The Opportunity in Difficult Times

Opportunity in Difficult Times

It has been exactly four weeks since the big Lending Club news. The marketplace lending world has not fallen apart but we are also in a very different place than we were a month ago. So, with this article I want to give a different perspective on the news now that we have had some time to live with the new reality.

So much has been written in the last month, most of it negative, that the casual observer could easily believe the online lending industry is dying. While I acknowledge these are difficult times I also think the fundamentals of our industry remain strong. The original premise of a better deal for both investors and borrowers is just as true today as it was last year.

To many people, myself included, this industry is more than a job. I am personally very passionate about online lending, I continue to believe in it and I want what is best for the industry. I have met hundreds of people at LendIt and other events over the years who feel exactly the same way.

For those of us who care deeply about our industry we know it has been damaged. The question now is this: what are we going to do about it?

This is Our Wakeup Call

Looking back now I can see we got ahead of ourselves. Thinking back to LendIt USA 2015 in New York there was a ridiculous amount of hype about the industry. We all thought we were changing the world and that the party would just keep going on and on.

That was a mistake. We should have kept a firmer grip on reality. Many of us tried to grow too fast, determined to make hay while the sun shines. That may be fine for a tech company like Facebook or Google but in financial services we should have taken a more prudent approach.

But we can’t have our time over again so what are we to do? It is time to rebuild the industry, time to make every company more resilient. Here are some things we can do to help move the industry forward:

  1. Transparency
    This industry began with an ideal to bring more transparency to the financial system. We have moved away from this ideal somewhat in recent years. It needs to return in a big way. I think all major platforms can do much better here. It may mean risking giving away some information that you would prefer to keep private but I think every platform should err on the side of more transparency rather than less.
  2. Support for a Robust Ecosystem
    It is not good enough for a platform to say that their data is trustworthy and clean. Companies like Orchard, PeerIQ, MonJa and dv01 should be encouraged to verify everything for investors. All platforms should be open to working with ecosystem providers like these.
  3. Enhanced Disclosure
    For large investors to get comfortable again they are going to need to see disclosure beyond just the loan book. There needs to be operational and servicing data made available as well as financial information on the state of the business. Not to mention an established compliance culture that can deal immediately with any irregularities that occur.
  4. Behold the Hybrid Model
    Many of the leading platforms in our industry are pure marketplaces, holding no loans on their balance sheet. This has been a good model but when times are tough it can be beneficial to have the ability to fund loans from your own balance sheet. While I still like the pure marketplace, I have moved on from believing it is the best way to run a business. This has nothing to do with having skin in the game, I believe pure marketplaces have that anyway, but rather having the flexibility to fund loans from your own balance sheet can make these lending platforms more stable.
  5. Resist the Impetus for Rapid Growth
    In some ways I think the focus on growth is at the root of the problems we are facing. A culture centered around rapid growth may encourage a tendency to cut corners. I am not saying that is what happened at Lending Club but today rapid growth is going to be seen more as a negative than a positive. We want companies to take on a sustainable growth path that may mean the occasional down quarter and that should be ok.

The Fundamentals are Critical

What has been lost in the noise of the past month is that Lending Club had a great first quarter. Their business fundamentals have been solid. Now, their second quarter will look nothing like the first quarter as they have been dealing with the fallout. No doubt originations and therefore revenue and profits will be significantly down from Q1.

I am hoping every platform CEO has taken a long, hard look at their business over the past month and refocused their management teams on the fundamentals of the business. This means underwriting, service, compliance, marketing, engineering, legal – all the departments of a business need to focus on doing the fundamentals well.

The Rebound Has Begun

While I don’t want to paint too much of an optimistic picture I can tell you that conversations I have had in recent days leads me to believe that a rebound is already underway. Investors that stopped buying loans at the major platforms are now back or about to be back and some of these are large investors.

Now, my sense is we have a long way to go before the industry is back to where it was in Q4 as far as origination volume goes but right now some positive movement is a good thing.

Let’s Not Waste This Opportunity

Everyone is watching us. Regulators are watching. Banks are watching. The media is watching. Investors are watching. What we do as an industry in the next 3-6 months will define us for many years to come. If we go back to the status quo and nothing changes I don’t like our long-term prospects. But if embrace bank-like compliance, become more transparent and open our doors to the ecosystem we will come back stronger than ever. We may end up seeing this time as a positive turning point for our industry.

The events of last month do not undo all the good things this industry has done. We have helped millions of people access credit quickly and easily and we have provided investors with a new high-yielding asset class.

