Marketplace Lending
The marketplace lending industry has been tangled up in a string of internal controversies lately. (Art: Jacob Stringfellow)

Troubling revelations have rocked the marketplace lending industry recently, leading some fiscal observers to question the sustainability of the still largely unregulated sector, and others to chalk up the bad press to inevitable bumps in its natural evolution.

First, online marketplace lending juggernaut Lending Club announced the resignation of founder and CEO Renaud Laplanche, after a probe by its board discovered improprieties in the sale of $22 million in near-prime loans allegedly violating explicit investment criteria. Not only was there foreknowledge of the loans’ inadequacies, it found, but alterations to $3 million to facilitate the sale of the portfolio.

Next came news that another online marketplace lending giant, Prosper, is no longer accepting loans from the popular CreditKarma and LendingTree platforms—a fundamental shift in the way the industry has historically been sourcing and underwriting its loans. According to Prosper, lending volume is expected to be down again in the second quarter, after falling 12 percent in the first quarter this year compared to fourth quarter 2015.

Laplanche’s exodus sent shockwaves through an industry already strained by faltering investor appetite for loans, increasing defaults, and the possibility of more stringent regulatory scrutiny. As a result, Lending Club’s stock has been hammered. Loan volumes for the second quarter are down nearly 33 percent compared to the previous. The company announced it was slashing its workforce by 12 percent, or 179 jobs. Prosper also announced layoffs, to the tune of 170 jobs, or 28 percent of its workforce, and has even started to explore what it calls “strategic alternatives,” which may potentially include a sale of either part, or all, of the company.

Both Lending Club and Prosper have taken steps to not only shore up their respective firms, but investor confidence in the marketplace lending sector.

“We use a variety of online and offline marketing channels, and we are able to quickly and efficiently adjust those channels to best match borrower and investor demand,” Prosper CEO Aaron Vermut told The Wall Street Journal regarding its discontinued use of CreditKarma and LendingTree. “This ensures we maintain equilibrium, which is the number-one priority when running a marketplace business.”

Some industry observers and lending professionals, however, say the recent epiphanies are likely just the beginning, with more to come as the still-nascent industry evolves.

Dara Albright, a leading keynote speaker on topics within the crowdfunding industry, and cofounder of the internationally renowned FinFair and LendIt conferences, believes the recent turmoil in marketplace lending is all part of its “growing-up” process, and that overall, the outlook remains promising.

“I believe the recent turmoil in marketplace lending is nothing more than growing pains of a young industry that is continuously maturing and constantly improving,” she tells the New York Financial Press. “Invaluable lessons were learned in recent months that will only benefit the entire ecosystem. Going forward I see platforms implementing better internal compliance protocols, and doing more to accommodate retail investors.”

Albright also predicts a culling of players as the market continues to mature.

“I foresee a heightened period of FinTech innovation, where new technologies and platforms will emerge to overcome these recent challenges, and help the industry scale,” she says. “As I’ve been predicting for some time, new leaders will rise, some unexpected frontrunners will fall. The businesses that will best be able to oblige the retail customer, adapt to regulatory changes, and penetrate retail’s $14 trillion-plus retirement capital will prevail.

“This is already coming to fruition,” she continues, adding that one significant way the marketplace lending industry continues to evolve is through the introduction of new professional structures, products, and services.

“Just this month, Prosper launched a revamped user experience for its retail investors,” explains Albright. “Another online lending product, American Homeowner Preservation 2015A+ LLC, received SEC approval to use Reg A+ to bring a higher-yielding, fixed-income alternative to retail investors, and more and more platforms are incorporating IRA Services’ ISCP™ technology into their platforms in order to help retail investors facilitate tax-deferred P2P investing.

“The industry’s future has never been brighter,” she says.

Markus Lampinen, CEO of Crowd Valley Inc., a San Francisco-based digital infrastructure provider for online private securities portals and platforms, and the COO of Grow VC Group, another provider of digital crowdfunding and Peer-to-Peer (P2P) lending services, says there’s no question that this evolution pertains to both market participants, structures, and regulation.

“Working with debt and equity marketplaces around the world, we see a clear increase of professionalization and sophistication in the operations of the marketplaces themselves, as well as the individual and institutional investors participating in the marketplace,” he explains.

“Despite the fundamentals of the business models not having changed, as the market continues its growth, it becomes increasingly important for us, as a new market, to hold all parties accountable to the highest standard,” he continues. “This means the right transparency and tools for the investors, and the right safeguards in place for the marketplaces. We believe the digital finance market is still at its infancy, therefore, it’s fundamental the right structures are in place for the expected growth of the digital finance sector.”

According to Steven Wolf, an independent real estate investor and developer with Chicago-based Mission Capital, the marketplace lending industry, and lending, in general, is going through what he describes as a “crazy” period. Since his first real estate transaction in 1969, Wolf has acquired and operated more than 500 multifamily residential buildings, and has participated in sales and lending transactions totaling more than $1 billion.

Wolf believes the recent turmoil plaguing both traditional and alternative lending markets was inevitable, and describes the current deal flow and investment trends his firm has encountered as of late as different than in the past. He attributes this to a disconnection between underwriting standards, investor interest, and valuation.

“We have been getting a lot of smaller loans lately,” he explains. “Fifty thousand dollars, $75,000, those kinds of amounts. Our typical deal ranges anywhere from $1 million to $10 million.

“On the other hand, you have Blackstone [one of the world’s leading investment firms]buying smaller properties and units,” he continues. “[But] this is not going to continue forever.”

Since 2008, Wolf notes, stricter underwriting standards from traditional banking institutions have resulted in not only the growth of the marketplace lending and hard money loan sector, but also several unintended consequences.

The buying activity of institutional investors is squeezing out smaller investors, which has resulted in rental prices across the United States at record levels, he says. Part of that comes from institutional investors looking to move assets from marketplace lending portfolios, explains Wolf, and seeking returns elsewhere, such as in Chicago real estate.

“A lot of mom-and-pop investors are being squeezed out, and that is a big problem,” he says. “One example I will give, is that for instance, a lawyer making $300,000 dollars a year, even he is being squeezed out.

“Real estate taxes are too high,” he continues. “Insurance is sky-high. All the associated costs continue to rise, and it’s getting more difficult. These larger investors have more liquid cash and they are buying the smaller properties that the mom-and-pop investors typically buy, and driving up the property values.

“In Chicago, you have someone just fresh out of college, graduated, and they are making $25,000, $30,000 a year,” he adds. “For even an efficiency studio in the downtown area, they are looking at $2,000 a month in rent.”

This discrepancy causes disconnect in the flow of capital and valuations, which Wolf feels might potentially cause even greater fiscal calamity down the road.

“I think with all of these factors,” he says, “we could easily be looking at a recession in the future.”

Whether due to the inherent nature of an unsustainable marketplace or costly hiccups for an industry still coming into its own, marketplace lending is unquestionably weathering a rough patch, and there will likely be many more bumps in the road ahead—whether as a result of burgeoning regulation, or more surprises from within.