Following our regular weekly interview, the Finanser talks this week with co-founder and CEO of Zopa, Giles Andrews.
How did Zopa start?
Well firstly, it wasn't my idea. I joined a team of three people who had an idea, about four slides of PowerPoint. They weren't quite sure where to take the idea and how to get it financed. I joined them to help out on that side of things, and enjoyed it so much that I stayed.
And that's what, 2003, 2004?
2004 was when the idea was hatched. I would say in the first quarter of 2004. I joined the team in spring, and we went on to raise money in the summer of 2004 and closed the first round of funding in the autumn of 2004. The business was launched in March 2005.
And this was the very first peer-to-peer lender on the planet.
And has now been copied in most countries around the world.
People all over the world. All and sundry.
In the 11 years since you started, what has changed?
The basic idea hasn't changed, which idea was to provide better value to consumers by being a more efficient connection for people who have money to connect with people who wanted money, and to do it in a fairer manner that didn't involve having to be a bank. This meant not taking deposits, but connecting people's money through a market place solution.
The original vision was for all that to be done at an individual level by individual lenders . Now that idea has moved through a pretty subtle morph, as there are now some businesses supplying capital. Institutions supply capital and, more recently, banks and the UK government supply capital. In our case, we only lend to consumers but now there are also other lending models too. For example, retail consumers funding businesses through, for example, Funding Circle. Even so, the basic idea of connecting people with money to people who want it hasn't changed.
The idea of that happening in a market place, not involving a bank, or bank balance sheets means not requiring the regulations and the associated regulatory capital requirements of deposit-taking and, crucially in my mind, without any maturity transformation taking place. Therefore, it is not only creating a more efficient system in the market place, but also a more stable one where both sides understand and agree the duration of a loancontract. It avoids the situation where people are borrowing short and lending long, as brought down the financial world in 2008 in the global financial crisis.
As I said, the basic idea has not changed. It's remarkably consistent. Every market is different in terms of how regulators deal with the idea though. Regulators in different markets all around the world require subtly different interpretations of the basic business model. In some cases they require different licenses and different permissions and, in some cases, banks have to be involved. For example, in the USA, securities are created and sold for the loans, and that has to done via banks. In Germany, a banking license is involved. Even so, by and large, around most of the world, the idea is pretty much as it was created by us.
You saw a real uptick in business after the crisis hit in 2008 and as the bank credit markets dried up. Has that demand sustained itself?
Yes it has. That was an inflection point in our growth. How causal the crisis was is difficult to tell, as it happened when we were three years old with an increasing track record. We had prioritized delivering a great credit performance. That meant that when the crisis hit we were just coming of age, gaining some maturity and showing great results but, no question, the crisis helped us get to where we are today.
Had the crisis occurred when we were younger, without so much of a track record, we probably wouldn't have benefitted so much. It wasn't just the crisis but the timing of the crisis that was helpful therefore. As for many genuinely new businesses, consumer adoption can be a bit slower than optimistic entrepreneurs may hope for but, similarly, accelerating growth is sometimes more traumatic than you might hope for as well, it can be difficult to keep up with.
I remember when we first met, the concept of peer-to-peer lending was actually quite alien.
It was interesting as, completely by accident, our early adopter customer base contained many IT professionals. The way I rationalize this is that if you show an IT professional a solution to a known problem that involves the clever use of IT, then their due diligence on the business involves checking the IT works. When it came to the really thorny stuff like, “Do these people know how to lend money and get it back?” these IT professionals seemed to take this more on trust. In fact they were, with hindsight, a fantastic early adopter user base and most of them are still with us.
How has the demographics of the customer base changed?
Surprisingly, in the first year or two, the average borrower was from a higher demographic than the average lender. This was probably due to our overly stringent credit risk requirements. Back then, you basically had to be rich and have no need for a loan whatsoever to be given one by us.
