How well does industry disruption serve the consumer?
Financial technology companies, so-called “FINTECH,” have received a lot of venture capital funding in recent years. One area that has been of particular interest is that of peer-to-peer lending, whereby companies, such as Lending Club and Prosper, connect investors (lenders) with consumers (borrowers) to facilitate loans on-line. These companies function as financial intermediaries, as an alternative to banks, credit unions, and other financial services companies. Because they offered high returns, the companies grew quite large. Marketplace lending grew by 700% in the past four years. But both companies have faced significant recent challenges, including loan losses, that have dropped their volume and value, leading some to question the business model.
The model is a bit complicated, involving many entities, including a traditional bank and several intermediaries. Consumers apply on-line and are assigned a risk rating based on their credit scores, debt-to-income ratios, and other inputs. The borrower’s loan is put on-line through these platforms and made available for individual investors to select and they are paid a return, commensurate with the risk. In theory, this marketplace enables an individual borrower to connect with an individual lender. The practice, however, has drawn much more large-scale institutional capital, than small investors. The majority of these loans are personal, unsecured credit. Contrary to the name, peer-to-peer, there are a number of entities involved in each transaction, all of which take some form of fees that provide their revenue, so borrowing costs are actually fairly high in comparison to traditional loans. As with payday loans and subprime auto loans, marketplace lending tends to attract less creditworthy borrowers, who typically use traditional financial products.
Half of Lending Club’s stock value was erased last month when founder and CEO, Renauld Laplanche, was recently fired for falsifying loan data. In a consumer lending business, transparency and accountability are critical to maintaining confidence. Shareholders do not like news like this. Lending Club has also suffered from an influx of competition, including Prosper.
Prosper’s problems are not malfeasance, but a struggle to find investors to buy their loans. Their investor demand has dropped significantly in the past two quarters and they have been forced to lay off 28% of their employees.
While capital markets are strongly attracted to companies that are “industry disruptors,” particularly those with a technology platform, these companies’ troubles raise concerns about whether innovation really works all that well for the consumer or the shareholder. Default rates for these products have been fairly high, with industry losses of over $34 million last year. The reality is that it is expensive and time-consuming to assess borrower quality in the optimal way – using character-based lending and other tools besides just formulaic risk scoring models. Bringing borrowers and lenders (investors) together can work very well in an organization like On the Road Lending. Ironically, in peer-to-peer lending, the distance between the two gets fairly large.
Can we regulate our way out?
Ask most financially sophisticated people and they will tell you that payday lending is predatory and morally wrong. These products are designed to provide immediate cash to a person who has no other options, thus taking advantage of a desperate situation. Relief of an urgent need is the entire driver of the business model. Regrettably, nearly half of all Americans are likely purchasers of these products and services. The Atlantic Magazine ran a recent cover article called “The Shame of the Middle Class” that says that 47% of Americans could not access $400 if they needed it in case of emergency. This is a crisis for our country and we all, collectively, have a moral obligation to restructure our complex economy to incentivize greater financial security for our citizens.
If you talk with users of these non-traditional financial systems, however, you may get a different perspective. For many low-income people, use of payday lenders is an unfortunate reality and it is not uncommon to hear them say they don’t want the services to go away because they have nowhere else to turn. They often understand that these services are taking advantage of them and they may feel ashamed at having to use them, but there is no other option.
The Consumer Finance Protection Bureau is taking aim at this industry. Their proposed new rules would require a radical change in how payday lenders operate by requiring these companies to underwrite their borrowers in a more traditional way, effectively requiring them to evaluate whether this loan will benefit the borrower more than it will harm them. The industry says this new requirement will cripple it. Requiring them to pull credit reports and take the time to evaluate a loan in the manner that normal lenders do will greatly increase their costs, meaning that the cost of these loans – already in the triple and quadruple digits – will increase. As a character-based lender that works with weak credit clients, we do understand that evaluating a person’s creditworthiness, particularly when credit scores are not the basis for the loan (as in our case), takes a greater deal of time and expense than just handing someone cash and taking their bank account information. There is no question that the business model of payday lenders will radically change, which, of course, is the intent of the CFPB.
While some articles have posited otherwise, there is no question in our minds that predatory lending is highly profitable. Many mainstream companies publicly take moral objection to the practice, but in looking at stock offerings and annual reports, we have found many of them are investors in these companies. The returns are just too great. The Journal has run several articles recently on Google banning payday lending ads, while simultaneously being an investor in LendUp.
