Interest rates hold particular interest these days.
Inverted yield curves. Fed fund rates. Even negative interest rates — in one bit of recent news on that point, a Denmark bank is effectively paying borrowers to take out mortgages, where rates are quoted in negative basis points.
Eventually, all of that has an impact on how much consumers and businesses pay when they borrow money.
Conventional wisdom may hold that alternative lenders — those companies that leverage data and analytics, along with various funding models matching investors with borrowers — could be harder hit than more traditional lenders by a volatile rate environment. It’s thought that lower rates and recession (or fears of recession) will cast a pall over borrowings, crimping consumer demand and investor returns, squeezing results at the alt-lenders themselves.
Scott Sanborn, LendingClub CEO, tells Karen Webster that conventional wisdom needs a gut check.
Sanborn tells Webster that, at least from where he and Lending Club sit, expanding origination services, honing cost efficiencies and introducing a broadened palette of credit offerings will help the company weather any near-term macroeconomic headwinds.
It’s an important point, because the data so far, even now, during a lingering trade war between the United States and China, and a global economic slowdown, the U.S. consumer remains solid. The latest retail sales reading was the strongest in months, up 70 basis points in July, beating expectations, and accelerating from the 30 basis points seen in June. The latest Bureau of Labor Statistics reports show wages up by mid-single-digit percentage points.
So at present, Sanborn said any recession is not likely to be consumer-led.
The fact that delinquencies have crept up a bit, and auto and student loans are up in recent reports is more a function of market dynamics than the consumers themselves, said Sanborn. He pointed to a supply-side crunch, following several years when LendingClub competitors jumped into the personal loan market late in the cycle and acquired customers without robust credit models in place. Those firms extended credit to borrowers who might have been the best choices to receive those loans. The current trends are moving toward what he termed a normalized base of loss, he told Webster.
Of the environment in general, he noted that as LendingClub’s investors are institutional in nature, the fact that the company can create a market each day and sell loans shows that investors are sanguine about the loans’ performance potential over the next three to five years.
Digging a bit into the characteristics of the LendingClub platform, he contended that the marketplace model is likely to continue to see healthy supply (in terms of investor capital) and demand (from borrowers) regardless of the rate environment.
He said LendingClub benefits from tapping into a pool of diversified investors, he told Webster, including scalable deep-pocketed investors with a broad range of risk tolerances. Even in a downturn, he said, borrowers will desire credit and investors are going to be looking for yield.
“Which borrowers and which investors? Well, that will change,” he said.
The Rate Environment
As to how that will change: Amid rate cuts from the Fed and where at least some observers expect there to be more cuts in the offing, Sanborn noted that if nothing were else were to change (in terms of macro-economic shocks) and rates were to go down, Lending Club would benefit.
Credit card rates, he said, are at their highest level in 25 years, and with borrowers paying an average of 18 percent on those cards, alternative lending’s (and in particular LendingClub’s) value proposition remains healthy for both sides of the lending equation.
The cost of capital also decreases, so investors’ expectation of returns on their capital deployed comes down as well.
“If return expectations come down, we can lower the prices to borrowers and if we lower the prices the borrowers, even more of them find our offering attractive,” he said.
Looking Back To Look Ahead
Through the last few years and a rising rate environment, LendingClub has grown its originations by 60 percent since Sanborn took over as CEO three years ago.
In finetuning LendingClub’s operations and getting the firm ready for any number of economic outcomes, he said the company has been lowering its servicing and operating costs, embracing a variable model through the use of business process outsourcing.
Lower variable costs and lower fixed costs buffer LendingClub from shocks and help the company ramp up and ramp down on a short timeline, he said, adding that the past few years have proven the ability to navigate through a number of critics’ perceived threats.
Among those criticisms: LendingClub would not be able to deal effectively with a rising rate environment or with the entrance of banks as competitors. He countered that LendingClub, now on track to achieve profitability in the back half of this year, has indeed gained share and grown through a macro environment marked by rising rates. Also, he added, the online credit markets have seen the emergence of Citi, Barclays, and Goldman’s Marcus, the online direct bank that offers loans.
“We’re still here,” he said, with a nod toward Lending Club’s personal loan market share of 10.5 percent.
LendingClub and peers, he told Webster, have over the past few years been navigating a softening or normalization credit and personal lending environment. In reaction, he said, the company has trimmed higher risk customers, reducing credit by 20 percent over the past 18 months.
“We shifted the focus,” he said, “and we shifted to higher quality consumers — and we also shifted the mix of funding towards banks. This allowed us to keep competing and as rates went up, rates moved up more slowly for banks. This made our assets attractive.”
The funding mix sourced from banks, he said, range from high yield savings and brokered certificates of deposits (CDs) to funding from community banks that have low-cost deposits.
As LendingClub has tightened credit, he said, of some of the perceived riskier borrowers and some investors expressed enthusiasm for the riskier loans.
“Essentially we said ‘well, why don’t we let them put their money where their mind is,’ ” said Sanborn.
Earlier this month, the company launched its Select Plus platform, which lets investors approve borrowers who fall outside the current LendingClub criteria. Sanborn described Select Plus on the firm’s Q2 earnings call as an incremental opportunity to expand its customer base and existing as the next step in its “product to platform” strategy broadening services and products embraced by consumers, turning them into repeat customers.
Said Sanborn of Select Plus, “it enables us to turn a ‘no’ on our platform into a ‘yes.’”
The Bank Charter
Sanborn also expanded on the news that LendingClub is exploring a national bank charter — where he said on the earnings call that the company would strive to maintain its marketplace model and support it with a marketplace bank.
The bank charter, he said on the call, would drive growth and margins and through the medium-term help secure a new source of low-cost funding.
As Sanborn told Webster, there is a perception that alternative lending models are not highly regulated and they’re benefiting from that lack of oversight.
However, he countered, nearly half of LendingClub’s funding comes from banks, and banks are required by the Bank Services Act to treat third parties as an extension of their operations. He said the company has built up the three lines of defense — compliance, control and infrastructure — that are required of a bank. Obtaining a national bank charter, he said, adds benefit to the cost the firm already bears.
He said that, upon establishing the bank charter, LendingClub would be able to offer more products and services to customers, including the ability to save money.
In one illustration, he said that in saving $80 a month on an auto loan, half of that money could be put into a high yield savings account so that when an individual is done paying off their loan, they have a nest egg built up to safeguard against future financial shocks.
“We’ve got a working, viable business at scale and the addition of the bank only enhances the capability of that business to generate value,” he told Webster. “We’ve got a lot of the infrastructure and controls that the regulators would expect to see in a financial institution,” he said. “So we feel good about the eventual outcome. The timing is TBD.”