After years of rapid growth the industry in the US has gone into reverse
A new breed of online platforms was supposed to upend the banking industry by connecting creditworthy borrowers with investors hungry for yield
It has not quite turned out like that. After years of rapid growth, the industry in the US has gone into reverse, as concerns over the quality of the assets pumped out by the likes of Lending Club, Prosper and Avant have spread a chill across the sector.
Losses have generally been greater than forecast, raising questions about the quality of underwriting and prompting many investors, both individual and institutional, to put buying programmes on hold.
New data from Orchard, a technology and data provider based in New York, shows that volumes across US consumer-loan platforms slipped for a third successive quarter between July and September, dropping 21 per cent to $1.86bn. That was less than half of the peak in the fourth quarter last year.
Some think a big rebound is unlikely. Platforms such as Lending Club did well to grow quickly “but didn’t come up with new schemes to underwrite and to judge creditworthiness,” says Rick Yang, a fintech specialist at NEA, a venture fund in Menlo Park.
He says he has always steered clear of the online lenders. “The value creation was [in] gaining scale, rather than any kind of innovation.”
Executives say they have tightened things. At Lending Club, for example, management has raised rates for borrowers several times this year to account for higher delinquencies and losses. It has improved its “skiptracing” processes, using e-mail and social media information to keep closer tabs on delinquent borrowers.
Meanwhile, it has bent over backwards to keep its big buyers happy in the wake of a governance scandal in May. Philip Bartow, portfolio manager of online lending strategies at RiverNorth Capital Management, which runs one of the big three US mutual funds dedicated to the sector, says he carried out “multiple days of on-site due diligence” at the San Francisco-based company.
Prosper, for its part, has raised the average credit score of its borrowers by 10 points since the turn of the year — a reflection, it says, of its “continued increase in loss-conservatism”. It also removed its chief executive this month, replacing him with the former finance chief.
Both companies have become founder members of the Online Lending Network, a system designed to catch people signing up for multiple loans within a short space of time using old credit information — a phenomenon known as “stacking”.
“There are two parts to growth: getting people to show up at the door, and deciding who to open the door for,” says Patrick Reemts, vice president of credit risk solutions at ID Analytics in San Diego, which supplies software to the network. “We want to prevent the bad people getting in.”
Through measures such as these, Lending Club says it has lured back almost all of the banks and hedge funds that were active earlier in the year.
Everyone you talk to feels good, like the worst is behind us. But until we start seeing it in the numbers you won’t know that it’s done
But buyers, rather than sellers, still have the whip hand, says Matt Burton, chief executive of Orchard. He notes that platforms have been offering discounts for volume, and sometimes sweetening deals with warrants and preferential servicing fees.
“This time last year, there were 30 institutional investors lined up around Lending Club waiting to get in,” says Mr Burton. “Now it’s a much more difficult process; the bars investors are setting are much, much higher.”
He says this year’s credit glitches are a consequence of a headlong dash for growth in the latter half of last year, when platforms relaxed standards while lengthening loan terms. Executives are now chastened and running better businesses.
“Everyone you talk to feels good, like the worst is behind us,” he says. “But until we start seeing it in the numbers you won’t know that it’s done.”
Some investors may feel burnt by the year’s performance, however. One investor, Nate Chenenko, says he is not hanging around to find out. He opened a Lending Club account in January this year and within weeks regretted it. Two of the five-year loans he had invested in were charged off almost instantly, without a single interest payment. By the summer another couple had gone awry.
The 30-year-old consultant from Rochester, New York, was not invested in the riskiest loans, ranked F, G and H on the company’s seven-point scale. His were ranked D and E, and he had picked out loans where the borrower had declared a debt-to-income ratio of less than 10 per cent.
Now he says he won’t be buying any more loans and will reinvest his interest income elsewhere.
“The early indications are startling enough to me, enough outside my comfort zone, that I’m pulling out completely,” he says.