Efforts at the municipal level to regulate predatory lenders have typically been in the form of zoning control. The response by these lenders has been to change the terminology of their products and services so that they can avoid the classifications in the tighter zoning regulations. The industry finds a way to maneuver, no matter what is thrown at it. When half of all Americans are potential customers for a very lucrative business, the financial temptation is more than enough to overcome the moral objection.
It remains to be seen what the consequences of this new regulation will be. At On the Road Lending our approach has been to offer a lower-cost, socially conscious option for consumers. Not only do we provide consumer-beneficial car loans, we also ensure that our clients have an extended warranty on their vehicles so that they avoid the financial shocks that come from unexpected auto repair bills. This is often what drives consumers to payday loans. In addition, our clients have, on average, $150 more in cash because of their reduced expenses each month and many of them manage to save.
It has proven difficult to regulate our way out of predatory lending in our society. Our strategy is to crowd them out by offering a market-based alternative.
Not your average traffic stop
Last month, a Mountain View, California policeman noticed that traffic was piling up behind a little white car. The car was only going 24 miles per hour in a 35 mph zone, so he decided to pull it over and talk with the driver. There was just one problem. There wasn’t one.
Google has logged over a million miles on California roads since 2009 testing its driverless concept cars. Forecasters predict that these cars will be on the roads in most major cities within only three years and many companies are pursuing their own versions – Google, Apple, Tesla, and many mainstream manufacturers.
There have been a lot of questions raised about driverless cars, but the most compelling deal with how the technology interacts with a human world. If we have a split second to decide between hitting a person or animal in our path with swerving off the road and into a tree, how do we make that decision? How does a driverless car make that decision?
It will be interesting to see what happens with this idea. It would seem, given the proliferation of distracted driving – it seems now that almost every car you see is being driven by someone staring at their phone instead of the road – that driverless cars would reduce accidents. Will people embrace them? Do they offer a way for people to relax and read the paper on their way into work like people who ride mass transit do? Will they be affordable enough that an average person can afford one? Will they become widely used? Time will tell.
We more often read about the fact that driverless cars are programmed too perfectly, that they obey the traffic laws better than humans do. But what happens in the case of this traffic stop? If a car driven by a human would have been given a ticket for driving too slow, what happens with a car not driven by a human? Who gets the ticket?
An Unknown Story
Since Thanksgiving is tomorrow, we wanted to write about something other than mobility and finance. We wanted to write about history. There was a great editorial in today’s Wall Street Journal about the untold story of Squanto, the friendly Indian who helped the Pilgrims survive their early days in Plymouth. The remarkable story of Squanto’s life and his fortuitous meeting of the Pilgrims is not well-known and is a fascinating read. We won’t restate the story in this blog, but it inspired us and we hope you’ll take a minute to click on the link below to read the story as written in the Journal.
Today we give thanks for the many people who are on the On the Road Lending journey with us. We are grateful to the women, men and children who are our clients who openly share their stories with us and who work with us to further our mission. We are grateful to the investors in our impact investment fund and to the supporters of our nonprofit who have placed their trust in us to be good stewards of the funds they have shared. We are grateful to our boards of directors, our staff, and our volunteers who give their time to this endeavor. And we are grateful to you, people who are interested enough in our work to take the time to look at our Web site and read about our work.
As you travel to be with your family this holiday, we hope you will remember what a blessing it is to have a car to take you their homes (or take you to the airport to fly). Being able to get together with family and friends is an important outcome of the better life we try to provide by having better transportation.
We never know who will be put in our path, where our journey will take us, or how our own story will be written.
On the Road Lending's 3rd Annual Client Appreciation Party
On the Road Lending annually celebrates its clients’ success by hosting a Client Appreciation Party. This year marked our 3rd celebration, which was held on September 26th at Reverchon Park in Dallas. This year we put together a committee to plan the event made up of board members and clients. We thank Paula Stein (BOD), Shaylon Scott (client) and Rose Fleeks (client) for putting together a fun day.
