Benjamin Franklin, one of the US founding fathers, wrote that, “in this world nothing can be said to be certain, except death and taxes”. To those one could add a third, which is equally inevitable: the credit cycle.
People who are only allowed to borrow when money is easy may default on their loans when times get tougher. This principle has brought banks low for centuries and it has now struck fintech, the blend of finance and technology that was supposed to be cleverer and more efficient than them.
As of Monday, when Renaud Laplanche resigned as chief executive of Lending Club, the US online lending platform, it does not look quite like that. Marketplace lending, the industry formerly known as peer-to-peer lending, now seems more fragile than banking. With the first sign of trouble from higher loan defaults, the hedge funds on which it came to rely took fright.
Bad loans are bad loans, no matter how you disguise them, underprovision for them, magic them into credit derivatives or try to ignore them. Even refusing to carry the debts and selling them to someone else - the financial innovation that was supposed to make platform lenders safe - is no panacea. In some ways, not holding loans and deposits only makes matters worse.
Lenders such as Lending Club, Prosper Marketplace and Social Finance (SoFi) have grown rapidly in the US since the 2008 crisis, which damaged banks’ balance sheets and made them unpopular. They at first democratised lending, matching online individuals and small businesses seeking loans with others willing to lend money, but steadily drew more funding from institutions.
It was not really peer-to-peer, unless you count hedge funds as your peers - 48 per cent of Lending Club’s loans in the first quarter of this year were made by hedge funds and banks - but it worked. They had lower costs than banks with branch networks and could provide cheaper loans. A lot of customers refinanced credit card debt or student debt with them.
It also looked like a pretty good business, without the same risks as banks. Lending Club took fees for matching lenders and borrowers and then got out of the way - when any loans went wrong, it would be someone else’s problem. Like Uber, which does not (it insists) employ drivers or own taxis, Lending Club was valued more like a reach-to-the-sky technology start-up than a cyclical bank.
Lending Club had a charismatic French boss in Mr Laplanche and attracted a blue-chip board, including John Mack, former chief executive of Morgan Stanley, and Lawrence Summers, former US Treasury secretary. Its shares popped by 56 per cent above the issue price on the first day of its $5.4bn initial public offering in 2014, and it became a bellwether for fintech’s rise
But “there is a crack in everything”, as Leonard Cohen sang in Anthem, and the cracks in marketplace lending started to appear at the end of last year.
The US Federal Reserve raised short-term interest rates, signalling at last some prospect of the end of the era of cheap money, and customers started to default on some higher risk loans - the credit cycle had appeared.
Being ancient, banks have plenty of experience of this kind of thing, and advantages in coping with it. Their balance sheets are founded on retail deposits, which tend not to take flight easily. Most of their loans carry on paying interest even when others are being written down. The ship sits a little lower in the water but it keeps sailing.
Marketplace lenders do not have interest income - hold no loans, earn no interest - and so rely on new trans- actions. They have to carry on pulling in lending and arranging fresh loans to make profits but as capital markets have tightened, their funding has come under strain. Prosper has laid off a quarter of its workforce and its chief executive has waived his salary.
It turns out that fintech is vulnerable to the credit cycle, rather than floating in a brave new technology world. The strain is evident in one incident that prompted Mr Laplanche’s departure - Lending Club sold $22m of loans to one investor that broke the specified terms and had to buy them back.
Marketplace lenders have responded to the downturn in quite a traditional manner. Before he had to leave suddenly, Mr Laplanche was trying to return Lending Club to its peer-to-peer roots by pulling in more funding from individuals. The share of its lending by hedge funds and banks had nearly doubled between the first quarter of last year and this year, leaving it vulnerable to their whims and moods.
The lenders meanwhile are trying to channel more funds to loans themselves by managing money - SoFi has set up its own hedge fund, while Lending Club has an investment arm called LC Advisors. OnDeck Capital, an online lender to small businesses, is retaining more of the loans it makes on its balance sheet in response to the financial squeeze.
Raising retail deposits and holding on to loans; what financial industry does that remind you of? Oh yes, banking. Some of the antiquated methods of lending money demonstrate their value when the credit cycle returns.