The leading company in our industry made mistakes. That is not disputed. The positive impact these mistakes can have on this industry could be the enduring legacy of this difficult time. Let’s all work together to make it so.

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Rob L
Rob L
Jun. 6, 2016 5:19 pm

And not one mention of retail investors. Yeah, I did a search to be sure and the word retail is not to be found in the blog post. Full disclosure regarding my view; The Eagles — “I’m already gone”.

Brian Dally
Jun. 10, 2016 8:59 am
Reply to  Peter Renton

In point of fact there are three, not two, platforms allowing accredited & non-accredited retail investors to participate. There is LendingClub & Prosper in consumer debt, and Groundfloor in real estate lending.

There are at least two reasons retail capital matters, and they relate to points you make Peter. First, a broader base of capital makes for a stronger and more resilient base of capital. Second, the “draconian” regulations you reference are the impetus for the very transparency that you point out is needed today. Of all the “real estate crowdfunding” portals out there, for example, there are only two that submit to this level of disclosure (Fundrise for its eREIT under Reg A+ and Groundfloor for our p2p-style LROs). That’s not an accident, but a function of what’s required by law to cultivate retail capital.

While adding retail investors now may not solve the problems as you say, the discipline of focusing on retail would have served the industry better over the past few years, and still will. At Groundfloor we believe that voluntarily adopting those constraints and the slower growth path that entails begets the best long-term sustainability and customer value for us, and the industry overall.

Brian Dally
Co-Founder & CEO

Jun. 6, 2016 8:49 pm

Thanks as always. I often read but rarely comment on your articles.

I agree with your assertion that too much emphasis was placed on rapid growth rather than organic, sustainable growth.

As an investor since 2006, I’ve experienced consistently good returns. I’ve selected lower risk loans so my returns aren’t quite as good as yours. With such great returns on a unique asset class, I continue to be perplexed that there isn’t even more investor demand. Retail or otherwise. Any thoughts on why?

Jun. 7, 2016 8:43 am

Many mortgage companies and auto dealerships are not balance sheet lenders, but they do not struggle with funding. Two key differences is a very large market for mortgage securitizations and the use of banks to fund the loans and hold them until the sale to the securitizing entity. I think the first piece is the key issue. If there was a market, there would be banks willing to rent their balance sheets out just as Webbank does now.

Jun. 7, 2016 5:29 pm

I’m a retail investor who hasn’t stopped buying notes. I’m more conservative than Peter, but happy with my 8-1/2% return on B and C notes after 2-1/2 years (a little better at Prosper, but only 1-1/2 years investing there.) Lending Club and Prosper are too wonderful to go away. Lending Club’s Board is amazing and the staff is, too. I only wish retail investors like myself were allowed in some of the other opportunities.

The share price drop is a shame, especially because it tends to take a very long time to rebound from a steep drop. But it will come back as the growth returns. And the growth will return.

Jun. 9, 2016 12:18 pm
Reply to  Kate

Wow – I’m surprised and impressed with your returns. I have not been on LC but a year and 1/2, but I find the late payment and default rates atrocious. I have had about 786 loans of which 110 have paid back. However I have 3 defaults and 11 at various stages of default. I have been ultra conservative and almost exclusively lent to A-1 – A-4 categories. Many of the defaults (late payments) are A-1. Many of the default (late payments) had a credit rating of 785 and higher. Many of the default (late payments) only made about 4 payments before defaulting. I am getting out as quickly as possible because this rate of return is not good for loans of this short period of time. Apparently it is extremely easy to default. A bank could not survive on loans of this “supposed quality” and the rate of non-payments. I am honestly scared to death that I have over 625 loans out there for 2 more years or so. I’m not sure where the blame needs to be, but I’m sure lending club will lay it on my loan selection criteria (I do have a few B and C loans, but not many). I honestly think the methodology of trying to enforce payment on late payments must be very slack. Lending Club seems to take a nice cut in that, but not much progress with my loans.

James Wood
James Wood
Jun. 9, 2016 8:10 pm
Reply to  Ken

ROI for A and B grade loans is poor. I’m getting just less than 10% with some C but mostly D and lower grade loans.

The trick is in the filtering. I don’t for a second invest in the bundles of loans that LC selects for you. Frankly, I don’t trust the financial industry to bundle anything! Instead I’m hand picking loans that meet specific criteria and I’m mitigating risk with a combination of filtering and haveing a whole lot of small $25 loans. Keep in mind that if you are not filtering and letting LC choose for you, you are buying the loans that are left over after people like me, and more importantly, professionals,have cherry picked the best from. Your not getting average loans if the best one are removed from the pool withing a few seconds of being posted. That and your A grade choice is hurting your return IMHO.


