For Renaud Laplanche, founder and chief executive of Lending Club, things are looking up -- or more accurately, up and to the right.
That's the desirable direction that the startup's finances are heading at present. Lending Club connects investors who have money to lend with borrowers who need it, making money on fees as it goes. Of late, the value of the loans it's arranged has been increasing at 9 percent each month. In May, the San Francisco-based company funded $148 million in loans, and Laplanche expects 2013 will total $2 billion.
Laplanche, a 42-year-old born in Paris and raised in the south of France, plans to expand well beyond consumer loans, he said Thursday in an interview with CNET. First on the list will be loans geared for small businesses, and later, international loans.
With its low expenses -- it's got only 200 employees -- Lending Club can beat the banks' interest rates both for borrowers and lenders. More than three-quarters of its loans go to people dumping more expensive credit card debt for a three- to five-year loan through Lending Club, and investors typically spread small amounts of money over many loans to minimize the problems of defaults.
And the investors' interest rates -- an average 8 percent to 9 percent return after the company extracts its 1 percent off the top of every monthly loan payment -- are good enough that institutional investors like pension funds now supply a third of the cash for loans. Investors are eager enough that they now fund a loan on average within 16 hours of its arrival, typically before Lending Club has had a chance to even verify the borrower's reported income.
Laplanche is onto a good thing, but there will be challenges that could interrupt that smoothly ascending graph. Regulatory constraints can hinder expansion, and traditional financial services companies could get a piece of the action.
And then there are the growing number of rivals. Lending Club outpaced its predecessor, Prosper.com, but outside the U.S., rivals such as Auxmoney in Germany, Funding Circle in the U.K., and SocietyOne in Australia are sprouting up. And in the States, others are moving already into the same markets Lending Club wants to reach, such as SoMoLend for the small-business loans and CommonBond for student loans.
Lending Club is building a track record that newcomers lack. It's moved into profitability, eking out net income of $40,000 in the first quarter of 2013. And in May, it snared a $125 million investment from Google that valued Lending Club at $1.55 billion and provided a high-profile endorsement on its way to a planned initial public offering.
Laplanche is excited about his technology collaboration with Google, which will bear fruit within the next year, but he shudders at the idea of a tie-up with traditional bankers. Here's an edited transcript of his discussion with CNET News' Stephen Shankland.
CNET: In the market that began as peer-to-peer lending, you're the largest company out there. How big is the business, and what's your growth rate?
Laplanche: We originated about $720 million in loans in 2012, and we're on track to do about $2 billion this year. That's between two and three times larger than last year. We're really controlling the growth. We're not growing as fast as we could, but growing at a pace commensurate with good risk management.
What led you to found this company?
It's the experience as a potential user. It really struck me when I was on vacation and for the first time I took the time to pay attention to the credit card statement I received in the mail. If I were going to carry the balance to the next month, I would be paying an 18 percent interest rate on my credit card. I would earn 1 percent on the bank [savings account] and pay 18 percent the other away around for what seemed to be the same money.
I started thinking there could be a better way to get capital from the depositors to the people who need it, to the borrowers. I started digging into that spread between the 1 percent and the 18 percent. When you're an entrepreneur and you see a spread like this, you see an opportunity. It turns out my instinct was right. It goes into the operating costs of the bank. That's where we could generate efficiencies.
You weren't first to the market. How did you surpass Prosper.com?
Prosper.com started a couple years before we did. I think what happened is we had a more conservative approach. Our credit policy has always been tighter. We've always been focused on prime consumers and on offering responsible borrowers the ability to lower the cost of their credit, and offer investors better terms than they could get from their bank. Prosper took on more risk, went deeper into the credit spectrum. I think that really backfired in 2008.
Then we started growing faster. We very quickly became six times larger. A larger marketplace becomes more attractive just because it's larger. I don't think it's a winner-takes-all-market like with eBay. I think there can be several successful marketplaces. But there's a premium for the leader because we have more choices, more inventory, more lenders.
For the last few months, the value of loans you've arranged has grown at 9 percent each month. What's going to limit that growth?
