In this edition of the Lend Academy Podcast we have someone quite a bit different than our typical guest. Jonathan Morris is a banker, but he is not your conservative banker who works at a big bank, he is very much an innovative and forward thinking banker. His bank, Titan Bank, was one of the first banks to invest on the Lending Club platform. They started in June of 2013 so they already have some track record with their Lending Club investments.
I thought it would be very useful to get the perspective of a banker on this industry. I learned a great deal in this interview – here are some of the key points:
- When Lending Club and Prosper first came on to Jonathan’s radar.
- How Titan Bank operates and the kinds of customers it attracts.
- Why Titan Bank had to wait until the platforms matured before coming on board.
- Why p2p lending was such a natural fit for the bank.
- One of the real benefits that Lending Club provides in the way of loan customers.
- The kinds of borrowers that Titan Bank is looking for at p2p lending platforms.
- Why they can only buy whole loans.
- How the returns have performed versus expectations.
- Why Titan Bank needs to use their own credit models and underwriting.
- How Titan Bank is investing in the loans in Lending Club and Prosper.
- What he would need before considering a third platform.
- What percentage that p2p lending will become as part of the bank’s overall portfolio.
- How he approached the bank regulators about p2p lending.
- What the regulators required from Titan Bank to become comfortable with their p2p lending investment.
- Why most banks will have difficulty in embracing p2p lending.
- What Jonathan’s impressions were of Lending Club when he first started doing his due diligence.
- Why Titan Bank is not interested in creating their own p2p lending platform.
- Jonathan’s impressions of large banks and their attitude towards p2p lending.
Peter Renton: Welcome the Lend Academy Podcast, session number 24. This is your host, Peter Renton, founder of Lend Academy.
Peter: Today on the show, I am delighted to welcome Jonathan Morris. Now, Jonathan is a little bit different to other guests that I’ve had. In fact, I’ve never had anyone quite like him because he comes from the other side of peer-to-peer lending, shall we say, he comes from the bank side. Yes, he is a banker, he is the President of BMC Bancshares which is a holding company that owns Titan Bank. They are a small bank based in Texas. Now, for those of you that have been following closely for a while may recognize the name Titan Bank. They were one of the first banks to invest on the loans on Lending Club platform. They made a big announcement back in June of 2013, Lending Club did with two banks that had decided to invest in Lending Club loans. One of those banks was Titan Bank so Jonathan has been investing for a while now. I thought it will be very interesting to get his perspective on things. Hope you enjoy the show.
Peter: Welcome to the podcast, Jonathan.
Jonathan Morris: Thank you very much, Peter.
Peter: Let’s start off and tell the listeners a little bit of background about yourself and how you came to own a Texas bank.
Jonathan Morris: Well, we have another company in the space which is also a financial services company called BMC Capital which is an affiliate of the bank. So we had been working with a number of banks around the country helping to rationate (?) itself hundreds and millions of dollars of small balance commercial real estate loans. Five or six years ago, when the banking sector was blowing up there was a good opportunity to buy a small national bank in Texas and we were fortunate enough to acquire that and that’s called Titan Bank which we own now.
Peter: Okay, then what was your background before you…I mean, you got into financial services, I know you’ve also been in the tech business, what’s…can you give people a little bit of….. more color about your history?
Jonathan Morris: Sure, before that, I actually got to have some fund before we bought a bank. (laughs) When I started off my career, I had started several tech companies that were located in Asia. I actually lived in Jakarta, Indonesia for about five years. One of them even sold software to banks. Probably starting about ten years ago, I started to focus more on financial services and getting into this lending space. Ever since then we’ve been working fairly closely with banks or running around.
Peter: Okay, so then describe, if you would, a little bit about Titan Bank; how big is it, what sort of loans do you do right now, what’s the bank like?
Jonathan Morris: Sure, Titan Bank…it’s about a 107-year old national bank, we’re based in Texas, we do loans around the country for all our business lines, but it’s a very small bank. It’s what you would think of as a traditional community bank in all respects and customers in Texas can walk into our branches. We’re a small bank, we don’t have very many branches, but they walk in and have all the services of a typical bank except for the fact that we actually know their name unlike a lot of the larger banks.
