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Speaker 1: But knowledge to work and grow your business with c

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Speaker 1: i T from transportation to healthcare to manufacturing. C i

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Speaker 1: T offers commercial lending, leasing, and treasury management services for

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Speaker 1: small and middle market businesses. Learn more at c I

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Speaker 1: T dot com put Knowledge to Work. Hello and welcome

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Speaker 1: to another edition of the Odd Lots podcast. I'm Joe Wisntal,

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Speaker 1: Managing editor at Bloomberg Markets, and I'm Tracy Alloway, Executive

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Speaker 1: editor at Bloomberg Markets. Tracy, you sound very distant. Why

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Speaker 1: is there? Well, it might be because I'm across the

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Speaker 1: ocean from you. I'm over in Abbey Dhabi. Amazing. So

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Speaker 1: today is kind of like a special edition of the podcast,

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Speaker 1: not just because it's the first one that you're recording

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Speaker 1: from Abu Dhabi. We also had a guest lined up

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Speaker 1: for today and at the very last second, within the

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Speaker 1: last few minutes, and we're not going to name them

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Speaker 1: because that wouldn't be right, but within the last few minutes,

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Speaker 1: the guest pulled out, so because they were nervous. So, Tracy,

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Speaker 1: what's going on. There's a big scandal and a guest

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Speaker 1: that was going to talk got nervous. What's happening? Yeah,

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Speaker 1: for once, it's a scandal that has uh well, that

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Speaker 1: doesn't come directly from the banking industry. Instead, it's something

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Speaker 1: to do with what's known as peer to peer lending

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Speaker 1: or also known as marketplace lending. And we'll get into

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Speaker 1: why it's described by two names, but basically, we had huge,

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Speaker 1: huge news out of one of the first ever peer

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Speaker 1: to peer lenders earlier this week, the CEO resigned amid

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Speaker 1: a major scandal. The shares went plunging. The company is

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Speaker 1: now worth, you know, basically a fraction of what it

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Speaker 1: used to be worth, and we are going to dig

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Speaker 1: into why all that happened. Awesome, I can't wait. So

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Speaker 1: our guest, who is very familiar with this industry, given

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Speaker 1: the heat going on right now, it decided not to talk.

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Speaker 1: But let's step back. So we have this industry. Oh well,

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Speaker 1: let's the good news is that, Tracy, you're an expert

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Speaker 1: on this industry and you've been following it essentially sinceince inception,

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Speaker 1: and frankly, you're probably the best guest for it anyway.

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Speaker 1: So let's take a step back. Years ago, idealists founded

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Speaker 1: this concept called peer to peer lending. Rather than going

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Speaker 1: through banks, you could borrow money online you could go

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Speaker 1: on lend many money to your peers. It was supposed

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Speaker 1: to disintermediate the traditional financial system. Tell us about this

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Speaker 1: origin of peer to peer lending, how it started, and

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Speaker 1: where we are. I guess that's kind of ambitious, but

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Speaker 1: I think we can do it. I believe in us,

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Speaker 1: all right. It actually started before the financial crisis, and

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Speaker 1: there were a couple of companies that came up with

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Speaker 1: this idea of us sing the internet using online platforms

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Speaker 1: to directly match borrowers with lenders. So instead of me

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Speaker 1: going to a bank and asking for you know, a

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Speaker 1: small loan so I could I don't know, remodel my

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Speaker 1: kitchen or something like that, I could go online and

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Speaker 1: someone online would agree to fund the loan. So basically,

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Speaker 1: you go on, you say I want to borrow ten

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Speaker 1: thousand dollars to remodel my kitchen. Here are some stats

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Speaker 1: about me, my credit score, how much I make, etcetera.

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Speaker 1: And then I might have ten thousand dollars in cash

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Speaker 1: sitting around and then say I'll fund that loan. Is

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Speaker 1: that basically how it works. So in the beginning, it

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Speaker 1: was very unlikely that a single investor or lender would

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Speaker 1: be funding an entire loan. Instead, what you would do

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Speaker 1: is you would fund small pieces of loans, right, so

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Speaker 1: you wouldn't put up ten thousand, but maybe you would

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Speaker 1: put five dollars up on the platform so that you

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Speaker 1: could buy pieces of various loans of various quality to

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Speaker 1: diversify the credit risk exactly. And as a borrower on

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Speaker 1: the platform, you wouldn't necessarily say here are all the

