Goldman Sachs Sizes Up Direct Lending

It was reported this week that Goldman Sachs may start a lending operation to rival that of Lending Club and OnDeck.

Bloomberg reported that the bank hired Harit Talwar, the head of Discover Financial Services’ U.S. cards division, to help the bank develop an online lending effort for individuals and small businesses.

Previously Goldman Sachs has largely steered clear of the retail businesses but it will now increase lending at its Goldman Sachs Bank USA subsidiary in order to lend to consumers and small businesses.

In a memo to the company, CEO Lloyd Blankfein and President Gary Cohn said:

“The firm has identified digitally led banking services to consumers and small businesses as an area of opportunity for GS Bank. Today, we see an opportunity to leverage our competencies in technology and risk management to capture this opportunity at accretive returns and without the burdens of legacy costs and fixed infrastructure.”

It has been suggested that Goldman is still finalising its online lending strategy and it is unlikely to have any major operations this year. After the 2008 crisis Goldman became a bank-holding company but to date the bank has mostly made loans to big institutions and private wealth clients. Unlike Lending Club and Prosper, Goldman will make loans directly but by utilising on online strategy it can expand its lending business without the heavy fixed costs of bank branches.  

Earlier this year Goldman Sachs published a research note that detailed the potential of non-bank lenders to capture the banks’ profits and market share. It said that in 2014 US banks earned a $150 billion profit and it estimated that in 5 years time $11 billion of that could be captured by non-banks lenders. The investment bank obviously sees it as prudent to be part of this new wave of lending.

Hedge Funds too are jumping in to the lending space. Apollo Global Management is one that is looking at this new opportunity.

Leon Black, Chairman and Chief Executive Officer of Apollo, speaking at the Milken Institute Global Conference noted the diminished role of banks in providing loans. He said, "Credit in general is a huge, huge opportunity today."

MidCap Financial, a subsidiary of Apollo Global Management, recently committed to purchasing $1 billion of student consolidation loans originated on the LendKey platform.

AIMA, the London based Alternative Investment Management Association, has estimated that private debt funds, including hedge funds and private equity funds, now amount to $440 billion globally, with $64 billion of new capital allocated to the sector last year alone.

Jack Inglis, CEO of AIMA, commented: 

"Many small and medium sized businesses would miss out on growth opportunities or fail altogether if it were not for the absolutely vital support of hedge funds and other alternative asset managers."

However, somewhat unsurprisingly, not all banks are as enthusiastic about non-bank lending. John Stumpf, chief executive officer of Wells Fargo & Co, has said that hedge funds and peer-to-peer companies are driving competition for loans and could pose a hazard to the US financial system.

Stumpf commented in an interview with Bloomberg News that:

“It’s a risk in that if you start to stretch for loans to produce some revenue. Competition for loans is really, really high.”

Wells Fargo is America’s largest mortgage lender. Stumpf continued, stating that about a third of U.S. financial firms are regulated and “you’re seeing more and more things happen outside. I don’t see that abating anytime soon.”

According to data compiled by Inside Mortgage Finance four of the top 10 mortgage originators in the first quarter were non-banks. Such lenders made 37.5% of loans last year, up from 26.7% in 2013.

These new funds are filling a gap left by the banks after the 2008 crisis. Tougher banking regulations and capital requirements have made it much more expensive for banks to lend to small businesses and so the non-bank lenders are picking up the slack. One of the main problems is the lack of regulation within the non-bank lending sector. Although, according to AIMA, one of the benefits of private lending is systemic- instead of a few big banks there are lots of little funds to share the risk. But the leverage they employ to undertake the lending could be a problem in the future.

Previously much of the commentary around the alternative finance space has been quite anti-bank and has focused on the platforms usurping the place of the banks. However, what we might start to see is more banks coming into the market and trying to beat the platforms at their own game.