By Bo Brustkern, CEO NSR Invest, Crowdfund Beat Gust Post
Well that was unexpected.
I certainly didn’t think I would be reading about Renaud Laplanche’s resignation as CEO of Lending Club while drinking my morning coffee last Monday. Since then, the news hasn’t gotten any better and emotions are… shall we say, running high? Here at NSR Invest we have fielded a large number of calls from anxious investors over the past several days, so in lieu of our traditional monthly newsletter I figure let’s just talk about Lending Club.
But before I weigh in, I need you to keep a couple things in mind. First, this short missive can only scratch the surface of the issues at hand. It is a summary of events as they have been reported, together with a few of my thoughts as of this moment. Second, this is a dynamic situation and facts and perceptions are surely going to change rapidly and continuously for many weeks to come. What I say today may not apply to tomorrow’s situation, to tomorrow’s facts, to tomorrow’s revelations. What’s more, there are always at least two sides to any story, and at this point it feels like we have only one: the alarmist. Or half of one: the alarmist who is still coming up to speed on the story.
To recap, here’s a brief overview of what we understand happened at Lending Club that led to the ousting of Renaud. Note that essentially all of this has already been reported in the media, and we have made no effort to independently verify any of the below “facts,” nor have we received the benefit of hearing the other side(s) of the story.
What we think we know
Renaud Laplanche, CEO of Lending Club, apparently made an investment in a fund that purchases loans from Lending Club. Doing this creates a conflict of interest, as Lending Club is supposed to remain neutral when it comes to serving its client-investors. If Renaud is invested in one of his clients, can he remain truly neutral?
Renaud apparently requested that the Board of Directors (BoD) approve an investment by Lending Club in the same fund. This only exacerbates the conflict of interest. What’s more, Renaud apparently did not notify the board that he had already invested in the fund. From the company’s recently filed 10Q we learn that “The Board did not have the information required to review and approve or disapprove investments made by its former CEO… in accordance with Company policies, including the Code of Conduct and Ethics.”
After years of saying no to securitization, the company began working with a prominent investment bank, Jefferies, to put together loan portfolios that could be securitized and sold, which supported Lending Club’s growth plans. As part of this effort, Jefferies required Lending Club to enhance its disclosures to borrowers, making more prominent a Power of Attorney (PoA) clause. This Lending Club faithfully did. Later, however, a staff engineer was allegedly ordered by a Senior VP to change the origination dates on $3 million worth of loans that were allocated to the Jefferies securitization portfolio, possibly to obfuscate the fact that the loans were not originated in accordance with the new PoA clause; upon investigation, it was discovered that in total $22 million in notes allocated to Jefferies did not meet Jefferies’ requirements. Lending Club later reversed the transactions and allocated the loans to other investors, but the breach of contract — and confidence — was recognized.
According to the Wall Street Journal, LC’s BoD “was presented with evidence that Mr. Laplanche knew many of the details of the $22 million loan sale and wasn’t upfront with directors about what he knew.” Naturally, this would have caused great discomfort at the board level.
On Friday, May 6, Renaud was asked by the BoD to resign, and at least three of his lieutenants were summarily dismissed. Scott Sanborn, who had been President of Lending Club, became also Acting CEO while Hans Morris of Nyca Capital assumed the role of Chairman of the Board.
So that’s what we “know” about the situation at Lending Club. To sum it up, it sounds like Renaud made some bad decisions related to conflicts of interest and compliance, and he and/or his lieutenants got caught manipulating data in the loan book. If all of this is true, then my deepest concern is that some members of the LC team chose (and were able) to tamper with the data provided to investors. This is of grave concern to me because our loan selection system at NSR Invest is only as reliable as the data we receive. In other words, if Lending Club were to send us inaccurate data, then our system could very likely make an imprudent judgment about which loans to buy for our clients.
We’ll dig deeper there in a sec, but for the moment let me underscore a very important point: in my opinion, none of these apparent transgressions contradict the basic tenets of the Lending Club model, which is to provide responsibly structured, lower-cost loans to borrowers while providing uncorrelated, higher-yielding investment opportunities to lenders. Nothing here undermines the clear market need for p2p lending. In the words of the inimitable Dara Albright, people are “not going to suddenly start liking banks more than root canals.” While these are sad days indeed for our friends at Lending Club, I perceive no Achilles Heel in the p2p lending industry.
So if the model works, and the credits are good, and the data is reliable, then what we have here is a headline-grabbing corporate governance scandal and conflicts-management problem. With this perspective, we can continue purchasing Lending Club loans with confidence, and we are doing that very thing for ourselves and for our clients.
Confidence
Every day after the scandal broke we engaged in countless conversations with investors, partners, and key players in the space about the scandal, and what it means for Lending Club, for investors and borrowers, and for our industry. And while everyone was shocked and dismayed, there was also a certain feeling of confidence shining forth… an “our industry is going to come out stronger as a result” kind of sentiment.
“The FinTech train has long left the station and there is no turning back. The earth doesn’t spin in reverse. What we are experiencing now is the natural evolution of an industry. In order to evolve, we must err. Stumbling is how we learn and grow. This is nothing new. Mankind has been advancing in this manner for centuries.”
— Dara Albright, co-Founder of the LendIt Conference, One scandal does NOT mean that marketplace lending is over, CNBC
And then on May 16, Acting CEO Scott Sanborn, a well-respected executive with a long tenure at LC, issued a letter to investors through Lending Club’s investor relations department, asserting that a Big Four accounting firm had been retained to conduct “forensic data change analysis” on 673,000 loans sold to investors over the past 8 quarters, and “99.99%… display either no changes or changes explained by the normal course of business.” While the results of the audit are not yet complete, they are indeed encouraging. In fact, the audit simply re-confirms the due diligence performed by presumably scores of institutional investors like Banco Santander, Morgan Stanley, BlackRock, and others, prior to collectively pouring billions of investment dollars into loans originated by Lending Club.