Interestingly, lenders were from a lower demographic. They were generally younger and lending quite small amounts of money. They typically weren’t terribly wealthy and, as the business matured, that has changed gradually.
Today, our average lenders are ten years older than our average borrower. Our lenders are typically in their early 50s, and that's getting older all the time. This means they are now often wealthier and more conservative.
These folks are attracted to us because we started getting written about in the Daily Telegraph rather than Wired. So, over time, the customer base and view has changed a lot, which has been helpful.
Can you give me a few numbers in terms of the volume of lending and borrowing?
We have been lending £45 million a month and expect that to be £50 million this month.
That indicates that your lending seems to be doubling year on year?
Yes. We've doubled most years since 2008, and certainly are on track to double our volumes again this year.
If you look at that in the context of the mainstream banking marketplace for credit, it's still peanuts though, isn't it?
Well, we've got about 2% market share now. I remember when we started and were presenting our business plans, we said: “it's a very big market, we only need 1% of it”, and the Venture Capitalist looks down over their glasses and says, “Yes, the first 1% is always much the hardest one to get”. We achieved about 1% last year of the UK unsecured consumer loans market and are now on track to do about 2% this year.
It's doubling year on year.
It's doubling year on year. This means it gets to be significant pretty quickly and certainly now, there’s no reason why we shouldn't get into double digit market share at some point very soon. It will level up at some point, but not in the immediate future.
Do you see this as taking market share from the banks or is this creating an alternative marketplace?
I think it's substitutional. I don't think we're growing the market for consumer finance. I think we are taking share from banks on the basis that we have the better product. It's typically about providing the best value, but customers are not choosing us because we're always cheaper. We have won customer service awards for the last six years in a row with influential consumer finance provocations like MoneyWise, Money Facts and more.
This is because we began by trying to not only create a great offer, but a great service too. We went on service; we went on value; and we went on some other product benefits as well, such as the fact that you can repay your loan at any point and leave with no charge.
Therefore, we created new product features which also would attract. The idea with all of this was to set us apart from the banks. The fact that we had a slightly funny sounding name, and it was new.
Then there was the PPI (Payments Protection Insurance) scandal which clearly helped us.
But even despite our features and benefits, and even despite all of that bad bank history and headlines, most people are still, on balance, more likely to go with someone they've heard of. In other words, we still have to fight hard to win business as the average lender and borrower will still go to the brand they know first.
That is where we have had a pretty big nut to crack, in terms of growing awareness of what we do. We need to have more awareness to achieve the level of conversion from marketing and from Best Buy tables and awards for service.
Another notable factor is that your loan default rates are lower than the banks. Is that because of the software, analytics, risk management or something else?
I think now it’s down to superior analytics and risk management but initially I think it was because we were more conservative than banks. So our losses in the early years from loan defaults were zero, which is clearly too low. It meant that we were turning down a lot of business that we should have been writing. Since the crisis we've continued to outperform banks, but we have seen some credit loss, which is a good thing. It's a good thing as long as we manage the risk effectively. During the first years, we were too stringent and we learned lessons from being very conservative. It's always better to learn by starting from a conservative base. It's easier to add more risk than to take it away. You learn a lot from conservative behaviour, because you can do retrospective analysis of the customers you declined. You can look at the past data and find cells of people who didn't look great to you when you made your decision, but who actually turned out to be fine. By doing this, you can then improve your models and your algorithms to reflect that. In other words, we were building a credit model in exactly the opposite way to a payday lender strategy which is to learn from the people they shouldn’t have lent to
We learned from this that we had been lending incredibly conservatively. We didn't lend to people who subsequently went on to get a loan and behave well, and pay it back. We then asked: “How can we try to lend to those people, as well as the people we lent to before?” It’s just a slow process. You have to wait a couple of years to find out who the people you declined were, who then went on to pay back and behave well, because you can't judge them quickly. You can't judge them on their first six or twelve months behavior, for example. You have to wait a couple of years. Contrast this with the payday lending credit model. Payday lenders can lend indiscriminately at first. They are lending small amounts of their own money, and learn more rapidly based on very quick repayment cycles, but we couldn’t do that because it isn't our money and the repayment cycles are much slower. We lend somebody else's money. But, if you take longer, you can work intelligently to build better credit models.