Jonathan Morris: On the lending side, what we primarily do is small business loans for small merchants so we make loans typically used in the SPA program which might range from half a million dollars to $5M, most typically.
Peter: Okay, so how many branches do you have in Texas? Are the branches all in Texas?
Jonathan Morris: It’s a two-branch bank and we’ve been watching carefully and it just seems difficult to build branches these days because ultimately, it’s unclear if you’re ever going to need more than one branch and a really good mold on the Internet side, the way the world is going.
Peter: Exactly, exactly. It’s probably a smart move not to have lots of real estate.
Jonathan Morris: One of our challenges in that is that ultimately, we don’t have that many consumers coming in to the branches to ask for loans so peer-to-peer was such a natural fit for us.
Peter: Okay, so let’s just start to get into that. When did you first become aware or how long have you been following the space?
Jonathan Morris: I don’t know exactly when I became aware of it, but I think fairly on when Prosper had initiated, let’s say, its 1.0 model, their initial model they were working on. I started following at that point in time more of a curiosity. I wasn’t into the master on their head that time, but I would check in from time to time and really continued to watch it ever since until we got involved with the model ourselves.
Peter: Okay, so let’s go back to that. I mean, I remember it was June of 2013…. announced at LendIt where you had….Lending Club basically announced the partnership with you, with your bank and another community bank. Can you give us a little bit of background about that deal. I mean, how long had you been talking with Lending Club? Did you go to them, did they come to you? How did the deal get put together?
Jonathan Morris: Yeah, if I recollect, we had been talking to several of the platforms for several years before that deal was announced and a lot of what we needed to do was kind of wait for platforms to evolve to be able to support a national bank as an investor in the loans. There are several things that we do as a bank and several requirements that we have that may be different from a standard individual or even some of the other institutional investors and we just needed to wait until the platforms matured to support that. Obviously, we felt Lending Club did, they entertained (?) and we felt comfortable going forward with the partnership.
Peter: Okay, so what makes peer-to-peer lending so attractive for a bank like yours?
Jonathan Morris: For us it’s two things. The first is that ultimately it’s difficult for a bank, especially a small community bank like ourselves, to do very small loans in the $5,000 to $20,000 range let’s say that are not secured by any assets because you need a lot of technology and a lot of data to be able to make sense, whether or not that loan makes sense and what the rate should be. So we were able to effectively lift all that underwriting technology from the peer-to-peer providers. We’ll ultimately make our own credit decisions. It would be so expensive for us to have to build the systems that these guys use to gather all that information for us to make that decision that we would never be able to do it to the same level ourselves.
The second thing is that we’re not marketing experts. We have branches, but we have the home people come into these branches and the ability to get access to so many more consumers that we can help and provide loans to through these platforms versus what we have today was fantastic for us so it turned out to be a great opportunity on both dimensions.
Peter: Okay, so you started with Lending Club basically 15 months ago thereabouts; what kinds of borrowers are you investing in? Are you doing a range of all the different loan grades or are you focusing just on the lower risk and where are you going with that?
Jonathan Morris: We’re a bank, obviously, and as part of that we tend to be risk averse in general. We take responsibility seriously because we’re working with government insured funds. We will tend to focus on the lowest risk rates of the peer-to-peer platforms and either… typically borrowers were also paying lowest interest rates, but they have the most prudent history. We tend to be quite different from a lot of the institutional investors like hedge funds and private equity funds who are completely focused on the high risk/high yield loan opportunities. I think that banks are fairly useful for the peer-to-peer platforms because we can really fill in areas that a lot of institutional investors otherwise can’t afford to buy loans in.
Peter: Right, right, that makes sense. So are you buying whole loans only or are you buying whole and fractional, what are you doing?
Jonathan Morris: We can only buy whole loans.
Jonathan Morris: My interpretation of the banking regulations means that’s just a requirement for us.
Peter: Right, right, okay. You’ve been investing now for a while, are you happy with everything? Obviously, you’ve had some returns come in, you’ve probably even had the occasional default. I imagine it with the lowest risk ones, I mean, are you happy with the way things are going?
Jonathan Morris: Oh, we’ve been very happy and you know, we bought more than a thousand loans and while we’ve certainly had some defaults, similar to our offline portfolios, the returns most of all have been virtually exactly what we’ve predicted and that makes up feel pretty good and we’re certainly continuing to have our presence in the space. We’re continuing to reinvest proceeds and even slowly kind of increase our activity in the peer-to-peer space.