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Speaker 1: things about me, you know, there'd be some forms that

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Speaker 1: you would fill out. But the interesting thing about using

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Speaker 1: the online platform to borrow money was that a lot

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Speaker 1: of the underwriting process was automated. So you would give

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Speaker 1: these peer to peer companies permission to access some information

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Speaker 1: about you, um that was available online, and then they

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Speaker 1: would automatically go and do that and kind of fill

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Speaker 1: out these profiles. And if you were an investor on

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Speaker 1: the platform, one of the selling points was that you

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Speaker 1: would get really good detail about the person you're investing in. Actually,

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Speaker 1: in the early days, you could see all sorts of

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Speaker 1: information where the loan was coming from, UM, you know,

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Speaker 1: the salary UH employment status of the person. I rememb

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Speaker 1: We're going back in two thousand twelve and checking UM

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Speaker 1: which bank employees you know, JP Morgan and City Group

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Speaker 1: had gone to Lending Club instead of their own banks

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Speaker 1: to take out loans. And how were the interest rates set?

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Speaker 1: Was it set by the lender or sent set by

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Speaker 1: the platform? Well, this was an interesting thing. So the

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Speaker 1: idea here was that it was supposed to be a

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Speaker 1: marketplace for lending, although that name didn't happen until a

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Speaker 1: few years later. However, the interest rates have always been

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Speaker 1: set by the platform. Um, you know, I'm sure they're

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Speaker 1: in negotiation with investors, especially some of the larger investors

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Speaker 1: that they attracted as the years went by, But in

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Speaker 1: the beginning they set those rates, all right, So let's

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Speaker 1: go ahead. Because when you hear peer to peer lending,

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Speaker 1: you think of the sort of idealist people helping each

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Speaker 1: other out of sort of makes you think of like

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Speaker 1: napster or something like this, like this real organic thing.

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Speaker 1: Now that term isn't used so much. They talk about

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Speaker 1: marketplace lending, which has a slightly more institutional feel. So

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Speaker 1: tell us about the evolution of these idealist sites to

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Speaker 1: what now is a bit more um, a little bit

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Speaker 1: more grown up, I guess you could say. Yeah, So,

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Speaker 1: I mean, let me tell you this from my personal perspective,

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Speaker 1: I think that's probably a good way into it. So

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Speaker 1: in two thousand and twelve, I think it was I'm

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Speaker 1: a reporter at another media outlet. I was covering the

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Speaker 1: big banks, including Morgan Stanley, and an ex Morgan Stanley

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Speaker 1: CEO John mac joined the board of this up and

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Speaker 1: coming peer to peer lender called Lending Club. I wrote

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Speaker 1: the story, and after that I kind of took an

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Speaker 1: interest in the sector because it had these aims of

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Speaker 1: disintermediating the banks. It was after the financial crisis, when

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Speaker 1: a lot of the big banks were under regulation that

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Speaker 1: they said made it more difficult for them to lend. Basically,

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Speaker 1: they were all these factors kind of making a positive

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Speaker 1: case for peer to peer lending and certainly making it

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Speaker 1: an interesting story at the time. And so I remember

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Speaker 1: meeting eventually the CEO of Lending Club, Renault Laplanche, and

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Speaker 1: he came in at the time without any pr people,

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Speaker 1: any minders. He just came into the office. We had coffee.

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Speaker 1: I learned more about this sort of fast growing fintech company,

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Speaker 1: and at the time, the message was very much one

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Speaker 1: of sort of cutly togetherness, right, Lending Club. We were

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Speaker 1: all going to club together and lend directly to one another,

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Speaker 1: cut out the banks, cut out the middleman from the transactions.

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Speaker 1: Investors or lenders would get higher returns and borrowers would

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Speaker 1: get lower rates as a result, and the whole thing

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Speaker 1: was called, of course, peer to peer lending. Now, as

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Speaker 1: the years went by, the in stry expanded really really rapidly,

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Speaker 1: and one of the ways it did that was by

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Speaker 1: first of all, making whole loans available to larger investors,

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Speaker 1: so instead of buying pieces of loans, you would just

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Speaker 1: buy entire ones, and then tapping institutional investors to expand.

