It feels as though the world’s largest online lenders have at last begun to emerge from the shadow of what has undoubtedly been the toughest six month stretch in the lifetime of the industry. But are they emerging unscathed? Or have their recent struggles left an indelible mark on their business models?
Concerns over credit performance and over the internal controls of the major platforms prompted a sharp waning in investor appetite for marketplace loans earlier this year. In late May, conditions turned so arid that Lending Club was forced to take the decision to fund some loans on balance sheet. This represented a significant shift in structure for the poster-child of the marketplace lending industry. Similar but less ground-shaking were the slowdowns in marketplace sales that were stomached by some of the largest hybrid lenders, such as OnDeck and Avant. This general cooling of investor demand led to revenues falling short of expectations, and to mounting losses across the industry.
The fallout from these events has been stark, and has revealed itself most plainly in two ways: in the platforms’ attempts to shore up their funding bases, and in company cutbacks.
The US marketplace lending sector is well-known for its reliance on institutional funding. It’s patently true that a great deal more thought has gone into the courting of retail investors within the UK sector. But when the institutional taps began to run dry in May, the major US platforms were left suddenly scrambling for retail money. Lending Club launched a new tool with the retail-facing robo-advisor LendingRobot, while Prosper revamped its individual investor experience. Were these efforts a flash in the pan, or will the US platforms make a more concerted effort to cement a foundation of retail funding in the future?
Perhaps, perhaps not. Early on in August, Prosper was said to be discussing a $5bn loan purchasing agreement with a group of major investment firms, while Lending Club was rumoured to be exploring a similar deal for $1.5bn with Western Asset Management. Such agreements would signal an invaluable vote of confidence in the sector – but one has to wonder how much room would be left for retail investors, and indeed just how much the platforms would have to give up in order to close the deals out.
And industry turmoil over the past six months has claimed another victim, or rather hundreds of them. Most of the largest online lenders in the US have announced cutbacks during the past couple of months. Lending Club and Prosper have cut loose close to 400 employees between them. The economic viability of marketplace lending is contingent on achieving massive scale, and with the biggest platforms forced to scale back on borrower marketing in the middle of the year, primarily for fear of lacking the money to lend to successful applicants, scale – massive or otherwise – has not been forthcoming. And so the platforms have been forced to refocus on the leanness of their operations, cutting back on jobs but also on side projects. Avant announced in May that it would be putting its planned auto loan and credit card launches on hold. With share prices plummeting and venture capital drying up at a pace to rival even the evaporation of loan capital, the industry has had no choice but to recalibrate. Or, as Prosper CEO Aaron Vermut put it in May, to concentrate on “building more resiliency” into their business models.
But is it all just buttressing lending capital and trimming down costs? Has nothing else changed?
One other factor – one that is as deeply ingrained in the makeup of the marketplace lending model as any – may also have changed shape. Transparency has long been pitched as the panacea to the industry’s so-called incentivisation problem. To spell out that problem briefly, the revenues of a marketplace lender are often largely, if not wholly, dependent on origination fees. But investor returns are dependent on loan performance – which industry detractors would argue is less of a concern for the platforms themselves. Forgetting for a moment the fact that some platforms back-load their fees, it’s disclosure that has so far stood out as the primary aligner between investors and platforms in industry discourse. The logic is that investment will quickly tail off at platforms which show themselves to be undershooting the expectations of their investors.
However, as we at AltFi have repeatedly pointed out, standards of disclosure vary immensely across the industry. There are limits to the alignment that static loanbook disclosure can effect. There are also limits to what sense can be made of static loanbook disclosure, and to what extent investment decisions can be based upon this granularity of information.
In the UK market, AltFi Data Analytics provides investors with a real-time view of the performance of four of the “big five” marketplace lenders – Zopa, Funding Circle, RateSetter and MarketInvoice. It’s “real-time” because the product is powered by loan-by-loan, cash-flow level data. But more important, perhaps, is the fact that the data has been packaged up into a series of tools which allow for seamless segmentation and intuitive analysis. The impressive level of disclosure delivered by the industry has in effect been transformed into practically useful transparency. Independent third party data providers are crucial in delivering this sort of transformation, and a number of these companies are vying to do the same in the US. Such an achievement, should it come to fruition, would put an end to speculation over credit performance within the US sector – as answers would be readily available.
The other point is that the principle of transparency extends beyond simply disclosing loanbooks. The dismissal of Renaud Laplanche from Lending Club in May – perhaps the height of the sector’s difficulty – revolved around a failure of internal controls. Laplanche had overseen the falsifying of loan data, while also failing to declare an interest in a fund that Lending Club was looking to do business with. This demonstrates a certain lack of transparency at the corporate level. We’ve repeatedly been told since that internal controls have been tightened to the point that this sort of incident could never happen again, but only time will tell if this proves true.
Finally, in questioning whether or not the online lending sector is changing shape, it would be remiss of me not to mention the imminent arrival of a brand new cadre of formidable-looking sector entrants. This new breed of combatant may well come to represent a major threat to the existing disruptors. And they’re being launched by incumbent financial services companies.
Goldman Sachs is set to launch Marcus, an online lending outfit that will target both consumers and business, in October. Rumour has it that Marcus loans will be funded by Goldman’s New York State-chartered banking subsidiary, which was birthed in the wake of the 2008 financial crisis when Goldman became a bank-holding company. To date this arm of the company has mostly written loans to private clients and institutions, and held $128bn in assets as of June 2015. The presence of such a leviathan within the online lending sector will doubtless cause a level of nervousness among existing platforms – all the more so given the recently proven fragility of their funding bases. The message from companies like Goldman appears eminently clear: elements of online lending platforms, namely the front-end, are well worthy of imitation. But when it comes to funding sources, Marcus is more than content to prop itself up with good old-fashioned deposits. Never mind the marketplace model.
American Express, the $55.13bn market cap credit card giant, has also launched a platform – a short-term lender for small business owners in the US named Working Capital Terms.
And, of course, there’s the JPMorgan Chase initiative, made possible through a collaboration with OnDeck. That partnership effectively entails Chase licensing OnDeck technology as a means of powering online loans for its millions of small business customers. Chase then funds the loans off its own balance sheet.
It might not necessarily be related to the recent growing pains of online lenders, but competition from incumbents-in-new-clothes certainly appears poised the intensify – and that will surely change the way that online lending looks. But can the original crop of disruptors, trimmed down and still searching for the perfect mix of funding sources as they are, hope to compete?