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Lending Club Expands into Small Business Loans

by Peter Renton on March 19, 2014

Lending Club Small Business Loans

It was nearly a year ago when an astute Lend Academy reader first noticed Lending Club’s plan to start a small business lending operation. Then, in October, Lending Club announced the hiring of Sid Jajodia, the former head of small business lending at Capital One Bank. Today, after what has clearly been a deliberately planned process, Lending Club announced the launch of their small business lending operation.

Lending Club began a pilot operation a couple of weeks ago and has been running a small test with Google ads to ensure all their systems are working. They expect to begin issuing loans in the next two weeks.

Lending Club Google Ad for Small Business Loans

Last month I chatted with Sid Jajodia, the Vice President of Small Business and Tom Green, the Vice President of New Business Initiatives just before the launch of Lending Club’s pilot program. They provided some more information about the kinds of loans Lending Club will issue and more information about this new program.

Before I delve into the details of this new program I want to stress one point. Some investors may think that Lending Club has been providing “small business loans” for many years because that is one of the stated purposes of the loans we see on the platform today. But these are not true small business loans. They are consumer loans that are completely dependent on the credit of the individual. The small business does not receive these funds directly, it is the individual, so they are not true small business loans.

Details of Lending Club’s New Small Business Loan Program

Lending Club will offer a variety of term loans: 1, 2, 3-year and some 5-year. Initially, they want to issue a mix of all four loan durations but will limit the number of 5-year loans issued. These loans will be unsecured but Lending Club will require a personal guarantee from the business owner.  Down the road they may provide secured loans backed by the assets of the business but that is not the plan right now.

The target market for these loans will be small businesses with less than $5 million in sales. But they are not focused on micro-businesses or hobbyists. These are small businesses with some track record that are looking to grow. Larger companies have plenty of lending options and will not be a target for Lending Club.

While these loans will leverage the expertise of Lending Club’s consumer lending operation, particularly when it comes to analyzing the credit of the business owner, Lending Club has put together a team, headed by Jajodia, that are small business underwriting experts.

“One of Lending Club’s key areas of expertise is integrating data sources. In the small business area there is a lot of heterogeneous data coming from multiple sources,” said Jajodia. Lending Club will be using a combination of traditional data sources as well as alternative data but they would not disclose exactly which sources they will be using.

Interest Rates ranging from 5.9% to 29.9%

Lending Club Small Business Loans Interest Rates

As you can see in this graphic there will be a broad range of interest rates offered by Lending Club that will be dependent on the creditworthiness of the business. These small business loans will be graded in a similar way to consumer loans and the data for issued loans will begin appearing in the data download shortly.

The online process to obtain a loan is a little more complicated than a consumer loan because you have to enter in your personal information as well as your business financials. But when I ran through the application myself it took just three minutes before I was able to obtain a decision from Lending Club. And for the record I was denied for a small business loan, which tells me they do have reasonably strict underwriting standards.

What’s in it for the Investor?

This is the big question, I am sure, for most Lend Academy readers. As was mentioned in earlier articles small business loans will not be available to retail investors any time soon. Lending Club has hand picked a small number of institutions to partner with in this pilot project.

While Lending Club has a high level of confidence in this new program they pointed out that it is a pilot program and therefore has a higher level of risk than the consumer loans. They wanted investor partners who understood these risks and were comfortable with them. These initial investors have committed to fund every loan issued by Lending Club during this pilot period.

The good news for retail investors is that Lending Club has stated several times now that they intend to make this product available for retail investors eventually. But given this is a new program that change is not imminent and may not happen for a year or more.

What about returns? While Lending Club is not making any specific claims regarding investor returns they did say this. Their intention is to provide returns to investors on their small business loan product that are equivalent to returns on consumer loans.

My Take

I think it is difficult to overstate the importance of this news today. Lending Club is the world leader in p2p lending and this is their first foray into a new loan product. If they execute well and provide a great product for investors, then they are well on their way to becoming the future leader in financial services. If small business loans end up performing badly and investors flee the product then Lending Club runs the risk of remaining a one-trick pony – providing unsecured consumer loans.

Most banks have been reducing their lending to small businesses over the last few years, so there are many people watching this move closely. While Lending Club will have competition from the likes of Funding Circle USA and Dealstruck, there are very limited options today in the market Lending Club is going after, and no clear winners in the online term loan market more broadly.

