Banks Conspicuously Scarce in Supercharged Online Loan Field
Because of a regulatory quirk, Lending Club and its competitors depend on banks to issue their loans. The set-up raises questions about the regulatory outlook for the fast-growing marketplace lending sector.December 18
Once known as peer-to-peer, online marketplace lending grew phenomenally and evolved rapidly in 2014, as capital flooded in from institutional investors and traditional bankers sat up and took notice.December 17
Alternative lenders, once considered competitive threats, are becoming allies for some banks. BBVA Compass now pitches its clients on OnDeck loans in the hopes of better retaining small-business customers.May 8
Union Bank has entered into a strategic alliance with Lending Club, a peer-to peer lending marketplace provider that connects creditworthy borrowers with investors.May 5
The peer-to-peer lender, which has both threatened banks' traditional businesses and cultivated Wall Street ties, is now selling its loans to community banks and working with them to offer personal loans as a counter to big banks' dominance in credit cards.December 11
Banks remain noticeably few and far between in the booming field of online marketplace lending.
The two largest U.S. platforms in this budding industry, Lending Club and Prosper, facilitated a combined $2.4 billion in loans in 2013, nearly triple the 2012 figure. Some investors are expecting explosive growth in the sector to continue over the next decade.
Banks do in some cases act as investors in marketplace loans and refer customers to the marketplace lenders. But no bank has emulated fully the model pioneered by Lending Club and Prosper making loans online and selling them to investors.
The concept of marketplace lending is foreign to traditional financial institutions. "The notion of who would be in charge of that is a tough one," said Daniel Latimore, the senior vice president of Celent's banking practice. "It's a classic innovation problem in a lot of banks."
To be sure, the rapid growth and hype around what was once known as peer-to-peer lending raises legitimate concerns that the market could be in a speculative bubble. But online marketplaces, which match borrowers with lenders, fill real needs. Consumers and small businesses appreciate the streamlined application process and availability of these loans; investors like the double-digit returns.
"The question for banks is, what do they do in response?" Latimore said. "Do they just say, 'that's a segment we don't ever want to deal with and we'll feed that to these new entrants?' That has a lot of danger in it. I always wonder what's the next area of banks that's going to get PayPal'd. This seems like a pretty good candidate right now."
Among the few to dip their toes in the water, Union Bank, Titan Bank and Congressional Bank buy loans through the Lending Club platform; Titan also buys loans from Prosper. BBVA Compass in Birmingham, Ala., has a partnership with OnDeck whereby it refers small-business customers who might not qualify for a bank loan to the alternative lender. SunTrust runs a Lending Club-like online lending operation.
Titan Bank, an $80 million-asset institution in Mineral Wells, Texas, was the first bank to acquire loans from Lending Club and it's one of the few banks acquiring from Prosper.
Jonathan Morris, a director of Titan and president of its holding company, BMC Bancshares, says these arrangements are working well for the bank.
"The risk versus return has been attractive, we've been pleased with the loan performance, and they're great companies to work with," he said. "Lending Club has also funded several loans for customers for which we didn't have a product set up, like a three-year unsecured installment loan." While in theory, the bank could offer the same product, it's more cost effective to partner with Lending Club.
The bank had to create its own algorithms to evaluate the loans Lending Club and Prosper take in and decide which to fund.
"We've put a lot of work into that relationship and making our own lending models," Morris said. "It's not something that was effortless, but we were willing to put in the time and the investment and it made sense for us. Lending Club has been a good ally, it gives us the capability to use the kinds of lending systems a large bank would have in place," he said.
The bank that comes closest to being an online marketplace lender itself is probably SunTrust, which bought online lender FirstAgain in 2012, integrated its platform with the bank's core system, and relaunched the business as LightStream, a division of the bank, in 2013.
LightStream provides an "Anything Loan" of $5,000 to $100,000 at rates of 1.999% to 9.999% and terms of 24 to 84 months. Customers fill out a short online application and typically get an answer the same day. These are not payday loans or loans for the underbanked; they're for people with credit scores around 700.
"We're similar to Lending Club and Prosper to the extent that we make unsecured loans," said Randy Ellspermann, LightStream's chief financial officer. "They focus more broadly on the credit spectrum, so they will lend to people who aren't quite as strong as we would like. But the concept is similar, from the lending to the consumer side." Where Lending Club gets funding from institutions and retail investors, LightStream gets funding from SunTrust.
