Online lending platforms test investor confidence

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Tianqiao Chen still wants to be part of the Lending Club. Last week, as shares of the largest publicly traded online lender in the United States fell after further decline in earnings forecasts, the CEO of Shanda Group bought an additional 4 million, strengthening its position as principal shareholder of the company.

However, many other investors have put their faith to the test, and not just in Lending Club.

Over the past few years, billions of dollars in capital have flocked to online platforms that match aspiring borrowers with yield-hungry investors, harnessing vast amounts of data to secure loans to consumers and small businesses. quickly and cheaply – and promising to make redundant bricks and mortar banks in the process.

But dozens of platforms have taken off, as rising defaults make equity investors reluctant to provide more funding and loan buyers look for better risk-adjusted returns elsewhere.

“The only thing that can blow this all up is the loss of credit control,” Brian Graham, managing director of Alliance Partners, a large lending club loan buyer, said at an investor event. organized by the company on the day of its profit warning.

Lending Club had already announced last month that it would stop issuing loans to substandard borrowers – loans it labeled with F and G ratings – following the rise in prepayments and delinquencies, which meant that the net returns to investors were often not as good as advertised.

Many operators are feeling the effects of a sharp increase in market share during the second half of 2015 and the first months of 2016, said David Snitkof, chief analytics officer at Orchard. As platforms rushed to offer new loans, credit quality has suffered and loans issued during this period are among the worst performing, with loss rates well above expectations.

The platforms “have faced a lot of pressure to grow quickly, and some of them have grown too quickly,” said Mr Snitkof.

Across the industry, valuations have fallen. Earnest, a San Francisco-based student loan specialist, sold in October to Navient, the loan services company, for $ 155 million, about 40% of its peak valuation. Once a “unicorn” personal lender Prosper saw its price drop from a high of $ 1.9 billion to $ 550 million during a fundraiser last month.

One of the victims was Dealstruck, a San Diego-based small business online lender that collapsed just over a year ago, after providing a few key clients with more debt than they could. endure it.

“When you’ve raised capital and generated an investor base, whether public or private, you feel this tremendous pressure to find ways to grow,” says Ethan Senturia, former managing director and co-founder of Dealstruck. “And there is no more immediate way to increase volumes than to lower prices. “

The arguments for online lending companies were many and varied but boiled down to one: Banks are ripe for disruption. As Mr. Senturia said in a brief published this month, Process: Real-time reflections of a struggling entrepreneur, the reason banks can’t pay more interest on customer deposits is because they have expensive branch networks, paper-heavy processes, and stringent compliance regimes.

If you remove the buildings, digitize the underwriting, and protect the business from regulatory oversight, the same interest income that funds the bank’s overhead costs could instead flow to the buyers of the loans. It was – and remains – an attractive proposition.

But the surveillance hypothesis didn’t really work. Last year, for example, following a governance scandal at the Lending Club, regulators such as the Federal Deposit Insurance Corporation tightened the screws. In guidelines released last summer, the agency said it would assess banks’ lending activities conducted through third parties – such as buying loans from an online lender – “as if activities were carried out by the institution itself “.

This meant that the platforms had to spend a considerable amount of money to upgrade the compliance and control systems. Lending Club’s latest quarterly filing, for example, shows he had $ 1.21 in operating expenses for every dollar in commission income in the first nine months, up from $ 1.03 at the same time ago. two years.

However, the biggest miscalculations concerned the subscription. Some traders have boasted of sifting through thousands of data points, in addition to traditional credit ratings such as a FICO score or credit report, arguing that it gives them a better idea of ​​default risk.

But models have always failed, forcing almost constant adjustments and upgrades. Lending Club is in its fifth iteration, G5, “our next generation lending model and our most powerful risk differentiator yet,” according to Scott Sanborn, CEO of the company. Prosper, which has made approximately $ 10 billion in loans since its inception in 2006, is in seventh place.

The result is that investors large and small have suffered losses. Sean Murray, a New York-based editor who writes the debanked.com blog, has liquidated his portfolio of 3,262 notes since May of last year, penalized by consistently below-average returns. He says he’s about to generate a loss for 2017 – which “looks even worse” when he considers he could have gotten around 18% in an S&P 500 index fund or more than 1,500 percent in bitcoin.

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It’s best to grow loan portfolios slowly, says Senturia, who now advises a handful of fintechs and specialist financial firms.

“The way to separate the wheat from the chaff with a high degree of certainty is to plant crops, wait and see what is left at harvest time, and adjust. . . for next season depending on the results, ”he wrote in his memoir.

“By the time your wallet is emitting smoke, there is probably a fire burning underneath. “

Letter in response to this article:

The word ‘fintech’ is a contrast of two halves / By Alex J Pollock, Washington, DC, US


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