, we’ve built everything you’d want, it comes with our award-winning Dave Overdraft Advance. It also is the first checking account that if you pay your rent through Dave…we have a partnership with the credit bureaus so that you can actually improve your credit score just by paying your rent through Dave. And so, you know, this is what we feel is the most empowering banking product in the country right now.

Peter: So, then do you have any intention to actually get your own banking license at some point, or are you happy with the relationship you have now?

Jason: I think we’re fine with what we’re doing right now. You know, at the end of the day, there are some attractive features of having our own bank charter, but at the moment, those are far dwarfed by the opportunity right now of just acquiring as many users and servicing them to the ultimate happiness we can.

Peter: Right, right. Can we just dig into those users for a second, tell us a little bit about them. These, I presume, are predominantly people living paycheck to paycheck, but can you give us a little bit more color on the typical Dave user?

Jason: They are paycheck to paycheck, some of them, you know, on average they are definitely making under $100,000 a year on average. The most popular age demographic is in the 22-ish range so, definitely a younger customer. They’re in college or just out of college, they clearly have been working with a bank that their parents got them set up on and now we’re helping with that digital transformation…people are really hungry for financial literacy.

As everyone can claim, you’re not taught in school how to balance a checkbook or pay your taxes and Dave is a really nice and lightweight introduction to that by helping you forecast all your bills and expenses.

Peter: Sure, I think I read the other day that you just crossed five million customers, maybe you can give us the latest update on that and also maybe just tell us like who is included in that? Is it everyone that’s downloaded the app, everyone that’s actually using it, what do the numbers mean?

Jason: Those people who are using it that have passed through our entire registration process so that’s where we look at that number and benchmarked against, you know, how others in the space count their user base as well.

Peter: Okay, what was the number at the beginning of the year and like how have you grown this year?

Jason: I think at the beginning of the year it was a million, now, we’re approaching five so it’s been significant growth just in the past nine months.

Peter: Yeah, that’s one word to say, significant. (Peter and Jason laugh) I think most…any financial institution would die to have that kind of growth number. So, how is that happening, what has been the impetus to go, really you’ve quintupled your user base in let’s just say nine months, how have you done that?

Jason: We’ve done that through strong brand messaging, through building a fair product that people want to talk about. It’s what’s helped us continue to have the lowest cost of card customers in the industry, and really, because we’re a friendly product with an easy to remember name with great investors and a product that works, it takes care a lot of that on its own.

Peter: Sure. So then, I’ve touched on it before, you launched, you didn’t change your name, right, you launched with Dave.com, is that true? Can you give us…I mean, it couldn’t have been an inexpensive domain name to buy. Obviously, it was considered so important to you that you wanted to acquire it…tell us a little bit, who had the domain before you?

Jason: It was a guy named Dave (Peter laughs) in San Francisco, who owned a design agency named Dave Design. He had the domain since the 90’s, he, for some reason, wasn’t using it, he was still using his other domains for the agency and I was persistent to try and acquire it. I emailed him every week or so for maybe six months to no response.

I soon just started sending over offers, unsolicited offers, through this email that I wasn’t even sure if the guy was getting and after I, you know, got to a certain number, I finally got a response. I just knew that if we were going to be in this company to win it, that having a strong brand presence from the beginning was really important so owning Dave.com is ten times a better domain than any other challenger bank or budgeting product in the country. We feel like it’s easy to spell, it captures what we’re trying to do and it’s easy to remember.

Peter: Yeah, for sure. It’s a very friendly name, as you say, everyone has a friend named Dave and the way you’ve got it, it’s an impressive way you’ve done the branding, for sure. So, then maybe give us a sense of like you’re funding these advances obviously, the capital has to flow through to your customers there, so how are you funding, who are your capital partners in this venture?

Jason: So, we’ve just done the advances off of our balance sheet, we have not raised any outside debt. We’re nearing our deal with Victory Park to help supplement some of that, but we most recently, just raised our Series B with Norwest Venture and that will help us get to the next level as well.

Peter: And speaking of raising money, I know that you have famously, I’ve read before about the Mark Cuban relationship you have.

Jason: Yeah.

Peter: And he has also invested in previous companies…I think everyone here knows who Mark Cuban is, but tell us first how you got on his radar, how you met him.

Jason: I met Mark in 2008 when he was the keynote speaker of TechCrunch Disrupt. I think, back then, it was called TechCrunch40, he was on stage talking about the different ways to get him to invest in your company. At the time, he was really not doing any angel investing at all, he had several deals and I was at the time figuring out what I wanted to do next. In my free time, I was writing a personal blog about different startups that I liked and just different things in the startup community.

