The ecosystem that is being built today around marketplace lending is becoming more important as the industry matures. Today, more than ever before, investors are demanding independent analysis of the risks they are taking.
Our next guest on the Lend Academy Podcast is James Wu, the CEO and co-founder of MonJa. MonJa is a relatively new member of the marketplace lending ecosystem. They stand between the investor and the platforms, providing investors with analysis and monitoring to help them become more comfortable.
In this podcast you will learn:
- How James’ time at Morgan Stanley Capital International (MSCI) during the financial crisis gave him the idea for MonJa.
- The two questions all investors need to ask themselves.
- The services MonJa provides for investors.
- The kinds of investors currently working with MonJa.
- How James is working with platforms to enable more transparency for investors.
- How they help investors see whether their portfolio is performing as expected.
- How the MonJa benchmarking works across platforms.
- What James saw in some of the 2015 loan vintages that was different.
- The different indexes MonJa has created and how they work.
- What James is hearing from investors today in the context of the Lending Club issues.
- How delinquencies are tracking today compared to 2015.
- Why James is bullish on credit performance going forward.
- What was missing from the industry pre-2016 and why it is changing now.
- What the MonJa team is working on now and in the near future.
Download a PDF of the transcription of Podcast 68: James Wu of MonJa.
[expand title=”Click to Read Podcast Transcription (Full Text Version) Below”]
Podcast Transcription Session 68 : JAMES WU
Welcome to the Lend Academy Podcast, Episode No. 68. This is your host, Peter Renton, Founder of Lend Academy.
(music)
Peter Renton: Today on the show, I am delighted to welcome James Wu. He is the CEO and Founder of MonJa. Now MonJa is one of these new breed of companies that have become an integral part of the ecosystem where they’re really providing investors with valuable services to help them get comfortable with this asset class, help them monitor their portfolio, help them with risk management and really get them comfortable that the decisions they’re making are the right decisions. And so we talk a lot about MonJa and what they’re doing and how they’re really helping to bring more transparency and bring more independent third party analysis to the industry. We talk about the Lending Club issues and the pull back with investors. We also talk about delinquencies and what trends James has been seeing there and also what he thinks the future holds. Hope you enjoy the show!
Welcome to the podcast, James.
James Wu: Hi, Peter, thanks for having me.
Peter: My pleasure so let’s just get started by giving the listeners a bit of background about yourself, about what you did before you started MonJa.
James: Sure, before MonJa I worked at a company called Morgan Stanley Capital International. So I worked really…primarily focused on software products for quantitative portfolio management and risk management. So I guess a big part of my career there was…or I guess a lot of people’s career was the 2008 global financial crisis. Yeah, that was around the time when I remember helping a couple of large institutional investors really make sense of their portfolio and the biggest problem back then was I guess coming down to the realization that they don’t have a good way to manage their asset allocation in a quantitative way. We’re not talking about small investors; these are sovereign wealth funds, public pensions, asset managers and so on.
So definitely saw similar analogies in the marketplace lending space though. I guess we’re looking at…so I personally was looking at the space back in…I want to say 2014 and man, it was kind of interesting because I remember first seeing the peer to peer lending space back in 2006/2007 and back then it was simply two platforms to pick from, Lending Club and Prosper, right? I’m sure you remember those days. So we looked at the space in 2014 and there were a lot of different platforms and the growth of many smaller platforms just coming up every day and I started talking to institutional investors. So really a big problem that I saw everyone had was trying to make sense of new platforms that come up and try to manage the complexity.
Peter: So you were talking with institutional investors while you were still at MSCI and you were…so I’m just trying to get the…was this something that…obviously you discovered it and you were thinking about it in your spare time, but it sounds like you were getting some feedback before you even started MonJa, right?
James: Yeah, well for the lawyers listening (Peter laughs), I actually didn’t start the idea since after MSCI.
Peter: Of course.
James: I found a lot of the problems were very similar so when I was looking at the portfolio right after the global financial crisis there was a sense that people didn’t really know what’s in their portfolio because of the growing complexity. So I guess in a way you kind of see a similar dynamic for marketplace lending, not that people didn’t know what they own, but now that you’re going beyond just two platforms, now you have dozens and dozens of platforms and now it’s not just consumer lending but small business lending, asset-backed lending, student loans and so on. It’s just a lot more complexity and it requires really infrastructure and analytics to organize everything.
