The alternative lending industry is about to cross the $500 billion valuation threshold, and market analysts have confidently predicted the sector to hit a $1 trillion worth in just a matter of years.
These forecasts have largely been in response to two explosive IPOs from alternative lenders: that of Lending Club, which hit an $8.5 billion valuation, and of OnDeck one week later, reaching a $1.5 billion valuation. Both shattered records, and Lending Club took second place in the largest IPOs ever recorded (surpassed only by Alibaba’s debut).
Collectively, these market forecasts are generating a storm of excitement among investors and small businesses looking for working capital. But a new whitepaper from consulting firm Bridgeforce, published through its Capital Management practice, warns that the technological advantages of these alternative lenders over traditional banks – often the focal point when valuing these firms – will not carry the same weight it currently holds for much longer.
Bridgeforce’s report, “Alternative Lending Market: A Valuation Perspective,” similarly analyzes the alternative finance market in the context of Lending Club and OnDeck’s IPOs. But instead of these public offerings proving the financial strength of the industry, they instead highlight the lack of background on which investors can justify these high valuations.
“Valuing established and profitable companies with consistent, clear accounting statements, long stable histories and lots of comparable firms is relatively straightforward,” the report reads. “However, technology-enabled alternative lenders are young, high growth companies with different business models in a rapidly evolving sector.”
One only has to look at the current market valuations of Lending Club and OnDeck, analysts said, to demonstrate how volatile the sector can be. “The recent decline in OnDeck and The Lending Club’s stock prices may be the first signs of the market beginning to account for more traditional lender valuation considerations,” the report said, noting that Lending Club “would need to originate between $4.1 billion to $21.1 billion of annual volume to support is post IPO valuation.”
Those traditional lender valuation considerations mentioned by the Bridgeforce report are likely what will quell the frenzy over alternative lenders, analysts said. Instead of focusing on these lenders’ technological advantages over traditional banks, investors will need to examine other factors, including an untapped potential for future growth, strong partnerships with lenders and investors, the use of Big Data, management, regulatory compliance and cyclical factors.
While technology is “undeniably” a significant factor when considering the strength of an alternative lender, these more traditional considerations that are also applied to traditional financial institutions must also be taken into account when considering alternative financers.
Complicating this process even further, Bridgeforce said, is the youth of the market. “As such, [these traditional considerations’] long-term ability to predict true value, particularly in changing credit cycles, has not been firmly established.”
Additionally, not every alternative financer will be impacted by these considerations in the same way. In a relatively short span of time, the alternative finance market has generated three categories of businesses: funders, which fulfill loans and fund those loans through their balance sheets; marketplaces, which fulfill loans but then sell those loans to other investors; and aggregators, which act as a third party, connecting lenders with loan applicants. The Funders and Marketplace players, Bridgeforce said, “truly are creating loan portfolio and as such traditional financing lending institution valuation considerations must be given their due weight.”
Looking ahead, Bridgeforce suggests that as industry analysts and investors begin to place the same considerations of traditional lenders against those of alternative lenders, the excitement surrounding the industry will likely be muted. This is particularly true, the report suggested, as jurisdictions across the globe begin to explore legislation to regulate the alternative finance industry, and the impact of these rules has yet to be known.
Already, policymakers in three of the world’s largest alternative lending markets are in the process of introducing alternative financing legislation. The U.S. is continuing to explore Title III of the JOBS Act, which applies specifically to crowdfunding and who can qualify as an investor. The European Commission is similarly working on rules that would facilitate cross-border alternative lending that has been largely confined within the borders of individual states.
The U.K., which holds the strongest alternative industry today, recently released a report that largely downplayed the market hype and warned that alternative lenders, just like traditional banks, can have significant pitfalls for small business borrowers.
But the U.K. has also recently revealed plans to introduce new legislation that would require traditional banks that turn down SME applicants to refer those businesses to alternative lenders, suggesting that these regulators are taking an objective approach to alternative finance, considering both the industry’s up- and downsides.
Similarly, Bridgeforce’s recent report does not take a wholly negative view on the future value of the alternative financing industry. Instead, the consultancy highlights that while today’s alternative lenders are valued based on their use of technology and sophisticated platforms, other factors – that have historically impacted the valuation of traditional financial institutions – are likely to come into play. Still, it is undeniable that the industry has made waves, and will likely continue to do so.
“Technology-enabled alternative lenders, while still representing a small portion of consumer and small business lending, have already had considerable impact on the industry,” Greg Rigg, Director of Bridgeforce Capital Markets, said in a statement. “Although their current valuations may shrink over time, we are already seeing trending changes across all lending platforms as a result of the innovations they are bringing.”
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