I happened to write an article on how to get Mark Cuban to invest in your company, the ten ways to get Mark to invest in your company which ended up on the homepage of Digg and Hacker News and one of the ways that he said for people to get him to invest was to email him and he gave the whole crowd his email address (Peter laughs) and I used that same proxy to send him this article. I ended up seeing him out at the TechCrunch party that evening, approached him.

He had seen the article, he had read the email and that was our first interaction. I had followed up with him many times on the various things I was interested in working on, was incredibly persistent with him and he ended up becoming the lead investor in my last company. That was a very successful outcome for him. I think we returned like 40 times his capital that he gave us and then he became the lead investor for Dave on our seed round and joined the board.

Peter: Okay, so he’s on your board so do you have interaction with him on a pretty regular basis, I take it?

Jason: Yeah, absolutely. I mean, he responds to emails, you know, quicker than anyone else and he is really on it…I don’t know how he manages his schedule, but he does it.

Peter: And so then, what kind of advice do you receive from him?

Jason: He will respond on whatever you want, from strategy to customer acquisition to customer success. He’s really kind of been there and done it all, it’s nice that he’s an operator that’s taken his own companies from zero to $5 billion so he has a lot of learning there and he and I have had a similar kind of background in that he grew up doing startups, sleeping on couches and doing whatever it took to make it. So, he and I have a similar respect for the work ethic there and I think that’s why we’ve got along and have worked so closely together over the last ten years.

Peter: Okay, sure. So, I just want to dig in a little bit into your business model. If you could sort of tell us how you make money today and into the future maybe, but let’s just focus on today first. You’ve mentioned a couple of things, but what are the major sources of revenue for you guys today?

Jason: So, we have our subscription for our budgeting product which is the most popular product that we offer. We have our Side Hustle product which we make referral fees from companies from Uber and Lyft and various other partners there. We have our Advanced Business where we make money out of optional fees, including the tip and then we have our banking product where we make money only from the card networks when someone swipes their card, we take a piece of the interchange off of that.

Peter: Right, right, okay, fair enough. I looked at your company here and you’ve got these millions of engaged customers. There’s a lot of different ways that you could expand into other areas, but I’m curious to know, when you look at your customer base, and look at what you’re doing, obviously, you want to keep delivering on a great experience on your core products, but what do you see as sort of some of the next logical steps for Dave, different areas that you could get into?

Jason: We’re continuing to try to look for non-traditional products that we can kind of reinvent, what typically have been successful bank products in the past and that’s all I can really say on that, but continuing to try and innovate this industry which has been kind of doing the same thing for the last 50 years. It’s been a lot of fun to try and pull apart and rebuild things from the ground up.

Peter: So, do you hear from banks, from traditional banks? I’m curious about how you’re kind of viewed…because in many ways…I’ve read articles that are both positive and negative about you guys, and I’m curious about…I mean, because you’re sort of attacking a pretty big cash cow for a lot of these banks, you know, that make…some of them make billions of dollars from overdraft fees. So, do you hear from these banks, or what is your relationship like with them?

Jason: We don’t really hear from them often. We do have Capital One, J.P. Morgan and I guess by proxy, Norwest, their main LP is Well Fargo, so we do have several major institutions that are invested in the business and they’ve all been a pleasure to work with. They’re generally curious about the space, we have meaningful conversations and we’re all looking for different ways we can continue to work together or partner.

I will say we are serving a demographic and customer income profile that has generally been less attractive for them so to some extent they are supporters of what we’re doing in that their legacy structure is not been known to support this ecosystem to date. Dave is finding ways to do that through being a digital first product.

Peter: So then what do you think about overdraft fees? It’s something I’ve thought about for a while and I read a quote from you recently.  You said something like it just makes no logical sense to charge $35 when someone goes overdrawn by $10. Are you on a mission to sort of eliminate them completely, or do you feel that this kind of fee will be a thing of the past eventually?

Jason: I think overdraft is always going to have to be there, it’s just we need to be thinking about how to properly underwrite and charge for it. Really, banks have gotten away with it being carved out as not a credit type of product so really, the whole thing needs to be reinvented because the reality is how do people just have their cards rejected at zero is not going to save anyone.

So, the way that Dave is approaching it, we think, is the right one which is let the user pay what they think is fair, don’t base it off of a credit score, don’t make it a loan and finally, to empower users with it versus hit them with heavy fees. And I think the challenge for a lot of big banks here is you have to focus relentlessly on having a great brand that people trust and people will pay accordingly, but you know, I think that will be a challenge if that is the model that the banks need to try and emulate in the future.

