One of the more hopeful consequences of the 2008 financial crisis has been the growth of a group of small companies dedicated to upending the status quo on Wall Street. Bearing cute, Silicon Valley–esque names such as Kabbage, Zopa, Kiva, and Prosper, these precocious upstarts are tiny by banking standards, and pose no near-term threat to behemoths like Goldman Sachs, Morgan Stanley, JPMorgan Chase, Bank of America, or Citigroup—banks that between them control much of the world’s capital flow. But there is no question that these young companies have smartly exploited the too-big-to-fail banks’ failure to cater to the credit needs of consumers and small businesses, and will likely do so more noticeably in the years ahead.
At the forefront of the group is Lending Club, a San Francisco–based company founded in 2007 by Renaud Laplanche, a serial entrepreneur and former Wall Street attorney. Laplanche, 43, grew up in a small town in France and, as a teenager, worked every day for three hours before school in his father’s grocery store. He also won two national sailing championships in France, in 1988 and 1990. Now an American citizen, he created Lending Club after being astonished at the high cost of consumer credit in the United States. Lending Club uses the Internet to match investors with individual borrowers, most of whom are looking to refinance their credit-card debt or other personal loans. The result is a sort of eHarmony for borrowers and lenders. Lending Club has facilitated more than $4 billion in loans and is the largest company performing this sort of service, by a factor of four.
The matching of individual lenders with borrowers on Lending Club’s Web site takes place anonymously (lenders can see would-be borrowers’ relevant characteristics, just not their name), but each party gets what it wants. Many borrowers can shave a few percentage points off the interest rate on the debt they refinance, and lock in the lower rate for three to five years. But that interest rate is still more than the lenders could earn on a three-year Treasury security (about 1 percent), or a typical “high yield” or “junk” bond (averaging about 5 percent). Lending Club claims that its loans have so far yielded an annual net return to lenders of about 8 percent, after fees and accounting for losses. It’s worth noting, however, that what lenders gain in yield, they lose in safety: the loans are unsecured, so if a borrower does not pay his debts—and each year, between 3 and 4 percent of Lending Club borrowers do not—the lender can do little about it except absorb the loss and move on. The average consumer loan on Lending Club is about $14,000; many lenders make several loans at once to hedge against the risk of any single loan going bad.
Lending Club’s astute initial investors, including the venture-capital firms Norwest Venture Partners, Canaan Partners, and Foundation Capital, also get what they want: no liability for the loans being made, no oversight from persnickety bank regulators (Lending Club is regulated by the Securities and Exchange Commission), none of the costs associated with the typical bank-branch network, and, best of all, a plethora of fees, collected from both the borrower and the lender, totaling about 5 percent of the loan amount, on average.
Compared with Wall Street firms, Lending Club is a flea on an elephant’s tail. In the first quarter of 2014, it helped arrange 56,557 loans totaling $791 million; JPMorgan Chase made $47 billion in what it classifies as consumer loans during the same period. But the company is growing quickly. In 2013, its revenue—the fees it charges for the loans it helps arrange—tripled, to $98 million. There is talk of an IPO later this year. In April, the company was valued at $3.75 billion—38 times its 2013 revenue and more than 520,000 times its net income—when it raised $65 million in additional equity from a new group of high-powered institutional investors, including BlackRock and T. Rowe Price. Lending Club used the cash to help it acquire Springstone Financial, which provides financing for school loans and some elective medical procedures.
In other words, Lending Club is backed by quite a few smart-money players, eager to buy its equity at nosebleed valuations in return for the chance to get in on the micro-loan market—and perhaps to change the way consumers and small businesses get credit. “It’s a value proposition that really comes from the fact that we operate at a lower cost, and then pass on the cost savings to both borrowers and investors,” Laplanche told me. “We give each side a better deal than they could get elsewhere.” That’s certainly true: Lending Club doesn’t have physical branches, or several other layers of costs that weigh down traditional banks. But Lending Club also seems to exploit a market inefficiency that is really quite shocking, given the supposed sophistication of the big Wall Street firms. When it comes to interest rates, the major credit-card issuers—among them JPMorgan Chase and Citigroup—do not differentiate greatly among the many people who borrow money on their credit cards. They charge just about all of them similarly usurious rates. While a dizzying array of credit cards offer a plethora of introductory interest rates and benefits—cash back, for instance—regular interest rates on cards issued by the big players to consumers with average credit scores typically range between 13 and 23 percent. Lending Club’s business strategy, in part, is simply to differentiate more finely among borrowers, particularly those with good credit histories.