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
Did Peer-to-Peer Lending Sell its Soul to Wall Street?
May 8, 2016
“We have so many fans but we also have some people here that are looking to take advantage of us, that are here for a short term trade and they won’t be part of this industry.” – Ron Suber, President of Prosper Marketplace
Ron Suber may have been talking about specific players in the capital markets when he said those words at LendIt just a few weeks ago but that characterization could just as easily apply to all of Wall Street in general. During his presentation, he offered two real world examples about how their message got hijacked by the same facilitators they originally believed were there to help them. The first was a case of bad buyers.
“When a marketplace lender sells a bunch of loans and the buyer isn’t aligned with the marketplace, if the buyer of those loans is going to buy those loans and leverage them, rate them, and securitize them every single quarter without alignment with the industry and just sell those bonds into the marketplace, […] that won’t be good for you, for the industry,” he said. “And we learned that lesson. When we don’t have alignment with our investors, when groups sell our loans into the market no matter what if the market’s not ready, it’s not good and we learned that at Prosper this year.”
Keynote Presentation by Ron Suber of Prosper at the LendIt USA 2016 conference in San Francisco, California, USA on April 11, 2016. (photo by Gabe Palacio)
What he was saying is that the buyer matters because if they’re repackaging up the product for mass consumption, it is ultimately the original seller (i.e. companies like Prosper) that is being judged for the success or failures of the product’s reception down the line.
A second example stemmed from mismatched projections. You might think it’d be a good thing if a rating agency’s own analysis of your loan portfolio projected even lower loss rates than you projected on your own. Not so, and this actually happened; Moody’s projected loss rates for the loans packaged inside of Citigroup-issued Prosper bonds were lower than what Prosper projected itself for the same vintage. So when default rates were on pace to exceed Moody’s aggressive projections (and fall in line with Prosper’s), news of an impending bond downgrade due to allegedly poor performance roiled the market. The media interpreted Moody’s adjustment to mean that something was wrong with Prosper, not that something was wrong with Moody’s initial assessment.
Suber summed these experiences up by telling the audience, “we must control our story.” That’s a challenge because Wall Street loves to commoditize things, especially loans. The value goes up, the value goes down, and Wall Street will sell it if there is a buyer for it without any regard for the story. What to do then?
CommonBond CEO David Klein said on a panel in late March that marketplace lenders will look to tap back into individual investors, that there will be a return to the industry’s peer-to-peer roots.
Fundera CEO Jared Hecht, a co-panelist, said that “retail investors are more loyal to a specific platform” and that this can create a “network effect.”
The problem of course with retail investors, aside from the steep regulatory hurdles to sell to them, is the comparably slow speed at which they allow a platform to scale. The downside for any company that takes this organic approach is that they could grow so slowly that they get eclipsed by everyone else.
But perhaps the underlying issue is that some companies that originally set out to be peer-to-peer lenders have succumbed to this identity of being “online lenders.” That’s a problem because traditional financial institutions can use technology to lend online too and the Internet will eventually become the standard medium for all lending. That means that soon being an online lender will just mean being a lender period. And if you are just a lender, well then Wall Street will indeed take advantage, control the story and charge their standard fare just for playing the game.
The price? One soul.
And once you sell yours, it’s hard to get it back.
Jim Cramer Unimpressed With Square Capital’s 4% Bad Debt
May 6, 2016
Jim Cramer told TheStreet that he wasn’t impressed by Square Capital’s 4% bad debt because as he put it, the average default rate on credit cards is about 2.67% right now. That comparison belies the fact that Square’s customers make payments daily, the cost of capital is more expensive than a credit card, and that Square did little or no underwriting to achieve these results.
In fact, a study conducted jointly by deBanked and Bryant Park Capital last year determined the average industry (SMB Lending & MCA) default rate to be 6.4%. Square if anything, is outperforming some of their successful peers and given some recent structural changes, they probably stand to improve even further.
OnDeck’s default rate is reportedly about 7% and that’s with an underwriting model often touted as revolutionary.
The comparison between credit cards and Square Capital’s daily payment product is interesting but misleading. Nonetheless, Cramer appears to be unimpressed with alternative lending in general. “Is Square going to be like an On Deck and Lending Club? We don’t want that,” he said, referring to their recently depressed stock prices.
