Digitallenders are facing fresh questions about the industry's viability amid a roughweek as OnDeck CapitalInc. missed expectations in its earnings release and announced massive layoffs. As capital markets have on digital lending, reportsabound of smaller platforms facing funding pressures that could necessitatemore bank partnerships or M&A activity.
ForOnDeck, the inability to find buyers for its loans proved more concerning thanthe actual earnings figures.
"That'sthe key concern in the industry: the funding of these platforms," saidMichael Tarkan, an analyst with Compass Point Research & Trading. "Andif the funding is slowing, then it will severely constrain the platforms'ability to lend."
Valuationsfor OnDeck and LendingClubCorp. have gotten crushed since the beginning of the year, and thisweek's news has pushed valuations even lower. OnDeck's shares tumbled 42.41% injust four days, closing May 5 at $4.97 per share after closing April 29 at$8.63 per share. LendingClub's shares were affected, too, dropping 13.29% overthe same time period. Meanwhile, the SNL U.S. Specialty Lender index shed only2.80%.
Forthe many private digital lender platforms, raising additional equity willrequire accepting lower valuations. Some companies might instead look to sellto a competing platform or a retail bank, said Peter Renton, co-founder of bothdigital lending publisher Lend Academy and conference organizer LendIt.
"Myprediction is that in the next three to six months, we're going to see a lot ofactivity in this space when it comes to acquisitions," Renton said.
Rentonis a self-proclaimed bull for the industry, but the bears see moreconsolidation, too. Todd Baker, managing principal with Broadmoor Consulting,has said the digital lending industry would eventually face funding pressuresand this week penned a "told you so" columnfor American Banker. He said in aninterview that digital lenders will need to become a de novo bank, sell to abank, buy a bank or ink significant long-term arrangements with banks,essentially turning the digital lenders into technology providers.
"Ifcurrent conditions continue for a while, it will be inevitable that all of themwill look to partner either through M&A or long-term alliances withbanks," Baker said.
Inthe first quarter, On Deck sold 26% of its term loan originations toinstitutions via its "marketplace" platform, down sharply from the2015 fourth quarter. During a May 2 conference call to discuss results, CEONoah Breslow said the company now expects to sell 15% to 25% of its loansthrough the marketplace, as opposed to previous guidance of 35% to 45%.
Theslashing of its full-year guidance was most concerning, Tarkan said. Thecompany also cut its guidance for loan growth to 30% to 35% this year, downfrom a 45% to 50% year-over-year growth projection offered in the 2015fourth-quarter results.
"Iwas thinking there was a chance guidance would come in lower … but themagnitude of the guidance revision was beyond my expectations," Tarkansaid.
MirandaEifler, senior communications manager for OnDeck, declined to comment.
Rentonsaid he was more concerned by Prosper's layoffs than OnDeck's guidancerevision. This week, Prosper announced 170 employees would be laid off and that thecompany would shutter its Salt Lake City office.
"Iknew there were challenges, but … it didn't even occur to me that that wouldhappen. I think it's the first time we've had a round of layoffs in thisindustry's history, as far as significant layoffs are concerned," Rentonsaid.
Withthe layoffs, the company will be focusing solely on consumer loans. A year ago,Prosper purchased American Healthcare Lending to facilitate financing medicalprocedures at the point of service. Media representative Sarah Cain saidProsper will no longer pursue point-of-sale financing but will continue to workwith health care providers to fund medical procedures but borrowers will applydirectly on Prosper's site.
In astatement, Prosper CEO Aaron Vermut said the layoffs came "from a positionof strength to ensure we continue on our path to long-term success." Thecompany emphasized that the layoffs would not affect core operations such asunderwriting and risk assessment. At the same time, Prosper confirmed that JoshTonderys, chief risk officer, is no longer with the company. On May 6, MarletteFunding, a large marketplace lender, announced Tonderys had been hired aspresident of the company.
Lookingahead to LendingClub's earnings, to be reported May 9, Compass Point's Tarkansaid the company might not face the same funding pressures as OnDeck or Prosperdue to enjoying a broader investor base, particularly retail investors.
"Theirinvestor pool is deeper than OnDeck's and it's deeper than pretty much everyoneelse," Tarkan said. "It's possible we're not going to see as muchpressure [on LendingClub] as we saw with OnDeck."
LendAcademy's Renton also said he expects LendingClub to fare better, predicting thecompany will meet expectations or miss by a small margin but could lower itsfull-year guidance.
Aglance at stock price movement this week underscores the importance of broad,diverse funding sources. While LendingClub and OnDeck saw double-digit lossesthis week, Yirendai Ltd. shares barely budged, dipping just 4.05%. Yirendai isChina's largest consumer marketplace player, owned by financial giantCreditEase. Renton said the company is less reliant on institutional investorfunding, which can be pulled at a moment's notice.
"It'sa lot of retail money, so they don't have the same headwinds that we havehere," Renton said. "It's still a little surprising since peopleusually get pulled down together."
Lookingforward, both Baker and Renton said the digital lending revolution is here tostay and both see M&A activity increasing due to funding pressure. Wherethe bear and bull differ is in the staying power of individual brands.
"Thelarger platforms, I think, are in a more secure position; it's the small andmidsized platforms that are more vulnerable," Renton said.
WhileBaker said the strongest companies can survive funding challenges for asignificant amount of time, he is less optimistic. Tellingly, digital lendersface this funding crisis despite continued strong credit performance. Rentonsaid such low delinquency rates show the fundamentals of the industry remainstrong while Baker said it is a sign of the industry's fragility.
"Ifit's this bad when credit is really good," Baker said, "then you reallyhave to think: 'How resilient is this group of companies going to be whencredit turns bad?'"