On the eve of Lending Club's successful initial public offering in December, a handful of people involved in alternative lending — entrepreneurs, lawyers, and investors — met at the law firm Covington & Burling's Washington office to discuss what was next for the industry.
Upon news of Lending Club's opening price of $15 per share — one dollar above the anticipated price — eyes widened with the same mixture of near-disbelief and excitement that landowners likely experience when discovering a patch of oil on their property.
Soon after the price announcement, Keir Gumbs, the partner at Covington who played host that night, gave some brief remarks about the night's theme: perils that regulatory action can hold for this young sector.
Alternative lending remains minuscule when compared with traditional banking, accounting for an estimated $9 billion in loan volume last year. In order to grow into the $800 billion-plus sector that some boosters predict, the industry will need to maintain the delicate regulatory balance it has so far achieved.
[Coming this November: Marketplace Lending + Investing. Hear how participants in this fast-growth niche are using data and technology to propel lending into the 21st century.]
The question now, which Gumbs sought to address that night, is how do these companies keep growing without screwing everything up?
Over the last few years, federal regulators have largely taken a wait-and-see approach with respect to alternative lending. That has been due to the novelty and small size of the industry, as well as the fact that these lenders appear to be providing tangible benefits to borrowers.
Still, there are practices on both the consumer and small-business sides of the alternative lending business that seem likely to attract more regulatory scrutiny. Among them are tying multiple small business loans to the same collateral, fair lending issues and interest rate disclosures.
Most everyone close to the industry acknowledges that tighter regulation is a risk. "There's not a ton of predictability for companies that are thinking about entering this space or that are already in this space," Gumbs said in an interview shortly after Lending Club's IPO.
So Far, So Good
If April's LendIt Conference at the Marriott Marquis in Times Square were a speakeasy, the phrase "regulatory arbitrage" would have been its password, bandied about by investors and executives alike. The basic idea was that alternative lenders have an advantage by avoiding the regulatory burden that has been foisted onto banks following depressions and recessions.
This kind of talk can set off alarm bells in Washington. But financial policymakers have countervailing reasons to cast a more favorable eye on alternative lenders, a category that includes so-called peer-to-peer, or marketplace lenders, as well as nonbank firms that lend from their own balance sheets.
This is especially true for firms that specialize in small-business lending. Since the recession, policymakers have become increasingly concerned about the difficulty many small businesses have in obtaining credit. Alternative lenders have helped to meet their needs.
Karen Mills, who was administrator of the Small Business Administration from April 2009 to September 2013, is among those concerned about the small-business credit gap. She said it is particularly difficult for small businesses to get loans of less than $150,000. "And we know it's a structural situation," Mills added.
"It costs as much to underwrite a $150,000 loan as it does to write a $1 million loan," Mills explained.
The role that alternative lenders are playing in meeting the credit needs of small businesses has made the industry attractive to politicians. On the campaign trail, job-creating small businesses are as wholesome as apple pie.
During a recent congressional hearing, an industry witness argued that the federal government could be doing more to support P-to-P lending, to which House Small Business Committee Chairman Steve Chabot, R-Ohio, responded: "Well, you've come to the right place for that."
The name of a 2012 law that has eased regulation on marketplace lenders offers another reminder of the political appeal of Main Street businesses. The law is titled the "Jumpstart Our Businesses and Startups Act" — literally, the "JOBS Act."
Alternative lenders' ability to meet the needs of many credit-starved small businesses gives them a compelling argument in the halls of power.
"In general I think the best protection for small businesses is to give them access to more sources of capital," former Treasury Secretary Lawrence Summers said in an interview following a speech he gave at LendIt.
Summers sits on Lending Club's board, so he has a financial incentive to support the P-to-P industry. Still, his views about the need to improve small businesses' access to credit likely reflect those of many inside the Obama administration.
Executives at alternative lenders say they have been in contact with the National Economic Council regarding how they use data, in an effort to maintain their positive relationship with Washington.
Bill Phelan, co-founder and president of PayNet, a financial analytics firm that provides data to alternative lenders, has formed an industry advisory group that is meant to present a unified front to the federal government. Phelan said he has met with staff of the National Economic Council, which is part of the White House, and received favorable feedback.