Peter: Right, right, okay. We’re almost out of time, but I’m really curious about your vision for Dave. I mean, do you want Dave to be like the J.P. Morgan Chase of the 21st century, or something else? I mean, really you are a financial institution in many ways, but when you sort of talk to investors, or when you talk to your staff, what is the vision that you provide?

Jason: Yeah, we think building the next J.P. Morgan one step at a time is where want to take it. We realize that’s a tall order, but, you know, the side meaning of Dave is David versus Goliath, that’s the story we’re telling and that’s what we’re trying to accomplish.

Peter: So, one day do you feel like this…you obviously have the customer base to be a very sizable operation, but what do you think is the maximum, or is there an upper limit to where you can go with this, particularly as far as users is what I’m really thinking.

Jason: Yeah, I don’t think there is a limit, I mean, we’re continuously growing each month, we’re adding more customers every month than Wells Fargo is. We’re in a really interesting position right now.

Peter: Yeah, you are indeed. Well, thank you very much for coming on the show today.

Jason: Thanks a lot.

Peter: Okay, see you.

You know, it really is impressive being able to go from one million customers to five million customers in nine months, adding more on a monthly basis than a large bank like Wells Fargo. Clearly, Dave is offering something that people value and people are telling others about it. What it speaks to, as far as I can see, is that people want tools that are useful, that can actually help them in their daily life and as Jason said, their customers are in Dave a lot, they’re using it, they’re appreciating the overdraft protection and the fact that they can get notified proactively when their account is in risk of being overdrawn.

The fact is, banks have this information, they could have done exactly what Jason and the team at Dave has done, they haven’t, certainly not in a way that Dave has implemented. Not to say that banks’ mobile offerings are poor, I think there’s some really excellent offerings, but what they haven’t done is really, I think, get to these really practical applications that consumers are truly hungry for.

Anyway on that note…before I actually sign off, I have a favor to ask. If you’ve been listening to this podcasts for a while, I would really appreciate you going to your favorite podcast platform, whether that is Apple Podcasts, Stitcher, Spotify, what have you. I would very much appreciate an honest review. I read every single review and certainly appreciate them very much. So now on that note, I will sign off. I very much appreciate your listening and I’ll catch you next time. Bye.

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

PODCAST TRANSCRIPTION SESSION NO. 216  –  NEIL ROBERTS & DAVID STEVENS

Welcome to the Lend Academy Podcast, Episode No. 216, this is your host, Peter Renton, Founder of Lend Academy and Co-Founder of the LendIt Fintech Conference.

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

Peter Renton: Today on the show, we are heading down under to Auckland, New Zealand and I’m delighted to welcome Harmoney. In fact, we have two gentlemen on the show today; we have one of the Co-Founders, Neil Roberts, who is the outgoing CEO and we also have David Stevens, who is the incoming CEO. By the time you listen to this he will be in the job and I wanted to get them both on the show. Obviously, Neil has the background and history with Harmoney, we talk quite a bit about that, we talk about the loans themselves and the segment of the market they’re going after.

We also talk about the banking environment in Australia and New Zealand, it’s very different to the United States and David has a lot of history there and we talk about the fact that they’ve been able to scale pretty significantly to over a billion dollars, $1.2 billion, in a market that’s about one eightieth the size of the US so that gives you some sense and we talk about how they’ve been able to do that and what the future holds and possible expansion. They’re already in Australia, but really building up their Australian presence. It was a fascinating interview, I hope you enjoy the show.

Welcome to the podcast, Neil and David!

Neil Roberts: Thank you, Peter.

David Stevens: Thanks, Peter.

Peter: Okay, so great to have you guys on, always good to be speaking to someone from down under, but before we get started why don’t you give the listeners, both of you, maybe we’ll start with you, Neil, give the listeners a little bit of background about yourselves, particularly what you did before Harmoney.

Neil: Sure, I’m well into my career now so maybe I’ll just pick out two relevant projects. In 2001, I saw an opportunity with a consumer finance company to build some tech to automate credit and to build a business with direct mail and we started it in 2001, did $3.6 billion in personal loan applications and over the next five years, raised about $1.6 billion of that. Finally sold the business in 2006 to GE Money so it was myself and some of the Harmoney core team. Some of us then went over to Australia from New Zealand, that’s where I met Dave and we helped FlexiRent float, it became FlexiGroup and after that, sort of ten years stint, decided to come back to New Zealand and just saw an opportunity to start Harmoney because the law was changing and I’m sure I’ll get an opportunity to talk about Harmoney in a moment.

Peter: Okay, over to you David.