We are asking ourselves the same question. We have really good visibility into the next couple years of growth. We are comfortable managing to the same growth rate in the next couple years. Most often when companies slow down it's because they hit some sort of market share limit or there's more competition. In our case it's hard to see any significant market share or saturation that would come into play. The consumer credit market in the U.S. is $2.4 trillion. When you include mortgages, it's $15 trillion. We don't play in mortgages and home-equity lines of credit, which we will do eventually.
Right now there are a lot of states where people can't invest in Lending Club loans. Are you working to change that?
You can be a borrower in 45 states. You can only be a lender on the retail platform in 26 states. It is certainly a limitation. We are working on it. We believe at some point we will be available in much greater number of states. It's a matter of getting proper regulatory approvals. It's annoying, but it's not a limiting factor.
The average loan is funded in 16 hours, and most are funded before Lending Club has had time to verify the borrower's income. You've recently dropped the new-lender referral promotion from $300 to $100. Is the balance out of whack? Do you have too many investors?
I don't know if we have too many. Having a strong investor appetite is a benefit to the borrower. They can get money faster. We will do income verification before issuing the loan.
But there are financial services companies with much bigger brands and much larger customer bases. What's to stop somebody like Citigroup or Bank of America from coming into your market?
Generally, the customer satisfaction rate in financial services is pretty low. Financial services companies are notorious for not generating a lot of positive word of mouth from their user base. We measure customer satisfaction frequently, and we come out as one of the most trusted brands. We really have a culture of being the good guys of the financial services industry and doing the right thing for our customers. That makes all the difference in the world
Can Citibank do the same thing? They need to change they way they look at their customers and service them. There's also a cost question. One reason we can offer lower interest rate than credit card companies is we operate at a lower cost. Our operating expense ratio is less than 2 percent compared to banks around between 5 to 7 percent. I don't know if Citibank could cut their expense ratio that dramatically considering a lot of these expenses come from a network of branch offices.
But they could create a subsidiary or even acquire you. We've seen airlines spin up low-cost divisions like United's Ted.
The airline analogy is a great one. Delta did the same with Song. Blockbuster moved online with Blockbuster.com. Barnes and Noble did the same thing with bn.com in the book business. Each time, the low-cost player wins -- Netflix and Amazon. Southwest continues to win against the low-cost carriers of the big airlines. Most of them have shut down. It's really hard to spin off a low-cost version from a high-cost operation.
You started as peer-to-peer lending, but that's changed. What fraction of your lenders are institutional investors?
About a third of of the capital on a monthly basis is provided by retail [individual] investors. Another third comes from individual investors, but generally high-net-worth investors with an investment fund. We have created a subsidiary called Lending Club Advisors that manages funds for those accredited investors. The remaining third is institutional capital like pension plans and insurance companies.
How are they changing Lending Club? Does it make it harder for individual investors to participate?
Initially it was 100 percent retail. The retail base is growing nicely -- 4 to 5 percent month over month. It's not growing as fast as the other segments. Institutional investors don't have priority or any preferred way of accessing the loans. Right now there are a lot of investors and things are faster. There are some retail investors as well as traditional investors who aren't used to that
You said last year you're planning on expanding into other areas such as home mortgages and student loans. When will that happen?
The expansion is going to be phased over several years. The next product we'll release, probably within the next months, is a small business lending product. There's a lot of unmet demand from small business owners. It's a really important segment of the U.S. economy, creating the most jobs, especially in the current environment. We feel we can bring more transparency, more user-friendliness, and lower costs to that market.
But you already lend to small businesses today. What'll be different?
We're only doing consumer loans. It limits the use case to very small businesses -- sole proprietors and businesses with just a handful of employees. The small business lending platform would allow...larger loans.
The limit now is $35,000.
Yes, that's the limit for personal loans. We haven't decided on the limit for small businesses, but it could probably go as high as $250,000. Not everybody will qualify for that, though.
You've got competition now. Are you worried others like CommonBond will get to new lending markets before you do?
Not really. Hundreds of billions of dollars are being lent through the mainstream banking system. There could be several successful marketplaces. We now have the operation and investor base to really do it at scale.
More than three-quarters of your loans go to refinancing credit card debt. Are you just contributing to the United States debt problem by shuffling debts around, letting consumers borrow more money but not actually get out of the hole?
