Speaker 1: But knowledge to work and grow your business with c
Speaker 1: i T from transportation to healthcare to manufacturing. C i
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Speaker 1: small and middle market businesses. Learn more at c I
Speaker 1: T dot com put Knowledge to Work. Hello and welcome
Speaker 1: to another edition of the Odd Lots podcast. I'm Joe Wisntal,
Speaker 1: Managing editor at Bloomberg Markets, and I'm Tracy Alloway, Executive
Speaker 1: editor at Bloomberg Markets. Tracy, you sound very distant. Why
Speaker 1: is there? Well, it might be because I'm across the
Speaker 1: ocean from you. I'm over in Abbey Dhabi. Amazing. So
Speaker 1: today is kind of like a special edition of the podcast,
Speaker 1: not just because it's the first one that you're recording
Speaker 1: from Abu Dhabi. We also had a guest lined up
Speaker 1: for today and at the very last second, within the
Speaker 1: last few minutes, and we're not going to name them
Speaker 1: because that wouldn't be right, but within the last few minutes,
Speaker 1: the guest pulled out, so because they were nervous. So, Tracy,
Speaker 1: what's going on. There's a big scandal and a guest
Speaker 1: that was going to talk got nervous. What's happening? Yeah,
Speaker 1: for once, it's a scandal that has uh well, that
Speaker 1: doesn't come directly from the banking industry. Instead, it's something
Speaker 1: to do with what's known as peer to peer lending
Speaker 1: or also known as marketplace lending. And we'll get into
Speaker 1: why it's described by two names, but basically, we had huge,
Speaker 1: huge news out of one of the first ever peer
Speaker 1: to peer lenders earlier this week, the CEO resigned amid
Speaker 1: a major scandal. The shares went plunging. The company is
Speaker 1: now worth, you know, basically a fraction of what it
Speaker 1: used to be worth, and we are going to dig
Speaker 1: into why all that happened. Awesome, I can't wait. So
Speaker 1: our guest, who is very familiar with this industry, given
Speaker 1: the heat going on right now, it decided not to talk.
Speaker 1: But let's step back. So we have this industry. Oh well,
Speaker 1: let's the good news is that, Tracy, you're an expert
Speaker 1: on this industry and you've been following it essentially sinceince inception,
Speaker 1: and frankly, you're probably the best guest for it anyway.
Speaker 1: So let's take a step back. Years ago, idealists founded
Speaker 1: this concept called peer to peer lending. Rather than going
Speaker 1: through banks, you could borrow money online you could go
Speaker 1: on lend many money to your peers. It was supposed
Speaker 1: to disintermediate the traditional financial system. Tell us about this
Speaker 1: origin of peer to peer lending, how it started, and
Speaker 1: where we are. I guess that's kind of ambitious, but
Speaker 1: I think we can do it. I believe in us,
Speaker 1: all right. It actually started before the financial crisis, and
Speaker 1: there were a couple of companies that came up with
Speaker 1: this idea of us sing the internet using online platforms
Speaker 1: to directly match borrowers with lenders. So instead of me
Speaker 1: going to a bank and asking for you know, a
Speaker 1: small loan so I could I don't know, remodel my
Speaker 1: kitchen or something like that, I could go online and
Speaker 1: someone online would agree to fund the loan. So basically,
Speaker 1: you go on, you say I want to borrow ten
Speaker 1: thousand dollars to remodel my kitchen. Here are some stats
Speaker 1: about me, my credit score, how much I make, etcetera.