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Speaker 1: That meant hedge funds, It meant wealth management companies, mutual funds,

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Speaker 1: pension funds, insurers, all the big guys. So when you're

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Speaker 1: suddenly using these big guys to fund a big portion

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Speaker 1: of your loan, you can't or of your growth. You

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Speaker 1: can't really call it peer to peer lending anymore, right,

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Speaker 1: unless you think your peer is fund And this is

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Speaker 1: really key because you know you talked about having met laplanche.

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Speaker 1: In this post crisis era has been characterized by this

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Speaker 1: multi year search for anything offering higher than normal yield.

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Speaker 1: And so, as you mentioned, the um lenders on this

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Speaker 1: platform were offered a chance to get more for their money.

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Speaker 1: So it only made sense that all these hedge funds

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Speaker 1: and other investors looking for yield started seeing the loans

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Speaker 1: being generated on these platforms and said, hey, how can

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Speaker 1: we start buying them in meaningful size and adding them

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Speaker 1: to our portfolio. That's exactly right. So the major selling

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Speaker 1: point of peer to peer loans was that they were

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Speaker 1: higher yielding, shorter duration assets that were also uncorrelated with

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Speaker 1: traditional stocks or bonds. So if everything else was tanking,

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Speaker 1: in theory, you could still buy an unsecured consumer loan

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Speaker 1: and get a decent return. Now, the kind of crazy

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Speaker 1: thing with some of the big guys is that even

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Speaker 1: though these peer to peer loans had higher yields, they

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Speaker 1: still felt the need to apply leverage to the assets

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Speaker 1: to get an even higher return. But the other slightly

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Speaker 1: crazy thing, and I think this is all always been

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Speaker 1: debated with the model, is that the vast majority of

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Speaker 1: these peer to peer platforms, the borrowers on them are

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Speaker 1: using them to refinance existing debt. So you're basically buying

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Speaker 1: unsecured consumer loans from someone who probably already owes quite

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Speaker 1: a bit of money to a credit card company somewhere

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Speaker 1: and is just trying to get a lower rate to

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Speaker 1: refinance that debt, so, you know, pretty risky. All right,

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Speaker 1: let's take a quick break for a word from our sponsor,

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Speaker 1: but knowledge to work and grow your business with c

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Speaker 1: i T. From transportation to healthcare to manufacturing. C i

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Speaker 1: T offers commercial lending, leasing, and treasury management services for

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Speaker 1: small and middle market businesses. Learn more at c i

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Speaker 1: T dot com put knowledge to work and back. I'm

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Speaker 1: here with Tracy Ellaway, my co host but also an

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Speaker 1: expert in the world of marketplace lending or peer to

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Speaker 1: peer loans. We're talking about the sort of big scandal

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Speaker 1: that royaled the industry, and so let's get to this.

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Speaker 1: You mentioned before the break that in you met this

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Speaker 1: guy Runault la Planche who founded this company called Lending Club.

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Speaker 1: He was really in the news. And these last few

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Speaker 1: days you expect you explained to us how this organization

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Speaker 1: and these companies that started off as these peer to

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Speaker 1: peer we're all going to lend to each other became

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Speaker 1: these entities that started serving institutions and started packaging loans

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Speaker 1: and large scale What is the what is the scandal

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Speaker 1: that the industry is now seeing and how does Laplanche

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Speaker 1: fit into it. Alright, Uh, where to begin? Um? Alright,

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Speaker 1: let's start in twenty four December. All right, la Planche

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Speaker 1: lists Lending Club on the New York Stock Exchange. It's

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Speaker 1: this huge I p O. At the time, it was

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Speaker 1: described as a coming out moment for the entire industry.

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Speaker 1: They listed a valuation of something like eight point nine

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Speaker 1: billion dollars. And I was there on the stock exchange

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Speaker 1: floor the day that it happened, and I can tell

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Speaker 1: you there were investors there that became instant millionaires. Everyone

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Speaker 1: was thrilled. People were amazed at the valuation. To be honest, Um,

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Speaker 1: the whole thing was massively oversubscribed. A lot of excitement. However,

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Speaker 1: there was also some concern at the time that going

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Speaker 1: public basically meant that Lending Club was now under additional

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Speaker 1: pressure to maintain its growth. Right, it had to lend consistently,

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Speaker 1: and it had to get uh financing for those loans consistently,

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Speaker 1: which could be difficult as a public company on a

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Speaker 1: quarterly basis. In any case, the company did was it

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Speaker 1: went out. It struck a bunch of new agreements with

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Speaker 1: big institutional investors that would help maintain its growth and

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Speaker 1: one of those investors was Jeffries, which is a financial

