Securitization U-turn behind catastrophe at Lending Club

By:
Louise Bowman
Published on:

Jefferies deal scuppered by loan date changes; Laplanche, Mack investors in Cirrix fund.

Any firm that had just released first-quarter results showing sales up 68% year-on-year, operating revenue up 87% year-on-year and a profit of around $4 million after a loss of $6.5 million the prior year should be feeling pretty pleased with itself.

Lending Club, which has just done this, instead finds itself on “death watch”, its share price languishing at $3.50 on May 13 to give it a market valuation of just $1.34 billion. This for a firm that has $868 million sitting in cash.

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Renaud Laplanche

The fall from grace of the marketplace lender will go down as a classic case study in the risk and impact of fraud on a business. Since news of CEO Renaud Laplanche’s departure broke on May 9, the impact on the business has been brutal.

The firm received a grand jury subpoena from the Justice Department on Monday and now faces a slew of class action lawsuits from investors, many of whom had been nervous about the company for a while: on April 29, the short interest in the stock was already $71.05 million, or 23% of the float.

This is in addition to the class action lawsuit recently filed against it by Ronald Bethune in New York over the breach of usury rates – which has been strengthened by recent Consumer Financial Protection Bureau proposals against arbitration clauses in consumer credit.

It was Lending Club’s decision to embark on a series of securitizations – having previously insisted that such a programme would not be necessary – that proved eventually to be Laplanche’s undoing.

He had made much of the firm’s strong retail investor base, but like all marketplace lenders was struggling to find the capital to match that 68% year-on-year loan growth. It was therefore working with Jefferies on a $150 million deal that was due to launch in May.

It was the selection of $22 million of near prime loans for this deal that triggered the exposure of “a violation of business practices” at Lending Club when it emerged that the power of attorney language in the documentation made them ineligible for the pool – but they were sold anyway.

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Scott Sanborn,
Lending Club

In a letter to investors from the firm’s new CEO Scott Sanborn, it was revealed it had detected changes in the application dates of 361 loans sold to a single investor (Jefferies) and had addressed the issue within 48 hours.

Anxiety

The search for capital to match its growing loan book was also behind the other violation of business practices uncovered at Lending Club. All marketplace lenders are anxiously courting institutional capital, indeed SoFi has established its own fund for this purpose.

Before the Q1 results, however, it emerged that Laplanche had been pushing for Lending Club to invest in a fund, Cirrix Capital, for it to be able to increase purchases of the firm’s own loans.

By April 1, Lending Club had invested $10 million in the fund and Laplanche himself had invested $4 million. Another Lending Club board member, ex-Morgan Stanley CEO John Mack, had also invested in Cirrix Capital.

These interests were not public when Laplanche was encouraging the Lending Club investment: it was only in an April proxy statement from Lending Club that it was revealed that Laplanche, Mack and Lending Club together now owned 31% of the Cirrix Capital fund.

These revelations have unsurprisingly given investors pause for thought. In its 10Q, released five days after the scandal broke, Lending Club revealed that “a number of investors that account for, in the aggregate, a significant amount of investment capital on the platform, have paused their investments in loans through the platform in the last five business days”.

The exodus has been sufficient, however, to prompt a rethink of the entire premise of Lending Club. It now plans to abandon the pure platform structure and use its own capital to fund loans.

“In order to obtain additional investor capital to our platform, we may need to enter into various arrangements with new or existing investors and we are actively exploring several possibilities,” the 10Q stated.

“These structures may enable us or third parties to purchase loans through the platform. Such actions may have a material impact on our business and results of operations, and may be costly or dilutive to existing stockholders.”

Securitization

Given that marketplace lending (MPL) ABS was already trying to put the questions over the speedy deterioration of three ABS tranches backed by Prosper Marketplace loans behind it, the revelation that the leading online marketplace lender was doctoring loan documentation before a securitization was a disaster for the MPL sector.

Both Jefferies and Goldman Sachs, which was also working on an ABS deal for Lending Club, have now suspended purchases of loans from the firm.

Just how much investor confidence has been damaged remains unclear. Research firm PeerIQ spoke to more than 50 investors in the wake of the scandal and found a mixed reaction to the news. Unsurprisingly, dedicated MPL-only funds are continuing to buy whole MPL loans, but have seen an uptick in redemption activity and are focused on reassuring their LPs.

In contrast, many bank investors have suspended purchases although they plan to resume when successful audits have been completed. Prospective investors in the space have, however, taken fright. Many large asset managers that PeerIQ spoke to are postponing any whole loan purchases for six to 12 months and some are cancelling their investment plans altogether.

The highest-profile example of this is Blackstone, which has abandoned its plans to enter online consumer lending through proprietary platform Lending.com. The project was announced in October with the platform offering more than $1 billion capacity to offer loans in partnership with retailers at the point of sale.

Blackstone is now understood to have let the team behind Lending.com go, including its ex-American Express head Jason Hogg, and has shelved its plans.

Existing buyers of MPL-backed ABS paper remain eager for new deals, according to PeerIQ, maintaining that recent events impact equity and are not credit material. They anticipate wider ABS spreads because of reduced participation at auction and will increase scrutiny on wholesale prices into the SPV.

Prospective investors in MPL ABS are now requesting loan-level transparency and demanding “agreed upon procedures” reports for deals and enhanced disclosure.

The move by Lending Club away from being a “pure technologist” platform towards becoming a balance-sheet lender calls into question the entire premise of MPL, which the firm was such a pioneer in developing. It is, however, something that some veterans in this industry have foreseen.

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Gilles Gade,
Cross River Bank

Speaking to Euromoney before Laplanche’s resignation, Gilles Gade, founder and CEO at Cross River Bank in New Jersey, stated: “The pure technologists face an uphill battle. Their knowledge base of compliance and underwriting is not as robust as that of the legacy lenders.

“However, they are good at marketing and originating loans – on that front they have a leg up. The legacy lenders have been regulated for a long time, but for the pure technologists this is all new. Regulation will level the playing field between technologists and legacy players.”

The disrupter is now morphing back into the disrupted, but as its first-quarter results showed, the Lending Club model was working. If other platforms are not to suffer the same fate it is essential that institutional money can be attracted back into this sector and the blowback from this scandal contained.