Transparency can cure US online lenders

Online lending in America has had a rough month.

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Three separate stories about three of the largest online lenders in the world had the same cause: investor demand for their loans has suddenly dried up.

Now these lenders face an urgent communications challenge – convincing investors that their business models are strong enough to withstand an economic slowdown. 

On the 2nd May small business lender OnDeck announced a grim set of results that showed a higher-than-expected net loss and a significant slowdown in growth. When OnDeck makes a loan it does so straight off its balance sheet.

Some loans remain on the balance sheet until maturity, others are sold off to front load the incoming revenue. This helps OnDeck to continue to invest in hiring and marketing to pursue what are no doubt aggressive growth targets. The problem is that all of a sudden no one wants to buy the loans.

Just one day later it was the turn of Prosper – the second largest marketplace lender in America. Prosper announced a decline in loan volume and the cutting of more than one quarter of its workforce. In a show of solidarity CEO Aaron Vermut also announced he would not be taking a salary this year. Prosper is primarily lending to consumers and it takes no balance sheet risk. Again the slowdown is said to have been caused by a lack of demand from investors.

Both stories hit the share price of Lending Club, the largest marketplace lender in America, which was approaching the end of its pre-results quiet period. That quiet period ended with quite a noise on 9th May when Lending Club announced both a mildly disappointing set of results, but also the departure of its charismatic Founder, CEO and Chairman Renauld Laplanche. The Lending Club story is more complex, but still looks to have been driven by the need to generate investor demand for buying loans.

So what has gotten investors so spooked all of a sudden?

While it could be that confidence in online lenders’ ability to assess credit risk has disappeared overnight, it is more likely investors see the loans as particularly vulnerable to economic headwinds. The rocky start to 2016 has them worried about a downturn that might see defaults spike.

If online lenders want to remake the financial services industry, they can’t just be a boom time business.

This is primarily a communications problem.

Online lenders have to be much more convincing about the quality of their credit under-writing if the sector is to get back on track. Satisfying investors that default rates won’t be hit by the broader economic cycle is not easy without going through the cycle and pointing backwards.

A number of online lenders in the UK have taken steps to ease investor concerns by arranging independent stress-tests of their loan books.

A second tactic that is common in the UK is for lenders to publish their loan books. This level of transparency is important and admirable, but it only tells investors about past and present performance of loans, when what they’re really worried about is future performance.

On top of the stress-tests and the loan books, a quick way to build credibility is to hire leading risk experts from top financial institutions, and it’s no surprise to see that happening more and more.

With online lending in the UK continuing to grow at pace, these tactics seem to be working.

More can still be done. Perhaps a more disruptive way to achieve credibility is to be increasingly open about both risk methodology and results. Underwriting processes and systems are – for some online lenders – key intellectual property they will be reluctant to share. However, the more the investing public understands of the sophistication that goes into underwriting credit online, the more comfortable they can become. Where lenders are secretive, investors will naturally worry.  

UK-based online lenders have taken the lead in transparency and are being rewarded for it; now is the time to keep pushing transparency further. American lenders should follow suit. 

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