But couldn’t you just use FICO, Experian, Equifax and credit rating agencies to assess risk?
We don’t really take a huge amount of notice of their scores. Scores are useful to people who don't have their own data, and are directionally accurate but we have found that having our own data is more valuable. We still buy raw data from the credit bureaux and use this in the construct of our own scores.
Less experienced lenders tend to buy a score and that’s all they do. I’m not belittling that as a product, but we've moved it on a stage. We buy raw data from several bureaux, which costs more money, and then overlay that with our own data. This means we have far more accurate models for lending.
If you're doubling your volume of lending year on year, have you had to also double the number of staff here?
The staffing hasn't gone in the same way, no. We've tended to grow staff numbers more in steps, rather than directly in tandem with growth. We operated consistently with somewhere between 25 and 40 people during the start-up period, during which we probably quadrupled our business. So business growth and growth in staff numbers were not consistent. Staff growth was slower.
This year, we're up at about 100 people, and so over the last ten years we have more than doubled staff. Now we're investing in a team that could probably deliver three or four times the business that we're currently writing, which will already be twice what it was last year. So we've sort of invested ahead of the curve if you like. A lot of that investment is in areas like technology.
100 people with a £500 million portfolio of lending sounds fairly efficient when compared with a bank?
Yes, and I think that will continue. In fact, our operational cost advantage should harden rather than soften over time. In terms of general numbers though, we will do £550 million of lending in 2015. In fact, the loan book will probably end up nearer £600 million. In 2016, we're forecasting a billion pounds of lending, and the portfolio should end up around £1.3 billion by the end of 2016, or something like that.
In terms of technology, do you process everything in-house or do you use any external software houses and suppliers?
We use a mixture of services that are hosted remotely, particularly the hardware, so it’s a mixture of in-house software development and external hosting. We have invested in hardware from time to time for certain areas of application processing, and we host certain parts of the applications on our own systems remotely. We probably won't forever but we do now.
Why do you need some things on your own service?
That's a very good question. There are some people who think that security is easier if it’s on your own hardware and they have concerns about regulation. There are some very good cloud based solutions out there that we could use, and other players do use, but they aren't typically new businesses getting regulated for the first time.
I find it interesting that peer-to-peer lending has been so successful but, if you look at peer-to-peer insurances or crowdfunding mortgages, they don’t seem so successful. Do you have a view as to why that might be?
Well, the kind of lending we do is a great marriage for a marketplace platform as it is relatively short to medium term. This means that there is an easily understood return for lenders without maturity transformation. The matching of those loans to somebody who wants to make a return on their cash is quite an easy match. The match of a mortgage is a harder match because of the extra duration involved, and what could happen to interest rates and so on. In this country at least, consumers are signed up for their mortgages for 25 years. Lenders might sign up for that in the States but that's not the nature of the market here yet, as that requires a different level of sophistication from the providers of the capital.. But it absolutely doesn't mean it won't happen.
Life insurance companies and institutional investors are buying mortgage backed securities today, issued in loan securitisations. The investment cycle for that marketplace has to go through lots and lots of middlemen and so it's not too farfetched to imagine them going straight to the originators and cutting out a lot of middlemen. I think that will happen, and we might have played a part in making it happen, but it's a more complicated business. Also unsecured lending is all done on a loan contract. Our contract doesn't involve taking security and conveyancing, and having to perform legal searches and due diligence. None of that is unsolvable, but it is more difficult. That's another reason why mortgages are more difficult.