Three days ago, Cramer made his views known through a tweet.
I do not like these new kinds of “banks” https://t.co/DO33G0cBCz
— Jim Cramer (@jimcramer) May 3, 2016
You can watch his comments about Square Capital, OnDeck and Lending Club below:
So far his analysis is quite the opposite of what it was imagined to be 18 months ago.
Online Lending APR ‘SMART Box’ To Apply To Loans, Not Merchant Cash Advances
May 5, 2016
OnDeck, Kabbage and CAN Capital have launched an initiative to make online loan shopping easier. Dubbed the SMART (Straightforward Metrics Around Rate and Total Cost) Box, these lenders plan to present small businesses “with a chart of standardized pricing comparison tools and explanations, including various total dollar cost and annual percentage rate metrics that enable a comprehensive pricing comparison of loans of equivalent duration.”
The Box, clearly meant to increase transparency, was explained in an ironically confusing way, particularly where it said it would include annual percentage rate metrics. An Annual Percentage Rate (APR) is indeed a representation of several metrics and thus it wasn’t clear if the Box would just include some of these individual metrics and conveniently leave out the APR itself.
OnDeck CEO Noah Breslow for example told Forbes only six months ago that annual terms don’t make sense. “The APR overstates the actual cost of the loan to the borrower,” he said. He was not alone in thinking that way. Several studies have concluded too that merchants don’t always even know what APR represents. Lendio for example, found that two-thirds of small businesses selected the total dollar cost of a loan as the easiest to understand. Only 17.4% said the APR was the easiest.
And there’s another thing, the fact that CAN doesn’t just do loans, they also do a significant amount of merchant cash advances. What role could an APR have there? While the Box’s final system won’t be decided until after the conclusion of a 90-day national engagement period that begins next month, one can only imagine that it might have a Schumer Boxer feel to it.
A Schumer Box explained:
Via: NerdWallet
The syntactic ambiguity in the announcement however was unintentional. A spokesperson for the group (Known as the Innovative Lending Platform Association) said that the SMART Box will indeed include Annual Percentage Rates.
But that’s where loans are concerned…
When deBanked asked about merchant cash advances, Daniel Gorfine, vice president and associate general counsel of OnDeck; Parris Sanz, Chief Legal Officer of CAN Capital and Azba Habib, assistant general counsel of Kabbage, submitted the following joint response:
“As part of the SMART Box initiative, we are interested in engaging with providers of MCA products. Based on consistent assumptions about a small business’s future sales volumes and its ability to deliver the contracted amount of receivables within the period of time estimated during underwriting, the SMART Box could apply to MCA products.”
So long as SMART Box disclosure is voluntary, an MCA company could perhaps employ their own version of it. It just might come sans APR given the product’s history with state regulations. The Association is emphatic however that this concept could be used by MCA companies and others in the small business financing space. After all, the initiative is rooted in transparency for the small business owner, they say.
In September, the Association “will encourage those interested in promoting the responsible development of the small business lending industry to voluntarily adopt or support the model disclosure.”
Given the level of influence these companies have on the industry, the voluntary nature of the SMART Box has the potential to spark an industry-wide box revolution. MCA companies however would need to structure transparent disclosure around their contractual frameworks. But even that could be a good thing. One commercial financing broker for example, posted a redacted service fee agreement to the DailyFunder forum earlier this week that purported to show another broker trying to charge a merchant a 26% premium (26% of the funding amount) for their work. Despite this unusually high cost, the charge itself was hard to find, hidden among fine print on an otherwise benign looking page. Naturally, others in the industry did not respond kindly to it. Even other brokers referred to it as “outrageous,” “nonsense,” or “bs.”
Their reactions make clear that there is a desire for transparency even among the group most often blamed for the lack thereof. Some of the industry’s forward thinkers have told deBanked that a system like a SMART Box is the future of the industry whether one agrees with it or not. And if not for the sake of small businesses and regulators, then for the sake of being able to compete fairly against companies that may be relying on truly hidden fees.
SMART Box. All aboard the transparency train?
Square Capital’s Default Rate is 4%
May 5, 2016
Square revealed today that its Square Capital division had extended $153 million through more than 23,000 advances and loans in the first quarter. The company is still transitioning from merchant cash advances to loans to appease institutional investors. This was not only said at LendIt by Jackie Reses but also reiterated in their Q1 earnings report. “We believe that the transition to a loan product further increases our ability to attract new Square Capital investors,” it said.