David Stevens: Thanks, Peter. In terms of my background, I originally was with PricewaterhouseCoopers, ended up working on the float of FlexiGroup and got to know Neil and Brad and Simon, had a number of different roles there, really grew the business up from a one product/one channel business to a diversified financial services business, had a number of roles being the CFO in 2013 through to being Group CEO for about 12 months before taking on the Managing Director role of FlexiGroup New Zealand which represented about half of the business.

Since then, I went to a startup business called MiFund, which recently sold off 35% equity interest to the Bank of Queensland and, you know, and I’ve been excited by the opportunity of what Neil has been doing in the Harmoney business and just came across last week into Harmoney.

Peter: So were you living in New Zealand or living in Australia before this?

David: I’ve been living in Australia, but I commuted when I was Managing Director of FlexiGroup New Zealand. I sort of came over every second week for about 18 months.

Peter: Right, right, okay. Are you going to stay in Sydney or are you going to head to Auckland?

David: I’ve got a new baby due in about six weeks time so I’ll be commuting for a little while, but the intention is to look to move over to New Zealand sometime next year.

Peter: Okay, so then back to you, Neil, I want to get into the founding of Harmoney, what was it you saw in the New Zealand market and what was the impetus behind the founding of it?

Neil: Yeah sure Peter. So I think, first and foremost, there was a law change. So prior to that law change you wouldn’t have been able to contemplate doing peer-to-peer lending and that was because of the securities law and the fact that every borrower would have to issue a prospectus. So the law change came just following the tail end of the financial crisis and the legislation itself was sort of a once in a lifetime review of the fundamental financial services regulation.

So great opportunity and of course, we had a team that had done it before, had a team that had raised money on the one side through a call center and automated the process in that call center, you know, $1.6 billion in written deals, personal loan deals on the other side. So, with those two things coming together…another reason for the move by the government because we are, I think, still the only country in the world that offers a peer-to-peer lending license.

Part of the reason that the government was bold enough to do that was because New Zealand had struggled with a couple of key things over the last 20/30 years. One is productivity and the  other is savings. It inspired us both to help, do a startup and join the tech community and try to solve both of those things. So, you know, using tech which will ultimately help ensure productivity and offering risk weighted returns in a new asset class to the retail public. And also putting the team back together was fun too and getting back to what we knew, I suppose.

Peter: Right,

Neil: That was the thinking behind it Peter.

Peter: Okay, okay. So, maybe just briefly give us some of the milestones. I know it’s been…I think you were saying it’s been five years this month since you started. So, tell us sort of how things have evolved and maybe some highlights over the last five years.

Neil: Yeah sure, I think one of the key highlights to me has been the team and how we performed when we were just six people getting the startup up and running and getting to market. We set ourselves some goals and, you know, we were I think the very first platform to get $100 million to lend before we sold our first loan and we did that off the back of our ability to underwrite risk and, Peter, I think we actually met around that time because coming to LendIt was absolutely a pivotal time for us because we met some great contacts and it helped us down the track getting some funding.

So, putting the team together and getting to the point where the algorithm was right, the system was right and we were able to attract wholesale funding which meant that we could change a two-sided marketplace to a one. In other words, we could wait for retail to come onboard and of course, having the endorsement of some wholesale providers helped bringing retail on and, therefore, we grew rapidly.

I think the second thing would be how New Zealanders have embraced the platform. We have half a million people who have joined the platform, we’ve done $1.2 billion in lending in that 5-year period here in New Zealand, a country of 4.5 million people. So, New Zealanders truly have embraced it and I think getting to a point where we in-housed our technical resource. Today, Harmoney’s pulse is very much with its engineering team and we do see the future in our platform and automation.

So, getting our platform in order, getting a team together that was forming, norming and storming and I think that some of the challenges that we’ve had, I suppose, is an unclear…we didn’t know this until after we had launched, unclear federal laws that don’t perhaps work well together.

That meant that since 2015, we’ve been slowly operating a pivot and moving to lending our own money which we started to do December last year and we’re rapidly, you know, picking that side of our business up because the regulations, particularly in New Zealand are such that we don’t see a viable model for us doing peer-to-peer lending way into the future and we are sort of  managing that and have been for some time.

We made a decent amount of profit last year and good revenue growth as well so quite pleased about that. We measure and take very seriously our engagement here as a team and, you know, we have benchmarked our scores at employer of choice level and then finally, our net promoter score from our borrowers, in particular, is extremely high.

I mean, it’s higher than some of the names that you can think of, Amazon, Netflix, Apple, you know, we tend to score higher than that. So all in all, business is maturing and ready to grow and embraced by a lot of New Zealanders and by our licensor, the Financial Markets Authority. Yeah, so those are some of the highlights, it’s been a great journey.

