The post recession period in general — and the first half of the 2010s specifically — have at various times and in various publications been described as a “perfect storm.” A storm that the plethora of online lenders stepped in to fill. Though they come in a variety of flavors, the online lender class that flourished in the post-2008 world brought some common elements to the table.
Their primary distinguisher was around the use of data, technology and using a wider variety of information streams to create credit scoring and risk management models that they claimed allowed them to assess risk and extend credit more efficiently than their traditional bank counterparts. And, because they are all digital, this new class of lender could avoid the high overhead costs of physical branches and the personnel to staff them.
Some of the emerging online lenders are actually that — lenders, meaning they underwrite, extend credit and service the loans themselves. But the more attention-grabbing and VC-money-absorbing class of online lenders were the ones that didn’t actually lend the money, but connected those interested borrowers with a lender willing to make the loan.
The sales pitch has a strong “everybody wins” component. Consumers and businesses that might otherwise lack access to a reasonable line of credit can get one, investors have an opportunity to have their money make money when interest rates were being held at zero by the Fed, and the marketplace itself gets to make a lot of money selling those loans off to those waiting investors. Loans that were also extended to prime or near-prime borrowers.
And online lending had one more nice wind at its back: The CFPB has officially decided to take a wait-and-see attitude before drafting regulations.
However, just as quickly as winds can propel a market segment forward, they can change direction and start pushing back. The zero percent interest rate is a thing of the past, albeit only marginally. There’s another factor at play. Some of these online lenders are starting to go down market, which means that the risk to the lender is creeping up, and when the cost of capital creeps up and the risk creeps up and the returns creep down — well, that has the potential not to be such a hot proposition for anyone anymore.
“But what’s clear is that once-bullish investors seem to have cooled on the space as these platforms work their way through the natural cycle of business and they wait to see how good the new science of credit risk and underwriting really are. It’s really too early to tell,” noted MPD CEO Karen Webster in a recent article about the changing seas for online lenders in general, and marketplace lenders in particular.
And, because bad news always comes in clumps, it seems the latest batch of headwinds are blowing on the horizon and coming soon to online lenders everywhere. The CFPB, if recent reports are accurate, has waited and watched enough for now — and is starting to make some noise about what it doesn’t like in the online lending space.
Which, as most financial services players with experience with the CFPB can attest, does not usually mean that it’s time for party hats and noisemakers.
New Regulatory Interest
Signs of the CFPB’s growing interest in online lending marketplaces have emerged throughout early 2016, most recently with the regulators actively encouraging borrowers to submit complaints when they encounter issues with online borrowing.
The database consumers would be feeding is one of the organization’s guiding tools for supervision, enforcement and regulation creation — and the notice last week indicates an inclination to begin taking a closer and more comprehensive look at the emerging class of technology-backed lending outfits.
“All lenders, from online startups to large banks, must follow consumer financial protection laws,” Richard Cordray, CFPB director, said in a statement. “By accepting these consumer complaints, we are giving people a greater voice in these markets and a place to turn to when they encounter problems.”
Along with the advice on how to complain, the regulator also issued information about what to watch out for when working with an online lender. That specifically included warnings against losing certain protections when using an online lender.
That particular warning came in the context of a callout about firms that offer to refinance student loans, a service mostly associated with SoFi (Social Finance Inc.) and Darien Rowayton Bank. These loans have become popular quickly, with $2.7 billion of securities backed by such loans issued, almost four times the levels of 2013 and 2014 combined.
The CFPB noted that in taking such loans consumers may be trading away protections like loan forgiveness or payments capping in accordance with income.
SoFi had a response to the increased interest — and the warning.
“Given the increasing popularity of our space, we welcome the CFPB’s efforts to provide consumer education and help borrowers make sound decisions,” the company said in a statement to WSJ. “We’ve been participating in the CFPB portal for quite some time and take all feedback very seriously.”
Other Signs Of Recent Interest
The new set of guidelines about online and marketplace lenders come only a week or so after the CFPB took its first ever enforcement action related to data security.
Dwolla was dinged with a $100K fine after the CFPB found that the online payments platform had deceived consumers about the firm’s data security and the safety of its payment platform.
“Consumers entrust digital payment companies with significant amounts of sensitive personal information. With data breaches becoming commonplace and more consumers using these online payment systems, the risk to consumers is growing. It is crucial that companies put systems in place to protect this information and accurately inform consumers about their data security practices,” noted Cordray on the enforcement.
Dwolla has neither admitted nor denied the allegations, but has noted the complaint refers to a prior era in security, stating that the firm’s current protocols meet the CFPB guidelines.
The new era of interest in online marketplace lending, while ill-timed, might actually be a healthy look into an industry that operates quite differently than traditional lenders but impacts – and can hurt — borrowers, lenders, investors, shareholders and innovators. Some argue that the only people who could ever be hurt from these online marketplace loans are the big hedge fund guys who buy the securitized assets that they become in the first place – the loans are unsecured so the consumer isn’t going to have their house or firstborn taken away from them. But when hedge funds stop buying those assets because more and more people default, there’s potentially less and less money to go around. And the good people who benefit from such loans won’t be able to anymore, and the shareholders who bought shares will lose money, too. What’s clear is that this is likely a wake-up call for a good look into the business models of an industry that not a lot of people really understand but that touches many.