Sean Murray is the President and Chief Editor of deBanked and the founder of the Broker Fair Conference. Connect with me on LinkedIn or follow me on twitter. You can view all future deBanked events here.
Articles by Sean Murray
Are Retail Investors Really The Secret to Marketplace Lending Stability?
July 18, 2016
One anecdotal lesson that marketplace lenders seem to be circulating in 2016 is that outside institutional capital alone isn’t enough to succeed long term, at least on the consumer lending side where the yield spreads are typically narrower. Retail investors are crucial, some of them say, to achieve balance. In late March for example, a group of industry captains predicted there would be a return to the industry’s peer-to-peer roots, partially because of the assumed loyalty that retail investors offered. That was before several players stumbled, reported weak loan volumes and announced layoffs. So are we now seeing a return to the retail investor?
That assumes that they were a part of the industry’s capital structure to begin with. And that’s never really been the case. For Lending Club, about 20% of their loans were funded by self-managed individual investors in 2015. 47% came from individuals through investment vehicles or managed accounts. For Prosper, individual investors only made up about 5% of loan funding. And then that’s about it. Everyone else relied on wealthy accredited investors and institutions from the start.
“Retail investors are more loyal to a specific platform,” said Fundera’s Jared Hecht during that March panel. But he probably assumed, to his credit, that the platform wouldn’t do anything to jeopardize that trust. Lending Club, of course, is a good example of what happens when that trust is violated after the CEO resigned in a scandal that included the manipulation of loan data.
And here’s how retail investors reacted, according to a Morgan Stanley report: 24% of retail investors that were aware of the scandal and DOJ investigation said they would no longer be making new investments on the platform. Another 24% said they would stop temporarily. Only 16% of those aware said they wouldn’t be changing the amount of new investments they make. But that’s for those aware. Many retail investors haven’t any idea that something happened.
“82% of investors (not primed with information about the investigation) planned to invest more or the same amount on the platform,” they reported, which may speak more to why retail investors would be a more stable capital base than anything else, the fact that they may be more likely to be blissfully unaware or detached from what’s happening to the platform they’re investing on. That’s a frightening thought but perhaps not much different than some investors who don’t pay any attention to their equity investments so long as the dividend checks keep coming.
How many people cashed out their mutual funds after Brexit, for example? I know I didn’t. It never even entered my mind despite my portfolio losing about 4% in a few days. It of course came right back up. Contrast that with Lending Club investors who haven’t lost anything as a direct result of the investigation.
And in that sense, it probably all comes down to the relationship a retail investor has with the platform. Do they feel that it’s safe enough that they can just let it roll in the background of life to generate steady returns like a mutual fund? Or do they consider it a speculative investment where they’re in today for some yield but out tomorrow at the first sign of danger? The former would indeed be the sweet spot for a platform looking for a stable capital source, but their long-term ability to tap into this group will depend on whether or not they can prove to regulators, particularly the SEC, that they will not violate the privilege bestowed on them to do this.
After all, Lending Club and Prosper for a long time were the only platforms to have obtained special SEC approval to solicit retail investors. StreetShares is another company that has recently joined them, but their ability to tap into this investor class is made possible under a different law, the JOBS Act’s Regulation A+. Under that, they can only raise a maximum of $50 Million, an amount too small for the likes of companies like SoFi or OnDeck if they were to seriously consider making retail investors part of their capital base.
Therein lies the conundrum about retail investors being a key component of long term capital sustainability, few platforms can even access them. And with regulatory skepticism starting to creep in, the window to pursue that as a realistic channel might already be closed. Which means that any platform that was totally reliant on Wall Street to begin with, might forever be stuck with them and their volatile whims.
One doesn’t need look any further than to see the consequences of that realization than the rumors that SoFi may consider becoming a bank to guarantee its long term survival, the company whose actual slogan is “Don’t Bank.” Dependent on raising evermore outside capital, the lender seems to have recently reached the ceiling of institutional investor appetite for its products, according to the WSJ. And this at a time when their loans are performing well and the economy is still expanding. The WSJ reported that SoFi CEO Mike Cagney might be seeking regulatory approval for a state banking charter in Utah and with that the ability to offer credit cards and deposit accounts. The story states that the deposits wouldn’t be used to fund the loans themselves. If true, they would still accomplish another objective by doing that, diversifying the company out of the one-dimensional rat race of having to make evermore loans even when the market can’t tolerate them anymore.