Speaker 1: And then I might have ten thousand dollars in cash
Speaker 1: sitting around and then say I'll fund that loan. Is
Speaker 1: that basically how it works. So in the beginning, it
Speaker 1: was very unlikely that a single investor or lender would
Speaker 1: be funding an entire loan. Instead, what you would do
Speaker 1: is you would fund small pieces of loans, right, so
Speaker 1: you wouldn't put up ten thousand, but maybe you would
Speaker 1: put five dollars up on the platform so that you
Speaker 1: could buy pieces of various loans of various quality to
Speaker 1: diversify the credit risk exactly. And as a borrower on
Speaker 1: the platform, you wouldn't necessarily say here are all the
Speaker 1: things about me, you know, there'd be some forms that
Speaker 1: you would fill out. But the interesting thing about using
Speaker 1: the online platform to borrow money was that a lot
Speaker 1: of the underwriting process was automated. So you would give
Speaker 1: these peer to peer companies permission to access some information
Speaker 1: about you, um that was available online, and then they
Speaker 1: would automatically go and do that and kind of fill
Speaker 1: out these profiles. And if you were an investor on
Speaker 1: the platform, one of the selling points was that you
Speaker 1: would get really good detail about the person you're investing in. Actually,
Speaker 1: in the early days, you could see all sorts of
Speaker 1: information where the loan was coming from, UM, you know,
Speaker 1: the salary UH employment status of the person. I rememb
Speaker 1: We're going back in two thousand twelve and checking UM
Speaker 1: which bank employees you know, JP Morgan and City Group
Speaker 1: had gone to Lending Club instead of their own banks
Speaker 1: to take out loans. And how were the interest rates set?
Speaker 1: Was it set by the lender or sent set by
Speaker 1: the platform? Well, this was an interesting thing. So the
Speaker 1: idea here was that it was supposed to be a
Speaker 1: marketplace for lending, although that name didn't happen until a
Speaker 1: few years later. However, the interest rates have always been
Speaker 1: set by the platform. Um, you know, I'm sure they're
Speaker 1: in negotiation with investors, especially some of the larger investors
Speaker 1: that they attracted as the years went by, But in
Speaker 1: the beginning they set those rates, all right, So let's
Speaker 1: go ahead. Because when you hear peer to peer lending,
Speaker 1: you think of the sort of idealist people helping each
Speaker 1: other out of sort of makes you think of like
Speaker 1: napster or something like this, like this real organic thing.
Speaker 1: Now that term isn't used so much. They talk about
Speaker 1: marketplace lending, which has a slightly more institutional feel. So
Speaker 1: tell us about the evolution of these idealist sites to
Speaker 1: what now is a bit more um, a little bit
Speaker 1: more grown up, I guess you could say. Yeah, So,
Speaker 1: I mean, let me tell you this from my personal perspective,
Speaker 1: I think that's probably a good way into it. So
Speaker 1: in two thousand and twelve, I think it was I'm
Speaker 1: a reporter at another media outlet. I was covering the
Speaker 1: big banks, including Morgan Stanley, and an ex Morgan Stanley
Speaker 1: CEO John mac joined the board of this up and
Speaker 1: coming peer to peer lender called Lending Club. I wrote
Speaker 1: the story, and after that I kind of took an
Speaker 1: interest in the sector because it had these aims of
Speaker 1: disintermediating the banks. It was after the financial crisis, when
Speaker 1: a lot of the big banks were under regulation that
Speaker 1: they said made it more difficult for them to lend. Basically,
Speaker 1: they were all these factors kind of making a positive
Speaker 1: case for peer to peer lending and certainly making it
Speaker 1: an interesting story at the time. And so I remember
Speaker 1: meeting eventually the CEO of Lending Club, Renault Laplanche, and
Speaker 1: he came in at the time without any pr people,
Speaker 1: any minders. He just came into the office. We had coffee.
Speaker 1: I learned more about this sort of fast growing fintech company,
Speaker 1: and at the time, the message was very much one
Speaker 1: of sort of cutly togetherness, right, Lending Club. We were
Speaker 1: all going to club together and lend directly to one another,
Speaker 1: cut out the banks, cut out the middleman from the transactions.
Speaker 1: Investors or lenders would get higher returns and borrowers would
Speaker 1: get lower rates as a result, and the whole thing
Speaker 1: was called, of course, peer to peer lending. Now, as
Speaker 1: the years went by, the in stry expanded really really rapidly,
Speaker 1: and one of the ways it did that was by
Speaker 1: first of all, making whole loans available to larger investors,
Speaker 1: so instead of buying pieces of loans, you would just
Speaker 1: buy entire ones, and then tapping institutional investors to expand.
Speaker 1: That meant hedge funds, It meant wealth management companies, mutual funds,
Speaker 1: pension funds, insurers, all the big guys. So when you're
Speaker 1: suddenly using these big guys to fund a big portion
Speaker 1: of your loan, you can't or of your growth. You
Speaker 1: can't really call it peer to peer lending anymore, right,
Speaker 1: unless you think your peer is fund And this is
Speaker 1: really key because you know you talked about having met laplanche.