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Speaker 1: group well known on Wall Street. So fast forward to

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Speaker 1: this week and on Monday, Lending Club announces its first

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Speaker 1: quarter results, it's earnings for the period, and alongside those earnings,

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Speaker 1: it shockingly announces the resignation of Renault Laplanche. And you

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Speaker 1: were really surprised. We were both um, we were chatting

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Speaker 1: over the Bloomberg ib instant messaging service and I said, Tracy,

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Speaker 1: you see this on Plunge news. And I mean, we

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Speaker 1: were not together, but I sort of could feel how

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Speaker 1: stunned you were at this news. He was resigning, just

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Speaker 1: by my messaging to you. When I pointed it out

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Speaker 1: to it was completely shocking. So you know, it's basically

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Speaker 1: the figurehead of an entire industry resigning amidst scandal. Um,

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Speaker 1: It's hard for me to think of an equivalent. It

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Speaker 1: was a complete shocker for the industry. Now what the

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Speaker 1: announcement actually said, and we're still getting details of this unfolding,

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Speaker 1: but the announcement said basically that Lending Club had knowingly

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Speaker 1: sold some loans to a large institutional investor, Jeffries, although

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Speaker 1: they didn't disclose that particular name at the time, but

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Speaker 1: that's come out in our reporter. That's come out in

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Speaker 1: our reporting loans that didn't comply with the sort of

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Speaker 1: express wishes of the investor. And there was also some

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Speaker 1: noise as well around Renault possibly making UM failing to

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Speaker 1: disclose a personal investment in a company that Lending Club

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Speaker 1: eventually bought. So all a bit of a mess, uh

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Speaker 1: and incredibly incredibly disheartening for the entire industry right and

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Speaker 1: the stock, the stock it should be worth, it's worth noting,

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Speaker 1: has done very poorly ever since going public. There's already

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Speaker 1: been ang xiety about this space. But the stock instantly

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Speaker 1: plunged on the news. And when I first read the

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Speaker 1: news and I said, these loans that they had sold

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Speaker 1: weren't exactly what the buyer thought they were getting, you know,

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Speaker 1: the first thought that I had was, this just feels

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Speaker 1: like the same old Wall Street type scandals from years ago,

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Speaker 1: almost exactly a buyer not getting what they thought they

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Speaker 1: were getting. Like it seems like the classic old thing

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Speaker 1: coming back with this new in this new platform that

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Speaker 1: was supposed to change how everything worked. Well, I think

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Speaker 1: there are a lot of people that would agree with

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Speaker 1: you on that. UM. The issue with lending club and

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Speaker 1: with peer to peer in general, has always been disentangling

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Speaker 1: the technology of the business, the fintech aspect, from the

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Speaker 1: lending side of the business, the specialty finance aspect of it.

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Speaker 1: Are these companies actually technology companies or are they just

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Speaker 1: sort of direct lenders in disguise or specialty finance companies

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Speaker 1: and delays. Let's pick apart this question, because I think

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Speaker 1: this is crucial. We actually just had comments from Jamie Diamond.

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Speaker 1: He was asked about the marketplace lenders and he said, yeah,

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Speaker 1: the platforms are great, the technology is great. It's great

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Speaker 1: that people can get approved for loans and fifteen minutes

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Speaker 1: as opposed to fifteen days. But on the other hand,

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Speaker 1: funding for these companies is unstable, and so he basically

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Speaker 1: threw a lot of cold water on the business model.

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Speaker 1: So let's pick this apart. Prior to this scandal, how

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Speaker 1: are people thinking about the sustainability of the marketplace lender

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Speaker 1: business model? So there was always a question mark over

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Speaker 1: marketplace lenders ability to withstand a downturn in the credit cycle.