Peter: Okay, we’ll dig into some more of that in a little bit, but I want to turn to David and just sort of…maybe we could start with, when did this sort of get on your radar? When did peer-to-peer lending/marketplace lending get on your radar first?

David: Yeah, probably around the same time that Harmoney started, maybe a little bit before, obviously seeing the businesses out of the US. You know, it was a natural sort of point where you had the investors looking for yield and you had borrowers looking for, you know, a fair-priced loan. I guess it obviously…when you simplify it like that, it makes a lot of sense. I guess having worked in consumer finance for the last 12 years or so, I really recognized that there was a lot of lenders out there that were very much, one size fits all approach.

So, particularly the banks where there was no rate for risk, it was very much, you either get approved or declined and this is both in the traditional finance businesses as well where you get a very similar customer demographic when you’re operating like that obviously when you’re only using one rate whereas with the…you know what impressed me about Harmoney’s business was the way they would grade risk in 30 different risk grades and allow a customer who is, you know, a higher credit quality to borrow at a lower rate and a customer that is maybe slightly lower credit quality was still able to borrow at a rate that is appropriate.

So, I think that was something that I didn’t see being done very well, particularly in Australia and New Zealand, something that made marketplace lending get on the radar. I think that’s why we see more businesses today adopt that sort of risk-based pricing methodology and it’s something that I think is the way forward.

Peter: Right, right, yeah, fair enough. So Neil, I want to turn back to you. We’re actually recording this during this transition. You’ve been Founder, CEO, Co-CEO and now, you’re stepping back, so what was the reason to bring on someone like David as CEO at this stage of Harmoney’s development?

Neil: Yeah, so the first thought or what I’ve always thought is that a lot of founders flounder when they get to the public markets and in this part of the world, the deep pockets of capital are in the public markets. As you know, Peter, companies tend to go a little sooner to those markets for that reason and, you know, the ASX is trying to attract those that perhaps don’t have the market cap to go on the NASDAQ. The source of super in Australia, is I think $2 trillion or some crazy number like that, so it’s a huge source of capital to access.

So, for me, I’ve always felt that, you know, I wouldn’t want to be a public market-facing CEO for two good reasons. I don’t think I’d be very good at it and I don’t think I’d enjoy it. Now, the team has worked with David before, a 9-year sort of interview process both ways (Peter laughs) and really enjoyed that. We enjoyed some great success at Flexi and that was during some tough economic times and it was great to see that Dave left Flexi and almost as a favor took on what would have been a failing startup because unfortunately, the founder of that startup had passed away and turned that around as well. So, proving that in the process, good at the big top end of town and good also with the startups.

So, knowing David well, knowing his skillset is absolutely bang on for what we’ve got going forward and having been on this journey myself for seven years, I just felt it was time for everybody’s sake that get a new CEO on board and from here, hopefully I can get back to doing the things that I really love and that’s starting new businesses or creating value in some way rather than what becomes quite a large beast to manage.

Peter: Right, right, okay, fair enough. So David, I want to turn back to you and just give a little bit of a sense because a lot of people are obviously not very familiar with the Australia or New Zealand market. So, maybe you could give us a little sense on what the banking climate is like down there, in particular the personal loan market as well.

David: Yeah, sure. Australia is unique and I guess New Zealand as well. The banks dominate sort of around 80% of the consumer finance market. We have big four big banks that are very strong and went through the global financial crisis relatively unscathed, didn’t require any sort of government bailouts and the like and they’ve really…I guess when you dominate a market so much for so long, you become quite complacent. On the other side of that you’ve got point of sale finance companies as well.

There has been a lot of companies that have come into the space, there are a lot of startups and the like that have come into the personal loan market, particularly in Australia, over the last few years on the back of Australia just had a Royal Commission into the financial services sector. That has actually created extra, I guess, regulation and challenges for the banks, particularly around some of their profitable areas that they are now looking to divest, well seen because it’s due to conflict of interest and the like with those sort of advisory businesses that sit with the banks. Fortunately, they all escape with legacy systems as well and processes as well that make it quite hard for them to adapt to the type of lending that consumers expect these days.

You know, they want to have…I think people have less patience now than what they might have had a few years ago and sort of want to be able to give a couple of pieces of information to a financier and then we go off and make our credit assessment and we’re doing all this in real-time. So, that’s where the fintechs, if you like, of Australia and New Zealand are really good at cashing in. When you’ve got four beasts that have 80% of the market, you’re able to chip away at that and get some good volume from that.

