They were going fast, they were adapting new technologies, high growth rates, they were the first to go public. Of course, they weren’t wearing a helmet (not fashionable) and the crash happened on the lower slopes.
In January we wrote in “Lending marketplaces grow up and get boring”:
“Lending marketplaces have heavy elements of old-fashioned finance and are becoming less innovative and cool, as they grow up.”
“Lending marketplaces have mirrored the old-fashioned credit card businesses practices, in order to be able to match lenders and investors from any state to a borrower in a state with strict usury laws.”
Matt Levine at Bloomberg View last week opened up an inquiry:
“Lending club got into trouble for being “too much like a fintech” and/or “too much like a bank”. ..But maybe it’s both”.
Increased elements of old-fashioned and conventional business choices have been appearing this year in the US lending marketplace. They come from many directions. SOFI in March decided to setup a Hedge fund, as a solution to manage the one leg of the three legged stool of the business, the lending leg (Think of your Business as a Three Legged Stool | Ron Suber @Prosper). Funding Circle six months ago launched a listed fund vehicle on the LSE and recently created the first Asset backed security with loans originated from its platform (this is a European ABS but the assets are held by a US asset manager). Lending Club, a US RIA, owns a conventional asset management business, LC advisors, that has grown to manage $882mil AUM!
Elements of conventional business practices in lending marketplaces already existed in the US from the start, in order to circumvent the cross state usury laws differences (i.e. mirroring the credit card business practices).
More than one year ago, the second batch of elements of maturity were clear (see “P2P Lending” to “Lending Marketplaces”: the graceful dance has started). Moving away from P2P lending and transforming into lending marketplaces through the involvement of institutional money on the lending leg of the stool. Currently, 80+% of LC’s transaction volume is through these bridges/channels. This is the part of business that the skiing accident happened.
A legal dispute between Jeffries and Lending Club. Jeffries seemed to be planning to bundle some LC loans. The disagreement came from the way that Lending Club disclosed to borrowers their right when using the platform. In layman terms, Jeffries wanted to make sure that loan applicants clearly understood that they were handing over their rights to the lender (Jeffries in this case) in order to complete the processes faster. This “power of attorney” allows the lender (the Jeffries on the other side of the trade) access to information of the borrower, like income and assets.
Matt Levine, Bloomberg View “LendingClub’s Troubles Bring Back Bad Memories” covers more details for those interested. He sprinkles his brilliance as a journalist:
“Signing your own loan agreements is so quaint and 20th-century! In the brave new world of financial technology, lenders will get your tax returns through an API, fair lending standards will be superseded by algorithms, and, you know, blockchain. … But probably it was just a pretty boring disagreement between LendingClub’s banking lawyers and Jefferies’ banking lawyers.”
Bottom line IMHO,
Lending Club’s stock price has been penalized disproportionally by an old fashioned Disclosure Dispute.
A Fintech is getting crushed (stock price down 45% in one week). Barclays dropped 20% at most when the LIBOR manipulation scandal broke out, with far broader industry and consumer implications (imagine all financial instruments indexed and priced off LIBOR, all the way down to the floating mortgages of Auntie Mary). How can we explain such a reaction, to an all familiar carelessness? Taleb would say, this isn’t a black swan. This can only be explained by this confession:
“ We thought we were in bed with a virgin; it turned out to be a 20th century woman (gone through multiple plastic surgeries)”
Source: Fintech fiction
The second wake-up call (not sleeping with a virgin) came from another familiar source. Non-disclosure of investment holdings of the CEO of LC and of one board member (John Mack, ex-CEO of Morgan Stanley) in a business that is linked to LC business. Laplanche owned 2% of Cirrix Capital without disclosing this investment. Cirrix is a 20th century business practice (still works): they borrow money (called leverage in the 20th century) and then buy loans. Cirrix Capital had been investing in Lending club loans. Things started to get tangled because during Laplanche’s reign at LC, the board and the risk team agreed to a 15% percent limited-partnership stake in Cirrix. This meant that LC added to its “Book” a position in Cirrix, another 20th century element. So LC started running a book and a position in a business that was making money by leveraging loans from LC and other marketplaces. How does that stink? What ghost from the 20th century is that? Mixing trading with lending businesses, and leaving room for the possibility of a Cirrix heavily concentrated LC portfolio; these seem eerily and rings bells of problems faced by Bear sterns, Merill Lynch, Morgan Stanley in the past.
The Book with a position in Cirrix, the disclosure disputes with a securitization counterparty on the Street, have spooked the market! Not because it is a black swan, on the contrary because it is all too familiar and it makes borrowers, investors, and shareholders feel dumb (as they thought they were sleeping with a virgin).
Two Disclosure bumps on the ski slope
The accident didn’t come from higher borrower default rates (we were all focused in that area as rates were spiking up + smells of recessions); it didn’t come from lenders pulling away from the table because the risk/return trade-off wasn’t decent anymore.
It came from the bridges being built between Fintechs (online lending marketplaces) and the incumbents (institutional money). The market has paused and so has the dance between the banks and the lending marketplaces. Unfortunately, this halt is damaging to consumers and SME that have been served through these channels as the traditional ones have been shut down from regulators. What may happen now in reaction to this skiing accident? We don’t want the slopes to close down! However, agencies and regulators may step in and start reviewing the agreements between banks and online lenders. The Prudential Regulatory authority in the UK and the Consumer Finance Protection bureau (CFPB) in the US may start examining individual company practices. The P2P finance Association in the UK, a self-regulatory body of the sector that has been proactive in setting industry standards, maybe facing a great problem (i.e. a membership line-up to join the transparency movement on P2P platforms).
The tangled web behind the scenes of lending marketplaces has been growing and a Fintech that can handle the corporate governance issues of this business, would be solving a real problem. Any Fintech out there that can handle this?
What do you think?
Where will the pain come from?