Move over, young'uns. The grown-ups have arrived, and they're mounting a serious challenge to the startups that pioneered online lending.
This year, industry heavyweights Goldman Sachs, Wells Fargo and Quicken all burst onto the digital lending scene. These big firms may have been latecomers, but their timing was still good, since they came to market amid rising doubts about many of the online lending sector's early entrants.
In recent months, Lending Club, Prosper Marketplace and other fintech lenders have been forced to lay off big swaths of their workforces after key funding sources turned fickle.
The larger, more diversified firms that are jumping into online lending are not all following the same blueprint. Some are banks that fund their loans with low-cost deposits, while others rely on the capital markets for funding. Some make personal loans to consumers, while others focus on small businesses. Their risk appetites vary.
But the better-established companies, some of which were already up and running prior to this year, hold some important advantages over their fresher-faced peers. For one, they generally have a lot of experience navigating the highly regulated financial services industry. That asset is becoming more relevant, since Washington has started to take a closer look at the online lending sector.
"We're not just a bunch of folks working out of a basement building a website," said Todd Lunsford, the chief executive officer of RocketLoans.com, which is owned by the Detroit-based mortgage giant Quicken.
In some ways, RocketLoans is mimicking the approach taken by Lending Club, Prosper and other Silicon Valley lenders. It offers three- to five-year personal loans of up to $35,000. The loans carry annual percentage rates of 5.98% to 28.99%. Borrowers usually use the cash to consolidate their credit card debt.
But Quicken's large existing base of mortgage customers may give RocketLoans a leg up in an increasingly competitive market.
"We do expect the company to quickly gain scale using its Rolodex of borrowers within its mortgage product," wrote Michael Tarkan, an analyst at Compass Point Research & Trading, in a recent research note.
Banks that have built their own online lending platforms hold other advantages over the tech-focused startups. Perhaps most notably, these banks are using deposits as a cheap, stable source of funding for their loans. That model stands in contrast with those used by the likes of Lending Club, Prosper and Avant, which depend on more expensive and less reliable sources of cash.
At an industry conference in September, Goldman Sachs Bank CEO Stephen Scherr indicated that his company's lower cost of funding will allow its lending platform, which is called Marcus, to beat other online consumer lenders on price.
Goldman, Wells Fargo and SunTrust all keep their online loans on their own balance sheets. In a future economic downturn, that model should give banks a steadier income stream than marketplace lenders that sell their loans to investors and rely mostly on origination fees for revenue.
"You have the ability to control your own destiny much more so as a traditional lender," Tarkan said in an interview.
Atlanta-based SunTrust Banks has been making online consumer loans through its LightStream unit since 2013. The company focuses on borrowers with higher credit scores than most marketplace lenders. Customers typically use the unsecured loans to finance purchases, rather than consolidating existing debt. "We've had just sort of massive growth," said Todd Nelson, business development officer for LightStream, though he declined to provide specific numbers.
Wells Fargo launched its FastFlex business loan product in May. The San Francisco-based bank is initially offering the loans only to its existing small-business customers, but it has plans to widen the net next year.
Banks that are getting into the online lending business have one additional edge over the startups – greater regulatory certainty. Firms like Lending Club and Prosper issue their loans through partner banks in a somewhat byzantine effort, which has attracted judicial scrutiny, to get around state-by-state interest rate caps.
Banks like Goldman and Wells do not have the same headaches. Of course, the flip side is that by choosing to build their own loan platforms, rather than partnering with an online lender, these banks got to the market late.
"For us, it made sense to build this," said Scherr, who is also Goldman's chief strategy officer. "It's probably taken a little more time, but I think what we have is a digital platform that will resonate well with the target customer base and equally conform to what we want in terms of our own risk management and what we think the regulators are looking for."
The new entrants do face some of their own challenges. As big companies, they are likely to be less agile than their innovation-focused competitors. In addition, they have given firms like Lending Club, which is now a decade old, a big head start.
For his part, Lending Club CEO Scott Sanborn downplays concerns about new competition from big firms like Goldman Sachs. "We've been competing with deep-pocketed large players since we started," Sanborn said at an industry conference in September, pointing to consumer lenders like Discover Financial Services and USAA, which have long offered personal loans.
"I feel very good about, in our case, the length of the track record, the amount of data we have, and a lot of the unique technical capabilities that we've built," Sanborn said.
But Sanborn, who took the reins of Lending Club in the wake of a scandal involving the firm's founder, is not blowing off the competitive threat from well-established companies.
He pointed out that lending decisions are highly dependent on access to relevant data. A range of companies that collect vast troves of data about their customers – including PayPal and Square – have started offering loans, he noted.
Square Capital extended $189 million in small-business credit during the second quarter, up from $85 million one year earlier. PayPal Working Capital, which also targets business customers, took more than two years to hit the $1 billion milestone and less than one year after that to reach $2 billion.
"They have data, they have access to customers, and they have an opportunity to actually provide credit in a way that may be unique to them," Sanborn said.
Of course, banks also have a lot of data on their customers, which is another reason to think that depositories will pose a stiff challenge to the startups that have so far dominated online lending.
Anthony Hsieh, the CEO of loanDepot, another mortgage lender that has started offering online personal loans, argues that the go-go era of marketplace lending, when startups were flush with cash from venture capitalists, are now largely over.
"The days of raising equity utilizing rich equity valuations to subsidize your operational flaws or deficiencies, those days are over," he said.