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Speaker 1: So you know, when money is no longer as easy,

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Speaker 1: are they still going to have all these investors and

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Speaker 1: lenders pouring into the platform who are able to finance

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Speaker 1: their loan growth. Setting aside completely, the major major question

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Speaker 1: of whether or not defaults on the loans that actually

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Speaker 1: go through their platforms would rise, which kind of seems obvious,

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Speaker 1: you know, in a recessionary scenario, Yes, those defaults would rise,

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Speaker 1: But the big issue was actually would they be able

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Speaker 1: to continue to fund themselves? And in fact, in the

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Speaker 1: first quarter of this year, we kind of got a

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Speaker 1: worrying clue about that because we saw a lot of

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Speaker 1: investors concerned about the overall credit market stepping away from

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Speaker 1: higher yielding corporate debt, and with that, a lot of

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Speaker 1: people started to become nervous about peer to peer assets

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Speaker 1: as well, and we did see a downturn in institutional

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Speaker 1: funding for these platforms. And so why is this different

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Speaker 1: than any other funding? I mean, this question of can

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Speaker 1: they survive a credit market downturn? But I mean credit

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Speaker 1: market downturn to hit everyone. So there's something specific to

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Speaker 1: this business model that makes them particularly that raises particular

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Speaker 1: questions about the viability of the whole thing. Oh sure,

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Speaker 1: I mean I think the answer is there. There are

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Speaker 1: trillions of reasons, trillions of dollars worth of reasons. Right. So,

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Speaker 1: JP Morgan, for instance, has a massive, massive retail deposit

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Speaker 1: base that's there. It's known as sticky funding because people

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Speaker 1: tend not to pull it out that quickly. Lending club

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Speaker 1: and other peer to peer platforms, by contrast, do not

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Speaker 1: have a deposit base. This is why they are not banks. Right. Uh,

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Speaker 1: they don't have a deposit base, and that enables them

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Speaker 1: to avoid a bunch of the regulatory burden that a

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Speaker 1: lot of actual traditional banks have to deal with and

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Speaker 1: thus have lower costs, but it also exposes them to

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Speaker 1: basically a funding risk. Right, These institutional investors can pull

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Speaker 1: their money out fairly quickly, right, So you get I

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Speaker 1: wanna you mentioned the regulatory aspect. One argument that people

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Speaker 1: say about the new breed of companies is that, yeah,

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Speaker 1: the technology is okay, but the real edge is in

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Speaker 1: the regulatory arbitrage and that they can do these things

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Speaker 1: that traditional bank can't because they're much more heavily regulated.

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Speaker 1: And that you know, now with added scrutiny on these

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Speaker 1: companies and light of the latest scandal, that also questions

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Speaker 1: the frozen to question whether the business model makes sense,

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Speaker 1: how how much how important has it been for these

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Speaker 1: companies that they're not regulated the same way as a

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Speaker 1: JP Morgan or a city or a Bank of America

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Speaker 1: is I think absolutely massive. Again, the interesting thing here

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Speaker 1: is really to disentangle the technology offering of a lot

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Speaker 1: of these companies, because for some of them it's been

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Speaker 1: very unclear. So, for instance, Lending Club says it uses

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Speaker 1: a proprietary model to sort of gauge customers risk, which

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Speaker 1: we were talking about earlier today, right However, it's never

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Speaker 1: been ad percent clear what the edges of that new technology,

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Speaker 1: that new sort of automated underwriting processes over traditional things

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Speaker 1: like PICO scores, you know, traditional credit scores. And in fact,

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Speaker 1: we've heard grumbling in the past from people saying that actually,

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Speaker 1: you know, of peer to peer lenders, proprietary risk models

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Speaker 1: are just FICO scores. They're not actually improving that much

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Speaker 1: upon the existing way that credit is extended, which basically

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Speaker 1: leaves them with you know, a pretty nice online platform,

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Speaker 1: a good customer experience for borrowers, and the added benefit

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Speaker 1: of not being a bank and not having historical creaky

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Speaker 1: I T systems and things like that. Right on this

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Speaker 1: you know, you mentioned that measure of credit risk until

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Speaker 1: we have an economic downturn. We really don't know if

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Speaker 1: say those you know, their credit measure is hold up,

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Speaker 1: or if they'll see a big wave of defaults. We

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Speaker 1: just sort of, right, I mean, until that happens, we

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Speaker 1: don't know much. Right, that's right. Although, again, you know,

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Speaker 1: you're dealing with unsecured consumer lending. A lot of the

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Speaker 1: information is self reported on the platforms, although companies like

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Speaker 1: lending Club will do their best to try to verify it. Uh. So,

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Speaker 1: you know, I don't think anyone would be surprised if

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Speaker 1: we saw an uptick in defaults once we had a recession.