Peter: Okay, so then let’s just go back then to the start of MonJa. You touched on it, but could you just maybe tease it out a little bit more about what problem you’re trying to solve with MonJa, what your company actually does?
James: Yeah sure, so I guess this was by then late 2014. I was able to recruit two of my co- founders, Matt Kelso and Jesse Velez so we got together and I guess we were really trying to answer some very simple questions for investors. I guess really two questions. One is what have I invested and how’s it working out for me and another one is if you’re looking ahead, what should I really be investing. Sounds deceptively simple, but these are questions that obviously drive to the core of the investment process.
Peter: So you’re talking about what you should invest in as far as within a platform, I mean, what do you mean? That’s a fairly broad statement so what you should invest in as far as the asset class versus other asset classes or within a particular platform, just tease it out a little bit more.
James: Sure, for an institutional investor the problem…it kind of organizes itself in this way so one, yes obviously should you invest in marketplace lending versus another asset class versus other asset classes, what’s the relative return, expected losses and so on. And then once you look in this asset class and decide you want to invest, what platforms should you be investing, what asset types should you be investing and what’s the relative returns and the relative risk between the different pockets and, of course, once you get really deep into it, it comes down to what risk level should you be investing, specifically which loans, should you be actively selecting loans and so on. So it’s a hierarchy of different questions that the investor needs to run through from top to bottom really understanding what are the opportunities for investments and what should you really invest.
Peter: Okay, so I see on your website here you’ve got four different solutions; performance attribution, loan scoring, portfolio monitoring, risk management, but these are all solutions I’m guessing specifically for institutional investors. Is that your core constituency?
James: That’s exactly right, Peter.
Peter: What kind of investors are you working with today?
James: When we first started working out, we primarily worked with hedge funds and asset managers. Really those who are directly purchasing whole loans and most of the time need to select loans or select platforms. We’ve expanded quite a bit so now we also work with banks, broker dealers and so on, people who have exposures to these loans on their balance sheet, whether it’s direct purchasing or in deals that they are…loans that they are purchasing for securitizations. So help them with things like behavioral modeling, for pre-payment risk, for delinquencies and losses and so on. Then also I guess branching into middle market lending for people who provide credit facilities, debt facilities for balance sheet lenders, again coming back to our core competency of being able to apply predictive analytics on loans.
Peter: Okay, okay, so then one thing…I think it was one of your blog posts you talked about bringing more transparency to peer to peer lending so I can see how a lot of the things you’re doing there really is helping the investor, but how are you bringing more transparency?
James: Look, a lot of people have been talking about transparency for a while and I think platforms are generally getting better, getting pretty good at it by providing data. I think there are also other vendors out there, a lot of people talk about standardizing data and I think that’s obviously a good first step, but for us it’s about peeling the onion and pulling the data into the right models and right analytics to help the investment process that I mentioned earlier. I can give you one example.
Peter: Sure.
James: I remember one time we were walking investors through a dashboard and this was a passive forward flow portfolio. They were supposed to be getting a fair slice of a platform’s origination and then we dug into the portfolio and the “aha” moment was we started seeing the portfolio having a 50 basis point, 100 basis point lower expected return compared to the platform average and then you look at it deeper. It comes down to…DTI is just a little higher, the average income is just a little bit lower. Sometimes it’s not a huge amount of discrepancy, but being able to have the right framework and the right model to look at the data, it goes a long way.
Peter: Okay, so then I’m just curious…brings up an interesting point, do you work with both investors who are doing a passive allocation just like you mentioned and those that are also sort of running their own models and doing their own cherry picking, shall we say, do you work with both kinds of investors?
James: We do and the distinction is less than what you think. Nowadays a lot of the passive investors would have a credit box around what they want to buy, things they want to include. At the end of the day, even if you’re passive you still want to be vigilant in understanding what’s going into your portfolio.
Peter: Sure.
James: Yeah, obviously from a selection perspective there is a difference between actively “cherry picking,” I hate that term but… (Peter laughs). The difference between that and really doing the selection on a criteria basis, it just comes down to the mechanism of connection, but yeah, both are getting the same types of benefits from working with us.