Speaker 1: In this post crisis era has been characterized by this
Speaker 1: multi year search for anything offering higher than normal yield.
Speaker 1: And so, as you mentioned, the um lenders on this
Speaker 1: platform were offered a chance to get more for their money.
Speaker 1: So it only made sense that all these hedge funds
Speaker 1: and other investors looking for yield started seeing the loans
Speaker 1: being generated on these platforms and said, hey, how can
Speaker 1: we start buying them in meaningful size and adding them
Speaker 1: to our portfolio. That's exactly right. So the major selling
Speaker 1: point of peer to peer loans was that they were
Speaker 1: higher yielding, shorter duration assets that were also uncorrelated with
Speaker 1: traditional stocks or bonds. So if everything else was tanking,
Speaker 1: in theory, you could still buy an unsecured consumer loan
Speaker 1: and get a decent return. Now, the kind of crazy
Speaker 1: thing with some of the big guys is that even
Speaker 1: though these peer to peer loans had higher yields, they
Speaker 1: still felt the need to apply leverage to the assets
Speaker 1: to get an even higher return. But the other slightly
Speaker 1: crazy thing, and I think this is all always been
Speaker 1: debated with the model, is that the vast majority of
Speaker 1: these peer to peer platforms, the borrowers on them are
Speaker 1: using them to refinance existing debt. So you're basically buying
Speaker 1: unsecured consumer loans from someone who probably already owes quite
Speaker 1: a bit of money to a credit card company somewhere
Speaker 1: and is just trying to get a lower rate to
Speaker 1: refinance that debt, so, you know, pretty risky. All right,
Speaker 1: let's take a quick break for a word from our sponsor,
Speaker 1: but knowledge to work and grow your business with c
Speaker 1: i T. From transportation to healthcare to manufacturing. C i
Speaker 1: T offers commercial lending, leasing, and treasury management services for
Speaker 1: small and middle market businesses. Learn more at c i
Speaker 1: T dot com put knowledge to work and back. I'm
Speaker 1: here with Tracy Ellaway, my co host but also an
Speaker 1: expert in the world of marketplace lending or peer to
Speaker 1: peer loans. We're talking about the sort of big scandal
Speaker 1: that royaled the industry, and so let's get to this.
Speaker 1: You mentioned before the break that in you met this
Speaker 1: guy Runault la Planche who founded this company called Lending Club.
Speaker 1: He was really in the news. And these last few
Speaker 1: days you expect you explained to us how this organization
Speaker 1: and these companies that started off as these peer to
Speaker 1: peer we're all going to lend to each other became
Speaker 1: these entities that started serving institutions and started packaging loans
Speaker 1: and large scale What is the what is the scandal
Speaker 1: that the industry is now seeing and how does Laplanche
Speaker 1: fit into it. Alright, Uh, where to begin? Um? Alright,
Speaker 1: let's start in twenty four December. All right, la Planche
Speaker 1: lists Lending Club on the New York Stock Exchange. It's
Speaker 1: this huge I p O. At the time, it was
Speaker 1: described as a coming out moment for the entire industry.
