If you’re plugged into the world of online marketplace lending then you heard this week’s news about Lending Club’s internal scandal which culminated in the resignation of its founder, chairman, and chief executive, Renaud Laplanche. Lending Club, a U.S.-based company, is the first billion dollar online lending marketplace, and Laplanche was viewed by many as the industry’s biggest advocate and one of its pioneers. Accordingly, industry participants and followers are wondering what Lending Club’s news means for the future of the company and the industry. Is this a sign that the promise of marketplace lending is too good to be true?
For dramatic pause, and context, a few facts on what happened. On Monday, after an internal review, Lending Club announced that $22 million in subprime loans sold in March and April of this year to a single investor went against the investor’s expressed terms. Furthermore, certain staff members, including Laplanche, were aware that the loans did not meet the investor’s criteria, and during the review process there was less than full disclosure by staff including Laplanche, which the board deemed unacceptable.
The review also revealed that, in an unrelated matter, Laplanche failed to disclose personal interests he held in a third-party fund while Lending Club was considering an investment in the same fund. Lending Club conducted the review under the supervision of a sub-committee of its board of directors with the assistance of independent outside counsel and other advisors.
Laplanche and three other senior staff resigned or were fired. The company’s stock price slid dramatically, and investors Jeffries LLC and Goldman Sachs paused their purchase of loans from Lending Club as they review the events. Jeffries, for example, had been looking to package roughly $150 million of Lending Club loans into bonds for investor sales in early May.
What does this mean? In the immediate aftermath of the announcement, industry players and commentators had mixed reactions. Some pointed to Lending Club’s falling stock prices and other signals from marketplace lenders as evidence of industry weakness. Others are taking a more optimistic view, asserting that as an emerging asset class, marketplace lending needs greater transparency as part of the process of reaching maturity.
Lending Club for its part, has managed to sustain impressive year-on-year growth. The company had $1 billion in loan originations in 2012, $7 billion in 2014, and at the end of the most recent quarter (ending March 31, 2016) it neared $18 billion. During this same quarter, Lending Club reported a modest $4.1 million net profit.
Looking to the future, marketplace lending is forecasted to grow immensely. Lending Club started out in consumer loans and has since begun lending to small businesses and medical offices. It’s estimated that small businesses make up 99 percent of companies in the United States as well as 54 percent of total sales and 55 percent of all jobs. However, only half of small businesses with $100,000 to $1 million in annual revenue received at least a portion of the financing they applied for from conventional banks in 2015. Business Insider estimates that the volume of potential loans that are not made reached nearly $100 billion in the fourth quarter of 2015.
But of course, this forecasted growth is only as the good as growth in borrower and investor interest, and marketplace players’ abilities to sustainably match the two. While the models first started as peer-to-peer lenders, sourcing funds from individuals, they have for several years been dominated by institutional investors. Indeed, to sustain its volume of lending outfits like Lending Club need big investors. It is notable that the issues raised in this episode raised all relate to dealings with investors, not placement of funds with borrowers, so that aspect of the business model has not been challenged.
Some investors are already declaring that the way Lending Club is handling the situation provides the assurance they need to continue trusting that the company’s operations, including their alternative credit-scoring methods, are sound. In a press release Lending Club reported: “The Company took, and will continue to take, remediation steps to resolve the material weaknesses in internal control over financial reporting identified in the first quarter of 2016 — one related to the sales of non-conforming loans and the other to the failure to disclose the personal investment interests — and to restore the effectiveness of its disclosure controls and procedures.”
Notably, last month Lending Club partnered with Funding Circle, Prosper and other marketplace lenders to form the Marketplace Lenders Association, which seeks to promote responsible business practices and sound public policy to benefit borrowers and investors. The Association established Marketplace Lending Operating Standards, addressing transparency for investors, responsible lending, governance and controls, and risk management.
A day after Lending Club’s news broke, the U.S. Department of Treasury released a white paper on marketplace lending, which offers an overview of the evolving market landscape, acknowledges its risks and benefits, reviews stakeholder opinions, and provides policy recommendations.
It is hard to say at this point whether Lending Club’s scandal represents minor growing pains, significant company concerns, or issues that are widespread and threatening for the entire industry. Though regardless, it’s never a bad investment to instill strong internal controls and transparency, especially when strong – and sustainable – growth is planned.
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