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LendingClub internal control issue spells 'bad times' for digital lending industry

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LendingClub internal control issue spells 'bad times' for digital lending industry

The emergenceof internal control issues at LendingClubCorp. have some investors and analysts worried about the state of thedigital lending industry, foreseeing lower volumes for the industry leader and potentiallyadditional regulation.

The company'sstock was hammered May9 following news thatChairman and CEO Renaud Laplanche resigned because of an improper loan sale anddata manipulation. Around 3 p.m. ET, the company's stock had lost 27.11%, down to$5.18 per share. The company's stock is nearly one-third of its of $15.00 per share.

Whilethe financial impact appeared to be minimal, the emergence of such egregious misconducthas investors and analysts alike thinking there will be implications for the broaderdigital lending industry. Last week,Prosper announced a massive round of layoffs and On Deck Capital Inc.'s earnings were hurt by a drop in institutionalinvestor activity.

"Ifeel like these are bad times," said Peter Renton, co-founder of Lend Academy,a digital lender publisher. "This is not something that is going to go awayin the next week or month. Hopefully, within a year we'll look back on this andsee that this was a major incident but we got through it."

The needfor a diverse array of funds to buy the loans originated by digital lender platformshas dominated industry news to start the year. Many predict some of the smallerplayers will go bust this year due to a lack of investor funding.

Renton,who is an investor in LendingClub loans, said he expects LendingClub's loan originationvolume to drop in the second quarter because of the concerns.

"They'vegrown every quarter and hit their numbers, and now that's gone out the window,"he said.

A mediarepresentative for LendingClub declined to comment. Bloomberg News reported thatJefferies Group LLC wasthe investor at the center of the loan sale.

JuliannaBalicka, an equity analyst with Keefe Bruyette & Woods, also said the companycould see lower origination volume. She said the timing of an internal control issuewas particularly poor since institutional investors had already signaled skepticismabout the loans, as evidenced by higher yields in recent weeks.

"Youwere already looking at lower volumes because investor demands making it uneconomicfor these lenders to originate on their platforms," Balicka said. As for timing,Balicka said it is hard to know whether volumes will drop in the second quarteror whether any pain will be more spread out through the rest of the year.

At leastone investor was unfazed by the news and sees opportunity in the disruption. ValKatayev, a managing partner with Prime Meridian Capital Management, said the newscould make it easier for investors to generate outsized returns by buying marketplaceloans.

"Ifyou're an investor, it puts you in a better position in terms of deals," Katayevsaid. He said Prime Meridian's funds have invested $140 million in loans originatedby digital lenders.

Katayev,who invests in the funds and who has also invested in marketplace loans as an individual,said the funds will continue to buy LendingClub loans. He said there is significantcomfort in the fact that the company identified the issue itself, as opposed toan outside party, and that the board's swift action shows a dedication to properchecks and balances.

"We'renot pulling back," Katayev said in an interview. "It doesn't make anydifference to us, but I do think some parts of the investment community will pullback."

Beyondinvestor reaction, concern also emerged that the issue could bring enhanced regulatoryscrutiny.

LendingClubhad widely been viewed as one of the premier players in the industry, so its issuescould play an outsized impact on smaller lenders' ability to secure investor money.

"Ithink LendingClub was viewed as a leader in just about every area. They've executedflawlessly until now," Renton said.

Prudentialbank regulators could prioritize their review of any agreements banks have withdigital lenders, the SEC could more heavily scrutinize securitizations that includemarketplace loans and the CFPB could speed its larger participant rule that willallow the agency to examine individual companies, said Isaac Boltansky, an analystwith Compass Point Research & Trading, in a May 9 note.

And FitchRatings issued a similar note, with Mike Taiano, director of financial institutionsfor the agency, predicting the news "is likely to further accelerate the paceof regulatory scrutiny."

The CFPBdid not immediately respond to a request for comment.

KBW'sBalicka agreed, saying banks could easily be spooked by the news. As digital lendersshore up investor funding, retail banks appeared ready to play a larger role asthe rate of partnerships have increased in recent months. Further, Balicka saidit remains to be seen how retail investors react.

"Thisevent already happened, and they've dealt with it," Balicka said. "It'sall about what happens to their volume from here on out."