The timing is good for Lending Club and I happen to think they will do very well. They have clearly not rushed into this; they have taken their time and put the necessary infrastructure in place in terms of people and processes.

As a long time entrepreneur I love supporting small business. And most small businesses are being underserved when it comes to access to capital today. Lending Club can play a significant role in changing that.

What do you think? Is this a good move by Lending Club? Or would you prefer they remain focused just on consumer loans? As always I am interested to hear your comments.

There is more coverage of this news from The Wall Street Journal and Techcrunch.

{ 22 comments… read them below or add one }

Sean Murray March 20, 2014 at 7:13 am

It’s my opinion that their interest rates are far too low. The business loan default rate will be high and I can foresee negative returns for investors.

Laplanche made a point of saying in a Fortune interview that they’ll be targeting a different group of small businesses than the merchant cash advance industry. He cited their costs starting at 20% as proof they target riskier deals. What he may not realize is that 20% is the rate offered to the highest quality applicants (750+ FICO) and even that is believed to be too low to be profitable.

OnDeck Capital charges more than 5x Lending Club’s prime client rate to prime customers and requires payments to be made daily.They are still not profitable. Expect defaults to be high.

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Peter Renton March 20, 2014 at 8:21 am

Hi Sean, The one flaw I see with your argument is that banks for been charging single digit interest rates for years to small businesses and making money doing it. Surely, there is space for a company to take on small business loans at rates between what the banks charge and what OnDeck and the merchant cash advance industry charges. Lending Club seems to be targeting those customers that almost qualify for a bank loan that would never consider taking an MCA product.

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Sean Murray March 20, 2014 at 8:47 am

I do not agree that banks make money charging single digit interest rates to small business. They have to be prodded to do such things by the SBA and given default guarantees as protection. There is evidence to suggest that banks do not make money by making loans under 100k to small businesses.

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Peter Renton March 20, 2014 at 10:13 am

Fair enough. At the sub-$100K level I would agree that banks do not like to make those loans. But to say it is impossible for anyone to make money on these loans is a bit of a stretch in my opinion. Time will tell, of course, but I wouldn’t bet against Lending Club on this.

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RawRaw March 20, 2014 at 7:36 am

I think this is a train wreck waiting to happen

“These loans will be unsecured but Lending Club will require a personal guarantee from the business owner. ”

In my experience in credit, that personal guarantee isn’t much of anything. It should be unsecured with a personal guarantee. Personal guarantees do very little to mitigate risk, justifying the “but”.

I sure hope they silo this and track it differently. Treating this stuff as consumer debt seems to be a mistake, unless they are dealing with people who actually don’t need financing (can cash flow alone, with cash flow from an unrelated source). This sounds on the surface as very loose underwriting

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Peter Renton March 20, 2014 at 8:26 am

I agree that personal guarantees are not that effective in pursing payment once a company starts having problems.

But keep in mind many people said that doing unsecured consumer loans online was completely crazy. Lending Club have a history of executing very well and they have hired some of the top minds in small business lending so I would be very, very surprised if this ends up being a train wreck as you predict.

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RawRaw March 20, 2014 at 8:43 am

I know you are always positive, but you have to remember that past success in something unrelated doesn’t mean it will transfer. If LC wanted to limit the ability of it being a train wreck, they’d purchase business score cards by S&P, Fair Isaac, ETC and then compare it to their internally developed ones. And you’d need collateral. The infrastructure for small business lending is just completely different than consumer — they are trying to fix them in the same box to keep costs low. This is why I really hope they silo it and track expenses separately, but it doesn’t sound like it. The only mitigating factor is that LC and most investors aren’t leverage like a bank, so they’ll lose their investment worst case but not go bankrupt. But the credit quality of this is still going to be interesting to watch. Especially depending on the “types”, since each type of credit requires vastly different analysis

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Peter Renton March 20, 2014 at 10:18 am

I am sure they have looked at many of the external scorecards that you mention and much more. No doubt Jajodia had developed his own scorecard at Capital One as well. Now, I am not privy to the internal workings of Lending Club but I can tell you they have a bunch of smart people there working on this for months and I am confident they have thought about all the issues you mention.

I will also be very curious to see the credit quality and that data once they make it available in their public download.

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Chris March 20, 2014 at 8:08 am

Peter thanks for sharing this development. Great to hear that LC is moving forward and at least giving this dramatically under-served market a try. Two questions come to mind:

1. I thought I would play with the small business site and immediately noticed that LC is not permitting all states to request a small business loan. For example, I live in MS and noticed that MS is not listed as an available state to request a business loan? I found that odd considering I can request a personal loan from their regular platform if I wanted to. What’s the deal?

