Caveat creditor – The recent travails of Lending Club are a reminder of the risks of P2P lending
The problem with setting yourself up as a more honourable, more transparent and generally more lovable alternative to an incumbent industry – as peer-to-peer (P2P) lenders have looked to position themselves in recent years in relation to banks – is it is all the more noticeable when your behaviour starts to resemble those of the businesses you are trying to supplant.
May has thus proved a challenging month for the P2P sector – now increasingly billing itself as ‘marketplace’ or ‘online’ lending – as Renaud Laplanche, the founder, chairman and chief executive of leading player Lending Club stepped down following what this FT article described as “an internal probe into the alleged mis-selling of loans”.
In response to the news, Lending Club’s share price dropped by more than a quarter to below $4 (£2.74) and, by the end of the month, it still stood at less than a third of the $15 at which investors bought into the company at its IPO in December 2014. To begin to pinpoint where it might have gone wrong for the business, see if you can spot what the following two quotes have in common.
This is from Peer review , one of the first pieces The Value Perspective wrote on P2P, back in January 2014: “Peer-to-peer lending businesses make money by charging people around 1% of the money they invest. As such, they are more incentivised to grow their overall assets under management than they are to investigate thoroughly the creditworthiness of potential borrowers.”
And this is from another FT piece: “A key selling point of online lending has been that the digitisation of the loan process means that data is easier to analyse and, critically, more trustworthy. But as we’ve argued before, it’s wrong to assume that greater transparency and detail equals greater accuracy, particularly when the key issue in lending has always related to incentives rather than information.”
Of course you spotted it – P2P business are very heavily incentivised to grow their loan books. They tend to have high earnings multiples or high funding-round multiples and so, to maintain their valuations, they need to ensure everyone is doing all they can to grow their revenues and earnings. Sometimes everyone doing ‘all they can’ can mean someone doing ‘more than perhaps they should’.
In the case of Lending Club, this involved originating a number of mortgages and packaging them up into products it then sold to Jefferies – even though it knew the loans did not fit its investment bank client’s criteria. It was later discovered Lending Club had also been changing the application dates on some loans and, worse, had been investing in a fund that was a buyer of Lending Club loans.
If this all feels very ‘2007 banking sector’, there is a pretty good reason for that – and, as we said at the start, it is all the more striking for coming from the supposedly squeaky-clean world of P2P lending. And as the FT suggests, the possibility that Lending Club under Laplanche “may have overreached, in his efforts to push loans out the door” could well have long-term implications for the sector.
According to one analyst quoted by the paper, “the big problem is that Lending Club is seen as a bellwether for the sector” – although investors in P2P lending will be hoping against hope none of the company’s own peers have been following it down its most recent path. They might also be asking themselves – purely hypothetically, of course – what it would mean if a big P2P lender were to go bust.
As we also observed in Peer review: “If you put your money in a bank account, not only do you have state protection [now £75,000] per person per account, there is also the capital specifically set aside from the bank’s equity to meet any losses on loans so its depositors do not get burnt.” P2P lenders may offer the hope of higher returns but it is all the more reason to be wary. ‘Caveat creditor’, so to speak.
Fund Manager, Equity Value
I joined Schroders European equity research team in 2007 as an analyst specialising in automobiles. After two years I added the insurance sector to my coverage. In early 2010 I moved into a fund management role, and then took over management of two offshore funds investing in European and Global companies seeking to offer income and capital growth.
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