Speaker 1: They listed a valuation of something like eight point nine
Speaker 1: billion dollars. And I was there on the stock exchange
Speaker 1: floor the day that it happened, and I can tell
Speaker 1: you there were investors there that became instant millionaires. Everyone
Speaker 1: was thrilled. People were amazed at the valuation. To be honest, Um,
Speaker 1: the whole thing was massively oversubscribed. A lot of excitement. However,
Speaker 1: there was also some concern at the time that going
Speaker 1: public basically meant that Lending Club was now under additional
Speaker 1: pressure to maintain its growth. Right, it had to lend consistently,
Speaker 1: and it had to get uh financing for those loans consistently,
Speaker 1: which could be difficult as a public company on a
Speaker 1: quarterly basis. In any case, the company did was it
Speaker 1: went out. It struck a bunch of new agreements with
Speaker 1: big institutional investors that would help maintain its growth and
Speaker 1: one of those investors was Jeffries, which is a financial
Speaker 1: group well known on Wall Street. So fast forward to
Speaker 1: this week and on Monday, Lending Club announces its first
Speaker 1: quarter results, it's earnings for the period, and alongside those earnings,
Speaker 1: it shockingly announces the resignation of Renault Laplanche. And you
Speaker 1: were really surprised. We were both um, we were chatting
Speaker 1: over the Bloomberg ib instant messaging service and I said, Tracy,
Speaker 1: you see this on Plunge news. And I mean, we
Speaker 1: were not together, but I sort of could feel how
Speaker 1: stunned you were at this news. He was resigning, just
Speaker 1: by my messaging to you. When I pointed it out
Speaker 1: to it was completely shocking. So you know, it's basically
Speaker 1: the figurehead of an entire industry resigning amidst scandal. Um,
Speaker 1: It's hard for me to think of an equivalent. It
Speaker 1: was a complete shocker for the industry. Now what the
Speaker 1: announcement actually said, and we're still getting details of this unfolding,
Speaker 1: but the announcement said basically that Lending Club had knowingly
Speaker 1: sold some loans to a large institutional investor, Jeffries, although
Speaker 1: they didn't disclose that particular name at the time, but
Speaker 1: that's come out in our reporter. That's come out in
Speaker 1: our reporting loans that didn't comply with the sort of
Speaker 1: express wishes of the investor. And there was also some
Speaker 1: noise as well around Renault possibly making UM failing to
Speaker 1: disclose a personal investment in a company that Lending Club
Speaker 1: eventually bought. So all a bit of a mess, uh
Speaker 1: and incredibly incredibly disheartening for the entire industry right and
Speaker 1: the stock, the stock it should be worth, it's worth noting,
Speaker 1: has done very poorly ever since going public. There's already
Speaker 1: been ang xiety about this space. But the stock instantly
Speaker 1: plunged on the news. And when I first read the
Speaker 1: news and I said, these loans that they had sold
Speaker 1: weren't exactly what the buyer thought they were getting, you know,
Speaker 1: the first thought that I had was, this just feels
Speaker 1: like the same old Wall Street type scandals from years ago,
Speaker 1: almost exactly a buyer not getting what they thought they
Speaker 1: were getting. Like it seems like the classic old thing
Speaker 1: coming back with this new in this new platform that
Speaker 1: was supposed to change how everything worked. Well, I think
Speaker 1: there are a lot of people that would agree with
Speaker 1: you on that. UM. The issue with lending club and
Speaker 1: with peer to peer in general, has always been disentangling
Speaker 1: the technology of the business, the fintech aspect, from the
Speaker 1: lending side of the business, the specialty finance aspect of it.
Speaker 1: Are these companies actually technology companies or are they just
Speaker 1: sort of direct lenders in disguise or specialty finance companies
Speaker 1: and delays. Let's pick apart this question, because I think
Speaker 1: this is crucial. We actually just had comments from Jamie Diamond.
Speaker 1: He was asked about the marketplace lenders and he said, yeah,
Speaker 1: the platforms are great, the technology is great. It's great
Speaker 1: that people can get approved for loans and fifteen minutes
Speaker 1: as opposed to fifteen days. But on the other hand,
Speaker 1: funding for these companies is unstable, and so he basically
Speaker 1: threw a lot of cold water on the business model.
Speaker 1: So let's pick this apart. Prior to this scandal, how
Speaker 1: are people thinking about the sustainability of the marketplace lender
Speaker 1: business model? So there was always a question mark over
Speaker 1: marketplace lenders ability to withstand a downturn in the credit cycle.
