Building a successful fintech platform is a seductive dream. That aspiration has led many smart entrepreneurs to sketch out carefully calibrated plans to build robust two-sided loan marketplaces that will bask in the glow of rising transaction volumes. As the last few years have shown, though, achieving this objective is a very hard thing to do. That’s why we were eager to hear from Funding Circle’s Sam Hodges, Co-founder of the company’s US business. That business is a core component of Funding Circle’s global presence, which has facilitated the flow of about $3 billion of debt capital to over 25,000 business throughout the UK, Europe and America. The FR’s Gregg Schoenberg recently sat down with Hodges to learn more about the company’s enviable success and its plans for the future.
The Financial Revolutionist: Thank you for taking the time. I appreciate it.
Sam Hodges: Pleasure.
Recent Capital Raise
FR: Let’s start with your recent financing. You took in an additional $100 million, which means you’ve now raised a total of $373 million. Why did you elect to add so much more money to the coffers?
SH: We think the size of the opportunity is massive and it's a global one. Building up the infrastructure and brand to seize the opportunities we see across the four geographies where we now operate — the US, the UK, Germany and the Netherlands — takes serious resources.
FR: Are you saying that given the opportunities, you actually needed $100 million more?
SH: Frankly, we didn't need that capital and we're not planning to spend most of it. But having a really strong balance sheet in itself has a value.
FR: For counterparties?
SH: Yes. I think raising the money when we did was a really strong show of confidence from our investors and it has real benefits in terms of the lending conversations we are having.
FR: Is there any color you can give as to how the capital will be allocated in the US? I ask that because Funding Circle has generated a fair bit of traction here, but there's a lot of competition here too.
SH: Sure. We're putting more resources behind all our systems. In terms of our engineering spend, we will be adding a lot of folks to the team here. We're also continuing to flesh out some of our global functions in risk and analytics.
FR: You’re obviously aware that some of your non-bank competitors here have been experiencing tough times. But Funding Circle is continuing to build momentum both in the US and overseas. Your volumes look strong and your recent securitization in the European ABS market went very well. Why do you think Funding Circle has outperformed?
SH: There’s no magic bullet in this business; however, I would start by saying that almost anyone can set-up a commercial lender. The barriers to entry are very low. You go and get one commercial lending license in a state and make a couple of loans — that’s easy. The barrier is scale, to be able to do it well and to originate loans at a marginal cost that makes sense. Also, being able to process loans in a way that's reasonably automated and doing the risk analytics properly is difficult. Finally, making sure you have diversified funding sources and servicing the loans over a lifetime are really hard things to do well.
FR: I take it many of the company’s functions are done centrally?
SH: Absolutely. Risk and analytics reports up to a guy named Jerome Le Luel, who used to be head of analytics for Barclays and the CRO of Barclaycard. He sits in London. Tech and product are run globally in the US by David Yu. David used to be the CEO of Betfair, which was the world’s largest betting exchange and was formerly listed on the LSE. The only way we were able to attract someone like David was to give him the opportunity to build out a global infrastructure.
FR: Speaking of being publically traded, has Funding Circle declared or can you say anything specific on the potential timing of a public offering?
SH: We have no immediate plans for an IPO. At some point, might it make sense to go public? I think it's probably too early to say, but our view is that if you build a really strong business, you can pick your moment.
Entering US Market
FR: Let's switch to how you got involved. You were head of Endurance Lending Network.
SH: Yes, I co-founded it and was the Co-CEO.
FR: I'm guessing that when Funding Circle made the decision to come to the US, it was confronted by the classic build versus buy calculation. What was it about ELN that convinced Funding Circle that it was the right partner for its US expansion?
SH: From our perspective, we were looking across the Atlantic and observing the great business that Funding Circle had established in the UK. By our estimation, Funding Circle was about 18 months ahead of us. I think Funding Circle’s team looked at us and saw a great deal of synergy in terms of mission and alignment. It’s been a great marriage ever since.
FR: Is there anything you can share about that marriage (i.e., the size of your US businesses)?
SH: We anticipate doing somewhere on the order of about $500 million in lending this year in the US. Four years ago it was zero, so business has been growing very nicely in this market.
FR: Very nicely? It’s more than that...
SH: Yes, we’ve seen pretty incredible growth over a four and a half year horizon.
FR: What’s the expected growth rate in 2017?
SH: Last year we did about $280 million in lending, so call it roughly a 75-80% growth rate we anticipate for this year.
FR: Let’s turn to the global economic environment and how that can impact your business. How are you thinking about rates and the impact they can have?
SH: We do anticipate rising rates. That being said, I don't think you're going to see a huge amount of divergence between rates across geographies in the near-term. That view has been incorporated into how we are running our business globally. That being said, the most important thing to keep in mind is that we have a lot of control over our spot rates. If interest rates spike in any one of the geographies where we operate, what we can do is raise the nominal rates we're charging our borrowers and make sure that the relative spread that's in our pricing stays in there for investors.
FR: And what’s the average term of your loans?
SH: Our range is one to five years, but our current average is about 24 months. So our investors aren’t taking a huge amount of rate risk on loans at the moment. I’d add that we feel pretty confident that we can navigate through an evolving rate cycle. Now if rates were to go up very quickly or very high, that obviously can cause a demand and supply shock, so that's an eventuality that we think about.