Peter: Right, okay, great. Are you deploying your capital and also you’re using whole loans only, you’re using the API, I mean, how do you actually, physically buy in the loans.
Jonathan Morris: Most of our buy-in has been through the API. We operate around computer systems, our observers, (inaudible) and that’s been another banking requirement that we can control the technology base that we’re operating off of, but one thing as a bank, I should clarify, is it’s been very important that we don’t just trust the platform’s own credit positioning. We need to use our own credit models and our own credit underwriting and that’s a significant requirement for ourselves. What we’ll ultimately do is look at all the variables that will come off the API, put it through our own decisioning models and make a selection loan by loan if it makes sense to the bank’s credit policies.
Peter: Okay, so did you develop this from scratch? Did you take your own expertise in underwriting. You see, you don’t really do consumer loans, you’re doing mainly SPA loans…obviously, you’re underwiting on the performance, but is that….I’m just trying to work out how you developed your own credit model.
Jonathan Morris: No, and on top of that I’m not a data scientist, I don’t have a Ph.D. in statistics. (laughs) Fortunately, I work with somebody who’s very, very talented that does. His name is Bryce Mason and he has been exceptional in helping us write the program.
Peter: Bryce has been on the podcast before. He’s the peer-to-peer Picks guy so that’s great you’re working with him. So then have you….you started off in Lending Club 15 months ago, are you doing anything else? Are you expanding to other platforms? What have you been doing.
Jonathan Morris: We’ve started off with Lending Club, we expanded and have also acquired some loans from Prosper. For now, those are the only two platforms that we’ve acquired any loans from and ultimately, what we look at is what’s the maturity of the platform, what’s the maturity of the data that they have, is there a meaningful enough data set that we can actually predict our returns or not. The other thing that we’re looking at is what are internal policies, their policies and procedures and how good is their documentation. If we don’t operate…I should put it this way, if they don’t operate to a bank standard, we can’t partner with them. So it’s ultimately when those platforms give us the ability to partner with them like they were another bank that we’re able to interact and acquire loans from them.
Peter: Okay, so it’s good to know that both platforms are up to banking standards, I guess. So then are you …..you obviously are doing your small business lending, are you interested in also the small business platforms that are sprouting up online or is that…you’re really going to stick with the consumer loans?
Jonathan Morris: I think for now we’ve been most comfortable with the consumer loans. That being said, we’re certainly in discussions with a number of the small business platforms. I think they’ve been interested in working with us not only because we’re a bank, but that’s the space that we’re typically in so we’re watching to see how that space evolves for now and we’re going to make our decisions later on.
Peter: So how big could this get for you? I mean, you’re a reasonably small bank, you’ve made a thousand whole loans, are you thinking this is going to be 50% of your business as far as making loans. I mean, what are your thoughts then?
Jonathan Morris: It’s a great question. One of the things that get looked at for any bank, regardless of the size is what’s called concentration of credit and one of the concentrations right now that we’re looking at is peer-to-peer lending itself. It’s difficult for any bank to get above let’s say 10 or 15% of it’s total loans going into any one sector so we’re trying to limit it at that size. We’ve certainly been increasing and the size of our bank steadily increases, but, unfortunately, there’s certain limits in the regulated world. That just happens to be one of them.
Peter: Right, that makes sense. We’ve talked a little bit about the banks regulations that you have to work with these platforms, did you approach the regulators about this? I mean, you are the first bank to come on to these platforms, how did you get comfortable with that? Did you seek approval with the FDIC or whoever or any other regulatory body when you made this decision?
Jonathan Morris: Sure, it’s another great question. We’re regulated by the OCC which is the Office of the Controller of the Currency. The OCC regulates all national banks so it could be from Titan Bank on the small side to Citibank or Wells Fargo on the large side. Every bank has it’s own approach towards the regulators. Our approach has been to be kind of very open, upfront, talk to them in advance on anything significant that we’re going to do. So we started talking to the regulators, our local office several months before doing anything. With the peer-to-peer side, we communicated with them, we showed them everything that we’re doing, the types of models that we’re running and part of that was just to get the regulators comfortable and explain to them what we’re doing. It’s a fair bit of work on any loan program with the regulators and frankly, it’s a fair bit of work for them because they have a difficult job of making sure banks don’t do stupid things with the government’s money. Effectively, we’ve both seen the ramifications of what happens when they do, but, I think they’ve been reasonable to work with on these programs.