Speaker 1: So you know, when money is no longer as easy,
Speaker 1: are they still going to have all these investors and
Speaker 1: lenders pouring into the platform who are able to finance
Speaker 1: their loan growth. Setting aside completely, the major major question
Speaker 1: of whether or not defaults on the loans that actually
Speaker 1: go through their platforms would rise, which kind of seems obvious,
Speaker 1: you know, in a recessionary scenario, Yes, those defaults would rise,
Speaker 1: But the big issue was actually would they be able
Speaker 1: to continue to fund themselves? And in fact, in the
Speaker 1: first quarter of this year, we kind of got a
Speaker 1: worrying clue about that because we saw a lot of
Speaker 1: investors concerned about the overall credit market stepping away from
Speaker 1: higher yielding corporate debt, and with that, a lot of
Speaker 1: people started to become nervous about peer to peer assets
Speaker 1: as well, and we did see a downturn in institutional
Speaker 1: funding for these platforms. And so why is this different
Speaker 1: than any other funding? I mean, this question of can
Speaker 1: they survive a credit market downturn? But I mean credit
Speaker 1: market downturn to hit everyone. So there's something specific to
Speaker 1: this business model that makes them particularly that raises particular
Speaker 1: questions about the viability of the whole thing. Oh sure,
Speaker 1: I mean I think the answer is there. There are
Speaker 1: trillions of reasons, trillions of dollars worth of reasons. Right. So,
Speaker 1: JP Morgan, for instance, has a massive, massive retail deposit
Speaker 1: base that's there. It's known as sticky funding because people
Speaker 1: tend not to pull it out that quickly. Lending club
Speaker 1: and other peer to peer platforms, by contrast, do not
Speaker 1: have a deposit base. This is why they are not banks. Right. Uh,
Speaker 1: they don't have a deposit base, and that enables them
Speaker 1: to avoid a bunch of the regulatory burden that a
Speaker 1: lot of actual traditional banks have to deal with and
Speaker 1: thus have lower costs, but it also exposes them to
Speaker 1: basically a funding risk. Right, These institutional investors can pull
Speaker 1: their money out fairly quickly, right, So you get I
Speaker 1: wanna you mentioned the regulatory aspect. One argument that people
Speaker 1: say about the new breed of companies is that, yeah,
Speaker 1: the technology is okay, but the real edge is in
Speaker 1: the regulatory arbitrage and that they can do these things
Speaker 1: that traditional bank can't because they're much more heavily regulated.
Speaker 1: And that you know, now with added scrutiny on these
Speaker 1: companies and light of the latest scandal, that also questions
Speaker 1: the frozen to question whether the business model makes sense,
Speaker 1: how how much how important has it been for these
Speaker 1: companies that they're not regulated the same way as a
Speaker 1: JP Morgan or a city or a Bank of America
Speaker 1: is I think absolutely massive. Again, the interesting thing here
Speaker 1: is really to disentangle the technology offering of a lot
Speaker 1: of these companies, because for some of them it's been
Speaker 1: very unclear. So, for instance, Lending Club says it uses
Speaker 1: a proprietary model to sort of gauge customers risk, which
Speaker 1: we were talking about earlier today, right However, it's never
Speaker 1: been ad percent clear what the edges of that new technology,
Speaker 1: that new sort of automated underwriting processes over traditional things
Speaker 1: like PICO scores, you know, traditional credit scores. And in fact,
Speaker 1: we've heard grumbling in the past from people saying that actually,
Speaker 1: you know, of peer to peer lenders, proprietary risk models
Speaker 1: are just FICO scores. They're not actually improving that much
Speaker 1: upon the existing way that credit is extended, which basically
Speaker 1: leaves them with you know, a pretty nice online platform,
Speaker 1: a good customer experience for borrowers, and the added benefit
Speaker 1: of not being a bank and not having historical creaky
Speaker 1: I T systems and things like that. Right on this
Speaker 1: you know, you mentioned that measure of credit risk until
Speaker 1: we have an economic downturn. We really don't know if
Speaker 1: say those you know, their credit measure is hold up,
Speaker 1: or if they'll see a big wave of defaults. We
Speaker 1: just sort of, right, I mean, until that happens, we
Speaker 1: don't know much. Right, that's right. Although, again, you know,
Speaker 1: you're dealing with unsecured consumer lending. A lot of the
Speaker 1: information is self reported on the platforms, although companies like
Speaker 1: lending Club will do their best to try to verify it. Uh. So,
Speaker 1: you know, I don't think anyone would be surprised if
Speaker 1: we saw an uptick in defaults once we had a recession.