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Speaker 1: The question is, uh, the degree to which that happens,

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Speaker 1: and again, the degree to which that scares off investors,

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Speaker 1: both the little guys, the you know, mom and pop

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Speaker 1: retail investors, and more importantly, the institutional guys. All right,

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Speaker 1: let's throw this uh, let's wrap this up and throw

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Speaker 1: this forward a little bit. So these stocks, Lending Club

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Speaker 1: is one, there's another one on deck. It's been absolutely

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Speaker 1: creamed lately. Everyone is trying to figure out the answer

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Speaker 1: to the question that you just alluded to, which is

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Speaker 1: is this is sustainable business or did they just build

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Speaker 1: fancy websites that would look good as a bolt on

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Speaker 1: to a traditional bank. What's your what's your guests? Where

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Speaker 1: is this industry in a few years Do all these

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Speaker 1: companies just get snapped up by the major banks? Do

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Speaker 1: they thrive on their own? If they if the sort

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Speaker 1: of business model and the lending model works, where do

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Speaker 1: you see things going next? So this is the million

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Speaker 1: dollar question. And I have to be really careful what

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Speaker 1: I say here. I think it's fair to say and

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Speaker 1: to point out that for the past few years, the

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Speaker 1: environment for marketplace peer to peer lenders, whatever you want

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Speaker 1: to call them, has been nothing short of fantastic. Remember,

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Speaker 1: you had all these people upset about the banks after

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Speaker 1: the financial crisis. You had the low interest rates that

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Speaker 1: drove a lot of investors onto the platforms seeking higher yields,

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Speaker 1: and that also made it easier for people to borrow

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Speaker 1: money from the platform is cheaper for them to do that, um,

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Speaker 1: And you had a sort of lack of regulatory scrutiny

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Speaker 1: for want of a better word. And despite all those

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Speaker 1: tail winds, basically, uh, we've seen the sector run into

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Speaker 1: some significant problems over the past couple of months, including

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Speaker 1: those credit concerns and now this scandal. So it's a

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Speaker 1: really really good question whether or not the industry can survive.

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Speaker 1: I do think there's a value prospect. You know, these

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Speaker 1: companies do have better technology on some things. They have

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Speaker 1: more efficient loan application processes. God knows that millennials um

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Speaker 1: like you and I. If we're applying for a mortgage,

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Speaker 1: I'm not entirely sure we're going to be walking into

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Speaker 1: the local city bank to do it. You know, the

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Speaker 1: idea that we can just go online and do the

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Speaker 1: paperwork that way and get a sort of instantaneous response

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Speaker 1: is definitely an attractive thing. How hard is it, you know,

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Speaker 1: if you had to guess, Obviously, the CEOs of major banks,

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Speaker 1: they're all under pressure. They all feel like they have

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Speaker 1: to catch up in terms of and invest in fintech.

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Speaker 1: Looking around, do they you think they'll make the calculation

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Speaker 1: that they can rebuild that good of a user experience

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Speaker 1: and essentially offer the exact same thing. Or do these

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Speaker 1: companies you think have good enough technology that it would

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Speaker 1: be worth just sort of buying or will it be

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Speaker 1: a mix? I imagine it will be a mix. And

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Speaker 1: we've already seen some of the bank's partner up with

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Speaker 1: peer to peer lenders, which is kind of weird when

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Speaker 1: you think about it. Uh, but that could continue going forward.

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Speaker 1: But again, are the banks going to be happy dealing

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Speaker 1: with an industry that now seems to be enveloped in

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Speaker 1: its own form of scandal? Who knows? All Right, Tracy

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Speaker 1: is so great to talk to you, and I'm even

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Speaker 1: though our original guest dropped out, I think you're probably

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Speaker 1: better and I learned a lot from this conversation. Well,

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Speaker 1: I think this gives you an idea about the degree

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Speaker 1: of nervousness in the industry right now, right, we can't

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Speaker 1: even get a guest on to talk about it exactly.

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Speaker 1: All right, This has been another edition of the Odd

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Speaker 1: Lodge Podcast. Thanks for listening. I'm Joe Wisenthal. You can

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Speaker 1: follow me on Twitter at the Stalwart, and I'm Tracy Alloway.

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Speaker 1: I'm on Twitter at Tracy Alloway. Thanks for listening. But

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Speaker 1: knowledge to work and grow your business with c i T.

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Speaker 1: From transportation to healthcare to manufacturing. C i T offers

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00:25:39,680 --> 00:25:43,520
Speaker 1: commercial lending, leasing, and treasury management services for small and

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Speaker 1: middle market businesses. Learn more at c i T dot com.

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Speaker 1: Put knowledge to work