For marketplace lending, the peers in peer-to-peer may only offer stability if you can access them. For everyone else, there’s another set of retail roots that platforms could over time head towards, deposits. Banks figured that out a zillion years ago. And to that end, marketplace lending might be known by a more fitting name in the not-to-distant future, banking. That will mean tighter controls and stricter regulations but in the end ensure long term stability. And if that’s what a platform is really trying to achieve, then maybe they’re heading to an ironic end.
The industry could return to its retail roots then after all, but a retail level far more simple and basic. Stability may just mean a teller window and an ATM machine…
Letter From the Editor May/June 2016
July 16, 2016
How can I possibly sum up the events that have occurred between this issue and the previous one? At the LendIt Conference, the excitement was still there but it had retreated from the blinding levels of sensational bliss it had exhibited in years past. That energy would only drop further in the weeks thereafter. Q1 reports showed a slowdown in originations at some of the industry’s largest players. Then, of course, Lending Club announced their chief executive had resigned in what originally appeared to be a small scandal.
The timing couldn’t have been worse because regulatory scrutiny was already starting to pick up. A controversial bill introduced into the Illinois State Senate was one of the first signs that the times are a-changin’. Several trade organizations have formed in 2016 to educate policymakers, an accomplishment that seemed almost impossible in previous years because of the competitiveness between rivals. And yet, there they were on Capitol Hill just recently, grouped together to tell their stories and explain the positive impacts they are having on the American consumer or small business.
The Internet will indisputably have a central role in how lending takes place in the future. But does that make the companies that provide loans over the Internet online lenders? Or will they just be lenders that are perhaps more tech-enabled or tech-dependent? Even banks are using technology and the Internet to interact with their customers. That makes naming the industry or sub-industries of which each company is a part of even more challenging these days. Are they online lenders? Marketplace lenders? Balance sheet lenders? Fintech companies? Crowdfunders? Peer-to-peer lenders? Non-bank funders? An identity crisis only makes advocacy more challenging, especially when distracting headlines are dominating the news. One can only imagine what a regulator must think. Hopefully all becomes clear in due time.
The Fed’s Analysis of Online Lender Satisfaction is Bogus
July 15, 2016
A strange statistic about borrowers and their supposed overwhelming dissatisfaction with online lenders is circulating where it shouldn’t be.
Only 15% of small business borrowers were satisfied with the loan they were approved for by an online lender, according to a Federal Reserve study published back in March. That’s actually not even what the study says but that’s the selective takeaway that some very influential people have gleaned from it. That figure in some way shape or form is being repeated at conferences, cited in academic papers, and even referenced in Congressional testimony. Apparently when it comes down to it, people are starting to believe that small businesses overwhelmingly hate their experience with online lenders because it’s something they think a very credible Fed study has confirmed.
It’s not a percent of satisfaction
The statistic in the study is actually representative of how many more people were satisfied than dissatisfied. That’s how they define it in their footnotes. 15% represents a net satisfaction score and it indicates that more borrowers were satisfied than dissatisfied. So 15% net satisfaction means that more than 50% of borrowers were satisfied.
Still though, banks scored higher than online lenders in the report so one might think that’s the important part at the end of the day. After all, this was a highly scientific study that we can still all make important decisions off of, right?
This wasn’t a scientific survey
The Fed disclaims any statistical meaning of their results in the fine print. Under methodology, it actually says:
- The data are not a statistical representation of small businesses.
- The SBCS is not a random sample of small employer firms, and therefore suffers from a greater set of biases than surveys that contact firms randomly.
- Businesses are contacted by email through organizations that serve the small business community in participating Federal Reserve Districts.
The Fed’s own authors seem to be pretty clear in stating that the data is not random, it’s biased, it’s not statistically representative, and that it was collected by third parties who coordinated distribution of the surveys on their own accord. Therefore for a policymaker, this report has no scientific value. Nonetheless, the Fed opens the report by saying “Our hope is that this report contributes to policymakers’ and service providers’ understanding of the business conditions, credit needs, and borrowing experiences of small business owners.”
Admitted falsehood becomes truth
Even though the figures are meaningless, they are being recited over and over. A major US Treasury report published in May for example, cited the Fed’s 15% satisfaction figure in its own analysis of marketplace lenders.
