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Community bankers sour on digital lender partnerships

Bankersappear to have soured on digital lender partnerships as fundamental concerns aboutthe industry emerged over the last couple weeks, and bank investors are also eyeingthe digital lenders with caution.

At D.A.Davidson's Financial Institutions Conference in Denver this week, several bankerssaid recent trouble for digital lenders validated fundamental concerns about thenew industry. Last week,Prosper Marketplace Inc.laid off more than a quarter of its workforce and On Deck Capital Inc. slashed its guidance. Then, started the leading headlines with the resignationof its chairman and CEO following revelations of loan data manipulation, among otherissues.

Digitallenders are in desperate need of stable funding sources because institutional investorshave scattered, leading many to seek partnerships with banks. In certain cases,digital lenders have secured agreements from banks or hedge funds to buy certainloans originated on the digital lender's platform. LendingClub's news this weekcalls those partnerships into question as the digital lender had offloaded loansthat did not meet the investor's guidelines.

Bankersand panelists at the D.A. Davidson conference said they are skittish about digitallenders, considering the industry's youth.

"They'reunderwriting off of things like Facebook profiles. … That's working great rightnow. When the cycle turns — and it will — will that work well then?" said RonFarnsworth, CFO for Umpqua HoldingsCorp.. "Those are the things you think about when you think aboutmarketplace lending. Three months ago, it was all the rage when we were at the [KeefeBruyette & Woods banking] conference."

Perhapseven more important than credit performance, poor compliance procedures and lackof proper internal controls have some banks shunning digital lender partnerships.The LendingClub news lends credence to those concerns since a member of senior managementwas able to alter the loan application dates on $3 million worth of loans.

JoshuaDean, a partner with Sheppard Mullin Richter & Hampton LLP, said he worked witha bank considering a major partnership with a digital lender that ultimately didnot occur.

"Theway [digital lenders] operate is completely foreign to how the folks in this roomoperate," Dean said. "The controls, the compliance approach [are] nowherenear what we see from even the smallest banks. And this could be the largest marketplacelenders."

Investors,too, have cause for concern. Asked whether the recent stock slide made an equityinvestment in a digital lender attractive, Joseph Stieven, CEO of Stieven CapitalAdvisors LP, said he was skeptical the digital lenders offered value.

"Dothey have a technology that is revolutionary? Or, are they just marketing to customersin a slightly different manner which could be duplicated? … The fact that you canget a loan quickly is not a financial technology invention. There were people doingcredit scoring, 10, 15, 20 years ago with data mining who said they could get youa loan in an hour. How many are out there still?" he said.

Stievenalso said lending can be easy in times of strong credit quality but that it remainsto be seen whether digital lenders can withstand a recession, a concern expressedby others. Another prominent bank investor, John Eggemeyer, founder of Castle CreekCapital, said financial technology is a real, significant development that banksneed to be aware of, but he sounded a similarly cautious tone.

"We'veseen how they've done in an expanding market," Eggemeyer said. "We'llsee how they do in a softer market where losses start to rise and whether they havethe background and infrastructure to collect on the credits they've extended."