This year we recognized several clients for exceptional efforts in the program – Evan Waldo, Alfie Wishart, Sharvonne Lynch, and Yasmin Flores. We also gave special awards to clients who inspired us – Jessica Wu (for paying off her car note in only six months), Tiffany Brown (for earning a promotion and raise at work), and Rose Fleeks (for making good decisions in the face of health issues). We also had a raffle drawing for a family portrait by our photographer, John Sutton, which was won by Torrie White.
Representatives of Wells Fargo were on hand to present OTRL with a check for $5,000 to go toward its financial education and mentorship programs. We were grateful for the gift and for the time that they spent with us. The day was beautiful with great food, terrific entertainment, and fun games.
It takes a bit of work to get a car loan through OTRL. It is as different from a subprime auto lender as can be. We take great care in selecting clients to participate in our unique program and try to ensure that the clients who join us are motivated to succeed. In the three years the program has been up and running, there has only been one default on a car loan. It is because of this amazing success that we expect to meet our short-term goal of working with 1,000 families within the next three years.
Thank you to all of our great clients for joining us on this journey. We celebrate your success!
Hackers Hit the Gas
Although a good “repo man” doesn’t usually need the help, tote-the-note-lot dealers routinely put GPS-locator devices on the cars they finance so that they can readily find the car if a borrower fails to make a payment on time. In the past year, there have been stories written about these dealers upping the ante by installing “starter interrupt devices” that can remotely lock the ignition system. As many as one-quarter of the subprime auto loans originated have these systems in place. Borrowers have reported of cars being shut down while they were driving. There are obvious safety issues here, but there are also privacy issues. The person who sold you your car knows exactly where you are, or at least where your car is at any given time.
A new twist on this is emerging that is a threat to mainstream borrowers, as well as those on the fringes, and it’s causing virtually all automobile manufacturers to take notice. Recently, two so called “white hat-hackers” – those without malicious intent – took control of a Jeep Cherokee and drove it off the highway, with no ability for the driver to do anything to avoid it. Unlike a 2010 incident when a couple of college kids were able to get into the Bluetooth system of a car that they were standing next to, this event was not nearby. The hackers were in Pittsburgh, while the car was in St. Louis. They were able to get through the car’s cellular connection to access its radio and from there were able to take over the car’s brakes, transmission and steering. Jeep has recently recalled over 1.5 million cars to install a patch to protect the electronics from outside hacks.
Cars are becoming increasingly computerized. KPMG did a study recently that said the average car runs more lines of code than a Boeing 787.
There are all kinds of implications from this. Clearly it isn’t safe for remote hackers to be able to take control of vehicles, especially in some other part of the country. The very real threat to public safety has led two lawmakers to sponsor legislation mandating that vehicle manufacturers take responsibility for addressing this. We are equally concerned about the intersection between safety and privacy. At On the Road Lending, many of our clients are women who have emerged from domestic violence. We’ve heard stories from our partner agencies about clients’ cars getting repossessed in the middle of the night at “safe houses,” where these women reside before getting into more stable housing, away from their abusers. If their cars can easily be found by their abusers, they will never be safe. This is an issue we will be following closely.
How Long is too Long for a Car Note?
A troubling trend was noted in Experian’s recent “State of the Automotive Finance Market” report – the average loan term for car loans is getting longer. Almost 30% of all of the loans for new cars in the past year were financed at terms of 73 to 84 months. This represented an 18% increase from a year ago and was the highest percentage on record since Experian began publicly tracking this data in 2006.
Why does this matter?
The longer the loan term, all else being equal, the lower the monthly payment. When a car is financed for a longer term, it usually means that the borrower is stretching to be able to afford the car and is pushing out the length of the note so that their payments will be smaller. But cars are depreciating assets, meaning they go down in value with each year. This loss in value can be exacerbated by other factors like putting too many miles on a car or not adequately maintaining it. The danger in long car notes is that the car’s value will drop before the owner finishes paying for it. This is negative equity – the owner owes more on the car than it is worth, commonly known as being “upside down” in their car.
At On the Road Lending, people come to us all the time in this very difficult situation. They have a car that is typically in poor condition and they still owe thousands of dollars on the note. Oftentimes, the car has broken down and only when they try to deal with what to do about it, do they discover they are underwater. Regrettably, many subprime lenders will finance this negative equity into a new loan for a borrower making an already bad situation even worse. We will not do this and we often find ourselves working with clients who face a difficult decision – do they give the car back to the dealer and watch their credit further deteriorate or do they try to make repairs on a worthless vehicle?