Testimony by Greg Baer, the President of The Clearing House Association, cited the study as well during a Senate hearing three weeks ago, but seemingly interpreted it to mean that only 15% of small businesses were satisfied with online lenders. “As reported in a recent small businesses survey, borrowers are generally dissatisfied with online lenders,” he said.
Marcus Stanley, Policy Director for Americans for Financial Reform, made the same mistake when he testified before the House Small Business Committee last month. “The evidence indicates they often provide a substandard and even exploitative product – just 15% of small business borrowers from online lenders expressed satisfaction with their experience,” he said, while arguing why they should be regulated further.
An article published by Nerdwallet also made the wrong assumption. “In fact, only 15% of small-business borrowers in the Federal Reserve survey said they were satisfied with their experience with online lenders,” they wrote in a story back in April.
Sadly, these are just a few examples.
Now what?
Does a study that’s not random, biased, not statistically representative, and not even controlled by the researchers, do more harm than good for an industry? Perhaps, because readers assume that a government study is scientifically sound on its face. Despite the authors’ move to disclaim the scientific value of it altogether, a mischaracterization of what is even presented anyway is becoming an oft quoted truism.
What is happening now is that both advocates and critics of the industry are starting to believe that only 15% of small businesses are satisfied with online lenders. No study has ever come to that conclusion though, not even the Fed study. It’s all in the fine print that openly says its not statistically representative and biased. And if that wasn’t enough, they even add “caution should be taken when interpreting the results.” Which in other words means, don’t use this stuff for anything important.
OnDeck Sets Q2 Earnings Date And…
July 14, 2016
OnDeck has one thing going for it when it releases its Q2 earnings on August 8th, the fact that the market seems to be anticipating bad news at every turn for the marketplace lending industry right now. A large drop in Q2 origination volume, if that is in fact what they report, would probably just serve as a confirmation of what everyone is already expecting.
OnDeck has already stopped referring to themselves as a technology company, a classification that likely propelled their IPO. Back in January, company CEO Noah Breslow said in a CNBC interview that OnDeck was actually a “non-bank commercial lender.” And after their first truly disappointing quarter, the company’s stock price has come down to a more sober level. It closed at $5.29 on Wednesday, down 74% from the IPO price and down 80% from the all time high.
With a good deal of doubt presumably already priced in, investors may look for reasons to be optimistic in Q2 even if the results are unfavorable overall.
A report circulated by Compass Point’s Michael Tarkan last month said that, “credit is holding up well, and the OnDeck-as-a-Service platform opportunity remains attractive.” Though it also added “overall profitability remains distant and tangible book value should continue to move lower.”
The earnings call on August 8th will take place after the market closes.
Fintech Hearing Summary (7/12/16)
July 13, 2016
A hearing about marketplace lending put on by the House Subcommittee on Financial Institutions and Consumer Credit covered a wide array of topics on Tuesday. From merchant cash advance to business loans to consumer loans, the witnesses tried to help members of Congress understand the circumstances in their respective industries.
Parris Sanz, the Chief Legal Officer of CAN Capital, explained the differences between a receivable purchase and a loan, a distinction that needed to be made in order to answer some of the questions from Missouri Congressman Lacy Clay.
The questions were generally exploratory and broad. For example, Georgia Congressman David Scott wanted to know what made consumer loans different from business loans. Sanz answered by saying that commercial loans power the economy and that their application was for creating jobs and growing businesses. More to the point, he added that these weren’t hobbyists calling themselves businesses because their average customer has been in operation for at least 13 years and does $1 million to $2 million in revenue a year. These are sophisticated users of capital, he said.
Missouri Congressman Blaine Luetkeyemer, who first read comments he obviously disagreed with that were made by CFPB Director Richard Cordray, repeated the question about the differences between the two. Rob Nichols, the CEO of the American Bankers Association, responded by saying that he didn’t believe the lines were blurred. Cordray had previously said that he believed the lines were indeed blurred, which created some fear in the commercial finance community
Where they might be blurred is in regards to data collection as mandated by Dodd Frank’s Section 1071, something that was only touched upon lightly. Ms. Gerron Levi, Director of Policy & Government Affairs, National Community Reinvestment Coalition, said that we don’t know a lot about marketplace lenders because the data isn’t being collected yet.