The market overall has been fairly benign in terms of growth of the market, but certainly the share of the non-bank lenders is certainly growing quite rapidly both in Australia and New Zealand. If you look at the success that Harmoney has been able to achieve, we have $1.2 billion in new loans written just in New Zealand, you can see the opportunity in Australia which is a population of around six or seven times the size.

Peter: Right, so I just want to go back, the listeners probably don’t know what a Royal Commission is, most of the listeners probably would need a little explanation, but I follow that to some extent. The banks have been really…I mean, what I’m curious about, maybe just 30 seconds on what the Royal Commission was all about, but then how has that sort of impacted you guys? I imagine it’s a positive because the banks have come out of this with their brands tarnished, does that mean that it’s really some tailwinds for you guys?

David: Yeah, look I think so. For the listeners, a Royal Commission is basically a…I think in simple terms a government deep dive or investigation into all practices that go on in that particular industry. They’re doing another one into health care coming up shortly, I’m not sure of the exact schedule, but it’s basically going into a deep dive where banks have to, in this case, present all of their I guess dirty laundry in those terms and they then are assessed on various things.

There are quite a number of areas where, not just the big four banks actually, some other providers like AMP and the like where basically some practices were called out that were not what you’d expect and as a result of that, the regulator and generally, the public as well has obviously been quite sort of shocked by some of the details that have come out of that. So, I think to your point, Peter, yes, there is certainly a bad taste left in some people’s mouths around that and, you know, I think that does create some opportunity for us.

You can see in Australia the personal lending as well as SME financing has really sort of…it was already taking off to be fair prior to the Royal Commission, but that has added some fuel to the consumer and SME finance businesses, both in Australia and New Zealand, pretty much the big four banks in Australia are the same in New Zealand, just may have different names, but they’re all owned by the same group.

Peter: Right, right. Okay, so we should just dig into the actual products themselves for a little bit. Tell us about…what are the range of interest rates, the loan sizes, loan terms, that sort of thing.

Neil: Yeah, maybe I could do that, Peter. So terms, we offer a 3 and a 5-year loan simply, absolutely no penalty of paying back early and therefore, we tend to get a weighted average term of around 58 months. In terms of the interest charges, keep in mind that we operate in a market where the higher FICO-type credit is paying 19/20% on their credit card so we start at 6.99% so we can do $70,000 for an A grade and we can do that in sort of turning it around in 10/15 minutes at the rate of 6.99% which is our champion rate all the way through to in New Zealand 29.99% and it’s 6.99% to 24.99% I think in Australia or thereabouts.

So, now we do very little of our business at the extremes so at 29.99% we might do by dollar 3 or 4%, but it’s a far bigger number by number of loans and, you know, we find that…if we were to help that sort of pricing, perhaps there are other lenders out there that are far more expensive. So, the science behind that is we took a credit card rate at the time we did a spectrum or universe of credit and we made that the weighted average and pushed out a typical bell curve across that spectrum. So, you know, we’re doing most of the business in the low B grade, C and high D grade.

Peter: And so what was the average loan size then?

Neil: Average loan size today is about $26 grand, $26,000 kiwi dollars.

Peter: So, what’s that exchange rate these days with the US?

Neil: US…um it is doing pretty good, it’s about 65/70c, is that right, Dave?

David: 65, yeah.

Peter: Right, okay. So, you take 35% off that for the US equivalent, okay. Then so what about the underwriting, I’m curious…I’d like to sort of dig into that a little bit and get into how you’re using technology, how fast this all is and what are some of the data sources, that sort of thing. How are you doing the underwriting?

Neil: Yeah, thank you for that. So, we obviously…credit, we pride ourselves on doing credit first and well. Obviously, I mentioned before the fact that we had that $100 million to lend before we sold our first loan and that wasn’t without some deep DD and rigor. So, we have a scorecard 1.0. 1.0 was a demographic scorecard, it wasn’t really using our own data because we didn’t have any, we just started.

We’ve since launched 1.5, we’re ready to go to 2. 1.5 set us up for really cutting back on the data points that we need to ask the customer for/the borrower for because what we’ve built in our platform is the ability to have an instant two-way conversation where we can highlight data to a potential borrower in a format having gone and got it externally and have that borrower just confirm and if it is wrong just make the amendments so, 1.5 has set us up for that. It’s really helped our conversion through the funnel.

The next addition which we’re about to do now really does cut back on data points. Peter, you may not know this, but this month is a big month in Australia because positive reporting comes in for the very first time with plenty of coverage from the banks. So, it’s been on the horizon for a while, the banks have kind of missed the dates a couple of times, I think, but now, we’re finally there. You know, it’s not quite a FICO score, we don’t have the ability to get the sort of data you can get in the States, but this is really a big step in that direction which will really, you know, help the likes of Harmoney underwrite.