When thinking about predatory lending practices, we have to go beyond just considering interest rates. We have to consider other factors like loan-to-value ratios. It is not always easy for a consumer who lacks financial knowledge to evaluate whether they are paying a fair price for a car. Often they are in such desperate need of transportation that they are willing to agree to just about anything to get it.
Paying only what a car is worth and financing it for as short a term as possible is really critical.
We help our clients find the best car for their needs and we negotiate the purchase price on their behalf, with the goal that they will be able to do it alone on their next vehicle purchase. Our typical loan averages 60 months and we encourage our clients to pay additional principal each month so that it gets paid off quicker and they reduce the amount of interest they must pay overall. (One of our clients paid off her note in only 6 months by paying 5 times the payment amount and using her tax refund to pay off the car early).
There are some who believe that subprime auto lending has taken the place of subprime mortgages in the capital markets and that we are headed for another bursting bubble. When a significant percentage of borrowers are stretching to make a car payment, there is cause for concern.
It Might Surprise You
We all understand that we need to strengthen and protect our health. We know we need to eat well, exercise, get a good night’s rest, and avoid risky behaviors. By taking care of ourselves, we not only live a better life today, we are able to have a better life in the future. We also have financial health. Our financial health is measured by our ability to manage our day-to-day financial lives, to be resilient in the face of ups and downs, and to plan for our future.
Unfortunately, the American family’s financial health picture pretty closely mirrors that of our physical health – it isn’t very good. More than half of American families – 57% (about 138 million) – are struggling financially. They have a hard time paying their bills on time, experience cash flow challenges, and find it very difficult to plan for the future.
The Center for Financial Services Innovation (in partnership with American Express, the Ford Foundation and the MetLife Foundation) recently released a sweeping study called “Understanding and Improving Consumer Financial Health in America.” The study surveyed over 7,000 people on their financial attitudes, behaviors and preferences and, through their research they categorized the population into three groups – Financially Healthy, Financially Coping, and Financially Vulnerable.
One of the most significant findings, in my opinion, is that increasing incomes is not really the answer. Having more money doesn’t necessarily mean that a consumer is financially healthy. Behaviors are the key. Those who are able to plan ahead for large, irregular expenses are ten times as likely to be in the Financially Healthy segment compared to those who do not, and those who have a planned savings habit are four times as likely to be in a Financially Healthy segment compared with those who do not.
It seems like common sense, but I think this is very important for policy-makers to consider. No one disputes that we want lower-income people to make a better income, but, the best way to help people of any income level live better lives, is to give them the tools that encourage planning and savings.
We have definitely seen this at On the Road Lending. Some of our clients make pretty good incomes — $45,000 to $55,000 per year – but struggle to pay their bills on time. Others make less, but their car payment is never late. Our most successful clients are planning for the future. We have had several ask us recently for advice on how to buy a house. These clients are much better able to withstand periodic “shocks to the system,” because their resiliency is much greater, as is their likelihood of having a strong future. We really believe that our clients need to build financial health, which will contribute to their family’s overall wellbeing for the long haul.
The Impact of Dodd-Frank after Five Years
Economies operate in cycles. There are periods of growth, followed by periods of contraction, followed again by periods of more growth. Many US consumers do not pay close attention to financial cycles, but they certainly know it when there are major shocks in the economy. When the US financial system nearly collapsed several years ago, the impact was felt by pretty much everyone in some way or another. For many people, it meant job loss. For others, it meant lost retirement savings. One lingering effect is lack of access to capital – illiquidity in the system.
Regulators are typically reactionary. Governments respond to what happens in society and try to course-correct to prevent negative situations from recurring. But often these legislative mandates end up causing unintended consequences, frequently because they go too far – in trying to solve one problem, they often create others. When you have a headache, you take a couple of aspirin, not the whole bottle.
Dodd-Frank was a major piece of legislation that was adopted in response to the concern about financial institutions that were so interwoven in the economy that their failure could trigger failure in many others – the so-called “too big to fail” syndrome. The legislation imposed a massive amount of federal oversight for banks and other financial institutions that was intended to reduce risk-taking, largely because of the investment in subprime mortgages and other financial products. One byproduct of Dodd-Frank (which has happened in other cycles with prior legislation) is a tightening of lending underwriting. This was intended to discourage banks from making loans to risky borrowers. When these policy changes happen, the credit markets contract, making it difficult for everyone (even people with high levels of income) to get loans. This is why there is a need for an organization like On the Road Lending. For people with weak credit, accessing affordable loans is nearly impossible.
