LendingClub – Pioneering Marketplace Lending & Reshaping Financial Services For Years to Come
In a move promising to transform the landscape of global finance for years to come, LendingClub, the leader in the nascent field of marketplace lending, recently filed for its initial public offering. Having now made over $5 billion in loans, the success of this booming fintech juggernaut might now seem inevitable. At this time, however, it is important to understand the state of the world when LendingClub opened its doors, the driving forces behind the need for a new approach to consumer lending, and what this watershed event means for the future of global financial services.
From my desk at American Express in 2007, the financial world was looking bleak. Delinquency rates on consumer loans at the world’s largest financial institutions were growing faster than anyone had ever seen. Markets were plummeting, central bankers were panicked, and seemingly invincible institutions were on the brink of collapse. Simply put, credit, the financial engine that powers economic growth, was broken down, with the plan for repair unclear. Pundits went so far as to predict the beginning of a long decline, even the end of capitalism itself. As banks closed their doors to new customers, where could a person go to finance a new home? How could an aspiring small business owner secure the capital to start up shop?
Amidst the chaos of the financial crisis, a small group of entrepreneurs, led by Renaud LaPlanche, had a new and innovative idea: to reimagine the business of credit by cutting out the middlemen and letting individuals lend to each other through efficient online markets that bypassed traditional banks. The result of this new idea was LendingClub, with LaPlanche at the helm. Seven years later, the company stands atop the industry as one of the most innovative, fastest-growing companies in finance.
In 2014, we deposit checks on our smartphones, transfer cash instantly between friends, and automate the payment of all of our bills, but before the term “fintech” was a household word, online banking was decidedly “web 1.0.” Each major bank had a website, but it was basically an online – and less personalized – version of what customers could do in a branch. Banking remained a centralized affair. Of course, a key effect of the internet is the decentralization of everything it touches. On marketplace lending websites, consumers and businesses can now apply for a loan not just from one bank, not just from one loan officer, but from thousands of potential investors, each with a unique risk tolerance and investment objective.
Having worked in risk analytics at American Express and Citigroup, the new peer-to-peer lenders came up occasionally in discussion. Fascinated by the open availability of information, the more analytically enterprising among us began to experiment with the data in our free time. The first person I knew to seriously invest on LendingClub was Angela, my then-coworker and now-cofounder. Angela had built her own credit risk model using LendingClub’s performance data and was using it to generate above-market returns. As more of us began to explore the data and make our own investments, we decided to start a meetup group to share ideas with other like-minded people. At our first gathering in early 2013, we met someone we didn’t know existed: an institutional investor in this space.
Over the past few years, LendingClub and similar companies have experienced massive growth. Much of this has been powered by an influx of institutional capital, attracted by the high returns, clear product construct, and predictable risk offered by these loans. On LendingClub, loans are funded by a diverse mix of investors, including institutions such as family offices, regional banks, specialty income funds, business development companies, and corporate investment arms. While there is likely enough interest among institutional investors to buy every loan on the platform, LendingClub has stayed true to its roots as a peer-to-peer market, maintaining a significant and growing volume of retail investors as well. Some industry experts estimate the number of unique individual investors on LendingClub to be north of 50,000.
Since its founding, over 350,000 individuals and businesses have received financing through LendingClub, and the company has the highest customer satisfaction scores in the consumer finance industry. Today, over 80 percent of its borrowers use LendingClub as a means of paying off higher interest rate loans; the other 20 percent use LendingClub for everything from home improvement to vacations. Credit card debt – with interest rates that are frequently between 18 and 27 percent – presents a particularly compelling refinancing opportunity for LendingClub borrowers.
As with any lender, the rate charged to borrowers differs based on the individual’s financial credentials. Those with a stronger credit history and other demonstrated measures of financial stability are charged a lower interest rate than borrowers with less sterling credentials. For the past four quarters, the average interest rate has fluctuated between 14 and 15 percent.
As of June 30, 2014, LendingClub loans had generated net interest payments to investors of $494.3 million, with investors earning a median annualized return of over 8%. This compares with money market interest rates that have ranged from a high of about 1.5 percent to less than one tenth of 1 percent currently, and bank certificates of deposit at around 2 percent. Hence the huge demand in the space from investors and the rapid growth of the platform.
At Orchard, we have witnessed the investor experience firsthand, as institutional clients have used our software to invest over $100MM in the broader sector in the past few months alone. In addition to the promise of a high-yielding fixed-income asset class, investors are attracted by the excellent opportunity for diversification as well as the ability to use vast amounts of data to accurately predict risk and returns. As LendingClub has grown, its credit quality has remained strong, even improving as more data has increased the precision of its underwriting strategy.
Even those investing relatively small amounts have been able to build diversified portfolios due to the availability of fractional lending, where the minimum investment is $25 per loan. Decades from now, we may look back on the creation of fractional investment in consumer loans as one of the major transformative innovations in the history of finance.
The impact of LendingClub’s innovation and growth extends beyond its own investors and borrowers. The company has pioneered a new business model for technology-enabled financial services. While many traditional banks rely on extensive manual processing and legacy technology systems, LendingClub has used automation to drive down the operational cost of underwriting and servicing loans. In addition to decreasing turn-around times for borrowers, these process innovations have yielded an operational expense savings of 425 basis points compared to traditional branch-based lenders, according to a recent study. This
cost savings allows LendingClub and other marketplace lenders to allocate their resources to marketing, improved customer experience, and lower interest rates for consumers.
Most traditional lenders finance their loans through bank deposits, securitization, or institutional lines of credit. While this approach gives lenders committed capital with a known cost of funds, it also limits the diversity of borrowers that can be financed and product types that can be offered. Under the business model of marketplace lending, however, loans and their associated data are placed on a transparent market where diverse groups of investors, from individuals to multi-billion-dollar funds, can decide whether or not to invest. The diversity of investor preferences creates a more efficient market, where a borrower is more likely to find someone willing to fund a loan. In addition, loan originators can take advantage of the diverse investor set to expand their product offerings and scale up quickly without having to renegotiate major credit facilities. For example, earlier this year, LendingClub expanded into small business lending and also entered the business of medical procedure financing with its acquisition of Springstone Financial.
The success of Lending Club and also Prosper – its primary competitor in online consumer marketplace lending – have caught the attention of many, who see the emergence of marketplace lending as a watershed moment and true, irreversible disruption of consumer finance. Venture capitalist Charles Moldow – an investor in Lending Club and other online lending services – predicts that online marketplace lending will reach a critical mass and then display precipitous growth, ultimately taking a 25 to 35 percent share of consumer lending, and reaching $1 trillion by 2025. He notes that consumers have paid one trillion dollars in interest and banking fees over the last decade, an amount that online lending will drastically reduce, freeing hundreds of millions of dollars for productive economic activity. Online lending industry pundit Peter Renton of Lend Academy is similarly enthusiastic about the future. He notes an emerging proliferation of new lending platforms coming to market over the near term – inspired by Lending Club’s success – addressing consumer, business and real estate lending markets in new ways.
As marketplace lending has evolved, its potential to transform the global allocation of capital has captured the imagination of an industry, and, increasingly, the public. Technology, efficiency, and data are rapidly changing the way lending is done around the world, and we are seeing a revolution in the democratization of capital. LendingClub’s inspiring success and IPO is a validation of this vision – a milestone for the industry and just the beginning of a brighter economic future. With tremendous upside and a world of opportunities for borrowers and investors alike, for marketplace lending, the best days are still ahead.