FR: With respect to the US economy, what’s your take on the current economic situation?
SH: Based on our data, which consists literally of thousands of small businesses, I think the view is reasonably optimistic. We're not seeing major swaths of rising delinquencies or defaults, and cash flow performance for most industries and geographies looks pretty healthy. That’s similar to our view in the UK and Europe. All of the political noise notwithstanding, our window into the economy indicates that it's doing pretty well in our regions.
Traditional Banking Competitors
FR: Assuming that rates rise gradually, how worried are you about traditional banks becoming more aggressive?
SH: Over the last 18 months, we’ve seen some banks on the margin get more aggressive in asset classes where they haven't played before. However, we still see a huge amount of opportunity and a big market in front of us.
FR: So no real concern about traditional banking competitors?
SH No. To be honest, a few more banks being slightly more aggressive isn't something that causes us deep existential concern.
FR: You’ve seen the various tech and infrastructure partnerships some banks have struck to improve their performance and usability. How do you view that?
SH: We've spent a bit of time thinking about what the lending as a service model looks like. Our perspective is that it's very difficult to build both a lending business and a lending technology business under one roof. If you look at a lot of the partnerships that are out there, I would say most of them are in early days. But it might be the case that some banks are able to use some of the technology providers to make their small business lending or borrowing experience significantly better.
FR: So why not be concerned by these LaaS partnerships?
SH I believe that inferior user interface technology isn’t the primary reason banks aren’t able to solve the small business credit gap. I think there are lots of other constituent factors involved.
FR: Like what?
SH Well, it's a pretty low margin business relative to the other lines of business that banks are often in. And even if banks benefit by some level of regulatory change, they still will have regulatory capital constraints that will likely stay in place for small commercial lending. Plus, banks often don’t have the data models necessary to underwrite loans. So unless they make a massive change in their approach to the market — which I don’t see — we are quite confident we can build a company that will continue to grow in the long-term.
FR: I wouldn't ask most fintech companies the next question, but because you have scale and plenty of capital, I’ll ask it to you. If you look at Amazon and Warby Parker, they have added a bricks and mortar dimension to their business. When I think about the huge numbers of small businesses in this country, it leads me to wonder whether Funding Circle would ever open a branch or two. Perhaps it wouldn’t be a major driver of your business, but as a way to get closer to your clients, could it ever make sense?
SH: Could we at some point have a kiosk somewhere or a physical location in an urban center where we thought there were a lot of small businesses? Potentially, but it's not something we're planning for today.
FR: How about new products?
SH: Our ability to deliver a term loan reliably and deliver a very high quality customer experience bridges us naturally to offer other financial services products. In the UK, for example, we have a commercial property product.
FR: How about a floating instrument of some sort?
SH: It’s a possibility, but not something we're planning for in the near-term.
Regulation and Politics
FR: Let's turn to the small business regulatory climate. I took note of the fact that you are a signatory of the Small Business Borrowers Bill of Rights.
SH: Actually, we’re more than a signatory. We're one of the sponsors.
FR: Do you think the leading marketplace lenders are doing enough to distance themselves from some of the underbelly elements that could benefit by deregulation?
SH: I would argue that it's unlikely that you're going to see the major states, who are very important in commercial lending, really changing their stance on things. So for our business, we're not anticipating major changes from a regulatory perspective that would either help or hurt the business. Now, with respect to what the major marketplace lenders could do in terms of separating themselves from some practices, I do think things like the Borrow Bill of Rights and the Marketplace Lending Association are helpful in terms of self regulation. It's a longer way of saying that as an industry, we’re approaching things in a pretty responsible way. I think there's more work to be done, but I think it's getting done.
FR: Regarding the OCC fintech charter, it seems to me that without some sort of sandbox like you have in the UK, the fintech charter is going to benefit more established companies at the expense of smaller ones. Funding Circle is now a big fintech company, but at one time, it was a small one. As an entrepreneur, how do you feel about that?
SH: I'll answer the question both with my Funding Circle hat on and then also as a general observer to the fintech ecosystem. With my Funding Circle hat on, I would argue that having the OCC serve as a standard-setting forum that brings the states together and gets the states to agree on things is a healthy development. Now, as an observer, I’d say that a sandbox is helpful in fostering innovation. Bringing a business into compliance in the US takes millions of dollars — it’s mind blowing really. So while it’s good for Funding Circle as one of the bigger guys, I think the system would work better if you had some level of graduated regulation. The fewer customers you serve and the more limited your activities are, the less regulatory complexity you should have to face.
FR: That’s a thoughtful approach, but it doesn’t look to be on the horizon.
SH: If I were a gambling man I wouldn't put money on it.
FR: My last question is on Brexit. This June will mark the one year anniversary of the Brexit vote and Article 50 has now been triggered. I realize you focus on the US business, but what’s your take on how the company has been performing since the initial Brexit decision?
SH: Well, clearly there are others more close to it than me. But what I can say is that we haven't seen a meaningful impact either on product demand or product performance. Those are the two metrics we look at all the time.
SH: US politics is plenty enough to keep me busy.
FR: On that note, Sam, thank you. I really appreciate it.
SH: It was fun to speak to you, Gregg. Thank you as well.
This interview has been edited for content, length and clarity.