Four Entrepreneurs Talk About the Fintech Revolution
Psyching Out Borrowers
Scott Saunders is the CEO of Payoff, which uses behavioral science to help individuals refinance their debt. —T.A.
Q: Why wade into refinancing debts?
A: The credit card companies and banks are perpetuating the cycle of debt. We’re reinventing lending from the perspective of wealth management. We actually want people to pay off their loans, and we don’t want them to get a second, third, or fourth loan from us. We want to help people cross the chasm from a borrower mentality to an investor mentality, and paying off high-interest-rate credit cards is the best investment they can make.
Q: What differentiates Payoff?
A: Our underwriting is like an interview process that helps us understand people’s levels of intrinsic motivation to really pay off their debt. We try to establish their willingness to do so, which requires some heart on their part. We’re also actively researching and building resources and tools to support motivated members who do not currently qualify for a loan.
Q: You’ve hired Dr. Galen Buckwalter, who’s best known for his work at eHarmony. Why?
A: Galen helped develop the matching algorithms at eHarmony, which are responsible for 4 percent of U.S. marriages. We’re using his expertise to bring psychology to finance. Our science is ultimately about behavior change and helping people make better financial decisions. This process of change begins with self-understanding, and we’re using advanced psychometric assessments to understand people’s mindsets— the goal being to improve how they approach their financial decisions. We’ve taken the hundreds of questions you might answer in a typical psychometric assessment and compressed them into a three-minute “gamified” online assessment that gauges your financial personality.
Q: How do those results play into your business model?
A: The psychology is not factored into our underwriting today, but there are three behavioral things we look at. First, historical credit performance; we get that from the credit bureaus. Second, cash flow; we have our own approach to understanding and evaluating that component. And finally, behavioral data; ideally, we get that through direct interaction with the consumer.
Q: What’s your role in the fintech revolution, then?
A: It’s really about using science to empower our members by partnering with them to help them make better decisions. We see evidence that our approach will result in lower costs for us to both engage new members and dramatically lower overall default rates. Our fundamental bet is that doing the right thing for our members will pay off for them and for us.
Fintech for Kids
Max Levchin, who co-founded PayPal, has a new company, Affirm, that helps millennials with loans for education and other big-ticket items. —N.B.
Q: Why focus on lending to young people?
A: Millennials are the largest generation of Americans— almost 100 million people. And they’re coming to a point in their collective lives when they’re graduating college, landing well-paying jobs, and getting apartments.
Q: Why do you talk about transparency?
A: A lot of the financial products that people can have today, they’re designed to be somewhere between confusing and entirely bamboozling. I think that’s going to be drastically reduced. People will demand extreme clarity: “If I don’t understand it, there is someone else who will offer me a clearer version.”
Q: Where did your journey into the lending business begin?
A: I financed my first company with credit cards, much as my friends were doing. Having grown up in socialist Ukraine, I wasn’t well educated in personal finance. When the company failed in 1996, I had something like $10,000 in debt.
Q: How dark did things get?
A: I ended up needing a root canal only to have the dentist refuse me because of my credit. I was hanging around Silicon Valley with this temporary filling, terrified of opening my mouth. I wound up in an emergency room because it got infected. I was the caboose of the American financial system.
Q: What did you take away from that experience?
A: After the PayPal IPO in 2002, I was perfectly fine financially and made all the efforts to clear my name and credit. It took almost a decade. The FICO score was popularized in the 1980s. The standardization and the push that took place back then was pretty awesome, but it’s quite outdated.
Q: How so?
A: What used to be a slow ramp, where you had your first apprenticeship after college and very slowly gained your earning capacity … the world just doesn’t look like that anymore. People don’t hold jobs for long. Their earning ability changes. They get vocational training through alternative learning platforms. Your financial and purchasing ability changes a lot faster than it used to, and your credit score should reflect that reality.
Getting a Grip on Risk
Ram Ahluwalia, CEO of PeerIQ, says peer-to-peer lending’s biggest challenge is understanding and managing risk. —T.A.
Q: What’s the biggest challenge in P2P?
A: The current economic environment. There’s a lot of capital chasing P2P loans that offer short duration and high yields in an otherwise low-interest-rate and low-default-rate environment. There’s also no obligation for investors to fund loans; they can change their minds if their perceptions of risk and return change. P2P platforms need to ensure they have access to diverse and sticky sources of funding that won’t suddenly disappear.
Q: What’s next?
A: Consumer and small-business credit is transitioning to the capital markets, with bank regulatory requirements a key driver of this trend. As bank balance sheets shrink, institutional investors and nonbanks are filling the gap. You are going to see dramatic growth in securitization and demand for risk management tools, like the ones we are building. I think you’ll have a very robust asset-backed-security market that underpins the industry growth.
Q: What’s so hard about managing risk?
A: There is no standardized valuation methodology for P2P loans. There is no mark to market. Funds use different valuation approaches. Also, there are asset and liability mismatches. Hedge funds may own pools of P2P loans with three- or five-year duration yet only offer quarterly liquidity. These mismatches are exacerbated in a downturn, when redemptions tend to accelerate. PeerIQ allows clients to benchmark loan performance, manage portfolios, meet reporting requirements, and project cash flows across scenarios.
Q: What about derivatives?
A: Securitization and structured products go hand in hand. The tools we’ve built to help institutions understand their risk can be used to structure and price other financial products, such as insurance-wrapped P2P loans. Risk transfer instruments are something that clients ask about and will eventually be part of a robust risk management tool kit. Institutions and banks are more willing to fund P2P, potentially through a credit cycle, when they know they can manage their risk responsibly.
‘It’s All Just Data’
Eric Poirier, CEO of Addepar, a startup that provides wealth management software, aims to get banks beyond spreadsheets. —M.C. & S.F.
Q: How are you disrupting finance?
A: There are $120 trillion of assets being managed in the world. The most common infrastructure for managing those assets? Spreadsheets run by people. The technology just hasn’t kept pace. At Addepar, we’ve built technology that gathers data describing all the assets in a given portfolio. It doesn’t matter if you’ve got stocks and bonds, investments in private equity and hedge funds, or even art and wine. From our perspective, it’s all just data.
Q: What’s your biggest challenge?
A: There are no data standards across the banks; Fidelity, Schwab, Goldman, and JPMorgan will each represent data differently. We throw a lot of technology at that problem. Most banks have a massive “tech stack,” many parts of which were built decades ago. The budgets associated with that are massive. But if you’re running a wealth management group, your primary concern should be: Is my team happy, healthy, and growing? Are the clients happy, healthy, and growing?
Q: What’s the secret weapon?
A: Amazon’s Cloud is a big one. At the end of the day, these are just a bunch of servers in a building somewhere being managed by people, and they keep coming up with new tools for us. For instance, say you just need to run a quick calculation. We can now spin up a server for a second, do something, and then shut the server down—and you don’t have to pay for it if it’s off. So if I have a whole bunch of data coming in at a certain point in the day, I crunch that data and then shut the server off.
These interviews appear in the October issue of Bloomberg Markets magazine.