All’s not well in peer to peer lending

Lending Club is the biggest marketplace lender (aka MPL, aka peer to peer lender, aka P2P lender) in the world. And it’s in serious trouble.

Lending Club (NYSE:LC) is the biggest marketplace lender (AKA MPL, AKA peer to peer lender, AKA P2P lender) in the world. And it’s in serious trouble.

Its CEO, Renaud Laplanche, has gotten the sack. He’s accused of making secret investments in a company which buys Lending Club’s loans. And an audit has found evidence of fraud on other loans.

Back in March I wrote about MPL and the ex-FSA chief Lord Turner’s claim that “The losses which will emerge from peer-to-peer lending over the next five to 10 years will make the bankers look like lending geniuses.”

So, was Turner right all along? Does the Lending Club fiasco show that the MPL system is broken? Or was this just caused by a few bad apples?

He had to go

Lending Club’s big idea is that it connects borrowers directly to savers. By cutting out the middleman, (ie the bank), the idea is that borrowers and savers get better interest rates.

Lending Club floated on the stock market exactly one year ago valued at $4.6bn. Its board includes heavyweights like the former Treasury Secretary Larry Summers, former Chairman of Morgan Stanley John Mack, and former Visa President Hans Morris. It’s the biggest company in the fast-growing field of MPLs.

But the IPO was the high point for Lending Club. Renaud Laplanche’s resignation is the latest setback in a miserable year for the company. The market values it at $1.1bn as I write, compared to $4.6bn a year ago.

The stock took a hammering in the aftermath of Renaud Laplanche’s sacking because his transgressions hint at a problem with Lending Club’s business model.

The company is supposed to be a software platform which matches buyers with sellers, not unlike AirBnb or Uber. Like those companies, Lending Circle takes a small cut off each transaction for the privilege of matching buyers and sellers. Like Uber, which doesn’t employ drivers directly, it doesn’t take deposits or issue loans itself.

It works fine for Uber, where a single customer might take ten taxi trips in a month. But Lending Circle can’t rely on repeat business like that. Borrowers don’t take ten loans in a month. So the company has been under constant pressure to find new borrowers and new lenders.

That was fine at first when the company was small and the market was growing quickly. But in the first quarter of this year, instead of being a true “peer to peer” lending platform, 48% of its loans were being made by big banks and hedge funds.

That’s where Renaud Laplanche came a cropper. The two scandals which hit Lending Club last month both hint at the trouble the company is having raising new loans. In one of them, Lending Circle employees fudged lending standards in order to sell loans onto a partner. And in another, Laplanche was backing a separate entity which was buying Lending Circle loans.

MPL is a good idea, but it gets much harder when interest rates start to rise. Rising interest rates mean that MPL’s competitors – ie, banks – can offer more attractive rates to depositors. It also means that the default rates on MPL’s higher risk loans start to go up.

So Lending Club and other MPLs have two problems: they need to keep growing transactions in order to keep growing profits; and the whole game is harder when interest rates start rising.

Lending Club is big in the US, less so here in the UK. Funding Circle is probably the closest equivalent over here. Does all this mean that Funding Circle is in trouble, and likely to collapse at any minute, and you should cash in your loans while the getting’s good?

Well, no. The prospects for Lending Club, Funding Circle and other MPLs as businesses are different to the prospects for the loans on their platforms. Funding Circle will be fine if it doesn’t prioritise growth above all else, like its American rival.

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