Their default rate continued to hover at 4%.
That number is shockingly low considering that under a pure merchant cash advance model they did not conduct credit checks, nor did even they review bank statements or tax returns. Rather the company relied almost entirely on a merchant’s sales history with Square.
This process may have made funding easy but was potentially a hard sell to regulators. As part of their transition to a lending model, all applicants are now subject to a credit approval and have to supply identifying documents. Square also bought an analytics startup less than two months ago to help them make more informed underwriting decisions. This can only mean that if their default rate was 4% with no underwriting, their prowess as a lender will likely increase considerably.
Jim Cramer Tweeted About OnDeck and Online Lenders
May 4, 2016Eighteen months ago and prior to OnDeck’s IPO, I joked about how an online business lender might be evaluated by the mainstream financial media, particularly through Jim Cramer memes.
You can view all of the rest of those on the bottom of this page here.
In the meantime, the real Jim Cramer is not as entertained by these types of businesses. Here’s what he had to say about OnDeck and companies like them:
I do not like these new kinds of “banks” https://t.co/DO33G0cBCz
— Jim Cramer (@jimcramer) May 3, 2016
Meanwhile, below is a video of Jim Cramer talking to Lending Club CEO Renaud Laplanche just 1 year ago when he was more open to the idea:
Video not working? click here
Is The Marketplace Lending Apocalypse Upon Us?
May 3, 2016
Days after rumors leaked that Prosper Marketplace had planned to lay off staff, the WSJ is now reporting that the company is indeed eliminating 171 jobs, closing their Utah office and letting go of their chief risk officer. CEO Aaron Vermut’s salary has also been cut to zero.
The timing for the industry they’re a part of couldn’t be worse. OnDeck’s stock closed down 34% today after Q1 losses and revised projections took analysts by surprise. The source of the pain? OnDeck’s “Marketplace.” The institutional investors typically willing to pay a high premium for loans disappeared, according to OnDeck executives on the earnings call.
Unsurprisingly, Prosper’s “Marketplace” has historically relied on institutional buyers for their loans too, as much as 92% of all loans on the platform in fact. Prosper’s roots as a peer-to-peer lender don’t make it an ideal candidate to just shift loans to their balance sheet like OnDeck, which could make the changing capital markets landscape even more painful for them.
Two months ago, Prosper raised the interest rates they charge, citing a “turbulent market environment.” And just weeks ago, Citigroup announced that they would no longer buy loans from Prosper to package into bonds. Now, signs of stress are finally starting to show.
And then there’s Lending Club, a “marketplace” rival to both Prosper and OnDeck, who experienced a 10% decline in its stock price today. The company’s model is under fire through a class action lawsuit that alleges among other things that they along with WebBank are Racketeer Influenced Corrupt Organizations. Lending Club plans to release their Q1 earnings on May 9th.
And it’s not just the capital markets and lawsuits shaking up the landscape. Half a dozen trade associations have been formed over the last few months to quell some of the negative rhetoric surrounding online lending in Washington and to educate policymakers on the positive aspects of these services.
In the Illinois State Senate for example, a pending bill has the potential to outlaw all nonbank business lending altogether.
Some of those that broker business loans have already fallen on hard times due to things like the cost of leads skyrocketing.
“Anybody can fund deals – the talent lies in collecting the money back at a profitable level,” said Capify CEO David Goldin in deBanked’s most recent magazine. “There’s going to be a shakeout. I can feel it.”
The early signs of that prediction may finally be starting to unfold.
After the Lendit Conference last month, I speculated that marketplace lending euphoria ended because the relationship between investors and platforms was in some ways based on lust, not love. The breakup is now starting to manifest itself in the form of missed earnings and layoffs.
Is the apocalypse upon us? Probably not yet, but these foreshocks are a good sign that we’ll soon be separating the wheat from the chaff.
Make sure to wear your hazmat gear as you enter the marketplace.
OnDeck Disappoints: “Marketplace” in Jeopardy?
