By Ryan Weeks on Wednesday 30 September 2015
Lending Club boss talks Madden vs. Midland, the Treasury’s RFI, transparency and retail money
Marketplace lending, peer-to-peer lending and the like have been the darlings of the mainstream media over the past few years – billed by many as the disruptive panacea to bank opacity and to the more predatory variety of non-bank lender. But the tides of sentiment have begun to turn. A series of recent headlines in the US have sounded a note of doubt over the future of the still rapidly expanding marketplace lending space.
Jonathon Ford of the FT, for one, believes online lenders to be “stuck on a hamster wheel”, based on what he perceives to be age-old structural instability buried within the increasingly institutional makeup of the marketplace lending model. In August, Matt Scully of Bloomberg raised questions about the exportation model that is employed by LendingClub and Prosper, and about whether their existing loans may soon be deemed to be in violation of state interest rate caps. The US Treasury issued a formal Request for Information (RFI) in mid-July, the purpose of which was to seek public input on expanding access to credit through online marketplace lending.
Who better to decipher the significance of these goings on than the Founder and CEO of the world’s largest publicly listed marketplace lender, Renaud Laplanche?
Renaud has been at the helm of Lending Club since launching the platform back in 2007. The company has just submitted a formal response to the Treasury’s RFI, outlining the core benefits of marketplace lending to both investors and borrowers, as well as offering four recommendations for legislative and regulatory consideration. You can read the response in full via our Views section.
But the RFI is only one of a number of balls that are presently being juggled. Are the exportation model concerns justified? What is the purpose of the Small Business Borrowers’ Bill of Rights? What is the state of (and importance of) transparency on the investor half of the marketplace lending equation? And what of the questions about the role that retail investors play in the Lending Club marketplace? Over to Renaud…
For context, the concerns that have surfaced over the exportation model stem primarily from a court case that has become known as “Madden vs. Midland”. Marketplace lending in the US entails funneling investment into loans that have been originated by a bank, but underwritten and approved by a platform. Lending Club is partnered with the Utah based WebBank. The platform buys loans from WebBank for the price of the principal, plus a fee. The state of Utah does not impose caps on the interest rates that borrowers pay to lenders. That means (under the National Bank Act) that WebBank is exempt from interest rate caps in other states. At the moment, Lending Club is also exempt from such caps, owing to its affiliation with WebBank. But without entering into too much detail, the Madden case may end up meaning that non-bank lenders are required to comply with state-specific interest caps.
To clarify for our UK readers, Renaud flatly stated that there is no connection between the Treasury’s RFI and the Madden vs. Midland hubbub. The Treasury has reportedly been working on the call for information for over a year. Furthermore, Renaud asserted that the Madden case has “no immediate impact” on the Lending Club platform, as Lending Club’s investors do not rely on rate exportation; they rely instead on the designation of Utah Law as the law governing the loan agreement, since the loans are issued in Utah.
Some months ago, the Lending Club boss stated on an earnings call to investors that around 12.5% of the platform’s loans may exceed state interest caps, and would have to be repriced lower if these caps were to apply. Renaud provided me with more colour around that statement. The ruling that stemmed from the Madden case is currently applied in three states (New York, Vermont and Connecticut). Renaud tells us that the 12.5% estimate was a reflection of a “worst case scenario”, which would only materialise if the Madden ruling were to be applied nationwide AND if another separate thread of court cases decided that Lending Club’s choice of Utah law was not permissible. If both of these situations developed unfavourably, then roughly 12.5% of existing Lending Club loans would be in excess of state caps, meaning that the interest rates of these loans would have to be reduced. Renaud not only considers this state of affairs to be extremely unlikely to occur, he also believes that such conditions would take at least a couple of years to take hold. Nevertheless, the Lending Club boss thought it prudent to clarify what a worst case scenario might look like, given the number of questions that had been raised about the case.
Turning away from the Madden case, the first item on Lending Club’s list of RFI recommendations pertains to small business lending protections. Whilst Renaud wouldn’t share exactly what proportion of the Lending Club loan book is comprised of small business loans, he clarified that the proportion is fairly small at this stage, having launched the product last year. However, Renaud clearly believes small business lending to be important, largely due to the low availability of affordable SME credit in the US. On the proposed Bill of Rights, Renaud noted:
“Small businesses don’t benefit from the same legal protections as consumers. The Bill of Rights is an effort to put them on a level playing field with consumers, because there’s really not much difference in terms of sophistication between a small business owner and a consumer, especially for the smallest businesses that have just a handful of employees. We propose more transparency and more protections for small businesses.”
Another of Lending Club’s suggestions from the RFI response relates to mandatory disclosure requirements. Renaud is keen to ensure that Lending Club’s investors continue to benefit from a high level of transparency in terms of loan performance. He described the call for greater clarity as a response to the “skin in the game” critique that is so often leveled at marketplace and peer-to-peer lenders. That critique essentially boils down to the suggestion that a misalignment of incentives exits between lending platforms and private investors, primarily because the platforms generally charge an origination fee, but they do not invest in any of the loans that they originate.
Renaud clarified that Lending Club in fact holds a great deal of skin in the game. 20% of the company’s revenue comes from the servicing of its loans, and the company doesn’t receive that revenue for loans that fail to perform. But fees aside, Renaud pitched performance-related transparency as the best answer to questions about skin in the game. The key is to place the investors “in the driver’s seat”. Lending Club publishes its full loan book for what Renaud called the “standard programme” – which represents about 75% of the platform’s loans. These are the loans that are publicly available for investment. About 25% of the platform’s loans sit within “new programmes”, and these are not available to the public – and thus data on these loan pools is kept behind closed doors. A fair comparison is Zopa’s Uber loans, which have been siloed away from retail investors and kept in reserve for P2PGI (although the major difference here is that data for these loans is included in Zopa’s published loan book).
Transparency serves as an important means of safeguarding the interests of retail investors. And on that front, a number of recent developments would suggest that Lending Club might be looking to open up a greater proportion of the marketplace to retail money. The platform announced moves in June and August to deepen its integration with LendingRobot – which is an automated investment service for retail investors. Lending Club also unveiled the LendingClub Open Integration (LCOI) in August. LCOI allows online advisors and broker-dealers to quickly and efficiently showcase Lending Club investment products to their clients. At the time of these developments, we suggested that Lending Club might be shifting its focus back towards retail. According to Renaud, that’s always been a strong focus.
“We’ve continued to be very active in promoting retail investment,” said Laplanche. “We really like our retail investor base, which we believe is very diversified, has been very loyal to us, and is very sticky. They will be very dependable even in an economic downturn. So for all these reasons we’ve continued to provide tools for retail investors and for intermediaries and technology platforms that can help retail investors to improve their experience with the platform.”
Although Renaud acknowledges the dramatic increase in institutional activity that has taken hold of marketplace lending over the past couple of years, he noted that Lending Club has never stopped actively courting retail investors. The platform now boasts a base of over 100,000 active retail investors, and will continue to preserve a healthy slice of its loans for this community.
In summary, marketplace lending is alive and well in the US, and the RFI appears to represent a gilt-edged opportunity for the industry to win greater support from government. Lending Club’s voice will be heard as loudly as any by the ear of the Treasury. Intriguingly, Renaud confirmed that he is an admirer of the FCA’s approach to policy within the UK:
“I think the regulatory framework and the way government embraces marketplace lending in the UK is actually ahead of us in the US.”
Might we soon see a similarly supportive approach adopted in the US?