Peter: Right, you say cherry picking…I mean, even if a person or an institution is a passive investor they have a credit box, they are doing some sort of selection shall we say, even if it’s just saying we don’t want any F or G loans or even saying we don’t want certain DTIs. I mean, I presume most people are not just buying the index, right? Buying every single loan, most investors at least have some kind of selection criteria, right?
James: Yes, Peter that’s exactly right and for us it’s obviously about helping investors craft that criteria, but back to earlier, you asked about the solutions…one of the things we help people look at in their portfolio is performance attribution. So it goes something like this, say a manager is investing in Lending Club in the D and E category. We can look at the portfolio and say, hey you can invest in a segment that has a higher ability to pay compared to the benchmark and this adds somewhere between 25 to 35 basis points to your portfolio return. So that ability to quantify, almost like playing x-ray on the portfolio that really helps tying it back to the investment process and the results.
Peter: So obviously to do this you have had to create your own benchmark right? I presume you’ve taken the history of whatever platform it is and created your own benchmark. I presume it’s a flexible benchmark so if you say I’m doing D and E grade loans with a DTI of less than 25% you can create a benchmark just based on that and then compare their selections to that benchmark. Is that what you’re talking about or you’re talking about just the overall platform benchmark?
James: Yes, Peter that’s exactly right. As you probably know, for many years I worked for a large benchmark provider so…benchmark by itself and isolation is not that meaningful, we don’t think it stands alone, but for us creating the right benchmark it comes down to having the ability to slice and dice against it and to do meaningful comparison like what you just talked about.
Peter: Right, because it’s not just one benchmark because one benchmark is kind of irrelevant unless you’re buying the index or buying across all kinds of loans. If you had a bank who is saying I’m only going to buy A grade loans, that’s it. They are going to want to benchmark just on the A grade loans so it sounds like what your technology does is create a benchmark based on the entire loan history from which they can then compare what they’re doing with that history.
James: Yes and that fit on the benchmark is extremely important because that bank that you’re talking about…it’s not fair to compare their return versus a higher risk portfolio, you know a portfolio that has D and E loans in it simply because this is a manager that’s taking a much lower risk and has a safer portfolio.
Peter: Okay, so then are you taking into account…like are you just really basing everything on past performance, I mean, are you taking into account macro environment…obviously, we’ve seen like four interest hikes in Lending Club, multiple at Prosper in recent months and obviously that changes the dynamics of the return because not every loan grade is increased evenly and other platforms have had different changes as well. So just explain how…like backward looking, are you taking in multiple variables, how does it work?
James: We definitely take multiple variables into account and we do it in a way that’s cross platform and that really gets you away from the fallacy of looking simply at past performance. If you simply look at the past performance of a platform then you don’t really catch the risk factor in which they are, shall we say deviating away from their underwriting criteria in the past. In fact, that was what we saw in somewhat the 2015 vintages where platforms, because they are under pressure to underwrite more, they’re under pressure to originate more volume, in a way loosen some of their underwriting criteria. If you’re simply looking at the platform performance, you can’t see that, but by looking across many, many different underwriting level of variables you can see those trends and translate to what the expected returns are.
Peter: Right, so related to this benchmarking I’m curious about the indexes that you have and maybe readers might not realize sort of the work you’re doing here and it looks like you’ve got some information that’s publicly available on your website, you’ve got consumer lending index obviously focused on the marketplace lending industry, you’ve got consumer lending, you’ve got small business, just tell us a little bit about the indexes and what goes into that.
James: The indexes on the construction, we take the larger platforms in each of the segments so whether it’s consumer or small business and reconstruct the return time series for the index. So, effectively this is a set of returns that you would get if you passively replicate the portfolio in a way that’s similar to the index. Now, Peter I guess related to your earlier comment, nobody really completely replicates this index so this is a starting point, generally speaking for investors that we help with benchmarking. We create a set of custom indices/indexes that measure specifically the criteria that they are investing in.
Peter: Right, right, okay. So I want to move on a little bit and just talk about Lending Club. Obviously, I’m sure you’ve got many investors who are clients of yours that are investing on Lending Club. What have you, just looking at the data, give me your take on…we’re recording this in mid-June just to give people some context here, what are you seeing with Lending Club these days?