We have seen the impact of legislation like Dodd-Frank on our business. There are many banks in our region that would like to partner with us, but find it difficult to do so because of regulatory oversight. Ironically, it would be easier for them to partner with less charitably-oriented organizations than ours because those businesses are so profitable, they are considered less risky than us.
As we move further away from the impact of the Great Recession, lending standards will ease again and people will once more be able to access the credit markets. Banks are, after all, in the business of loaning money. We will likely see banks be better able to serve the people we serve (although there will always be a need for the tremendous services that OTRL provides, in addition to facilitating car loans) and we expect that the banks will have an easier time partnering with us. The pendulum will swing again in the other direction, but hopefully with less abandon than the last time.
We get asked quite often how car-sharing services like Uber and Lyft factor into our thinking about how to enable families to have access to better transportation. I’m always a little bit surprised by this. Uber and Lyft are really alternatives to taxi services and, unless you live in New York, you probably don’t use a taxi as your primary form of transportation. It’s expensive, but also hard to comprehend that this could work for your daily commute or going to the grocery store.
Fortune Magazine just ran a feature about an organization in LA called “HopSkipDrive,” that has apparently just received several million dollars in venture capital funding to expand to other cities. The company is billed as an “Uber-for-kids” concept for busy parents, that combines childcare and transportation services into one technology-provided platform. I have to say I’m skeptical.
One of the most difficult things for transportation-challenged parents is the impact to their children of not having a car. Getting kids to school on time, enabling them to participate in after-school activities, and enabling them to access their “social networks” of church, organizations, and family or friends, is infinitely harder to accomplish without reliable, personal transportation. We have heard from our On the Road Lending clients that having a car has made their lives richer and less complicated. Their kids’ lives are better too.
Parents understandably are reluctant to let their kids ride public transportation alone. How do you keep them from harm? I don’t see the “Uber-for-Kids” concept as being much different. Wouldn’t that kind of company be a magnet for pedophiles? It’s one thing for a parent to ask a friend to pick up their kids from soccer practice, but I have a hard time thinking that most parents would feel comfortable going to an app on their phone and hiring a total stranger pick up their kids. How do you reconcile “telling your child this is okay” with admonishments about “stranger danger?” As a business owner who is trying to address transportation needs for people, I’d be very worried about the liability of offering a service like this. I can see the horrible headlines now.
What are your thoughts?
Access to Food, Access to Transit
Most socially aware people have heard of “food deserts,” areas in a community that are not well served by grocery stores. Food deserts are of concern to social scientists and policy-makers because lack of access to healthy food choices means that people who live in those communities end up buying poor quality packaged foods at corner convenience stores, resulting in compromised health, especially obesity. These food choices also tend to be more expensive, so the negative influences are many and varied.
A less well-known concept is that of a “transit desert,” which are areas in a community that are not well served by public transportation options. The Center for Sustainable Development at the University of Texas’ School of Architecture just released a study called “Identifying Transit Deserts in Texas Cities, the Gap between Supply and Demand.” These researchers developed formulas for evaluating populated areas where there was likely to be a high need for transit (demographic and economic factors) and measured demand against available supply (bus/train stops) in five Texas cities – Dallas, Fort Worth, Houston, Austin and San Antonio. Because these transit systems and generally “hub and spoke” layouts, there tends to be a high concentration of transit in the center cities that gets more sporadic as it moves outward into the region. In Dallas they found several areas where there were transit gaps – transit deserts – most notably in north Dallas.
This research is not surprising. Even in cities as dense as New York, it is practically impossible to get mass transit to fully cover the geography. DART (Dallas Area Rapid Transit) is the largest mass transit system in North America with 12,000 bus stops, 61 light rail stations, 10 commuter rail stations, and 93 linear miles of rail, covering a geographic footprint of over 700 square miles across 13 cities. There is just no way for the system to “go everywhere,” so it is reasonable that there would be areas that would be underserved.
An interesting analysis would merge the transit desert and food desert ideas and consider alternatives that mitigate both — a person who has their own car is not impacted by either.