Will The Market Cool-Off Freeze Some Alt Lending Players?

When the stock market opens and immediately drops a thousand points, it is an eye-catching moment for investors everywhere. And that is what happened on Monday, Aug. 24, 2015. The reactions on the day were mixed. Some called yesterday’s adventures in investing a long overdue market correction set off by what is legitimately a market crash in China. Others were a bit more pessimistic that the global financial system has had one too many shocks over the last eight years and is now facing some pretty significant troubles with fewer options to soothe the market.

A sudden drop in the market is not good news – but a day or two of falling stocks are probably not enough in the way of tea leaves to offer a read on what’s next for the economy. In the words of economist Paul Samuelson, the first American to win the Nobel Prize in Economics, “the stock market has called nine of the last five recessions.”

However, the last few days have been unusually tough on tech and financial stocks. Netflix has moved right smack in the middle of bear territory with its stock down 20 percent from its peak. Even Apple was briefly trading at less than $100 a share – though an unusual intervention by CEO Tim Cook seems to have calmed investors and sent the price trending back up. Amazon, Microsoft, Facebook and Intel all dealt with similar opening bell brutality in their stock prices.

While the rapid cooling in tech has been prominent for the last few days – the frost, so to speak, came early to the alternative lending tech stock at Lending Club and OnDeck, which have both been struggling for over a month.

Both firms were carried to prominence on early and impressive expansions in underwriting portfolios. Both firms were also greatly helped by an emerging consensus in the small business and personal lending market spaces that non-bank channels were the future of such loans.

The traditional lenders of the past, according to the conventional wisdom of the last five years or so, have little financial incentive to focus on small business lending in a highly regulated environment where it is costly for them to do so. Further, many of the “new economy” businesses have different asset bases to assess for risk, something that their current underwriting standards have been said to lack. The perfect storm of the financial crisis, more bank regulation and less bank readiness to lend has been a boost for the non-traditional lenders whose data assets and business models enable them to lend money and make money at the same time.

Alternative lenders – with souped-up and sped up credit evaluation and underwriting processes, on the other hand, are able to profitably tap into that market and provide needed credit to underserved borrower bases.

Both OnDeck and Lending Club pulled off impressively profitable IPOs in late 2014. Lending Club made $1 billion in its IPO with a share price of $15 and a market cap of $10 billion – something that made many in the industry question the rationale for such an enormous valuation. OnDeck followed suit with an IPO that raised about $200 million and left the firm with a valuation of $1.8 billion.

As of the date of this story, both firms are nursing their stock market wounds. Both are trading well below their IPO price and have lost over 50 percent of their market cap value.

So what gives? PYMNTS lays it out.

OnDeck’s Ongoing Issues

As of Monday, Aug. 24, OnDeck was trading at $9.14 a share with a market cap of $667.3 million. That doesn’t look bad until you compare it to its December 2014 stock price of $28.12 a share shortly after going public.

Over the last three months, OnDeck has seen its share price decline nearly 40 percent (38.21 percent). Its sharpest declines came this summer in the aftermath of its Q2 results – which disappointed investors to the tune of a 20 percent drop in stock price.

But the news wasn’t all bad. OnDeck announced that it hit $143 million in small business loan sales through its Marketplace platform, a figure that boosted its earnings expectations up to $63.5 million in revenue for the quarter.

However, the firm also acknowledged that its marketing campaigns where a bit of a fizzle, netting far fewer SME loan applications than expected from the initiative.

OnDeck CEO Noah Breslow also acknowledged the rising competitive landscape in small business lending.

“There are now two or three competitors dominating this trend, but we know the sheer number of marketing solicitations targeting small businesses have grown meaningfully over the last six months, which impacts our response rate,” he said.

On the upside, OnDeck’s recent performance has shown some signs of improvement — even in a weakened market. In the last two weeks, shares in OnDeck have improved by a little over 5 percent – certainly the right direction – but with a lot more ground to cover.

Lending Club’s Rough Time With Regulations

As of the writing of this article, Lending Club’s stock price was $11.61 per share, and with a market cap  — are you ready? – of $4.4 billion.

The firm has been having an extraordinarily bad summer since ending up on the losing end of a fight with a Federal Appeals Court decision about how it underwrites loans across state lines.

Lending Club, like many alternative lenders, uses out-of-state banks when underwriting over the Web, which allows them to skirt interest rate caps in states like Vermont or New York. In Lending Club’s case, that out-of-state lender was a Utah-based bank called WebBank.

The practice is referred to as “exporting” interest rates and, according to the firm’s August earnings call, accounts for about 12.5 percent of their loans. However, a recent ruling by the Second District Court of Appeals has essentially rendered that practice invalid. And, though Lending Club said it will appeal the decision to the U.S. Supreme Court, it and many alternative lenders are facing the loss of this tool.

Lending Club has also run into the buzzsaw of the CFPB which recently ordered the firm’s Springstone Financial subsidiary (which specializes in medical lending) to pay $700K in fines for deceptive credit enrollment practices.

In a statement accompanying the order, CFPB Director Richard Cordray stated that “deceiving patients in need of medical care into paying for services with risky credit adds insult to injury. The Bureau will not tolerate financial companies or their providers taking advantage of distressed patients and their loved ones with misleading sales pitches.”

A More Skeptical Market?

While OnDeck and Lending Club both benefited from a tremendous upswell of enthusiasm as they debuted, it seems that some players are suddenly feeling a bit more skeptical.

“The stocks are too expensive relative to underlying risk,” noted Michael Tarkan in an interview with Fortune. Tarkan is an analyst at Compass Point Research & Trading and notes not feeling optimistic about other firm’s prospects.

“The Street is realizing these stock emerged way overheated. The regulatory risks in the alternative lending space are really big unknowns at this point. There are also a lot of competitors in the space – and it might be too early to pick a favorite.”

Or assess how much these firms are really worth.