While there was some skepticism by the Members over how data was being used by fintech companies to make decisions, it appeared to be early days for a lot of the subjects such as the potential for creating a limited federal charter and whether or not these customers are truly underserved or are just being acquired by marketplace lenders because there is a degree of regulatory arbitrage occurring.
The tone of the hearing was overall neutral in nature.
Google Adwords Interruption May Be Coming for Business Lending and MCA This Week
July 12, 2016
Get ready for Google to probably misinterpret what you do come July 13th, the day that Google has decided to ban all consumer lenders that charge more than 36% APR or have terms less than 60 days, from paid search advertising. This is according to an announcement Google made back in May, as part of a campaign they’ve suddenly decided to undertake to stop profiting from payday lending.
Nevermind that Google is openly in the payday lending business themselves through their investment in LendUp, a short term lender they made a second massive investment in just a few months before they moved to ban everyone else. And nevermind of course that the CFPB has just extended their enforcement activity to middlemen, most notably by going after T3Leads and its owners for directing borrowers to questionable prospective lenders that pay top dollar, arguably in a similar banner to what Google does with its searchers and its paid payday search results.
Nevermind all that.
Here’s what you might mind. A Google Adwords specialist might have no idea what kind of financial activity you engage in and it could end up costing you. Eight months ago for example, the organic search results lumped merchant cash advance into cash advance, triggering a special box for merchant cash advance seekers that inadvertently (or maybe intentionally) referenced payday loans.
If your Google ads do get suspended this week, the semantics surrounding the term cash advance could create a challenge.
Google wrote that commercial loans are exempt from the ban and that should presumably mean all commercial finance products such as factoring and merchant cash advance. But if they screw up, and in all likelihood they probably will with some companies, be as clear as you can in explaining the commercial nature of your product and how it works.
Because if they don’t get it, you could be banned for life.
Online Consumer Lenders Stumble, While Online Business Lenders Stay On Their Game
July 8, 2016
Something is happening in the land of marketplace lending, painful setbacks. And it’s mostly on the consumer side.
Avant, for example, plans to cut up to 40% of its staff, according to the Wall Street Journal. Prosper is cutting or has cut its workforce by 28%. For Lending Club it’s by 12% and for CommonBond by 10%. And then there’s Kabbage, whose consumer lending division playfully named Karrot, has been wound down altogether.
Kabbage/Karrot CEO Rob Frohwein told the WSJ that Karrot was put to sleep about three or four months ago, right around the time that it became obvious to industry insiders that the temperature had changed.
Ironically, the person who best summed up the problem is the chief executive of a lender that rivals the ones that are suffering, but has announced no such job cuts of his own. In March, SoFi CEO Mike Cagney told the WSJ “In normal environments, we wouldn’t have brought a deal into the market, but we have to lend. This is the problem with our space.” And that is a problem indeed because the success of these businesses becomes entirely dependent on making as many loans as possible so they can raise more capital to make as many more loans as possible so they can raise more capital. Perhaps the end game of that dangerous cycle is to go public, but the market has gotten a glimpse now of what that might look like, and they’re not very impressed with Lending Club.
The pressure of living up to the expectation of eternal loan growth manifested itself when Lending Club manipulated loan data in a $22 million loan sale to an investor, but it was a problem all the way back to their inception. In 2009, the company founder made $722,800 worth of loans to himself and to family members, allegedly to keep up the appearances of continuous loan growth. It was never found out until last month, seven years later.
That is a perfect example of the vulnerability that SoFi’s CEO spoke of months ago when he said, “we have to lend.” Because if they don’t lend or investors won’t give them money to lend, well then we’d probably see things like massive job cuts, falling stocking prices, and a loss of investor confidence. And that’s what we’re seeing now.
This wave of cuts is not affecting much of the business lending side
Despite the rush to the exits on consumer lending, Kabbage’s CEO is still very bullish on their business lending practice, so much so that they intend to increase their staff by more than 25%.
And in the last month alone, four companies that primarily offer merchant cash advances, have announced new credit facilities to the aggregate tune of $118 Million, one of whom is Fundry which landed $75 Million. Meanwhile, Fora Financial secured a $52.5 Million credit facility in May. Fora offers both business loans and MCAs.
