Lend A Helping Hand
Suggestions for Online Lenders to Stay Relevant
Over the last few months online lending darling, Lending Club has been under scrutiny. Lending Club was once the example many people pointed to on how the banking system would be disrupted forever. But now after issues over transparency, a CEO resignation, and the stock price being well below the IPO price, questions are arising about the legitimacy of the online marketplace industry. If you want to get caught up on the current pressures that are facing the industry I suggest you check out this great TechCrunch article by Connie Loizos this week.
The online lending space’s messaging has always revolved around the belief that their technological tools and transparent processes enable these companies to quickly provide a superior investment opportunity for institutional and accredited investors. But with problems arising from Lending Club associated with the misrepresentation of loans and a general nervousness displayed by Wall Street and other institutional investors, these online lending players will have to do what they do best — originate loans. Because let’s face it these business models are only as good as the quality and number of loans the companies can originate.
But it’s not all gloom and doom from my perspective. I come with a ceremonial olive branch for the incumbents and startups in the online lending market. Unlike the media’s narrative that the sky is falling and lending platforms are a failed attempt at disruption, I believe this down period in the sector will filter out the pretenders and leave the banked and underbanked with quality options for loans. I am still bullish on the lending (debt and equity) platforms sub-sector and have detailed four different paths for lending platforms to utilize to weather the storm during this down period.
Suggestion 1: Build & Prove Your Predictive Algorithm
The rise of peer to peer lending marketplaces was a result of gaps left by the banks during the last recession and the reluctance by the industry to incorporated technology. Since the economic downturn in 2008, banks have left specific markets such as student loans and small business loans. Online lenders have always stated that their platforms feature algorithms that enable the company to quickly assess loan applicants and continue to learn from more data — a cost and operations advantage to traditional banks. Many companies claim to have this competitive advantage but only time will tell. I suspect the very best online lenders will develop this technological advantage but it is important that they share their high-level insights and data points (low default rates and successfully assessing risky loans) as proof.
Suggestion 2: Bundling of Lending Services
Another path to relevance and success will be players that diversify their loan offerings by expanding to other lending markets. We’ve seen this from fintech startups such as So-Fi, who originally launched a student lending platform but now has expanded to small business and consumer loans. While the fintech industry introduced us to the unbundling of the traditional bank, I expect that the next stage of “Rebundling of banking services” will occur through expansion of product offerings and consolidation in the overall fintech market.
Suggestion 3: Banks Acquiring Online Lenders
Many banking professionals have questioned how disruptive online lenders and peer to peer marketplaces have really been given banks, investment banks, hedge funds, etc involvement as institutional investors. Due to the transaction speed that online lenders possess, some banks have even developed strategic partnerships with the fintech startups so that they have a stronger presence in markets that they previously felt were not profitable. These joint ventures will continue to occur in the next couple of years for two reasons: 1) Online lenders have built superior platforms and processes and 2) Unicorns will begin to feel pressure from venture capital investors to continue growth or find a respectful exit opportunity. Banks will more than likely offer higher exit opportunities than merger opportunities with other unicorns that are nervous about the IPO market.
Suggestion 4: Bring in Retail Investors
The most unbeaten path for online lenders is finding a replacement for the institutional investors that have funded a majority of the loans that are originated. Another pool of capital could be the retail investing market. Startups like Groundfloor, which is a real estate focused lending platform has built their entire strategy on mobilizing unaccredited retail investors. Now that the immense interest from institutional capital in marketplace lenders is a thing of the past (for right now), the strategy to seek out retail capital could become more common — if the online lender is willing to take on the associated regulatory costs and limited upside. I expect some fintech firms will leverage the Tier 1 Regulation A+ offering, which is a lower cost, lower reporting requirement method to reach non-accredited investors, but it is limited to an offering of up to $20 million.
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