Riding The Waves Of The P2P Lending Market

Congrats to all involved with the Lending Club IPO. This is what it’s all about: Building something from scratch, enduring the ups and downs, then going public and making a boatload of money.

I’m no Wall Street analyst, so I couldn’t tell you if the ~$8.5 billion valuation that Lending Club (LC) hit at the end of its first day of trading is a fair assessment of its current or future value. But what I can tell you is that there are people who are deceiving themselves about what Lending Club is, and what its future prospects are. The delusions are reflected in articles like CNBC’s How LendingClub Aims To End Banking As We Know It, which states:

“LendingClub is setting out to transform the banking world. To get there, it’s following a playbook popularized by some of the world’s biggest tech companies. Any true comparison between LendingClub and the world’s most valuable tech companies is premature, of course.”

I guess any “true” comparisons between LendingClub and the world’s most valuable lending and investment providers aren’t comparisons worth making, eh?

My take: The conditions which made Lending Club possible and got it this far are temporal and likely to change in the next few years–to LC’s detriment.


First of all, can’t somebody out there come up with a better term for what Lending Club is than calling it a “peer-to-peer” lender? The institutional investors providing funds on the marketplace are anything but “peers” to the people looking to borrow money on the site.


There are two conditions that have enabled Lending Club to exist and prosper (get it?). The first is a pool of investors that would like to get a better return on their available capital than what they can get from other (i.e., existing) investment alternatives.

The second is a pool of borrowers who need funds and are willing to pay a higher rate than they would have to pay elsewhere, or, more likely, that need funds and are unable to get those funds from other (i.e., existing) sources.

The size of these two pools–and their willingness to use Lending Club to meet their needs–have been sufficiently large, and growing over the past few years to fuel Lending Club’s growth and drive the IPO.


The questions to answer are: 1) Why did these pools grow over the past few years? 2) Will they continue to grow in the future?

The investor pool grew largely because of two reasons: 1) incredibly low interest rates, making it hard to find acceptable returns, and 2) even in the face of an increasing DJIA, professional money managers are always looking for superior returns to outshine the competition.

Why did the borrower pool grow? Because the economy sucked, and, to some extent, because some  (many?) individuals are mismanaging their financial lives–many are, or have been, unable to pay off existing loans and credit card balances. In fact, 83%of Lending Club borrowers report using their LC loans to refinance existing loans or pay off their credit cards.

Reported Loan Purpose

20141215 LendingClubSource: Lending Club


So what happens going forward? It mostly depends on the state of the economy, the direction that interest rates go in, and the P2P lending market itself.

If we experience a period of economic prosperity, and people are more able to pay off their loans and credit cards, Lending Club may very well see a steep drop in loan volume. Roughly 62% of Lending Club’s 2014 loan volume came from borrowers with a Grade C or lower rating. What happens when the economy improves and the Gen Y population–who start off adult life with lower credit scores and grades–mature and move into higher creditworthiness classes? Is there another pool of risky borrowers to fill the void? And if interest rates rise, could the rates that borrowers must pay on the LC platform might be even too high for them to stomach? Grades E, F, and G are already paying interest rates in excess of 20%. We’re getting close to payday lending territory, no?

Will the investor pool grow? This is comprised of two components: 1) the number of investors, and 2) the amount of funds those investors put into the marketplace. I can’t talk to #2, but it seems likely there are limitations to the number of investors who can or will participate in LC. As the marketplace has grown, competition to fund the best borrowing opportunities has grown, and has even spawned new companies who help investors identify their best opportunities. As a result–much like the stock market itself–professional investors have an edge over individual, amateur investors. As a result, the number of individuals investing in LC will likely remain capped.

And with a first day valuation of $8.5 billion, I’m guessing that venture capitalists across Silicon Valley are firing up their bongs and thinking “Dude! I gotta invest in one of these pee-pee lending marketplaces!” And that means more competition for Lending Club. Increased competition will likely result in some erosion of LC’s overall share.


Claims that Lending Club is “disruptive” or that it will “end banking as we know it” are so totally ridiculous that it has to make you wonder what the claimants were smoking when they made these claims. Lending Club is a niche player in the lending market, a fringe player.