Jun. 12, 2016 10:04 am
Reply to  Ken

I have done a large amount of data analysis on the Lending Club loans and the data that they provide. The way I think about investing in different grades is.. with A loans you have about 5.5%~6% return if none default, but there are defaults. Actually around 6-6.5% defaults across all A loans. Yes the default rate is higher with D’s and E’s but your return on those loans is high enough that it wipes out the default $. If an A defaults in the 5th month, and a D defaults in the 5th month the A is much more damaging to your portfolio because the return you were risking for was only 6%, whereas the D was 17%. That means that you would need x number of A loans to cover that default. With the defaulted D loans you would need less other D loans to cover your default because you’re getting paid back much more per loan. Yes more D loans will default in your account than A loans, but each default is less of an impact on your return. Taking a look at the raw data there are definite statistically significant credit points that point to more or less defaults. If you’re able to single those out (by statistical significance, not logic) you can realistically decrease your default risk for any grade. But you’ll have the greater gain in riskier grades lowering the expected default rate from 24% to 13% rather than the A default rate from 6% to 3.5%.
*statistical significance meaning running the numbers vs. assumption – length of employment has no stat significance on default rate. Doesn’t matter if they’ve been employed 10+ years or 2 years, there doesn’t seem to be any data to suggest that 10+ pay off more than 1 or 2 years employed. Logically one may assume 10+ means more security in their income, but if they’ve had that security for 10+ years why are they in such debt in the first place? Poor money management? Maybe someone went through rough times and needed to take out debt and they just got a job that pays well and its been less than 1 year. The latter may be more likely to pay you back.
Thesis – Investing in A and B loans can be risky because for each default you're losing the same $ that you've invested in D and E loans but it impacts your return more because the return you're getting on your other loans is so low. If you want to invest in less risky loans like As and Bs, do the due diligence with the data and find ways to decrease your default rates.
Sorry for the long post – side note – I read an article about the poster who invested $5k in 12 notes and like 4 of them defaulted and he was ranting about the riskiness of the P2P lending space. Look at your own investment strategy and ask yourself if you did what you could to hedge risk and invest intelligently rather than blame the market.

James Wood
James Wood
Jun. 9, 2016 12:20 pm

I feel that the financial industry lacks transparency and am also frustrated by the continued focus on institutional investors. As a middle-class American, I saw one in 10 home owners lose their homes in one of the largest wealth transfers from the middle class to the banks, almost no one go to jail for robo signing and fraud on a national scale. At the same time we bailed out the banks; that is not a free market solution. I have been consistently blocked from investing in many start-up companies (for example FaceBook 12 years ago) as I am not an accredited investor. How do you become an accredited investor? Step 1, already be well off. . . P2P has the chance to be something better, to be a much more level playing field. To be something close to and Adam Smith free market. And it is just that. However, in the last few years, I see the same sorts of problems creeping in. I see more and more catering to big money and, unlike when I started with LC, I now see almost no breath focused on retail investors. I’m still here. I’m still playing the game. And I am buying on the dips right now. But I wonder how much longer retail investors will be able to invest on a (sort of) equal free market. Frankly, I don;t trust the financial industry to have my best interests at heart; there are many good reasons for that. I have a lot of respect for Peter but I cringe every time someone says retail investors or middle-class investors are not capable or interested in making their own investment decisions. Every time we get push to the side. I worry as the focus seems to have completely shifted away from us. The advice when buying loans is to invest small amounts in many different loans. Surely having many different retail investors also provides stability that a few big players can not provide.

Warren Lee
Jun. 10, 2016 3:18 pm

Excellent write-up Peter, I’m going to share this across our social channels. Cheers!

Jun. 10, 2016 6:56 pm

James Wood – I understand what you said. I don’t let LC do any bundling either. I picked the loans myself as they came up each day. I am not like most of the “more prosperous” guys that make many loans on LC, and I am not looking for big interest. A 4% return would beat the heck out of any “sure” investment in a bank saving account or CD. I would be quite happy with that. My complaint is that LC has an awful lot of A grade borrowers that I sure don’t understand how they rated A grade. There are way too many of them defaulting. Something is very non-transparent. And yes, I do go deeply into the full code sheets behind their ratings. A B, C, D 7 so on loan should be very, very, very, more likely to default than an A grade, but apparently if you invest heavily into those, such is not the case. My dad always taught me that an A was much better than a D. I don’t care about getting rich. I just want my savings to do better than 1% – and shouldn’t have to take much risk in doing so.