May 3, 2016
OnDeck finally bombed an earnings report and marketplace lending (at least their marketplace anyway) is being seriously questioned. The company is now predicting a full-year adjusted EBITDA loss of between $41 million and $49 million, down from the projection they made just three months ago of full-year positive EBITDA of $10 million to $14 million. They had a GAAP net loss in Q1 of $12.6 million.
Any positive details were disregarded by analysts who hammered away at the shifting dynamic of the OnDeck Marketplace. The premium earned on selling off loans to major investors through this channel shrank to a measly 5.7% Gain on Sale Rate during the first quarter. Bank of America’s Nat Schindler pointed out on the call that back when OnDeck was getting a 9% Gain on Sale Rate, that they believed even that number to be undervalued, but that they had said it was worth selling them at a discount to “seed the marketplace.” With the margins now compressed to a point where “seeding the marketplace” is no longer a rational excuse, he wondered why they still sold $123 million worth. “Why not just keep it all? What would happen if you just stopped the marketplace?” he asked.
Stop the marketplace
Stopping the marketplace quickly became the underlying theme of the Q&A session. Previously, 35-45% of their term loans were sold off through Marketplace but they now predict that only 15%-25% will be sold through it in 2016.
David Scharf with JMP Securities asked if and when the company could ever break even assuming there was no marketplace.
Vasu Govil with Morgan Stanley asked “if the risk premiums were to continue to rise, at what point does marketplace funding go to zero? At what point do you decide that it’s not worth doing it and that you want to keep all the risk on the balance sheet?”
OnDeck CFO Howard Katzenberg explained the decreasing margins as a retreat from one type of buyer. “Our marketplace buyers fall into two counts,” he said. “The first is those that buy and want to hold ’til maturity and the other segment buys with the plan on securitizing the loans and selling off the residual position of the portfolio. Given the inherent leverage in the securitization transactions, those buyers historically have been willing to pay higher premiums versus the kind of the more traditional hold ’til maturity investors.”
The appetite from those that plan to securitize the loans has dropped off, the ones that are typically willing to pay more.
Losses today instead of income
OnDeck did book more loans on their balance sheet than they had expected and as a result GAAP rules require them to book a provision expense for them. “So as our loan book grows, we will have a mismatch of the provision expense upfront versus earning interest income over the lifetime of the loan,” Katzenberg said. “Moreover, when we sell a loan through marketplace, we book a gain on sale upfront, which had the affect of accelerating the recognition of income.”
Translation: Booking a loan on balance sheet means recording a loss today while selling a loan through marketplace means booking income today. The first might be more profitable over time but transitioning from marketplace to balance sheet makes the books look worse in the short term.
Originations down
Actual originations grew by 37% year-over-year, missing the 40-50% range projected. OnDeck CEO Noah Breslow was unapologetic about that. “We’re not going to do anything unnatural because of those growth numbers,” he argued. “If we conclude that growing at a slower rate is best for our business then we will grow slower.”
The stock was down 3.82% on the day prior to the earnings release but plunged by nearly 30% in after hours trading.
Online Small Business Lending Task Force Initiated by the ETA
April 30, 2016
The Electronic Transactions Association (ETA) is now advocating on behalf of online small business lenders.
Though you might not have suspected it last week at Transact16, the ETA very much plans to involve themselves in the affairs of marketplace lending. That might not have been obvious from a Bloomberg article that reported that OnDeck, Kabbage and PayPal were forming a splinter organization as an “extension” of the ETA known as the Online Small Business Lending Task Force. Referred to as a new initiative in the announcement, the group’s mission is described as striving to “prevent hasty or overly restrictive regulations.”
But the group’s named lobbyist, Scott Talbott, is also the ETA’s lobbyist. And the three lenders named, were already members of the ETA. When Talbott was asked by deBanked to clarify the relationship between the “task force” and the ETA, he said that the two weren’t separate. The “ETA organized its members to lobby on the issue. It’s what we do every day,” he wrote.
The “task force” merely highlights members in the trade group that share a common interest.
Formed in 1990 and comprising of over 550 companies across 7 countries, the ETA has served the payments industry well. OnDeck, Kabbage and PayPal therefore find themselves in good company and led by advocates with well-established government relationships.
Along with the ETA, the online small business lending industry has found support from the Marketplace Lending Association, the Small Business Finance Association, the Commercial Finance Coalition and the Coalition for Responsible Business Finance.