But, what do we do from the technology point of view? I mentioned the platform and the two-way conversation that we’re able to have so the headwinds from the regulator is they do want you to check in with customers and we know ourselves that it is a lot better to get external data and actually be able to present that. So we have, over the last few years, been automating the lending decision more and more and more, it is an immediate payback if we’re able to automate more of the percentage of what’s coming through our funnel and the conversion goes up exponentially because people enjoy the experience.

The reason we’re on that track is because we obviously see voice and digital assistance in the not too distant future dominating our space. So, you can’t have a voice interaction where you’re asking lots of questions back and forth because that’s a telephone conversation so you really have to double down and invest in your ability to go straight through processing and automation. We’re on a journey to 80% straight through processing. We’re about 60 now and in that 60 there is some touch by a human eye and it is instant decisions and over the next year, we’ll start lifting that percentage exponentially.

Peter: That’s really interesting, super interesting, actually. It’s challenging to be able to do that straight through kind of automated underwriting. There’s several companies in the US that have tried, none of them have made it to 100% at least on the consumer side, but it’s certainly a goal of many of the companies here.

So, I want to switch gears a little bit and talk about funding. I know that you said you had $100 million before you got going which is very impressive, I don’t know any other platform anywhere that launched with that kind of war chest. I know that you’ve also had some good relations with several US investors, so maybe tell us about the funding side of the business, where the capital is coming from.

Neil: Yeah, sure. I think I mentioned a little earlier that, you know, we launched and we had since had reason to question the regulatory environment in which we operate and that has led us to a move to simplify our funding model. We operate as a peer-to-peer lender, we’re licensed as a peer-to-peer lender with 18,000 lenders operating on our platform.

The regulatory environment just threatens that business model just because of Harmoney’s ability to earn so where we see our future is going on balance sheet, we started that journey in December and Dave as CEO has a very good pedigree when it comes to his contacts and his ability in the capital markets here given the balance sheet that he ran in FlexiGroup. You want to comment on that Dave?

David: Yeah, obviously being able to diversify our funding sources, there is obviously the element of the peer-to-peer, but also being able to get wholesale funding warehouses and then lead to securitization of the receivables allows us to really optimize the best cost of funds and also provides us with the availability of funds at all different levels on the risk grade by having the bank warehouses in place, we launched our first bank warehouse in December last year in New Zealand, we’re looking to roll out another one in New Zealand with another bank and then also a couple in Australia as well in the coming months. So, that will give us some really good diversity of funding and also allow us to maximize the returns.

Peter: Right, so are you going to eventually shut down the peer-to-peer side of the business?

David: No, look I think we’re sort of…I said we look at the diversity of the business in funding. At this point in time, we’ll obviously look to…over time, we’ll continue to assess that, but certainly, we’ve got a lot of lenders on the books at the moment and that does create that diversity for us which is a good position to be in.

Peter: Right, okay. So, you did mention this earlier, but I just want to zero in on it, I mean, this is obviously, you’re a New Zealand company. New Zealand is a small country, it’s quite impressive, it’s like one eightieth of the size of the US or something like that and you’ve done over a billion dollars that would put you up over LendingClub if you extrapolate that out over here.

But, I’m curious about…the Australian market as you said is six/seven times the size. I think I read somewhere you passed $100 million in Australia so obviously the vast majority of what you’ve done has been in New Zealand, but with Australia being the bigger market, are we going to see a big push into that market coming up here soon?

David: Yeah, we certainly are. You know, the business has been run out of New Zealand and will continue to be run out of New Zealand. One of the things that attracted me about the business is it’s a highly scalable business due to the fact that Neil spoke about the straight through processing and various things like that in the platform. Australia is certainly going to be the key focus of the business, obviously we have an Australian accent as well in the room, we’ve got a passion about that and I’m quite familiar with the market over there.

So, as you correctly said, we’ve written over $100 million in Australia now which is always your hardest $100 million to write, it costs you the most, you learn from a losses perspectives and you’re obviously building up the channel and building up brand as well. So, I think the business has done fantastic to write that sort of number really, really without a focus and I think it shows the power of, you know, the platform and some of the relationships we have over here to be able to move that across into Australia. I’m very excited and very keen to really get Australia pushed particularly towards the end of this year. Yeah as we sort of get some of the funding lines sorted out as well. That will help that move as well.

Peter: We’re almost out of time, before I let you go, maybe…Neil, over to you just first, what are you going to do now, I mean, you’re stepping back from the day-to-day role…I mean, I presume you’re going to stay involved at the board level or something, what are your plans?