2. Any word if Prosper is going to try and compete with LC in this space as well?

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Peter Renton March 20, 2014 at 8:28 am

Hi Chris,

Not sure the answer to question 1 – I have reached out to LC to clarify.

I have spoken with Prosper and they have no intention of competing with LC in the small business lending space.

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Chris March 28, 2014 at 9:07 am

Hey Peter,

Did LC ever respond about the state limitation question?

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Chris April 1, 2014 at 8:11 am

I thought readers of this thread my find it interesting to know that new states have been added to the drop down list on the LC Business Website. One of which, is my home state of Mississippi.

Just an update,
Chris

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Peter Renton April 1, 2014 at 9:52 pm

Thanks Chris. Good to know. I never did hear back from LC on this.

Chris March 20, 2014 at 8:14 am

As an aside, I went over to the TechCrunch page referenced above. Two other tidbits of information they shared I thought others would find interesting:

“We’re told Lending Club business loans will range from $15,000 to $100,000 initially, increasing to $300,000 in the future. The loans carry fixed interest rates starting at 5.9 percent with terms of one to five years, no hidden fees and no prepayment penalties. We’re told the average interest rate on the platform hovers at around 12.5 percent.”

$300,000??? wow… Assuming they will want to secure these loans at that level…

“Lending Club CEO Renaud Laplanche says that the company’s existing tech and credit products catered towards consumer loans can easily extend to other types of loans, including auto, business, home mortgage and others. ‘We want to cover the entire credit industry,’ he says.”

Mortgage???

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Peter Renton March 20, 2014 at 8:31 am

Renaud Laplanche is playing the long game. He wants to be the Chase or Citi of online lending with products extending across all types of loans. There are plenty of online mortgage platforms popping up these days and you can bet that LC is watching them closely. Who knows, one of these new real estate platforms may be acquired by LC some time in the future.

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Small biz loan guy March 21, 2014 at 4:15 pm

Hi Peter, just curious – what are the names of some online mortgage platforms?

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Peter Renton March 21, 2014 at 8:57 pm
Thomas @ Expertwager March 21, 2014 at 9:35 pm

There is area for a organization to take on small economical loans at prices between what the banking organizations cost and what OnDeck and the business money enhance industry costs. Your article is informative. thanks for your quite nice post.

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Peter Renton March 22, 2014 at 4:17 pm

Thanks Thomas.

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Allen Graber March 22, 2014 at 2:12 pm

One of the advantage that LC will seemingly have is their ability to reach small businesses directly without having to rely on a broker channel or costly direct marketing. Many of the lesser known alternative small business lenders and merchant cash advance providers can’t get distribution and as a result have to pay high commissions to third parties or pay large direct marketing costs. They pass these costs off in the form of higher rates to the borrowers. If the lesser known players try and lower rates and thus commissions, then brokers may not steer as many opportunities to them. LC has the great advantage of having hundred of thousands of consumer borrowers to tell about small business loans and thus their cost of new business loan acquisition should be much less than the OnDeck, CAN and IOU Centrals.

Peter, regarding the real estate platforms that you mentioned, do you have any idea of what investors are earning by purchasing those type of loans. Seem to be selling pieces of short term rehab notes and am curious what return those are providing to investors?

Thanks
Allen

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Peter Renton March 22, 2014 at 4:28 pm

That is a very good point Allen and one I should have mentioned. This is going to be a very big advantage for Lending Club over the smaller players. And then all the press they have received this past week should have seen them create a large pipeline of largely free leads. Then they can definitely leverage their existing borrower relationships.

As for the real estate investments the returns vary. The properties range from single family rehabs to office buildings, even shopping malls. Cash on cash returns are usually in the high single digits but obviously none of the longer term investments have paid off yet.

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Thomas Corbin March 27, 2014 at 7:36 am

Hello,Peter Thomas here I am sorry I have not gotten back to you sooner. Peter I guess you are a ware of the Prime Program that use to
be for people who have $10,000 or $25,000. Now you can get in with $5,000.00. What advantage do I have or others have with this new
program? or is it worth it in the long run? I started with $5,000 in 8-12-2012.With this program do I have to put in new money or what? Thank
s for your good information. Try to get back to me before 3-31-2012 that is when the program ends. Thomas 3-25-2014 9:28am

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