And here’s one big difference between the consumer side and the business side. While online consumers lenders have found themselves trapped on the hamster wheel of having to lend, there is very little such pressure on those engaged in business-to-business transactions. Sure, their investors and prospective investors want to see growth, but only a handful are following the Silicon Valley playbook of always trying to get to the next venture round fast enough, lest they self destruct.
Avant’s latest equity investment, for example, was a Series E round. Prosper and Lending Club also hopped from equity round to equity round, progressing on a track with evermore venture capitalists that were likely betting on the companies going public.
But over on the business side, they’re much less likely to involve venture capitalists. Equity deals tend to be one-offs, major stakes acquired by private equity firms or private family offices, sometimes for as much as a majority share. These deals tend to be substantially bigger, are harder to land, and are less likely to be driven by long-shot gambles. In other words, the motivation is less likely to be driven by the hope that the company can simply lend just enough in a short amount of time to land another round of capital from another investor.
Examples:
- RapidAdvance was acquired by Rockbridge Growth Equity
- Fora Financial sold an undisclosed but “significant” stake to Palladium Equity Partners
- Strategic Funding Source sold a large stake to Pine Brook Partners
- Fundry sold a large stake to a private family office
Business lending behemoth CAN Capital has raised all the way up to a Series C round but they’ve been in existence for 18 years, way longer than any of their online lending peers. Several other of the top companies in the business-to-business space have relied only on wealthy investors that did not even warrant the need for press.
The upside is that these companies are less vulnerable to the whims of market interest and confidence. Having a down month would not trigger an immediate death spiral, where a downtick in loans means less investor interest which means a further downtick in loans, etc.
The margins in the business-to-business side tend to be bigger too, which means it’s the profitability that often motivates investments, rather than pure origination growth potential.
There are outliers, of course. Kabbage, which has raised Series A through E rounds already, admitted to the WSJ that they still aren’t profitable. Funding Circle, which also raised several rounds, disclosed that at the end of 2014, they had lost £19.4 Million for the year, about the equivalent of $30 Million US at the time.
These facts do not mean that either company is in trouble. Kabbage is not limiting themselves to just making loans for instance, since they also have a software strategy to license their underwriting technology to banks like they have already with Spain’s Banco Santander SA and Canada’s Scotiabank. And Funding Circle enjoys government support at least in the UK where they primarily operate. There, the UK government is investing millions of dollars towards loans on their platform as part of an initiative to support small businesses.
Business lenders and merchant cash advance companies may not necessarily be on the same venture capital track as many of their consumer lending peers because it is a lot more difficult to perfect and scale small business loan underwriting. Even the most tech savvy of the bunch are examining tax returns, verifying property leases, reviewing corporate ownership documents, and scrutinizing applicants through phone interviews. While this process can be done much faster than a bank, there’s still a very old-world commercial finance feel to it that lacks a certain sex appeal to a Silicon Valley venture capitalist who may be expecting a standalone world-altering algorithm to do all the risk related work so that marketing and volume becomes all that matters. Maybe on the consumer side something close to that exists.
Instead, a commercial underwriting model steeped in a profitability-first mindset makes online business lenders better suited to be acquired by a traditional finance firm, rather than a venture capitalist that is probably hoping to hitch a ride on the join-the-fintech-frenzy-and-go-public-quickly-so-I-can-make-it-rain express train.
Consumer lenders who had to lend and are faltering lately, will now have to figure out something more long term beyond just making as many loans as possible. It might not be something that excites their venture capitalist friends, but it is crucial to building a company that will last a long time.
Marketplace Lending Hearing To Be Held By House Subcommittee
July 7, 2016
On July 12th, the Subcommittee on Financial Institutions and Consumer Credit is scheduled to hold a hearing to examine the opportunities and challenges specifically in online marketplace lending. Among the witnesses offering testimony will be Parris Sanz, Chief Legal Officer of CAN Capital and Sachin Adarkar, General Counsel of Prosper Funding. Rob Nichols, the CEO of the American Bankers Association and Bimal Patel, a partner of O’Melveny & Myer will join them.
The hearing will be held at 2PM in room 2128 of the Rayburn House Office Building and also streamed online.
A memorandum circulated by the House Financial Services Committee said that the “hearing will give Committee members the opportunity to assess the development of the FinTech market, including how online lenders and banks interact. Further, the hearing will evaluate the current regulatory structure and recent policy developments.”
