Just another day…..
Quite the events in the marketplace finance sector over the last week. Originally icons, now fallen stars, Lending Club (LC), OnDeck Capital (ONDK) and Prosper (PSPR) are exhibiting possible growing pains or even further symptoms of a more serious condition, namely questionable business models. It seemed only yesterday that firms such as Goldman Sachs and execs like Jamie Dimon expressed anxiety about the challenges to the conventional banking business that these new models would bring on. Deal and profit erosion was the concern as these nascent yet compelling platforms were accomplishing what the banking industry couldn’t, wouldn’t or even shouldn’t do, but impact they will. With recent earnings releases, and notable events, such as the departure of thought-leader, Renaud Laplanche and layoffs at Prosper, there are now those that suggest the “sky is falling” and the marketplace finance industry, let alone the basic model, is suspect.
Both before and after the IPOs of ONDK and LC, I scribed a few pieces that stated that, even with the accoutrements of a technology spin, these were still finance businesses, and should be accorded, rather measured, on the same basis of their banking brethren. Simply, they generate revenues for facilitating finance, on balance sheet or off, regardless whether there is “pixie dust” applied through algorithmic analysis and machine learning. Heck, when I started my banking career with Bank of America a few decades ago, there was already the application of formulaic credit scoring, objectively and agnostically, for consumer loans. So now we use a computer to do the scoring. BFD. And don’t you think that WFB and BAC and Capital One have methods of assess credit quality in an expeditious fashion. I do believe their tech budgets for such things are not impecunious.
In many ways, I would love to advance the notion that we are seeing a redux of the dot com / dot bomb days, where nosebleed values were placed on models only because they were different, independent of having a legitimate revenue model and path to financial sustainability. The current “originate and sell” methods of the marketplace platforms is highly questionable, as they can generate revenues only by doing more deals, as there is no recurrent revenue stream within their activities. Does this bode ominously for sub-prime product being advanced to sustain growth, like the mortgage banking industry demonstrated in the mid-2000’s? There is already waning appetite for the product, i.e., consumer and SME loans, being sold to the investment community. Delinquencies are rising, losses too, and loan sale premiums are eroding. Is the party over? Not in the least. But yes, a reboot is coming upon us.
Lending, as a subset of finance, is an information business. Users of capital supply providers of capital information in an iterative fashion, hoping to become resolute on a financing decision. If the analysis proves out, the loan is made, the anticipated performance will follow. But as we know, this is not a riskless proposition, thus safeguards and structures need be established. The challenge in the new money lending business, i.e., marketplace finance, is whether these platforms can actually do what they do not only efficiently, but profitably. When you dissect the origination costs, servicing, technology, underwriting and so on, the unit economic model of the platforms is suspect. Even beyond the aforementioned lending platforms, there are now close to 2000 online finance platforms, whether doing consumer, small business, or real estate lending, in addition to originating equity financing for emerging businesses. Technology has enabled many industries to execute profitably in more acute and granular levels, and that has been the hope and dream of crowdfunding. But technology in this space is the art, while finance still remains the science, and how finance companies make money, in the analog world is worth revisiting. Intermediation can be efficient, but is there any wonder that some of these platforms now understand the value of balance sheets and recurrent income? Being dismissive of the conventional fractional reserve, balance sheet model may be premature. Do anticipate that the new will see merit in the old, as the old benefits from the new. The sky is not falling. Maybe a stubbed toe, and a time of reflection? The future is still quite bright, but it will require reassessment of both models and definitely some of the current players.