It's been a rather dark few days for the alternative lending industry.
On Monday, news broke that the chief executive of US giant Lending Club, Renauld Laplanche, had been forced to resign by his board. First, the platform disclosed that it sold near-prime loans to a bank (Bloomberg reported that it was Jefferies) which it knew didn’t conform to the bank’s criteria. Then, it came to light that there had been a failure to disclose – somewhere along the lines – a personal interest in a fund which Lending Club was contemplating investing in, and which we also now know, potentially even more seriously, was a buyer of Lending Club loans.
Peter Renton, author of The Lending Club Story and co-founder of the largest conference in the industry, LendIt, says “it is clear this is bad news not just for Lending Club, but for our entire industry. Really bad.”
If that wasn’t enough, the news creates a triple whammy for the sector: last week, the chief executive of Prosper Marketplace announced he wouldn’t take a salary for last year, as the company slashed 28 per cent of its staff. And platform OnDeck missed analyst expectations, with investor demand – and thus growth – slowed.
Bill Blain, a strategist at City firm Mint Partners, said on Tuesday: “we’ve long been warning the next big financial scandal will emerge from the platform sector, and that it could be regulated to the point of non-viability overnight. This morning, it looks like the first stage of that P2P unwind may be occurring.”
This is what you’ll likely see happening to the industry now.
Even faster consolidation
It’s blatant that not all sector players – small, or big – can survive forever. Industry reports for the Americas and the UK from Judge Business School have shown that both markets have already started to consolidate.
Blain points out that “some platforms will fail because they can’t differentiate themselves… others will fail because of unwise lending and insufficient controls, as rising credit losses flatten them… [and] others… because they fall foul of regulatory risk – an increasing risk if platforms such as Lending Club aren’t the only ones guilty of bad behaviour.”
There have been concerns for a while now that online lenders could accept poorer loans in order to retain volume.
Read more: What will happen to P2P during a downturn?
It’s worth remembering that, in the States, many of these are no longer P2P, but are facilitating the origination of loans in order to securitise those loans further down the line.
As one senior person at a leading lender put it, “growth is great. But inevitably to get that growth you have to keep pushing the boundaries of who you will lend to and at what rate.” Moreover, they add, there are “some indications that the much vaunted models aren’t standing up to a slightly tough economic environment, which doesn’t surprise me in the slightest.”
When Lending Club floated in December 2014, it was valued at over $8bn. But its share price has been reeling for several months now, and plunged 34 per cent on the Laplanche news. Since October 2015, it’s declined over 65 per cent, under-performing the S&P 500 by 71 per cent. “That’s clearly cheap – but maybe it can go even lower,” says Cormac Leech, director of alternative finance at Liberum investment bank.
“Valuations are going to come down massively,” he continues. “We can be pretty sure that the rest of the industry will feel it – everyone looks at Lending Club as a benchmark.”
Investment in the industry has already been waning. At the LendIt conference in San Francisco last month, many were talking about the rising risk aversion among VCs. It’ll be interesting to see how quickly (or not) money moves now.
It’ll also be worth keeping an eye on P2P funds that have exposure to Lending Club.
Nervousness piled on a recession
Of course, the bigger picture is that the P2P industry is booming. Despite the slowdown between 2014 and 2015, the UK market grew 82 per cent to £3.2bn in 2015, and the US’s to $36.49bn – a 212 per cent annual increase.
But the slight recession that’s been seen in the lending sector has made everyone a bit nervous, says Leech. And the news over the past week has amplified this. “It’s certainly a pothole, but I’m pretty confident that, taking a three to five year view, P2P will be far bigger than it is now. There will need to be some adjustments made, though.”
Leech had already said to Bloomberg that the industry, particularly smaller platforms, are going to have to work harder because of the Lending Club news. “Investors won’t give the industry the benefit of the doubt. Lending Club is the leading light in the sector, so if it’s not following best practices to the letter then investors are going to assume that second and third-tier platforms are doing the same thing.”
Tougher regulatory response
The Securities and Exchange Commission (SEC) enforcement division is set to review Lending Club’s disclosures. “Predicting what any regulator is going to do coming out of a scandal is extremely difficult. But it is safe to say that the SEC is going to investigate Lending Club very closely and this will likely spill over to other companies in the industry,” says Renton.
Unlike equity crowdfunding, P2P lending has been able to grow fast in the States, free from federal banking regulations that oblige the holding of reserves of capital against loans.
Here in the UK, where platforms are also not required to hold capital reserves, the Financial Conduct Authority has always been fairly accommodating of the industry, stating that it’s keen to “promote effective competition in the market”.
Many, however, think that this will now change. “I would expect platforms will be required to boost their financial and audit control functions, and would also expect a requirement for more extensive and/or frequent external audits,” says Leech.
It’s also been suggested that the Lending Club fallout could delay all major platforms from getting Innovative Finance Isa authorisation – a process that’s already suffered several delays.
But better standards?
But Leech adds that, in “something of a counterintuitive way”, the fiasco will actually improve the sector. “Platforms will tighten up disclosure controls and their best practices because of this”.
Members of the Peer-to-Peer Finance Association (which includes all our major platforms) publish their loan books in full, while providing “clear information on all fees and charges to both investors and borrowers, demonstrating a level of transparency unrivalled elsewhere in the financial services markets,” explained the industry body in a statement today. As Angus Dent, chairman of platform ArchOver, puts it, “all the due diligence processes in place at the larger platforms are at least as robust as the banks”.
And the other thing that might emerge is a drive for more simplicity, adds Leech. “Part of Lending Club’s problem was that there was too much variation in the business model – too much going on, which makes controls and oversight more difficult.”