WebBank And Alt Lending’s ‘Perfect Storm’

For the last 300 odd years, the term “perfect storm” has referred to a meteorological event wherein all of the wrong factors in a climate system came together at just the right time to create some sort of monstrous weather event.

For the last 20 odd years, since Sebastian Junger published the book “The Perfect Storm” (about a horrendous meteorological event at sea), the term has become the generally accepted euphemism for the spectacularly one-in-a-million shots that happen to be unlucky.

Which leads to the interesting tale of Utah’s WebBank — a small and mostly invisible entity that has recently found itself in the middle of the “perfect storm” of the financial services sector Luck-O-Meter.

The tiny Utah-chartered bank, through a series of events that would have been hard to predict when Warren Lichtenstein first took over its operations in 1998 – has found itself a central player in the online lending craze that’s been steadily gaining steam for the last half decade.

Now, through a series of equally difficult-to-predict events involving one of those online lenders and a national tragedy, WebBank once again finds itself under intense scrutiny along with the online lenders that it has allowed to flourish in the consumer lending market.

And that’s before all the stuff involving one of the Real Housewives of New York and the custody battle.

Like we said — perfect storm.

Why WebBank Matters An Awful Lot

WebBank may not be terribly well known, but its principal player, Warren Lichtenstein, was somewhat financial services famous. The Wall Street Journal referred to him as a wunderkind when describing his early career as a hedge fund manager during the pre-2008 boom years.

Post-2008 and down a few billion, Lichtenstein is now the proud owner of WebBank, through Steel Partners Holdings LP, a publicly traded investment firm of which Lichtenstein is executive chairman and has a 40-percent stake in both directly and through investments in other funds.

Steel Partners also holds stakes in companies that make deli-meat blades and build and operate youth baseball complexes. After Lichtenstein took control of the bank in the late ’90s, it was far from a standout in the investment firm’s portfolio.

That changed in the post-financial crisis world.

Bank-based sources of credit dried up consumers and small businesses. Investors — facing interest rates held at basically zero by the Fed to stimulate recovery — were looking for higher yield places to put their funds.

Those two factors allowed an emergent class of cloud-backed, big data powered alternative lenders to enter the marketplace and provide credit for the underserved — and an investment vehicle for those frustrated by the Fed.

But those emergent lenders needed a bank, in particular one regulated by the Federal Deposit Insurance Company, to easily make loans nationwide.

Hello, WebBank.

When working with one of its partners — say Lending Club or Prosper — WebBank is actually the financial entity that underwrites the loan offered by the alternative lending platform. WebBank than holds that loan on its own books until an investor purchases it — usually a day or two later.

WebBank also comes with an additional benefit of being classified as an industrial bank, meaning that it is not subject to direct oversight by the Fed, which has authority over many state-chartered banks and holding companies. It is however answerable to both the FDIC and Utah’s state regulator to make sure it is compliant with anti-money laundering rules.

But what WebBank is doing is creating an environment that benefits the lending market and its participants greatly.

It has also been a real success story for WebBank.

Online loan volumes have doubled every year the company has been making them and are set to reach $120 billion by 2020 if Morgan Stanley’s estimates are right. WebBank has also generated $46 million in revenue in 2015 so far, with a net income of $31 million — meaning its return on equity is 59 percent, according to SNL Financial. That’s six times bankings’ average.

When Regulators Come Knockin’

The relatively unencumbered field WebBank has played on so far, however, may not remain quite so for much longer.

WebBank has seen its business challenged by a U.S. appellate court decision which could make it harder for marketplace lenders to tap Utah-based banks (there is no usury law in Utah that caps interest rates on loans) from skirting state rate caps in less lending-friendly states. WebBank lost that case — and would now need the U.S. Supreme Court to overturn it.

Probably fat chance of that now.

The case, Madden v. Midland Funding, may force changes in those fees that may lead WebBank and the lending platforms it partners with to incorporate variable fees that would change with the loan’s performance, so as to avoid running afoul of rate caps.

Apart of court attraction, however, online lending platforms have also draw the attention of regulators — spurred by a tragic, if unlikely, event: the mass shooting in San Bernardino, California.

Prosper Marketplace — a San Francisco-based company that matches individual lenders with pre-approved borrowers — confirmed to Fortune that it arranged a $28,500 loan to Syed Farook, who was one of the two confirmed attackers.

“Yes, unfortunately, they did get their loan from Prosper,” an outside spokesperson for Prosper told the outlet.

There are no allegations that either WebBank or Prosper mishandled the loan — and though both firms noted they could not comment on the specifics on Farook’s application, they did note that all loan applications are reviewed in accordance with antiterrorism and anti-money laundering laws. But the news has drawn the wrong kind of attention.

Last Wednesday, the House Financial Services Committee said it was looking into whether rules for online lenders need to be strengthened.

The next day, the California Department of Business Oversight — the body charged with the oversight of securities and lending activity in that state — sent requests to 14 companies for details about their lending practices, investors and business models. The information is for the purpose of determining whether or not they are appropriately overseen, or whether changes to regulations need to be made reflect the changing world of lending.

On the list?

Kabbage Inc., Prosper Marketplace Inc., Avant Inc., OnDeck Capital Inc. and Social Finance Inc., according to representatives for those companies – The Wall Street Journal was unable to obtain a complete list.

The investigation was planned before the bad press. The timing is unfortunate insofar as it has heightened the emotions around the issue.

Still, for their own part, the lenders tapped by The WSJ were ecstatic at their opportunity to be scrutinized and potentially regulated some more. A Prosper spokeswoman said the lender is, “happy to work with the department to understand our company and the industry.”

“At SoFi, fairness and transparency are critical factors in our partnership with our members, and we strive to have an equally transparent approach with regulators,” said Debra Jack, a Social Finance vice president.

“We welcome the opportunity to engage with regulators to ensure that small businesses have access to the products and services they need to grow,” said Rob Frohwein, chief executive of small business lender Kabbage.

And while everyone is facedly delighted at the inclusion of regulators in their lives, we imagine behind closed doors no one at the lending platforms or banks like WebBank that support them are deeply looking forward to the increased costs and scrutiny that regulators tend to give as their standard Christmas gift.

Stay tuned.