Marketplace Lending: Bruised, Not Buried
We should all understand now that pure gain-on-sale marketplace lending businesses, like LendingClub, are inherently unstable.
The abrupt resignation of the firm's founder and CEO, under a cloud, seems likely to fan investors' growing fears about the marketplace lending sector. It could also hasten regulatory scrutiny.
Prosper Marketplace's decision to eliminate 22% of its workforce is more evidence that the bloom is off the rose for a sector that had been enjoying astronomical growth.
The May 9 announcement from Lending Club on the departure of CEO and Chairman Renaud Laplanche came as a shock to the market, as did the subsequent 35% fall in the share price. It has not been a great year for Lending Club, which had already suffered with other marketplace lenders before the news, making the stock drop that much more dramatic.
The reasons for Laplanche's departure were discussed in the Lending Club quarterly results call May 9. By all accounts, the board was seen to be acting decisively to address the concerns and ensure both that Lending Club gains investor confidence in its data and that it can continue to build out the marketplace lending model.
Many have compared the growth of marketplace lenders to what we saw in the subprime loan crisis, suggesting that that history will repeat itself here. They say marketplace lenders have a conflict of interest, looking to grow fee income regardless of credit quality of the loans that they issue.
But there are plenty of reasons why that history just doesn't apply to marketplace lending. It is true the recent news is a setback, and concerns about Lending Club and other companies could very well slow the growth of marketplace lending. But key factors point to lenders rebounding from hits to their share prices and issues with loan buyers.
On the May 9 Lending Club call, it was announced that first-quarter loans grew by 68% compared with a year earlier. It is worth pointing out that the growth of marketplace lending is a global phenomenon. The movement away from banks and toward a model where borrowers and lenders come together on a platform is now happening around the world. According to a report by the Cambridge Center for Alternative Finance, China saw 328% growth in alternative lending between 2013 and 2015, reaching upward of $101 billion in 2015. By comparison, the same group estimated in a different publication that alternative lending in the U.S. reached about $36 billion last year, small by comparison. But as other parts of the world look to a more efficient model of distributing capital to borrowers, we should expect to see that same trend here.
Another key driver of growth in marketplace lending is the relative cost of marketplace lending versus the process that traditional lenders use. According to the slide presentation that Lending Club reviewed during its first-quarter call, traditional lenders tend to have operating expenses of around 5% to 7% of outstanding loan balances versus marketplace lenders where that ratio is around 2%. Many are comparing this to the travel industry and how booking travel changed as technology was able to offer better customer experience while reducing costs. Although lending money is much different than booking a flight, the use of technology in the underwriting process has been limited in traditional lenders whereas technology has been part of the marketplace lending model since its inception. From day one, marketplace lenders have been able to reduce many of the redundant aspects of collecting client information and signatures while speeding up the process.
Yet there are still aspects of the marketplace loan ecosystem that are evolving. An example is the market for loan buyers. The sell-off of high-yield bonds in the first quarter contributed to a drop in the secondary market prices for marketplace loans, and therefore a drop in liquidity. This made it difficult for funds to allow redemptions. Although marketplace lending yields are inviting, many are still reluctant to invest in this space. Lending Club has 111 different variables for each loan for potential investors to weigh, and it is not clear yet whether investors are comfortable with the diversified portfolio model.
But the ability to purchase fractionalized securitized loans with the granularity and transparency that marketplace lending platforms offer is a significant differentiator. Over time, this is what will ensure the growth of this asset class.
Tom Grant is a managing partner with Intelligent Lending Advisers, a Boston-based adviser for investors in marketplace loans. He was previously a managing director with BBVA in global markets. He can be contacted on Twitter @thomaslgrant.