According to the Federal Reserve, consumer loans issued by the 100 largest banks (ranked by assets) grew 6.5% between Q1 2012 and Q3 2014 to nearly $1.18 trillion. From the 2015 Financial Brand Marketing Survey, 43% of respondents indicated that their FI’s loan volume increased by more than 10% in 2014 over 2013 levels.

Disruption? Ending banking as we know it? Hardly. More like creating a niche somewhere between credit card borrowing and payday lending.


Bottom line: I can’t tell if you $8.5 billion is a fair valuation for Lending Club. What I can tell you is that, if and when the economy improves, it’s going to face some stiff challenges.

That said, I would love to have a ride on the boat.


Maybe Banks Don’t Have To Innovate

An academic study, reported in Knowledge@Wharton, found that:

“Disruptive innovations need not lead to an incumbent’s fall, despite prevailing academic theory arguing otherwise. Startups introducing disruptive technologies are more likely to end up licensing to incumbents or agreeing to be acquired rather than turning into rivals. Once the technology is proven, among other factors, start-ups tend to form alliances or merge with market leaders, thus preserving the status quo.”

The authors of the study call a startup’s switch from competition to cooperation with incumbents a “dynamic technology commercialization strategy.”

The rest of us call it “selling out.”

My take: Although the authors of the study based their conclusions on an analysis of the automatic speech recognition industry, many of their findings apply to banking.


How many times, in the past year or so, have you heard:

“If banks don’t innovate, they’ll be disrupted.”

“Warning to banks: Innovate or die.”

“Banks have to avoid the innovator’s dilemma, or they’ll get Kodaked’.”

If it’s less than a million times, then come on out from that rock you’re living under, and put down that issue of CB Radio Monthly (good buddy).

What does the research (cited above) say about these Chicken Little pronouncements? That what banks really need to be able to do is:

  1. Monitor and assess technological innovations and their market potential;
  2. Acquire (i.e., invest in) those innovations at the right time; and
  3. Deploy (i.e., assimilate or exploit) the acquired innovations.

Now, you might say that this capability is an “innovation” (i.e., process innovation) in and of itself, but c’mon–you have to admit that what most Chicken Littles refer to when they say “innovation” is technology innovation.


So, maybe banks don’t have to innovate.

But they’re not off the hook. Of the three steps above, #2 is hard and #3 is really difficult. I don’t mean to imply that #1 is easy–but there are firms out there (like the one I work for, or Bank Innovators Council) who can help with it.

Determining the right time to acquire a particular innovation depends on a number of factors, many of which will be hotly contested by various factions within the bank.

One of the more controversial calls I made while working at another analyst came about 12 years ago when I wrote that banks should not be investing in mobile banking in the short-term. My argument was that there were higher priorities that deserved investment.

I had a colleague at the time who wrote the opposite.

The chief technology officer of a very large bank flew both of us down to his office to make our case to him and his team. I won the debate, and the bank chose not to allocate funds to mobile banking in the coming year. About a year later, I got an email from him saying it was the right call, and that I helped him put about $5 million towards things that really needed to be developed/fixed (I actually got an email from the SVP, of eCommerce at another large bank with the same story and thanks).


Why don’t banks and credit unions have this three-step “innovation” capability? A lot of reasons.

One reason: They spend so much of their “innovation” effort “brainstorming.”How many times have you been involved in an innovation effort designed to produce new ideas to feed the desire to innovate? Probably a lot. How many times were those meetings nothing but a waste of time? Probably a lot.

Another reason: Innovation efforts are deemed to be part of the bank’s strategic planning process (“buried” in the process is probably more apt). Strategic planing in too many FIs are simply budget allocation efforts.

I recently participated in a credit union’s strategic planning efforts by presenting (along with another consultant) at a board of directors meeting. The other consultant presented an excellent 90-minute overview of technological developments in payments. After he concluded, one of the board members asked: “So what do we need to DO about all that?” To which the consultant replied: “Right now? Nothing.”

I cringed. The presentation satisfied step #1 (monitor) but did nothing to help with #2 or #3.

Another reason: The split between IT and the business. Even if you have staff dedicated to steps #1 and #2 (as a number of large FIs do), #3 (deploy) is hard. How many years did it take banks to grow adoption of online banking and online bill pay? PFM been around for years, yet penetration is still really low. The ability of banks and credit unions to not just deploy new technology innovations, but to exploit them–that is, grow and profit from them–is a missing capability for many FIs.


