Online loan unanswered questions

The following chart from ratings agency Kroll Bond would raise eyebrows in any start-up, but for one online lender in particular, it poses troubling questions (click to enlarge).

That’s the total loans made to Marlette Funding, a Wilmington, Delware-based lender started by a group of former Barclays employees in 2013. It took them just ten months to reach $200 million – a milestone reached by the Lending Club after 5 years, Bloomberg noted. – then just a few more quarters to nearly double that figure to $395 million in Q3 2015.

But at the end of last year, the company’s meteoric growth faltered quarter-on-quarter, with creations dropping 21% to $312.5 million in the fourth quarter of 2015 – even though that remains up 51% year-on-year, a sharp slowdown from the 230% year-on-year growth it had recorded in the third quarter.

The sudden slowdown holds lessons for an industry that has had to dramatically raise interest rates for riskier borrowers to maintain investor appetite and has been facing rising delinquencies since the middle of last year. . What is even more interesting is what he suggests about borrower behavior in online lending.

Outside of consumer advertising, online lenders have basically two ways to find borrowers: the first is direct mail, an analog marketing channel that digital startups have embraced so wholeheartedly that they’ve helped significantly increase letter volumes. The second is aggregation sites, where loans from different lenders are listed together and can be ordered by cost.

These are the sites that have caused problems for Marlette, says general manager Jeffrey Meiler.

“We’ve found, typically in these situations, that brokers or digital brokers … optimize for their interests, and it’s not always in a lender’s interest,” he says.

Some of the dynamics at play are intuitive – if a group of lenders compete on price in a market, the lender willing to push its underwriting standards and pricing is likely to win customers.

Others are a little strange. “The people scrolling down are of lower quality. It’s not just about competition, it’s about placement,” says Meiler. It might have something to do with the general idea that people research a loan thoroughly – and presumably try to find the lowest possible price – are the people who need the loan the most, which, all things being equal moreover, is correlated with poorer loan performance (this is why banks prefer to lend to people who do not need the money). So if you don’t pay the broker for a high-level placement, you end up competing with lesser-quality borrowers.

All this in the context of an industry that had 163 online lenders in 2015, according to IbisWorld, compared to just 10 in 2010. All of these companies are trying to grow as fast as possible, even if they are in a business where rapid growth is not necessarily a good thing. Investors have been happy to give these companies ample cash to lend, with the key dynamic over the past year being a lack of demand from the borrower side, not a lack of cash from end buyers for these loans.

Now the mood has changed. Delinquencies rose on loans from market leaders Lending Club and Prosper Marketplace, which were forced to raise rates to maintain the risk premium for investors who are unsettled by the broader market turmoil. We’ve speculated previously about what these moves might signal for a certain type of American consumer, particularly against the backdrop of rising subprime mortgage defaults.

But taken with Marlette’s experience above, there are other unanswered questions which, to us at least, seem quite interesting (if these questions have in fact already been answered, let us know in the comments ):

1) Where do online loans fall in the debt hierarchy? If you’re someone with a mortgage, car loan, credit card, and loan that you got online through an aggregator site, which one do you stop paying first? It seems likely that your relationship with a website is probably less important to you than your relationship with your credit card or mortgage provider.

2) What did borrowers from online lenders actually do with the money? We know people say they use loans from Lending Club, for example, to pay off their credit card debt, but is that really happening and, if so, how quickly do they top up? their credit card again?

3) Did easy access to online credit make it easier for borrowers to stack loans, meaning they borrowed from multiple websites at the same time? What is the extent of this?

The other thing to consider, as online lenders and their lenders grapple with a changing credit environment after a long period of remarkable calm, is the ability of these companies to collect their debts. Marlette, for example, outsources its collections to a third party. Others have boasted of having no defaults, a boast that leaves them inexperienced in the legally tricky world of debt collection.

Marlette, whose loans were recently bundled and sold as bonds by Citi, describes its slowing growth as a sign of responsible lending. Meiler says reducing their reliance on aggregation sites has improved credit quality.

“We took a step back from the original point of view to make that happen. I think other platforms have taken the lead,” he says.

Related links:
The short history and long future of the online lending industry – Forbes
U.S. online lending credit deteriorates, here’s the data – FT Alphaville
Lending Club raises rates for riskiest borrowers – FT Alphaville

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David A. Albanese