Loan decisions are made by human underwriters, with an assist from FirstAgain's lending platform. "The loan file is presented very efficiently, summarized so they can make very fast decisions on the information they're provided," he said. Decisions are based on credit bureau data and information provided by the borrower.
Ellspermann said SunTrust bought FirstAgain for "the outstanding technology we've put in place, with a loan system specifically developed for lending over the internet directly to consumers. Perhaps Lending Club's and Prosper's were as well, but a lot of the traditional banks were not, that's one good reason SunTrust decided to acquire our business."
A startup called Cloud Lending started with mission of selling its loan software to banks, to help them compete with marketplace lenders. It found the banks were not interested, partly due to concerns about storing loan data in the cloud, and the company quickly shifted its attention to marketplace lenders themselves.
"Why are we now focusing on nonbanks? The innovation is happening outside of banks," said Cloud Lending CEO Snehal Fulzele. "Banks have not owned customer loyalty, they are not responding quickly to growing borrower demands. Most of their IT budget is spent on compliance issues. "
Fulzele estimates that there are 45 marketplace lenders in the marketplace currently.
"We expect more and more players bringing newer and more innovative asset types to the marketplace," he said. "One thing we're counting on is that the number of these marketplace lenders will go up."
One factor that keeps banks out of marketplace lending is risk: the very reason small business loan marketplaces like OnDeck and Funding Circle exist is they're filling a gap left by risk-averse banks: big banks (more than $10 billion in assets) granted only about a fifth (21%) of small business loan applications in December, according to Biz2Credit, an online marketplace lender that analyzes 1,000 monthly loan applications on its website. Small banks approved half their loan requests. Alternative lenders granted 62% of these small business loan requests.
"One of the reasons there's a market opportunity for these new entrants is banks have been unwilling to lend to a certain segment of the small business population with a risk profile they're not comfortable with," said Latimore. "So others have stepped in."
Indeed, some call the small-business-loan marketplaces, many of which charge interest rates above 40%, "payday loans for businesses."
"It doesn't look good to be charging your customers 40% interest, it gets questioned by regulators," Morris said. They will wonder "are you really doing the right thing by your customers?"
Technology is not really an obstacle large banks and card issuers have state-of-the-art underwriting systems. Nor is funding they also have low capital costs.
"I don't think it's that banks aren't in payday lending because they can't afford the technology," Morris said. "Banks aren't in payday lending because the regulators don't want them to be in payday lending. And banks have lost a lot of money doing exactly the types of loans some of these companies are doing."
On the consumer lending side, Prosper and Lending Club offer unsecured, fixed-rate consumer loans and let consumers and institutional investors invest in them.
Morris said the regulatory process banks would have to go through to sell consumer loan participations on an open market would be very costly and a headache banks would prefer to avoid.
They would have to create SEC-registered securities the way Lending Club and Prosper do, explain the process to regulators and provide customer service.
"I don't think it's what we're set up to do," Morris said. "It would be easier to sell to institutional investors. We haven't seen the bank that's creative enough to do that yet."
Smaller banks may wait for their core banking software providers to offer the technology support for this, Morris said.
Stessa Cohen, research director at Gartner, points out that upgrades to mobile and online banking are taking up a lot of banks' time and resources, keeping them from innovating in an area like online lending.
"But also, bankers tend to think in terms of product silos," she said. Marketplace lending doesn't easily fall into an existing bucket like loans or deposits, she pointed out. "And think of the back-office nightmare. If you're not a bank or you're a new bank, putting this in will be much easier."
Partnerships with marketplace lenders make sense, Latimore said. "Potentially they can say, 'we aren't comfortable taking on this risk ourselves, but we know others who might be and we'll put you in touch with them and perhaps collect a finder's fee,'" he said. "Progressive will give you quotes from competing insurance companies, and sometimes those quotes will be better than Progressive's, but those are the risks Progressive doesn't really want to underwrite itself anyway. So they enhance their market brand."
Or instead of giving a small business a $40,000 loan, a bank could offer $5,000 if the rest of the community could put in the other $35,000. "So they kind of act as a Kickstarter anchor," he said.
"It's something that community banks in particular are really well placed to get into if they just start thinking a little more creatively to make this happen, and not necessarily try to force it into their core ways of doing business," Latimore said.