Peter: When you first went to them did they think you were crazy, did they know what the hell you were talking about even? I mean, I imagine you had to through a learning process with them.
Jonathan Morris: Actually, the first thing I should say is for the regulators were well equipped. Everybody who’s listening that doesn’t run a bank which will be most of the listeners (laughs) may have the impression on bank regulators ….the guys that we worked with are smart. The first thing I said is I’m thinking about doing something with Lending Club and they said why not Prosper (laughs) and it turns out some of them had been playing the sectors themselves.
Jonathan Morris: …and were very, very familiar with what it was and a lot of the questions were more technical in nature as opposed to is this sane or is this not sane. It was more how do you comply with all the banking regs and the banking code with a platform like this. Ultimately for us, it comes down to what are the policies that are in place that platforms have or do the policies are in place that the bank they originate through has in place and a lot of work that we need to do ongoing as a bank to go through…how do we test our loans, how do we back test our models to see that they’re working. How do we go through each individual note to make sure that note is a real and valid note and wasn’t just made up by one of the platforms from scratch in a scheme. On top of that, reviewing subject data and verifications and all kinds of other information that’s required of a bank that fortunately the institutional investors probably doesn’t require of them, the outside parties. Other banks have comments and said, hey, is this a good idea for us and I said, well, it depends. It could be, but you better be prepared to put a lot of work into the programs because otherwise you’re probably not going to do it in a way that’s going to allow you to do it over the long term.
Peter: Right, that’s a good point because I imagine too, you’re talking with your local OCC people. I imagine a bank in California is going to have to deal with completely different people who may not have the level of education. Maybe you got lucky with the people that you’re in.
Jonathan Morris: Well, I’m lucky, I’m in Texas so, of course, we’re better than everybody else (laughs). I’m kidding. I joke about that, but I’m originally from Boston, but that being said, I think it may be less about the platforms themselves and more about how an individual bank is carrying out the program. You have to really understand what you’re buying. It can’t be I’ve said it and forget it and the bank deploying millions and millions of dollars into these programs and not having a fundamental understanding of what are you buying, have you verified that it’s real and do you really have a realistic way to predict what your returns are going to be, both in a good scenario and a negative scenario that market takes a nosedive, the economy takes a nosedive like it did five or six years ago. Those are all reasonable requests of the regulators and it’s certainly reasonable to request that banks are going to comply with that and are moving into some sort of new technology and a new sector. Let’s face it, banks are (inaudible) things and they’re certainly not that good at new technology so I think some of the banks are going to be able to do it and most will have difficulty doing it the right way.
Peter: Right, yeah, that makes sense. I just want to go back to when you started up with Lending Club. When you….obviously for them it was a big deal to get some banks on the platform. They’ve been talking about disintermediating the banks and here we are now, now we talk about partnering with the banks. Did they have to change much when you went to look at them and you obviously had lots of talks in advance of signing a deal, did they have to change much of their processes or they were so compliant that you went, okay, this is great, we just slide right in here and just really making sure it was comfortable. What was that like?
Jonathan Morris: It kind of was a shock at how good Lending Club was when we went there; the level of policies that they have, the quality of people, some of the verification systems that we were able to see on site really surprised me in a good way. I think there was then…. and over time as things evolved, a few things have had been let’s say tweaked, but they were running their programs better than probably 90% of the banks do themselves. It worked fairly well for us in that respect.
Peter: That’s really good to hear, actually, that’s good to hear because we don’t really know how it compares to the banks so it’s good to hear a banker saying that. So then has it ever crossed your mind….I know you’re a relatively small bank, but has it ever crossed your mind to cut out Lending Club and Prosper and start your own peer-to-peer lending operation?
