Online Lenders' Stumbles: Growing Pains or Flawed Model?
Ever since marketplace lending started its rapid ascent, many in the investment community have debated whether sector's pioneers should be viewed as technology firms or financial companies.
Investors often assign high valuations to tech companies based on expectations of fast, uninterrupted growth. By contrast, lenders typically get lower valuations, due to the cyclical nature of finance.
With the announcement Tuesday that Prosper Marketplace is laying off 22% of its workforce, the debate now appears to be settled. While Prosper and its peers have reinvented lending for the digital age, they are, at their core, nonbank financial firms, subject to the whims of the capital markets.
Some buyers are hanging in there, but as OnDeck Capital's disappointing first-quarter results show, investors who acquire and securitize marketplace loans are heading for hills. Among the reasons: fear of defaults, unfavorable pricing and shrinking loan yields.
Suddenly, online lenders are struggling, or paying higher prices, to attract the institutional money that has fueled their rapid rise.
The findings from the California Department of Business Oversight, which also included data on interest rates and delinquencies, could be a precursor to new state regulations.
The layoff announcement came just a day after another marketplace lender, OnDeck Capital, reported a quarterly loss that sent its publicly traded shares into freefall.
Both events appear to be a direct result of institutional investors' waning interest in marketplace lending.
Having fueled the industry's astounding growth in 2014 and 2015, institutions have pulled away from the sector in recent months amid worries about the quality of loans these firms are booking. That means less capital for the likes of Prosper, which saw its loan originations in the first quarter fall 12% from just three months earlier, to $973 million.
Prosper, based in San Francisco, said that it is laying off 170 of its 619 employees. The firm will close its operations in Utah, where it had been planning to stage an expansion into offering consumer loans at the point of sale.
"They're built to scale," said Brian Korn, a lawyer at Manatt, Phelps & Phillips, referring to Prosper and its competitors. "If scaling is being delayed somewhat, then their costs start to be overbearing relative to the actual income they're making on the loans."
Prosper says it will refocus its energy on its original business of making online personal loans of between $2,000 and $35,000. The company will also continue to extend credit for elective health care treatments, a business that was headed out of Utah, but those efforts are being scaled back. The firm's chief executive officer, Aaron Vermut, plans to forego his salary this year.
Even after the layoffs, Prosper will still have nearly twice as many employees as it did at the end of 2014. The job cuts came with an implicit acknowledgement that Prosper grew too rapidly in 2015.
"Over the past year we invested for growth," Vermut said in an emailed statement, "but with the recent tightening of the capital markets we are refocusing on our core consumer loans business and building more resiliency into the company."
Prosper, which is privately held, received a valuation of $1.87 billion when it raised $165 million in equity funding in April 2015. It is anyone's guess what the company's valuation would be today, but its publicly traded peers have seen their stock prices tumble over the last 13 months.
Shares in Lending Club, which is scheduled its first-quarter earnings on Monday, have fallen from over $18 to less than $7 since April 2015.
OnDeck, a New York-based firm that makes small-business loans, has suffered an even sharper fall. Shares in OnDeck were trading above $20 in April 2015. The shares plunged more 35% this week after the company reported a $12.3 million loss in the first quarter to close at just above $5 on Wednesday.
When Lending Club and OnDeck held their initial public offerings, some analysts warned against valuing them like high-growth technology firms. That advice went largely unheeded at the time, but today it has become conventional wisdom.
"If we expect these companies to continue to grow at this astronomical pace … I don't think that's reasonable," said Alex Johnson, an analyst at Mercator Advisory Group.
Today's lower valuations of marketplace lenders may carry some advantages for firms that are looking to invest in the sector. Johnson said that banks may now see some of these online lenders as more attractive acquisition candidates.
Jonathan Korngold, a managing director at the private equity firm General Atlantic, added that the market correction is not a bad thing since it is scaring away investment firms that pushed valuations too high in recent years.
"I think the pullback in some overheated subsectors of the fintech market has been a healthy respite," he said.