How does Moody’s respond to questions about whether online lending is a bubble?

Online lending won’t cause the next global financial crisis, says Moody’s Jim Ahern, because it’s simply too small.

Moody’s regularly fields questions about whether or not online/marketplace is a bubble – one destined to bring about the next financial crisis. And Moody’s Jim Ahern regularly reminds such inquisitors that the estimated size of the collective pool of marketplace loans in the US is a mere $70-80bn. A drop in the ocean when compared to the scale of the subprime mortgage bubble. In other words, were the marketplace lending sector indeed to blow up, Ahern says that it “would be like the tree falling in the woods”. He did not say that marketplace lending is a bubble waiting to burst, only that there wouldn’t be a major impact on the economy if it did.

At a breakfast in London this morning, Ahern, who is global MD of the structured finance team, offered a global perspective on securitisation markets. He and his colleagues noted the benefits of securitisation in fintech as a means of lowering funding costs and channeling finance through to the real economy.

Ahern also stressed that securitisation brings an extra layer of scrutiny to bear upon marketplace loan portfolios. When asked whether the dismissal of Renaud Laplanche from Lending Club in May – in which the falsification of loan data was a key factor – has changed the way that Moody’s assesses marketplace loan portfolios, Ahern noted that Lending Club has never issued a securitisation of its own, unlike its peers Prosper, SoFi, Avant and OnDeck. Whenever Moody’s rates a bond, the underlying loans are subjected to rigorous third party analysis. Ahern admitted that this process would not necessarily have identified evidence of loan tampering in the case of Lending Club, but it would have meant that the platform would have been guilty of misrepresentation were such an issue to have come to light subsequently. 

Moody’s published a report on the potential benefits and pitfalls of partnerships between banks and marketplace lenders on Wednesday. The core benefits were identified as lower acquisition costs and lower cost of capital, while “regulatory and loan performance pitfalls” were chief among the risks. The fact that the vast majority of marketplace lenders remain untested in a downturn was also mentioned.

The report highlights the importance of new-age lenders in financing micro-businesses, which are becoming increasingly reliant on fintech solutions. These sorts of businesses – which are defined as having annual revenues of less than $1m – often have neither the credit history nor collateral required by the banks. The fact that they are generally higher risk borrowers means that online lenders often charge high rates. 70 per cent of dissatisfied borrowers in marketplace lending cited high interest rates as the main cause of their dissatisfaction. For context, OnDeck’s average weighted APR for term loans and lines of credit was roughly 41 per cent in Q4 2015.

The report states that customer acquisition costs amount to around 25 per cent of revenues for some platforms, but that bank partnerships can lower these costs by “rebalancing the channel mix”. However, bank partnerships will not necessarily help micro-businesses – which tend to sit outside of the core of a bank’s customer base. For the smaller end of business, Moody’s suggests that other forms of channel partnership – with such companies as Worldpay and Intuit – could prove impactful, while pointing to Funding Circle in the UK – which has a listed funding vehicle (the Funding Circle SME Income Fund) alongside various government lines – as a model for lowering funding costs in the micro-business space.

Of course, the elephant in the room is the fact that some banks are now beginning to build their own indigenous funding solutions. The Moody’s report makes mention of Wells Fargo’s FastFlexFM. Bearing in mind these in-house operations, and the increasing number of platform-bank collaborations, Moody’s questions what quality of borrower will be left to those marketplace that operate independently of the banks.