The sentiment of confidence was echoed In a recent post on the Lend Academy blog, where Peter Renton wrote, “Lending Club’s business model is about providing a lower rate of interest to American borrowers using a more responsible structure than credit card-style revolving debt, and at the same time providing a high return by passing through 99% of the cash flows (that’s 100% minus a 1% servicing fee) to investors. Lending Club’s underwriting model – the way in which it selects loans to list on its marketplace – has absolutely nothing to do with the recent events that ended in the resignation of its CEO and founder.”
What the data tells us
In addition to all the grief Lending Club is going through, the media has also been bashing the purportedly surprising increase in credit defaults at both LC and Prosper. Makes for a nice headline, but where this conclusion comes from I don’t rightly know. It’s not what the data tells us.
We used NSR Platform to conduct a study of the loss rates for quarterly cohorts from 2009 to present. Our analysis examined the six-month loss figures across all loans originated by Lending Club and Prosper for each quarterly cohort. By comparing losses at a fixed age, we can quickly assess whether there is a material difference in performance during the early stages of portfolio maturation, when losses can lead to material detrimental effects to returns.
Note that the “Loss Rate” in this analysis is the NSR-estimated projected loss based on a loan status analysis 6 months after origination. These aren’t the final loss numbers for the cohorts, but a snapshot at a given point in time.
Note also that the “Average Rate” for Lending Club and Prosper are heavily influenced by the blend of loan grades originated for each platform for each cohort.
This test does not perfectly isolate underwriting, and can be impacted by many variables, including macro-economic impacts such as employment rates. However, it’s a reasonable way to quickly establish whether the results of Lending Club’s or Prosper’s underwriting has materially changed from one quarter to the next. And we conclude: it hasn’t. You can easily see that, contrary to media opinion, recent vintages are showing strong performance.
Press Contributions
For a detailed review of the reported events that led up to the sacking of Renaud, readInside the Final Days of Lending Club CEO Renaud Laplanche in the Wall Street Journal by Peter Rudegeair and Annamaria Andriotis with contributions from Michael Rapoport.
To read Lending Club’s official response, which can be found on their Investor Relations website, check out this two-page investor letter from President and Acting CEO Scott Sanborn, which explains the rigorous internal controls testing the company has conducted, along with its quick response to the crisis. In it Scott pledges, “The problems identified this quarter run counter to our values and will never be tolerated. We’re working hard to make things right and prove to you that we continue to deserve your trust.”
Nav Athwal of Forbes offers this opinion in the article Lending Club and What it Means for FinTech: “This is an unfortunate development, but it doesn’t erase the solid foundation and talented teams that most fintech companies, including Lending Club, have built over the last decade. Fintech will not only survive, but thrive, largely because the business model these pioneers developed is still sound.”
Kadhim Shubber of the Financial Times has this more sobering report on What happens if Lending Club goes out of business?, in which he extensively covers the difference between owning a loan and owning a borrower-payment dependent note, as is typical for individual investors who invest through Lending Club.
Mr Shubber also wrote in the FT Who knew what at Lending Club?, in which he unpacks some of the more salient footnotes that appear in LC’s 10Q filing, which posted on Monday, May 16, for the period ending March 31, 2016.
Stone Fox Capital wrote Lending Club: Death Watch Value and posted it on Seeking Alpha, arguing that LC “now trades at a death watch valuation despite no fundamental change to the performance of the loans on the platform.”
My partner Peter Renton wrote a piece called Why I am Keeping My Money in Lending Club for Lend Academy, in which he explains why the governance issues at Lending Club are not affecting his allocations to p2p investments on the LC marketplace. In it he states, “I am very confident that Lending Club loans will continue to perform well despite the governance issues that cropped up and came to light over the past two weeks… nothing in this narrative shakes my confidence in the underlying business model of Lending Club.”
Finally, Dara Albright throws a cold, wet towel on the alarmists with her article One scandal does NOT mean that marketplace lending is over, which appeared on CNBC.
There, that should get you a fair way into — and out of — the sea of information swirling about the industry.
Conclusion
Surely, the foundation of our industry is built on transparency and straight-arrow ethics, and our faith in those pillars has been shaken by recent events. But the peer-to-peer model has not been challenged here. There has been no discovery of a fundamental flaw in the business of originating healthy consumer installment loans. In fact, the apparent transgressions at LC seem to cry out for a return to the fundamentals of the industry: transparency, freedom from conflict, and service to borrowers and lenders.
If we find good in the events of the past several weeks, it will be because Lending Club specifically, and our industry generally, respond to this crisis in a reasonable, considered fashion. It will be because we used this opportunity to recommit ourselves to the heroic ideals that comprise our foundation. It will be because we march onward, putting forth new leaders who will carry the flag and find higher ground.
Once you’ve had a chance to read and digest it all, we’d love to have a thoughtful conversation with you. My colleague Summer Tucker has been draining the battery on her Polycom headset on a daily basis, and welcomes more. Ring her at 720-259-0455to get in the queue.
We love all of you, our dear clients, and enjoy every thoughtful conversation we have with you. You’re the reason we get up every day excited to hurl ourselves upon the challenges provided by this new and impactful industry.
Bo Brustkern
Co-Founder & CEO
NSR Invest
: CrowdFund Beat.
The post appeared first on The Crowdfund Network.