Financial institutions have bristled at the success of online “marketplace lenders” for some time.
These firms have built high profiles and even higher valuations by encroaching on what has long been considered financial institutions’ turf: extending moderate-sized personal and small business loans.
Yet again it appeared that banks and credit unions—in part due to being hamstrung by regulation—had been outflanked by Silicon Valley disruptors.
Late last year, however, the narrative began to shift. Players like Lending Club, Kabbage, OnDeck, and Prosper had established their brands and a steady flow of loan demand.
It was the other side of the equation that emerged as the “gotcha.”
Lenders needed to package and resell these loans into the secondary market to free up capital to satisfy the next wave of borrowers. The capital markets suddenly grew wary of these placements for fear of default risk.
In March, SoFi announced the creation of its own hedge fund to purchase a portion of its loans and hopefully keep the growth engine humming.
In early May, the other shoe dropped with the unexpected firing of Renaud Laplanche, Lending Club’s founder/CEO and one of the marketplace lending industry’s most prominent figures.
Already skittish investors took this as a sign to scramble for the exits: Lending Club’s stock is down 65% so far this year, and by half since May 1 alone.
There’s a lesson here in the psychology of investor confidence. Lending Club’s first-quarter results actually exceeded analyst expectations. The company’s board took swift action to address issues that were reportedly brought to their attention by Laplanche himself.
And the infractions disclosed to date, while serious, are short of catastrophic (misclassification of re-sold loans that fell short of the buyer’s stated investment criteria, Laplanche’s undocumented ownership stake in a company with which Lending Club was negotiating).
Regardless of the background, investor sentiment for marketplace lending has taken a beating. It’s hard to quantify how much other players in the space have suffered since most are privately held.
Suffice it to say an already challenging environment for their repackaged loans just got a lot tougher. Seemingly overnight, the pendulum swung from overheated hype to Inc. headlines like “Is the Marketplace Lending Revolution Over?”
And at the risk of piling on, that same week the U.S. Treasury released its long-awaited industry report, signaling that new borrower protections are likely.
In hindsight it’s easy to conclude these firms never justified their peak valuations. On the other hand, to date there remains no tangible evidence of significant credit issues in their underlying portfolios.
There is a strong and understandable temptation for credit unions to simply say, “I told you so.” This would be a missed opportunity.
Notwithstanding other model shortcomings, one thing marketplace lenders have clearly demonstrated is that consumer and small business demand exists for a new credit delivery vehicle.
Complaints that nonbank disruptors had an unfair advantage in building these front-end solutions (less regulatory oversight, unconstrained capital) are largely moot at this point.
Could financial institutions replicate the interfaces built by these startups? Probably. But would it be a wise use of resources?
The lead time necessary would mean forgoing a ready market opportunity, the required design/development skills would be diverted from other projects (if they exist within the financial institution at all), and there’s no guarantee the resulting solutions would be as elegant as those already in market.
The potential synergies are obvious. Credit unions have struggled to generate sufficient loan demand in recent years. Marketplace lenders seem to have solved this problem, but can’t match financial institutions’ prowess on the funding side of the equation—not to mention the compliance infrastructure they’re certain to need in the near future.
This isn’t to say a meeting of the minds will be simple. First, there’s the annoying detail of finding an economic model that works to all parties’ satisfaction, not to mention avoiding incentives to churn out the type of low-quality originations that fueled the 2008 financial crisis.
Some of these disruptors showed disdain for traditional banking models during their high-flying days and assumed any collaboration would come on their terms.
Now that the dynamic has shifted, credit unions should resist the urge to retaliate, instead taking the high road and working toward constructive terms of engagement.