As loan club stumbles, its entire industry faces skepticism

Renaud Laplanche and his crew piloted a 105 feet races boat across New York Harbor one day last spring, her towering sails ripping through the water at 30 knots.

An accomplished sailor and founder of the Lending Club, Mr. Laplanche hosted executives from hedge funds, Goldman Sachs and other banks – as part of his efforts to convince Wall Street of his plans to overthrow traditional banking with some form of lending. faster and more democratic. .

It already had the backing of Lawrence H. Summers, the former secretary of the Treasury, and John Mack, the former head of Morgan Stanley, who joined its board of directors. When the Lending Club went public in December 2014, the company was valued at over $ 8 billion.

But on Monday, the Lending Club announced that Mr. Laplanche had resigned after an internal investigation found irregularities in his lending process, including the modification of millions of dollars in loans. The company’s stock price, already in shock in recent months, has fallen 34%.

The company’s woes are part of a larger calculation in the online money lending industry. Last week Prosper, another online lender that focuses on consumers, laid off more than a quarter of its workforce, and the chief executive said he was giving up his salary for the year. .

The Lending Club problems, in particular, threaten to confirm some of Wall Street’s worst fears: As favorable economic conditions begin to turn around, they will reveal many companies with weak internal controls that have provided inaccurate information to investors. with starry eyes.

“Clearly this is bad news not only for the Lending Club, but for our entire industry,” Peter Renton, who founded Lendit, a leading conference in the industry, written in a blog post Monday. “Really bad.”

Marketplace lenders like Lending Club have created easy-to-use websites that suit consumers and small businesses, hoping to borrow a few thousand dollars, with individuals or Wall Street investors looking to lend from. money.

Freed from the costs of physical branches and federal regulations requiring them to set aside money on their loans, market lenders were able to grow quickly and with less expense.

The process is almost entirely online, with loans approved in days rather than weeks that a traditional bank might take.

While loans in the market represent less than 1% of consumer loans in the United States, a recent report by investment bank Jefferies indicates that in certain segments – like installment loans – new loan companies represent more than 10% of the market.

Just a few months ago, it seemed like market lenders couldn’t make loans fast enough. Investors like hedge funds, insurance companies and pension funds were asking for the purchase of large batches of these loans, which offered good returns at a time when interest rates were historically low.

But in the first quarter, lenders like Lending Club, Prosper and OnDeck Capital struggled to convince investors that their business models are sound.

Even though the majority of corporate borrowers continue to pay their loans on time, Wall Street investors have started to worry about the prospect of increased defaults.

Small business lender OnDeck last week said demand for securitized packages of its loans had all but disappeared in the first quarter.

“Investors shoot first and ask questions later,” said Christopher C. Brendler, financial analyst at Stifel, the investment bank.

The decline in loan demand on Wall Street exposed the Achilles heel of loans in the market. Unlike traditional banks that use their deposits to fund loans, market companies have discovered how fleeting their sources of funding can be.

Since the start of the year, the Lending Club has raised the interest rates on its loans three times to make them more attractive to investors.

As pressure to sell loans intensified in the industry, problems began to surface at the Lending Club, according to two people briefed on the company’s internal investigation, who spoke out under the guise of the Lending Club. anonymity.

They said that in early April, a Lending Club employee discovered that the dates of about $ 3 million for loan applications appeared to have been changed in some way. The employee raised the issue with Mr. Laplanche, who alerted the company’s internal auditor.

This investigation led to the discovery of other irregularities, said the two people. This time around, it emerged that about $ 22 million in loans sold to Jefferies did not meet investment banking criteria.

Although the gap is quite minor, they said the Lending Club board sees it as a serious issue. The company bought back all the loans.

“A key principle of the company is to maintain the highest levels of trust with borrowers, investors, regulators, shareholders and employees,” said Hans Morris, who was named executive chairman of the Lending Club on Monday, a newly created post, in a press release.

Both people briefed on the internal investigation said it revealed another problem. Mr. Laplanche held an interest in an investment fund in which the company also planned to invest. But Mr. Laplanche had failed to disclose his personal investment to the board.

Mr. Laplanche did not respond to a request for comment.

Mr. Laplanche, in many ways, was considered the face of his industry. He is a lawyer of French origin who spent the beginning of his career with Cleary Gottlieb, a large business law firm.

He got the idea to create the Lending Club in 2006 after seeing how small banks paid people to deposit their money and how much those same banks charged to lend. “We wanted to close the gap,” he said in an interview last year.

Mr. Laplanche is also a world class sailor who holds two speed records. He frequently took his staff to sail to San Francisco.

Last Friday, the board briefed Mr. Laplanche of its findings, making it clear that he had lost his confidence. Three senior executives involved in loan sales resigned or were fired. Company president Scott Sanborn has been appointed interim chief.

Before the recent turmoil, more traditional banks trusted the industry’s underwriting models and low-cost lending system. Banks bought loans from market lenders and also formed partnerships.

JPMorgan Chase, for example, has started a partnership with OnDeck to offer loans to small businesses. JPMorgan, the country’s largest bank, estimated Ondeck could offer the loans cheaper and faster than if the bank processed them in-house.

Some analysts predict that if the funding pressure continues, the big banks could end up acquiring market lenders, or pieces of them.

“They have good technology and it could eventually be adopted by the banks themselves,” said Todd H. Baker, founder of Broadmoor Consulting, which advises financial services companies.