As trouble piles up, online lenders pull back
A tough few months for online lenders got even more difficult Monday with the resignation of one of the industry’s leading figures, a development that adds to already considerable uncertainty for the business.
Lending Club, the San Francisco firm that’s become the largest of a new class of so-called marketplace lenders, announced Monday that founder and Chief Executive Renaud Laplanche would resign over problems with the sale of loans this year to an investor.
The news sent shares of the firm tumbling 35% for the day to $4.62, leaving them down 70% from their December 2014 initial offering price of $15. It added to an already lengthy list of concerns about an industry that have led firms to lay off workers and cut once heady growth expectations.
Lending Club and rival Prosper, both in San Francisco, originated $12 billion in loans last year, up from less than $3 billion in 2013. But there’s been growing concern about the quality of the industry’s loans, prompting ratings agencies to issue warnings about rising delinquencies.
Those issues combined have created an even bigger problem for lenders: They’ve made investors skittish, making it more difficult to find the capital they need to make loans.
“In the first quarter, fears about credit were so great that they basically precipitated a shakeout,” said Julianna Balicka, an analyst at brokerage and investment bank Keefe, Bruyette & Woods. “Investors have reacted to prospective credit problems quickly.”
Now, Lending Club’s news has the potential to add yet another concern. Laplanche’s resignation followed the company’s disclosure that it sold $22 million in loans to an investor despite those loans not meeting the investor’s requirements.
The company did not say how the loans fell short, but noted that credit quality was not the issue. Still, Balicka said the misstep could push more investors away from the sector.
“How do we know we’re buying what we think we’re buying?” Balicka said. “That’s a much bigger credibility question. Until they can get a clean bill of health, I wonder if certain investors can’t work with them.”
Unlike banks, these new lenders don’t have existing depositors’ money to lend. Rather, they serve as “marketplaces” where investors who want to lend money are matched up with borrowers -- often consumers looking to consolidate debt, or small businesses that can’t get traditional bank loans.
Over the last few years, when investors were less cautious, lenders fought to gain market share and bring in more borrowers, flooding consumers with online offers and direct mail. Now, finding capital to lend is the bigger challenge.
“For a long time, these companies had more investors than they had borrowers,” said Brendan Ross, president of Direct Lending Investments, a La Cañada Flintridge hedge fund that invests in business loans from online lenders. “Now, some of them have more borrowers than investors.”
For a long time, these companies had more investors than they had borrowers. Now, some of them have more borrowers than investors
Brendan Ross, Direct Lending Investments
Even before Lending Club’s announcement, other lenders had been paring back operations and expectations amid the investor pullback.
Just last year, Orange County mortgage lender LoanDepot started offering the same kind of personal loans made by Lending Club and Prosper. But now, instead of working to expand the new product line, Chief Executive Anthony Hsieh said the company is slowing things down, cutting back on advertising and extending loans to fewer borrowers.
“We’re going to just pull back a little bit,” Hsieh said. “We’re growing our mortgage side but turning down our personal loans.”
But while LoanDepot can fall back on its core mortgage business, most other firms in the industry offer only the kind of unsecured consumer or small-business loans that investors are pulling away from, prompting layoffs and slower growth estimates.
Last week, Prosper laid off one-quarter of its employees, while New York small-business lender On Deck Capital cut its growth projections for the year.
Hedge funds have been a big source of capital for online lenders. These lightly regulated investment firms were willing and able to buy billions of dollars’ worth of loans.
Now even some hedge funds have pulled back, as their own investors have faced losses elsewhere and asked firms to return their money, said Daniel Snitkof, a co-founder of Orchard Platform, which helps match hedge funds and other investors with online lenders.
On Deck in February bullishly estimated it would be able to originate about 50% more loans this year than it had in 2015. It also planned to sell as much as 45% of the new loans to hedge funds and other investors.
But last week, the company revised those estimates, saying it probably would grow originations by about one-third, and sell no more than 25% of its new loans directly to investors. Instead, On Deck plans to rely more on the bond market and banks to fund loans.
There also is available capital in the form of trillions of dollars managed by insurance companies, pension funds and other big institutional investors. Online lenders would need to tap into those sources if they hope to continue to grow, said Ram Ahluwalia, chief executive of PeerIQ, a firm that tracks bonds backed by loans from online lenders.
“As originations grow, you have to attract additional funding sources,” Ahluwalia said.
But courting big investors, which are more conservative and more easily turned off by signs of trouble in the market, could get more difficult, especially as ratings agencies issue warnings about the industry.
In February, Moody’s Investors Service said it might downgrade the credit rating of bonds backed by loans from Prosper because loan delinquencies were building up faster than expected.
And last week, Moody’s issued another report warning about the risks of bonds backed by marketplace loans in light of a federal lawsuit that accuses Lending Club of illegally sidestepping interest-rate rules in New York.
The case, filed in federal district court in New York, questions a practice widely used by marketplace lenders: Instead of issuing loans themselves, Lending Club, Prosper and others partner with federally regulated banks that issue loans on their behalf.
Those banks are permitted to make loans without regard to state limits on interest rates. The case argues the bank has no real interest in the loans, making the arrangement a “sham” that allows Lending Club to charge usurious rates.
In its report, Moody’s said that if plaintiffs win the case, lenders might have to cut interest rates on existing and future loans, and that some loans could be voided. Either scenario could mean big losses for investors.
Lending Club does not comment on pending litigation but reported in February that it was changing how it works with its loan-issuing partner, Salt Lake City’s WebBank, to address concerns about its business model. Under the new arrangement, the bank will have a financial interest in the loans.
Meanwhile, the Treasury Department is expected this week to release a report on the industry, and California regulators on Monday said they would request additional information from lenders as part of an inquiry that started last year -- both potential preludes to additional regulation.
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