On topof regulatory uncertainty, a skittish investor base and corporate governance issuesat an industry leader, digital lenders now need to answer questions about creditquality.
Eventhough the two largest lenders, LendingClubCorp. and Prosper MarketplaceInc., launched before the 2008 recession, most of their loans were madein the last few years. Some investors have expressed concern that the companies'underwriting processes have not yet been tested by a downturn.
Delinquencieshave ticked up in select places for both LendingClub and Prosper, dampening totalreturns.
At LendingClub,charge-offsfor the riskiest loans have nearly zapped any benefits from higher rates. In thefirst quarter of 2015, LendingClub's riskiest loans carried an average interestrate of 24.48%. Net charge-offs for the $50.4 million bucket of loans has alreadyreached 15.24%, driving down the net annualized return to 3.49%.
Prosper'sriskiest loans have a similar charge-off rate, 12.2%, since the 2015 first-quarterorigination. But the company estimates returns are still robust at 11.16% for thoseloans.
The riskiestslice of loans represents a small portion of the lenders' origination, generallyless than 5%. Returns for the overall portfolio remain relatively strong, with LendingClub's2015 first-quarter vintage coming in at 6.77%, compared to 6.82% at Prosper.
"It'svery, very close to expectations," said Ben Croes, a senior manager in capitalmarkets for Prosper.
Whiledouble-digit charge-offs roughly a year after origination might seem high, Croessaid those figures should be near a peak considering high prepayment rates. At bothProsper and LendingClub, more than half of the 2015 first-quarter loans have alreadypaid off.
In astatement, LendingClub spokeswoman Robin Shin said the company has taken steps tomanage credit quality. In June, the company reduced the maximum debt-to-income ratioto 35% from 40%.
MichaelTarkan, an analyst with Compass Point Research & Trading LLC, said the uptickin delinquencies at LendingClub was not yet of significant concern.
"Itis relatively minor thus far, but it is something to continue to track," hesaid.
Tarkansaid more worrisome would be increased debt loads among borrowers. A recent storyby The Wall Street Journal cited Experianresearch indicating 46% of borrowers showed larger credit card debt after obtaininga consumer loan, higher than the 30% rate across all lenders.
"Isthere double-levering going on … so you're sitting here with a LendingClub loanand credit card debt at the same level? That, to me, can dovetail into further creditissues," Tarkan said, adding that debt consolidation is by far the most commonuse of digital lender consumer loans.
DavidSnitkof, chief analytics officer and co-founder of Orchard Platform, a company thatanalyzes marketplace loan performance, agreed that the movement should not concerninvestors.
"Youexpect to see it swing back and forth a bit. We haven't seen wide spikes in delinquenciesor charge-offs," he said. "We're having higher delinquencies than therecord lows and lower returns than the record highs."
Whilecharge-offs have edged higher in riskier loans, better credits continue to performwell. Research company PeerIQ recently reportedthat second-quarter securitization volume touched $1.7 billion, up 14.8% from thefirst quarter.
Spreadshave tightened in the senior portions of securitizations. However, consistent withthe higher charge-offs for riskier loans, spreads were wider in the deals' morejunior tranches, according to PeerIQ.
Investor concerns reign supreme
LendingClub'sstock has been hammered since revelations that founder Renaud Laplanche loan figures by personallytaking out loans, among other improprieties, forcing the CEO to and the company to focus on .
But investorswere spooked even before the LendingClub news. Prosper had announced across the company, with100 employees laid off or relocated from the company's Salt Lake City office andan additional 73 employees laid off in San Francisco and Phoenix.
Anotheronline lender, Avant, expectsto slash loan volume by two-thirds and has offered all 760 staff members buyoutsfollowing earlier reports of 60 layoffs at the company. Last week, The WallStreet Journal reportedscaled-back plans at leading small business digital lender Kabbage.
Loanorigination volume should follow suit. Orchard Platform's Snitkof said he expectssecond-quarter volume to drop by roughly one-third from the linked quarter. In aJune 30 report, Orchard Platform reported origination volume posted its first quarter-over-quarterdecrease in years in the first quarter, down 6% from the 2015 fourth quarter.
PerryRabhar, CEO of dv01, a data analytics company, said investors have become especiallywary of consumer lending.
"There'san across-the-board tightening in the last one to two quarters," he said.
But Rabharexpects a bounce-back in the third quarter as larger asset money managers and sovereignwealth funds complete their due diligence. Investors might actually find now tobe an opportune time.
"Ifyou have less capital available, you're going to make the best loans you can,"he said. "You need to be conservative and have high rates."