Jonathan Morris: On the consumer side, those platforms are so strong. The technology investment they’ve put in has been so much, there’s just no feasible way that we could cost effect if we do that even with our low cost of capital. I don’t think we’re in a position to ever be able to do it better than they do it. We can’t put in the technology investment and they’re so far along in the data set that it would be difficult, I think, for very many banks to compete with them except for the large ones out there.
On the small business side, it’s certainly a market that we’ve been looking at. Part of our questions are is that we have a great program where we work with the SPA and in some phenomenal sort of business programs for small merchants, small businesses we’re looking at opportunities to take advantage of that via technology, whether it’s a traditional peer-to-peer or something that looks a little bit different.
Peter: Right, okay, so let’s talk about the big banks for a second because this is something that comes up in conversations many, many times, I find, where people say, well, you kind of look at other industries that has been really overturned and completely impacted by technology. There’s many like the travel industry, the music industry, the newspaper business, there are so many industries and banking today, for the most part, is still the same as it was 50 years ago, the core business. What do you think the impact like on the big banks and do you ever see one of the larger banks really going head to head and take a really aggressive stance in this business and take on Lending Club or Prosper or anything like that? I mean, what is stopping the big banks from really doing that?
Jonathan Morris: We’re kind of curious ourselves to see how it plays out. Now as the guy that hates big banks would….I have enjoyed watching is the fact that almost all the business that Lending Club and Prosper are taking at least are coming from large banks and typically…..as you know, Peter, customers that have high credit card balances and they’re paying just this outlandish rates and fees to the banks and they’re able to refinance that into an amortizing loan that they can eventually pay off. We think the peer-to-peer platforms have been in the customers’ best interest and that’s been one of the reasons why we’ve been comfortable in playing in that space. I think, right now, its kind of a very, very small pin prick for the banks when you look at…well, Citi and Chase just promised that they have on their books and even that is just a small premium amount for it, but it’s growing over time and we know it’s coming up on their radar screens right now and I guess our question here is are they going to try to buyout the platforms and effectively take them over and coop them or do they start their own. I think something’s going to have to happen eventually as the platforms continue to grow. I’d like to be able to watch all the big boys duke (?) it out.
Peter: Right, right, well, you talked to Renaud or the Proper guys, they seem to be convinced that a bank is not going to really be a good fit. Look at the multiples of banks and look at the multiples of Lending Club’s shooting for their IPO, it’s going to be a tough sell. I will be interested to see…eventually, it’s going to be more than pin prick, that’s the thing. If I keep doubling every year, they’re going to do somewhere around $5 Billion this year in loans, you keep doubling every year, it doesn’t take long to start to be a lot more than a pin prick.
Jonathan Morris: Sure.
Peter: That is the question so you’re going to follow along, I guess, like all of these….so what’s the future for your bank, for Titan Bank? Do you have a growth plan in place? Obviously, Lending Club and Prosper are only going to be a certain portion of your business, where are you taking your bank?
Jonathan Morris: Well, we focus on everyday, first and foremost, is going out around the country and we have sales offices around the country and funding small companies with SPA loans. A difficult customer might range from a doctor or dentist to a CPA to somebody that wants to build new car wash and that’s what we focus on expanding amongst ourselves. But as part of that, it’s been awesome to get the access on the consumer loans that we’ve had so much difficulty getting, otherwise, I think as part of that we hope to continue growing our bank, but also continue increasing the amount of loans that we have in the peer-to-peer sector (inaudible) that the sector keeps performing strong like it has been for us in the past.
Peter: Well, on that note, I have to let you go. It’s been a fascinating discussion, Jonathan. I really appreciate your coming on the show.
Jonathan Morris: Thank you so much.
Peter: Okay, see you later. Well, I thought that was just fascinating. The money quote for me and the key takeaway, I think, is that when he said about….about two thirds of the way through Jonathan said that Lending Club systems are really better than 90% of the banks out there and that when he went to Lending Club he was pleasantly surprised and really to get a bank on their platform was really not that big a deal for him…Lending Club’s perspectives so that was really good to see. Also interesting to see the hoops that banks have to go through and the opinions of the regulators and the other (inaudible) and all sorts of things. I think banks are going to be a part of this industry, they are going to be a bigger part, I expect, as we go forward. I think having some perspective here was very useful.
On that note, I will sign off and hope you enjoyed the show. I’ll catch you next time. Thanks. Bye.