p2p lending

Marketplace Lending and Investing Conference (Part 1)

Source Media’s Marketplace Lending and Investing conference kicked off today with a bang. During the opening keynote, two VPs at Goldman Sachs predicted that the industry would shift to retaining loans on balance sheets instead of continuing with the gain-on-sale model. The irony is that OnDeck appears to be going in the opposite direction since their recent path to profitability is being made possible by their new reliance on gain-on-sales.

The available solutions presented to small business financing problems at the conference covered the entire gamut. Pango Financial president Candice Caruso for example, explained that small businesses can get funding by rolling over money from a qualified retirement plan. Pango’s model capitalizes on The Employee Retirement Income Security Act of 1974 (ERISA), a 40-year old law that can be streamlined with the help of technology. ERISA established the regulation that allows for a private company to use retirement funds as business capital through an Employee Stock Ownership Plan (ESOP).

Companies like Pango have found a clever way to scale the benefits out of old policies and it’s opportunities like these that have everybody excited. QED Partners founder Frank Rotman summed it up best when he recited his own Wall Street Journal quote, “It feels like the Internet in 2000. Everyone is chasing it, but they aren’t sure what ‘it’ is.”

Rotman also cautioned lenders who are trying to throw money at technology as a fix to scale their businesses. You can’t just throw money at technology, he argued. “Technology needs to be in your DNA.”

For marketplace lenders like QuarterSpot, they fit that bill well. Their CEO Adam Cohen was the Chief Software Developer for JetBlue Airways.

And among some of the other names in attendance, many are on the fast track for success. Expansion Capital Group for example just closed a $25 million credit facility with Northlight Financial and Bastion Management. And there’s also Pearl Capital who was recently acquired by Capital Z Partners. And Herio Capital, founded by one of OnDeck’s earliest employees, recently reached a new funding milestone.

At the end of the day, Anjan Mukherjee, the Counselor to the Secretary and Deputy Assistant Secretary for Financial Institutions of the U.S. Treasury Department told attendees not to bank on regulatory interest being forgotten about with a new presidential administration. Certain agendas can be “de-emphasized”, he said, but overall at least as far as the Treasury is concerned, enough important people will not transition away. They won’t forget everything, he explained.

Alternative Lenders Are Waiting for a Shakeout

Back in April at the LendIt conference in New York, the big consensus was that not all underwriting was created equal and therefore several players wouldn’t survive long enough to make it back to LendIt in 2016. Six months later at Money2020 and so far everyone is still standing.

Loan terms are getting longer, rates cheaper and the cost to acquire borrowers higher. Somebody has to be feeling the pressure but in a rather benign economic and regulatory environment, it’s clear skies.

Valuations are soaring. SoFi is valued at more than $4 billion and Kabbage at more than $1 billion.

But Robert Greifeld, the CEO of Nasdaq warned attendees about the validity of private market valuations. “A unicorn valuation in private markets could be from just two people,” he said. “whereas public markets could be 200,000 people.” At best he described a private market valuation as being just a rough indicator.

And some wonder if these valuations are based on just scale, rather than the ability to underwrite more intelligently and efficiently than a bank. OnDeck for example, had a Compound Annual Growth Rate (CAGR) in originations of 159% from 2012-2014 when the average originations CAGR for their peers is currently 56%. But OnDeck has the advantage of time. With nearly a decade of data under their belt, they’ve been able to see what works and what doesn’t.

“You have to have enough bad loans to build a good credit model,” said OnDeck CEO Noah Breslow during a Money2020 panel discussion.

For Aaron Vermut, CEO of Prosper, getting their company to the next level was about having access to institutional capital. As a marketplace, and as a company that almost died several years ago, he pointed out, institutional money was the inflection point for them to grow. The peer-to-peer model that actually depended purely on “peers” is what held their company back.

One thing several lenders seemed to agree on was the limited applicability of FICO. FICO is not the thing to use for a small business loan, said Sam Hodges, Managing Director and Co-founder of Funding Circle. His words didn’t come as a surprise since credit scores are generally the domain of consumer lending.

But doubts about FICO’s ability to predict performance didn’t just come from the commercial finance side. Prosper’s Vermut explained that consumers still think their FICO score is the most important factor in the rate they get. So even though they’ve got a system to predict repayment outside of FICO, they’re kind of forced to incorporate it because consumers are being educated to believe that’s what matters most.

The irony was not lost that as Vermut said that on a panel, he was seated next to Kenneth Lin, the CEO and founder of Credit Karma, a company that educates consumers about credit. “A credit score is one of the most important components of a consumer’s financial profile,” says Credit Karma’s website. Such language puts a tech-based lender with their own scoring model perhaps at odds with what their own prospects believe.

For instance if a potential borrower with a 750 FICO score is offered a high interest rate because the lender’s advanced and more in-depth underwriting determined them to be high risk, they’re going to walk away confused.

That of course begs the question, who needs to change? Those educating consumers about credit scores or the lenders who are moving away from them?

Before educational services shift though, it would probably make sense if the lenders can prove that their non-FICO dependent systems will work in the long run. And the sentiment among many lenders is that there are plenty of flawed models out there that will inevitably fail. That makes a shakeout not just a matter of if, but when.

Six months after LendIt, everybody is still standing. Whispers from in and around Money2020’s halls and exhibit floor revealed that the confident lenders wish the correction would happen sooner rather than later but that they are prepared to wait however long it takes.

Right now, confidence about the future on the commercial finance side came in at an 83.7 out of 100, according to the Small Business Financing Report. While there are no other points of reference to compare that to, industry captains are generally very bullish.

That could mean that for those secretly under tremendous pressure already, you could be left waiting for a shakeout for a very long time.