Bottom line: One of the things I’ve learned from writing this blog is that words and their definitions matter. How we define “innovation” here is critical. The constant chorus of calls for banks to “innovate” washes over what I think the Innovation Snobs are really calling for: Banks to change and improve.

While the doomsday predictions from these snobs that banks need to “innovate or die” make for good sound bites, they’re terrible advice for bank and credit union executives.

For more on the topic of innovation in banking, see Why Don’t Banks Innovate?

Disruption Delusions

20130923 disruption2

If I had a nickel for every time the word “disruption” was mentioned in a blog post, article, or conference in the past 12 months, I’d be richer than Warren Buffett.

If I had a nickel for every time the word “disruption” was appropriately used, I wouldn’t even be able to afford the ukulele that Buffett’s playing.

The most recent flagrant misuse of the term comes from the Harvard Business Review blog, which is ironic, since HBS professor Clayton Christensen is credited with popularizing the term in the first place. If a Fellow at the Forum for Growth and Innovation at Harvard Business School can’t use the term correctly, then I guess that I shouldn’t expect the rest of us intellectual lowlifes to figure how to apply it appropriately.

In an article title Revenge of the HourlyNerds, the HBS fellow(ette) writes:

“Last week’s news that Mark Cuban put $450K into consulting startup HourlyNerd should make traditional consultants nervous. Founded only last year by a team of current MBA students, HourlyNerd is a prime example of disruption in consulting. HourlyNerd represents one of the newest business models in consulting, the facilitated network business, which is structured to enable the exchange of services between clients and freelance consultants. These businesses have powerful disruptive potential because they can provide consulting at a fraction of the cost of traditional models, largely because they do not need to carry expensive fixed costs like recruiting, training, consultant beach time, and expensive real estate. HourlyNerd, by encouraging students to bid against each other, likely drives down the hourly cost of projects even more.”

My take: Last week’s news has me laughing, not nervous. Coming into a market simply with lower prices doesn’t make you disruptive.

Wikipedia’s definition (which I think it Christensen’s) of “disruptive innovation” is:

“An innovation that helps create a new market and value network, and eventually goes on to disrupt an existing market and value network (over a few years or decades), displacing an earlier technology. The term is used in business and technology literature to describe innovations that improve a product or service in ways that the market does not expect, typically first by designing for a different set of consumers in a new market and later by lowering prices in the existing market.”

In this context, HourlyNerds is hardly disruptive. No new market is being created here. Nowhere is there any proof that HourlyNerds will improve the quality of consulting. There’s no evidence that HourlyNerds is even changing how the consulting service is delivered. The only new technology involved here is the one used to connect small biz owners and the Junior Scout consultants.

There’s an axiom in the consulting industry:”You get what you pay for.” Can’t wait to see what $10 gets a bunch of small business owners.


Which brings us to the world of financial services (how, exactly, it does that I’m not sure).

There’s apparently no shortage of startups in the financial services space claiming to be disruptive (I know some of them personally, so apologies in advance to any friends — or soon-to-be former friends — that I offend here).

Most of them aren’t disruptive in the least. Instead, they’re niche fillers. They’re filling gaps, or niches, in the current market by serving unmet needs.

As Wikipedia describes it:

“The automobile was a revolutionary technological innovation, but it was not a disruptive innovation, because early automobiles were expensive luxury items that did not disrupt the market for horse-drawn vehicles. The market for transportation essentially remained intact until the debut of the lower priced Ford Model T in 1908. The mass-produced automobile was a disruptive innovation, because it changed the transportation market. The automobile, by itself, was not.”

This is analogous to the situation in banking today.

Startups are finding cracks in the market serving people who don’t want to pay checking account fees, or who simply don’t like banks and want to find an alternative.

But these startups aren’t disruptive. They’re not creating a “new market” — they’re simply meeting the unmet needs of the existing market.

And they won’t be anywhere close to being disruptive until they develop some kind of technology that is adopted by other providers of financial services. In other words, just gaining market share in an existing market doesn’t qualify a technology development as disruptive. Ford may have been the first to mass-produce cars, but mass-produced cars only became a disruptive technology because other manufacturers learned adopted it as well.


Are there any disruptive innovations out there when it comes to financial services? The only thing I see that comes even close as a candidate to being disruptive is Bitcoin.

Your thoughts?