Currencies are difficult because genuinely matching two people peer-to-peer who need money at the same time is tough. The trade has to happen in real time, whereas lending uses money that is much more fungible. Exchanging my dollars to euros is not so easy, I need to send out euros for them. My dollars are not the same as someone else's in that sense, because some other person with dollars might want pounds for them. It’s just not a fungible item in the same way. A currency transaction has to be matched likean immaculate conception that occurs exactly at the same time, whereas our matching of lenders doesn't have to be an immaculate conception because the transactions can be separated.
Insurance is ripe for disruption, because I think the insurance industry is even more antediluvian than the banking industry. Their technology problems are as great as banks, if not greater, and therefore the opportunity for a new startup to do one bit of insurance and understand the risk of that insurance well is definitely a market ripe for change.
Maybe consumers also don't feel the same need, maybe consumers don't feel as ripped off by insurance companies, as the transactions lack transparency. The rate the bank will lend money to you over four years is pretty transparent but the rates for insurances are not.
The lack of a peer-to-peer insurer may be due to trust, as you’re buying a promise to cover my risk if an incident occurs and maybe the consumer wouldn’t trust an untested name and business model.
Maybe. There is trust involved in loans and savings, but it’s clearer as you’re getting a rate and can see the term. You're right in the insurance world, it’s different. I'm buying a promise, not a product and maybe that’s harder to trust.
Final question. Goldman Sachs came out with a report saying 7% of bank profits will move to peer-to-peer lenders and crowd funders over the next five years. Their response is that they've launched a peer-to-peer lender. If you’re doubling market share each year, won’t all banks do this?
Goldman Sachs has launched a direct lender, and it's not peer-to-peer at all. I mean it's a bank. It's just them saying they can effectively be a lender but they can take some lessons from these peer-to-peer or marketplace lenders. We take the capital and deploy it directly, but what they're doing is no different from any other bank. Why are they going to lend money any better than we can? I'm not sure they can. And the regulatory requirements are also no different to any other bank, because they are lending depositors’ money.
But the core question is, at some point, banks will want to squeeze you out or buy you out.
They might or they may just have to give up a bit of their business. They’re more likely to just go out and hire McKinsey though. I suspect the CFO of the bank will just order some very smart consultants to unpick the earnings from its personal lending operations. Do you think any bank has actually made money from consumer lending in the last thirty years? I don’t think so. Even before that £30 billion cost of the PPI payouts. Even ignoring the PPI bill, they tend to lose money through credit losses in bad times of the cycle, and then they tend to out-compete each other furiously at good times in the cycle. I'm not sure -that consumer lending is a bit of banking that they do that well.
Now how many bits of banking they can afford to give up on? This is a different question. In any conversation with bank board members, they all would fight to keep the main current account as they see that as a gateway product. They believe they can then make money by selling lots of other products through that account. Let's let them to continue to think that way.”
About Giles Andrews
Giles spent the first ten years of his career in the motor industry pursuing his interest in all things automotive. This included co-founding Caverdale in 1992, a start-up taken to a £250m turnover motor retailer and sold in 1997. After an MBA at INSEAD he set up his own consultancy business whose clients included Tesco and Tesco Personal Finance.
Giles co-founded Zopa, a social lending website which connects people who want to borrow money with people who want to lend it, in 2004. He led 4 fundraisings as CFO, raising a total of $33m from European and US investors. UK Managing Director since July 2007 and CEO since January 2009, Giles has led the company through a period of dramatic growth that has seen it established as a real threat to the banks.
Zopa is the UK's leading peer-to-peer lending service and can claim to be the first peer-to-peer lender. Since being founded in 2005 by chief executive Giles Andrews, with members of the management team of former internet bank Egg, Zopa has helped lend more than £1 billion in peer-to-peer loans. Over 51,000 people are lending between £10 and £1 million to credit worthy borrowers. The company has been voted 'Most Trusted Personal Loan Provider' in the Moneywise Customer Awards for the past six years in a row.
Chris M Skinner
Chris Skinner is best known as an independent commentator on the financial markets through his blog, TheFinanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal's Financial News. To learn more click here...