James: Obviously, the news at Lending Club was a big shock to everybody and really highlights the importance of transparency being a big issue. So stating the obvious, Lending Club has their work cut out for them, they really need to find ways to restore the confidence of investors. So I guess from our end we saw investors pull back immediately after the announcement, after the news broke yet at the same time, we’re seeing some signs that investors are returning to their platform.
But, obviously, there’s still obvious risk factors ahead and there is the risk that they’re not going to sustain the volume that’s in line with their cost structure so there’s got to be…there’s probably something they need to do there. They do have the liquidity cushion on their side and that’s a good thing if Lending Club were to either change their business model, in a sense maybe buy more on balance sheet or any other accommodations. That’s obviously a good thing having that cushion, but obviously still challenges ahead.
Peter: Right, so what about other platforms? You’ve obviously got Prosper, there’s many others in the consumer space that institutional investors are participating in, are you seeing this ripple across or do you feel…obviously, Lending Club has had the biggest impact from what I’ve heard and from what others have said, but are you seeing this ripple effect? We’re well over a month removed from the news, people have had some time to digest it, where are you seeing things land today?
James: I think for investors that understand the asset class fairly well, I guess I’m pleasantly surprised that many of them are pretty understanding about the potential challenges, but those are about understanding this is not the end of the world. In context, this is obviously a problem on Lending Club, but the larger case, the bull case for the business plan, for the business model has not gone away. So I think certainly for investors who see the fundamentals there’s definitely still a big amount of confidence, but for investors that were evaluating the asset class, this is probably…I think it pushes back some deals as some of the investment capital that were going to come into the space, it definitely delays things.
Peter: Right, so then I’m just curious…what in your view does Lending Club need to do and what can third party providers like you guys do to help get investors more comfortable so that they…particularly first time investors who are now…a lot of them are delaying, so what should they do and what can you guys do to help?
James: So one of the things we’re seeing recently, and it’s not just…it started to happen prior to the Lending Club news is there seems to be a growing divergence of platform performance. So some platforms still are able to underwrite well and have good results in terms of expected returns for investors and we get involved in due diligence pretty regularly and we do see some platforms do well, but there are some other platforms that sometimes the return is just not up to par. So for us being an independent evaluator of the space for platforms, we think we help investors separate the good from the bad. Warren Buffet, he once had a quote saying…”Only when the tide goes out, you discover who is swimming butt naked.”
Peter: (laughs) Right.
James. This definitely applies to platforms. I think the stronger platforms are going to continue being stronger despite some of the short term headlines and potential setbacks, but longer term, the good fundamentals in the business and the good performance will prevail and will help that process.
Peter: Right, so I want to go back to something you said earlier and that is around delinquencies. You said like there were some issues in 2015 and we’ve obviously had several interest rate hikes at the platforms since then. So I guess what are you seeing today from the first quarter, anything in the second quarter which is obviously not even finished yet, but what are you seeing as far as how delinquencies tracking? Have the platforms kind of moved beyond the challenges that they had in 2015?
James: I guess I’ll answer that in two parts.
In terms of current performance, the portfolio level of delinquencies it’s not really coming down just yet and a big part of that is it needs to still work through some of recent originations, I guess starting in Q4 2014 and even Q1/Q2 2015. There were some pockets of…I guess Lending Club calls them pockets of weakness and I think that’s the right term. It’s not across the board, but there are certainly some segments that weren’t underwritten as well as we think they should have been.
Peter: Before you go on, isn’t there always going to be pockets of weakness because you’re not going to have a perfect underwriting model. Are you saying that there’s pockets of weakness that is more than what they should be or more than average shall we say?
James: Yeah, pockets of weakness and that’s Lending Club’s term and for us what we’re seeing is some segments that you think should have been more static, it seems like there were proportionately more weaker borrowers coming in for some of those vintages, I mean obviously not without reasons right? Again, thinking back for a while a big challenge was there being too much capital coming in and hot money coming into the space and needing to buy loans and I think that probably had some pressure on the platforms to originate more and probably cause some of the weaker underwriting.
I guess the irony of it is looking at the origination in Q2, I mean obviously it’s still early, but just the underwriting criteria and the expected returns…I guess that also includes the rates, the lending rates, the coupons. When you combine everything together, these new originations are looking better than they have been in quite a few quarters so we’re actually fairly bullish about the new originations because the criteria is now better and I would like to think people have learned their lessons and it’s borne out by the numbers and some of the quantitative measures.