Most of our consumers aren't refinancing balance because they're maxed out. They're refinancing to get a lower interest rate. We pull credit reports three and six months after funding a loan to see if the balance has come down. In 80 percent of the cases, borrowers show a lower balance three and six months later than the time they took the loan. We're instrumental in helping the American consumer deleverage and get out of debt faster.
You say you have an innovation advantage over incumbent players, but do you have a regulatory advantage, too?
I don't think so. The way the loans are getting funded, it ends up being a different regulatory framework. In our case we are selling an investment to an investor, so it's regulated by the SEC [Securities and Exchange Commission]. The investment isn't guaranteed. The investors can ask Lending Club for their money back and get it on the normal monetization schedule of the loan. There's no risk of a run on Lending Club like there is risk of a run on a bank. For that reason there is not FDIC [Federal Deposit Insurance Corporation]-imposed reserve requirements.
It's a less risky system than the banking system because at any point in time we have perfect matching between assets and liabilities. Every $100 from investors goes to $100 of loan, as opposed to banking system, where they collect $10 of deposits and issue a loan for $100.
Can you expand by leveraging your investors' money [lending out more money that's not in hand but that is expected from existing loans' anticipated payments]? Or is that something you refuse to do?
It's something we refuse to do for same reason we have a very strict credit policy and are conservative on the underwriting. If there's anything we should have learned as a society in 2008, it's that leverage works both ways. In the banking system, when you're leveraged 9:1, if the value of the portfolio goes down 10 percent, you're entirely wiped out. In a system like ours that's perfectly matched, 1:1, even if the port sustained a 10 percent loss, investors would still have 90 percent of their money.
It's import to keep that unleveraged aspect. If it were to be applied across the board basis, it would really derisk the financial system and make it more stable.
Maybe that's another reason for Citi to buy you.
I don't think that would be an optimum situation for anybody. I think Lending Club would be more useful to more people by staying an independent company than by being a subsidiary of a bank.
In mergers and acquisitions there are always issues. The large banks are always very large -- they have a hundred or a thousand times more employees than us. The culture of the bank -- there's a dominance culture. It would be really hard for Lending Club to be innovative, to release new product quickly, to operate at low cost in a nimble way, and to focus on customers independent of the cost of customer service.
As you get larger, what's to keep you from getting as sclerotic and customer-unfriendly as the traditional financial services industry -- milking customers and taking advantage of the size of your market?
It's a matter of culture and focus and being the good guys for consumers.
Google is a great example of continuing to do the right thing for customers. You can be a very large public company and continue to focus on customer satisfaction and creating products that are truly adding value.
Speaking of Google, you weren't looking for money, but you chose to go ahead with its investment of $125 million. Google has said it wants to collaborate with Lending Club. What exactly might that mean? What do you get out of it?
The idea of welcoming Google as a shareholder of company was partly because of the shared culture and shared values I just mentioned, but also because Google really has changed the advertising industry by empowering the customers and driving costs down through technology. It's really what we're trying to do with fin services. There are many ways we can collaborate with Google and leverage all that experience they acquired over the last 10 years. We are working on several product initiatives. It's too early to talk about them, but i'm hoping something will come out of it in the next year.
So you are actively collaborating on technology?
When is the IPO?
[Laughs.] You know i can't answer that. In terms of size and financial structure, I think we'll be ready to act as a public company sometime next year -- which doesn't mean we will go public then.
What will you do with the new capital?
I don't have a great response for that yet. Currently we're only cash-flow positive. We are continuing to make infrastructure developments and investments. We'll continue to do that.
We really don't need additional capital now. The reason would be more continuing to build the brand, to build awareness, to build credibility. As we build the brand, we're really getting the benefits of more trust and confidence especially from new investors and new borrowers. They're more willing to take a chance. Being a public company reinforces the credibility and the brand.
As you get larger and see better economies of scale, do you have some kind of promise to narrow the gap between the borrower and investor interest rates? Is that part of your "good guy" promise?
The operating expense ratio is coming down every quarter, so yes, I would expect over time as we scale we can continue to lower interest rates to borrowers.
Financial services is one of the most international business out there. What's your strategy for expanding beyond the United States?
We haven't really thought about it yet. It's important as we develop the brand to be global, but I don't think we're there yet. The size of the U.S. market is such that we won't be doing anything internationally for at least a couple years.