|Gilles Gade, founder of New Jersey-based Cross River Bank|
Prosper Marketplace chief executive officer Aaron Vermut has announced a 28% cut in the marketplace lender’s workforce along with the shuttering of its Utah office, which focused on loans for elective medical procedures.
The news came after first-quarter loan volume at Prosper declined 12% year-on-year from $1.1 billion to $973 million.
Vermut joins rival online platforms OnDeck and Avant in reporting a slowdown in loan growth this year: OnDeck reported a loss of $13.4 million on revenue of $62.6 million in the period and first-quarter loan growth at Avant is down 27% year-on-year.
Given the breakneck speed at which these firms have been growing it is hardly surprising they are hitting some snags along the way. The industry has been growing at 123% a year since 2010 and Prosper grew revenues from $81 million in 2014 to $200 million last year.
Vermut says he is now focused on building more resiliency into the company rather than just growth.
The slowdown at some marketplace lenders will come as little surprise to close watchers of the industry and it is an illustration of the urgent need for these platforms to address their business structure: particularly in regards to regulation and funding.
“Every industry stumbles at some point,” observes Gilles Gade, founder of New Jersey-based Cross River Bank, which acts as agent bank to 20 online lending platforms.
“The legacy lenders have been regulated for a long time, but for the pure technologists this is all new,” he tells Euromoney. “Regulation will level the playing field between technologists and legacy players.”
Gade established Cross River in 2008 to focus on this sector.
Marketplace lending platforms need to match borrowers and lenders at the same pace – since they lack balance-sheet capacity – a trick that many of them are finding fiendishly difficult as institutional investor sentiment towards the sector cools.
OnDeck managed to sell just 26% of loans to investors in the first quarter of 2016, down from 40% in the fourth quarter last year. It runs a hybrid model using both balance sheet and a lending platform and recently signed a partnership deal with JP Morgan.
Gade at Cross River emphasizes the contrast between online lending platforms, such as Prosper and the legacy loan providers that his bank partners with such as loanDepot, Marlette Funding and BorrowersFirst.
“The pure technologists face an uphill battle,” he predicts. “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.”
What these young companies therefore need is to cement their funding relationships to smooth out their loan origination rather than be forced to cut back in line with capital market appetite for their paper.
Prosper, having been an early adopter in the securitization market through its tie up with Citi, has now severed ties with the US bank after yields for the lowest ranked tranches in its ABS deals ballooned from 7.3% in late 2015 to 12.5% in March this year.
Although an uptick in default projections for three Prosper securitizations has raised questions over the credit quality of some online loan pools, the spectre of tougher regulation is perhaps a greater challenge that marketplace lenders have to face in attracting long-term capital to this sector.
“The technologists may hit stumbling blocks along the way, which is what we are experiencing today,” says Gade. “New regulation and Madden versus Midland Funding are examples of stumbling blocks and it may take them longer to adapt.”
Cross River works with 18 live platforms and is passive co-back-up bank for Lending Club, which issues loans through Utah-based WebBank. It has an agreement with one other lender. Gade believes that banks such as his must take skin in the game for the industry to succeed.
“We like this paper,” he says. “In our view, you either believe in these loans or you don’t. We believe in having skin in the game all the way through. We have a holistic approach, which is our whole strategy behind the industry.”
That skin in the game takes two forms. With most platforms, Cross River takes a random selection of loans onto its own books. With one platform it puts the loans into an SPV and takes a vertical slice of each loan.
“We made a conscious decision before the Madden versus Midland Funding case to be involved in the loans in the longer term,” Gade explains. “We are not here to simply pass the loans on – we have been taking loans on to our books since 2014.
“We currently take loans from six of the 20 platforms that we work with and are keeping up to 10% of the volume to maturity, provided we preserve our capital adequacy ratios.”
It should be noted that while Cross River takes loans from six of its 20 platforms, it therefore does not from the other 14.
The breakneck growth of marketplace lending has been fuelled by the use of agency banks such as Cross River and WebBank, and Gade is adamant that for this business model to survive then taking skin in the game is inevitable.
“If you want to be a true lender, you have to own the loan,” he states.
“We are one of the stakeholders all the way through. The consensus seems to be that retaining a 1% exposure is enough. We have the capacity and are happy to retain 5% to 10% of the loans. We have a strong risk tolerance for that. We may not go all the way down to the 1% threshold, but will likely hold somewhere between 1% and 5%.”
The results of the US Treasury’s RFI on marketplace lending are due out shortly, and the expectation is that some form of risk retention will be on the cards. If it is, the quality of loans that online lending platforms issue via agency banks will be under sharp scrutiny.
“If you are a legacy player, you know a thing or two about compliance and underwriting – you don’t need to be told how to book a loan,” Gade points out.
“You have liquidity channels and 300 people in compliance – these are 800lb gorillas. We are very confident in their ability to originate. We believe in their underwriting standards and are comfortable with their compliance management.”
If agency banks are required to take a slice of every loan they issue, then that will have to be the case for every platform they work with – including the pure technologists.
Bullish forecasts of a further doubling of loan volumes at many marketplace platforms this year have now been tempered by the harsh reality of finding investors to fund this growth. As Euromoney reported in its May issue, this could lead them to refocus their efforts on retail distribution as more fickle institutional money looks elsewhere.
Matching borrowers with lenders is what these platforms were set up to do: finding borrowers isn’t the problem; matching them with funding at an attractive cost is.
The sector needs to work harder than ever to establish stable, predictable securitization platforms fed by loans originated by agent banks with a clear interest in their long-term performance.