Peter: Yeah, well it will be interesting to see because, you know right now you saw…there was news a week or two ago that Prosper is not buying on CreditKarma or LendingTree and I’m sure that their direct mail is down. These platforms, some of them, we don’t know exactly how far Lending Club is down, we won’t find that out for a while, but assuming they’re down 50% shall we say which I don’t think is unreasonable, it’s probably more than that, but assuming they’re down 50% I imagine when you’re doing your marketing spend you can tighten your criteria and maybe that’s what they’ve done. If they are increasing the interest rates, borrowers are paying more, borrowers don’t really like paying that much more, but you can tighten your criteria much more readily when you have smaller loan volumes. So I guess my questions is, is that what you’re seeing in the second quarter or is there something else in play?
James: We definitely see a tightening of criteria so we had a blog post recently about this tightening of criteria that Lending Club announced, kind of was a footnote in their quarterly earnings release. Obviously, nobody read that far into the quarterly earnings release beyond the unfortunate headlines, but it was telling and specifically they were eliminating some of their worser performing segments and we definitely saw that in the data in terms of borrowers they eliminated from their criteria and also keeping in mind then, they’re not doing this in isolation. I think the fact that different lenders, different originators…many of them were under the similar competitive pressure before, everyone kind of had to loosen their criteria…not had to but there was more pressure. Now that there are fewer loans being given out, that’s healthier from the perspective of being able to have a tighter underwriting criteria and ultimately better for investors.
Peter: Yeah, no I think…it’s going to be interesting to see once the investor demand comes back because I expect it will and I imagine you do as well, but when the investor demand comes back how are the platforms going to deal with this? Are we going to see it go back to the same way? I’m hopeful that we’ve all learned our lesson, you know, it will be interesting to see. I mean, what are your thoughts on that, if and when we get back to this sort of rapid growth? I think the days of like 100% growth annually for the larger platforms I’m guessing is pretty much over. Even growing at 40% or 50% a year is still…that’s a lot of new borrowers coming on board. What are your thoughts on that?
James: I think a large part of what was missing before was investor diligence and similarly, I don’t mean to say all investors. What I didn’t mean to say, not all investors were paying attention, but certainly when…I think sometime in 2015 when there was pressure to get the deals done and get them out the door there was certainly less diligence from the investor side. Now I think there will be more pressure for investors to look more closely. I think that creates the right incentives for both investors and ultimately the platforms because it’s investors that ultimately drive the disclosure and the behavior not the other way around.
Peter: Yes, that’s a very good point, very good point, James. So I’ve got to let you go, but before I do so give us some updates on MonJa, what you’re working on and what are some of the things we can expect from you guys in the future?
James: Sure, our plan is really just to stay focused and to stay focused on services that help investors add value and really back to what I said earlier, services that help with investment process, help select the right platforms and the right loans. So this means certainly risk management, pricing and different types of analytics including potentially secondary market.
Look we’re not building a secondary market, we don’t think that’s our strong suit, but we’re pretty excited that companies like Orchard are focusing on this.
Earlier in the year, we were involved in a couple of transactions where we helped evaluate the loans on the secondary market and I think longer term, this is one area that will grow quite a bit more if the asset class were to be mature and to attract more institutional capital so we’re excited about potential developments in this area. But I guess fundamentally, we’re really bullish about the asset class despite the headlines. The fundamentals, they haven’t been hurt and in some cases they’re better than before.
Peter: Yeah, I completely agree with you there James, I’m also obviously very bullish on this. On that note, I’ll have to let you go. I very much appreciate your time today, James.
James: Thanks for your time.
Peter: Okay, see you.
James: Thank you, see you.
Peter: In many ways, I think today is just a great time to be investing on these platforms, particularly with Lending Club and Prosper because they’ve increased their interest rates, they have tightened up their underwriting a little bit and returns are going to be better most likely barring an unforeseen major recession or something. If we keep kicking along the way we have been, returns are probably going to be higher from loans issued for the rest of this year than they were for the last half of 2015. So, as I said, this bodes well for investors and I think it bodes well for the industry. We could certainly use some good news and use some positive momentum here. Hopefully, this will be the upside of all that.
Anyway, on that note, I will sign off. I very much appreciate your listening and I’ll catch you next time. Bye.[/expand]
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