Neil: Look, I remain the largest shareholder in Harmoney and between myself and the founding team, we still own over 50% so my interest is in supporting David obviously and making sure that I help wherever I can in terms of the next phase of Harmoney’s growth. What I would like to do, Peter, is get involved in some of the opportunities that are coming out. We have great momentum around open banking data, around CCR coming out, around the willingness, particularly in Australia, of the population to actually want to take a positive move away from the big banks given the recent publicity.

I’d just like to get back to creating real momentum and well, taking on a big opportunity and delivering on it. So, we’ve got a few ideas, but what I’m going to do first is when the baton officially goes over to Dave, in a few weeks time, I’m going to take a holiday and get out of his hair for a little while (Peter laughs) and enjoy some summer and come back and ready to take on the world in the early new year.

Peter: Okay, enjoy that, and, David, what about you? I know you really haven’t officially even begun in this role yet, but what are sort of your priorities for the next 12 months?

David: Yeah, that’s a good question. The good thing about the business is it’s performing really well so it’s not like…if it’s not broke, you don’t need to fix it. But, really the key focus will be really leveraging the platform to grow out Australia, continuing the growth and building out some of those warehouses, funding warehouses that we spoke about and looking down the track to set them up so we’re able to securitize those customer receivables to ultimately optimize our cost of funds in the business.

So, that’ll be the things, Neil mentioned continuing to innovate, we’ve got an engineering team, around 50 people, and that’s really where the key to the business is in how we stay ahead of competition and make customer experience better. That’s something that we continually do. We don’t create a process and then forget about it. It’s about how do we make that customer experience better every week so keeping the those NPS scores up and the like that Neil spoke about so that’s something that, we almost count as hygiene in the business rather than projects that start and stop it’s rather that it is continual learning for us.

Peter: Right, okay, we’ll have to leave it there. Thank you, Neil, thank you, David, I really appreciate you both coming on the show today.

David: Thanks, Peter.

Neil: Thanks, Peter.

Peter: Okay, see you.

You know, I’m always impressed when I talk to companies in these smaller markets. It’s not easy to scale to get to a billion dollars not to mention, it’s not easy in large markets either, but it’s much, much more difficult in smaller markets to really get to a significant scale.

That’s what Harmoney has been able to do and, you know, they really have barely scratched the surface of the Australian market and that obviously has tremendous potential for them as well. I think given their track record of success in New Zealand and the fact that they actually have an Australian CEO now, I’d be very surprised if they don’t make really significant inroads into that market in the near future.

Anyway on that note, I will sign off, but before I do, just a note we’ll be in LendIt Europe next week, LendIt Fintech Europe 2019 in London so there will be no podcast episode next week. We’ll be back in two weeks. So, thank you very much for listening and I’ll catch you next time. Bye.

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

PODCAST TRANSCRIPTION SESSION NO. 215  –  NAT HOOPES

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

(music)

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

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

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

Welcome back to the podcast, Nat!

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Peter: Right, right, yeah.

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

Peter: Sure.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Nat: Terrific, take care.

Peter: See you.

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

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

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

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

PODCAST TRANSCRIPTION SESSION NO. 214  –  SAFWAN SHAH

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

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

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

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

Welcome to the podcast, Safwan!

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Peter: Right, right.

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

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

Peter: Right.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Peter: Okay, I wasn’t aware.

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

Peter: Right.

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

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

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

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

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

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

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

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

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

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

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

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

Peter: Okay.

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

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

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

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

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

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

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

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

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

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

Peter: Okay, see you.

Safwan: Bye.

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

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

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

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

PODCAST TRANSCRIPTION SESSION NO. 213  –  ZAC PRINCE

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

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

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

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

Welcome to the podcast, Zac!

Zac Prince: Hey Peter, thanks for having me.

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

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

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

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

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

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

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

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

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

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

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

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

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

Peter: Oh, geez.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Peter: Right.

Zac: And we landed on wealth management.

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

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

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

Peter: Right.

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

Peter: Okay.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Peter: Right.

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

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

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

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

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

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

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

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

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

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

Zac: Yeah, thanks for having me, Peter.

Peter: Okay, see you.

Zac: Bye.

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

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

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

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

PODCAST TRANSCRIPTION SESSION NO. 212  –  ARAD LEVERTOV

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

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

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

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

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

Welcome to the podcast, Arad!

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Peter: Exactly.

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

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

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

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

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

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

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

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

Peter: Right.

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

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

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

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

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

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

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

Peter: Right.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Peter: Okay, see you.

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

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

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

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