May 11, 2016
The last week has signified an interesting turn in the relatively young history of the alternative lending industry. In particular, online lending took a hit and perpetuated a wave of skepticism around it.
The event to contribute to it is related to one of the largest alternative lenders – Lending Club – whose shares plummeted significantly in less than a week. In the period between May 6 and 10, Lending Club’s share prices went from $7.09 to $4.10 with the lowest point at $3.98 per share.
Overall, Lending Club’s share prices were reported to drop by 35%. Investigations around the quality of loans didn’t particularly help the situation.
Although Lending Club has been making headlines with the latest news on the resignation of its CEO and the fall of its share price, it is not the only company to feel the hit of the market. Another large lender (that, for your information, goes hand in hand with JPMorgan), OnDeck, has been hit as well, raising concerns about the industry as a whole.
To continue the line of good news for Lending Club, on May 9, Renaud Laplanche, Founder and CEO of Lending Club, resigned (forcefully, as some sources indicate) due to investigations initiated by the company’s shareholders via the law firm of Kessler Topaz Meltzer & Check.
As the NYT explained, Lending Club sold an investor $22 million in loans whose characteristics violated the investor’s express instructions. The story took an ugly turn when the board found some members of the Lending Club family to be aware of the fact that loans didn’t meet the criteria.
Moreover, it appeared that the application dates on $3 million of those loans had been altered to make them comply.
Another detail that caused mistrust in the company was the role of the founder and other executives in failure to fully disclose a personal interest held in an outside fund while the company was considering an investment in the same fund.
The dark details with Lending Club and the reasons why the Founder/CEO resigned keep piling up and are well scattered across sources. But the main issue doesn’t appear to be limited to just one single company. The bigger picture contains a potentially significantly flawed business model and growing skepticism of institutional investors and industry professionals around it.
If a decade ago there used to be a gap between traditional financial institutions and a large pool of underserved and potentially risky borrowers, alternative lending became a blanket to cover that gap. Lending Club is a thread in that blanket that got ripped and revealed either the questionable quality of the blanket, or inadequate force of the founders in attempts to give it a big stretch to fit the large gap.
However, Lending Club is not the only thread and can’t be considered a single case because of a range of reasons. And the first one is related to the scale and the ability of a number of alternative lenders to gain substantial market power.
Being tech and software-focused, alternative lenders are free from the necessity to maintain large branch chains. They also got to enjoy the liberty from the strict regulatory environment that traditional players had to comply with. All that contributed to their ability to grow rapidly and gain traction in the market at a relatively low cost.
Lending Club is among the largest online lenders. More than $18 billion were lent through Lending Club since its inception with $2.8 billion being lent in Q1 2016.
The quality of loans always meant a great deal to institutional investors. Given that customer credit default rate has been declining over the past three years (less than 1%), alternative lenders with their average default rate 6–7% is quite a big concern and potentially a significant loss for investors.
Despite potential hazards, online lending in any variation (let it be P2P lending, SME financing, etc.) has been quite successful. In addition to the fact that it offers quick and painless loans, one of the reasons and consequences of its outstanding growth is the fact that it is fueled by banks themselves.
In fact, in the US, around 80–90% of the capital lent through the two largest P2P lenders – Prosper and Lending Club – is institutional money. It means when a lender originates a loan on a platform (even P2P platform), it is most likely secured by an institutional player (think JP Morgan & OnDeck, Bank of America & Viewpost). The fall of one of the largest lenders in combination with high default rates of the industry itself would breach a big hole in institutional pockets and question the whole business model.
If previously financial institutions have been willingly parting with money to fund the loans so quickly and easily originated by online lenders, Lending Club’s case has fueled questions on sustainability and viability of the model.
Another example that questions the trustworthiness of crowdfunding is PayPal. On Monday, PayPal revealed an update in its user agreement. With new terms being effective from June 25, the company will no longer protect payments made on crowdfunding platforms. In a nutshell, if you financially supported a failed crowdfunding campaign, PayPal won’t be returning you any money.
Not only would it make backers think twice before funding a project, but the company’s comment on the action has been quite interesting and insightful. As PayPal commented, In Australia, Brazil, Canada, Japan, United States and certain other countries, we have excluded payments made to crowdfunding campaigns from our buyer protection programs. This is consistent with the risks and uncertainties involved in contributing to crowdfunding campaigns, which do not guarantee a return on the investment made in these types of campaigns. We work with our crowdfunding platform partners to encourage fundraisers to communicate the risks involved in investing in their campaign to donors.
Some professionals may see the situation with Lending Club as an attempt to silently get rid of the bad part of the portfolio. But as Caton Hanson, Co-founder of Nav, said, …the focus is more on, Are these unicorns really worth what they say they are? It’s not, ‘Oh, my gosh, we knew this model wouldn’t work, let’s get rid of this technological disruption to the solid, respectable institutions who’ve already claimed this space for themselves.’ The story wasn’t about that—it was a human nature story.
Alternative lending in not the only industry with accumulating questions. In February, Parker Conrad, the CEO of Zenefits, resigned after being questioned about the actions he had taken to fuel the company’s hypergrowth, including flouting laws about who is allowed to sell insurance.
Acknowledging the situation with Zenefits, Mr. Hanson expressed an interesting thought, summarizing the general concern with the whole Lending Club and alternative lending situation:
…we all know that technology is moving at this incredible pace, and it’s changing the ways we deal with finance, insurance, etc. Especially when it comes to ordinary people—in many ways, they’re the biggest beneficiaries of all this pioneering and innovating. So as technology changes, we get more and more flexible and people start coming up with brilliant alternatives to institutions that have enjoyed monopolies until now. But the one thing that doesn’t change is human nature—the one thing you can predict about alternative lending is that people are going to get greedy and hide stuff and eventually get outed and shamed. But to use that as a stick to beat the technology or the model with—that’s just hasty, and maybe a little disingenuous, too.