Speaker 1: The question is, uh, the degree to which that happens,
Speaker 1: and again, the degree to which that scares off investors,
Speaker 1: both the little guys, the you know, mom and pop
Speaker 1: retail investors, and more importantly, the institutional guys. All right,
Speaker 1: let's throw this uh, let's wrap this up and throw
Speaker 1: this forward a little bit. So these stocks, Lending Club
Speaker 1: is one, there's another one on deck. It's been absolutely
Speaker 1: creamed lately. Everyone is trying to figure out the answer
Speaker 1: to the question that you just alluded to, which is
Speaker 1: is this is sustainable business or did they just build
Speaker 1: fancy websites that would look good as a bolt on
Speaker 1: to a traditional bank. What's your what's your guests? Where
Speaker 1: is this industry in a few years Do all these
Speaker 1: companies just get snapped up by the major banks? Do
Speaker 1: they thrive on their own? If they if the sort
Speaker 1: of business model and the lending model works, where do
Speaker 1: you see things going next? So this is the million
Speaker 1: dollar question. And I have to be really careful what
Speaker 1: I say here. I think it's fair to say and
Speaker 1: to point out that for the past few years, the
Speaker 1: environment for marketplace peer to peer lenders, whatever you want
Speaker 1: to call them, has been nothing short of fantastic. Remember,
Speaker 1: you had all these people upset about the banks after
Speaker 1: the financial crisis. You had the low interest rates that
Speaker 1: drove a lot of investors onto the platforms seeking higher yields,
Speaker 1: and that also made it easier for people to borrow
Speaker 1: money from the platform is cheaper for them to do that, um,
Speaker 1: And you had a sort of lack of regulatory scrutiny
Speaker 1: for want of a better word. And despite all those
Speaker 1: tail winds, basically, uh, we've seen the sector run into
Speaker 1: some significant problems over the past couple of months, including
Speaker 1: those credit concerns and now this scandal. So it's a
Speaker 1: really really good question whether or not the industry can survive.
Speaker 1: I do think there's a value prospect. You know, these
Speaker 1: companies do have better technology on some things. They have
Speaker 1: more efficient loan application processes. God knows that millennials um
Speaker 1: like you and I. If we're applying for a mortgage,
Speaker 1: I'm not entirely sure we're going to be walking into
Speaker 1: the local city bank to do it. You know, the
Speaker 1: idea that we can just go online and do the
Speaker 1: paperwork that way and get a sort of instantaneous response
Speaker 1: is definitely an attractive thing. How hard is it, you know,
Speaker 1: if you had to guess, Obviously, the CEOs of major banks,
Speaker 1: they're all under pressure. They all feel like they have
Speaker 1: to catch up in terms of and invest in fintech.
Speaker 1: Looking around, do they you think they'll make the calculation
Speaker 1: that they can rebuild that good of a user experience
Speaker 1: and essentially offer the exact same thing. Or do these
Speaker 1: companies you think have good enough technology that it would
Speaker 1: be worth just sort of buying or will it be
Speaker 1: a mix? I imagine it will be a mix. And
Speaker 1: we've already seen some of the bank's partner up with
Speaker 1: peer to peer lenders, which is kind of weird when
Speaker 1: you think about it. Uh, but that could continue going forward.
Speaker 1: But again, are the banks going to be happy dealing
Speaker 1: with an industry that now seems to be enveloped in
Speaker 1: its own form of scandal? Who knows? All Right, Tracy
Speaker 1: is so great to talk to you, and I'm even
Speaker 1: though our original guest dropped out, I think you're probably
Speaker 1: better and I learned a lot from this conversation. Well,
Speaker 1: I think this gives you an idea about the degree
Speaker 1: of nervousness in the industry right now, right, we can't
Speaker 1: even get a guest on to talk about it exactly.
Speaker 1: All right, This has been another edition of the Odd
Speaker 1: Lodge Podcast. Thanks for listening. I'm Joe Wisenthal. You can
Speaker 1: follow me on Twitter at the Stalwart, and I'm Tracy Alloway.
Speaker 1: I'm on Twitter at Tracy Alloway. Thanks for listening. But
Speaker 1: knowledge to work and grow your business with c i T.
Speaker 1: From transportation to healthcare to manufacturing. C i T offers
Speaker 1: commercial lending, leasing, and treasury management services for small and
Speaker 1: middle market businesses. Learn more at c i T dot com.
Speaker 1: Put knowledge to work