Blue Elephant Capital Management

Thoughts on Lending Club IPO

As many of our readers will know, there has been a lot of buzz around the Lending Club IPO. We’ve been asked our opinion of it a number of times, so I thought we’d write up a few takeaways from our perspective.

To start off, we have no idea what the “correct” valuation is. My only comment is that the market is in the mood to price innovative technology aggressively, and there is no doubt in our minds that there is something innovative going on in the lending markets. Beyond that, here are some bigger picture thoughts we have around the IPO.

1)   Transparency is a good thing. Lending has always been a market controlled by those in the know, namely banks and large private equity shops. The beauty of the loans being made by the large marketplace lenders is in their simplicity – most of these loans are for debt consolidation, at reasonably better rates, made by investors who have a pretty full slate of data in front of them to make a decision on whether or not to lend.

2)   No one really wants to walk into a bank for a loan. I’ve written about this more broadly, but in our minds the forward valuations of any marketplace lender includes a percentage chance that they become the way money moves in the future. Imagine two scenarios – one in which you walk into a bank to borrow $10,000, wait in an uncomfortable chair to get judged by someone you don’t know to find out in a few weeks time if you got approved. The second, in which while reading this thought piece, you type in some information to a website and find out your rate and approval over a few business days. Lets forget about the fact that “bank” has become a bad word – doesn’t the second process sound better?

3)   It gets harder from here. Tailwinds are a great thing. Take a look at the Fed data on credit card delinquencies, which has really never been lower. Investors have won, as returns have been good for just about everyone, and borrower rates continue to fall. This isn’t real life. There will be losses, moments of doubt and further debate around the technology these platforms are using. Some will stray, loosening underwriting standards when they should be tightening them. Investors will stay too long, and then complain they didn’t know they could lose money. This isn’t a negative, or a bad thing – it is life as an investor.

4)   This is only the beginning. I tried to touch on this last week, but I’m afraid I was suffering from a turkey-induced slumber or something. At Blue Elephant, we get calls all the time from new underwriters that want us to pledge capital to them. In some ways, the LC IPO has made our lives more difficult. Many of the calls on the consumer side, in our opinion, come from those who see the dollar signs from the IPO and hope that a small amount of loan origination will bring in big bucks for the equity holders of the platform. That’s the bad news.

What’s the good news? Private lending markets are opening up to a new wave of investors. That sounds simple, but it isn’t. Technology is part of it, but I wouldn’t oversell the technology side. The consumer unsecured loans of Lending Club and Prosper are uniquely positioned to be mass-produced by technology because of the trillions of dollars of credit card debt that has been revolved over the last few decades. The loans are small enough that a small level diversity can be achieved without massive capital infusions.

The next wave of opportunity is going to be different. We are working with underwriters in secured real estate, secured commercial real estate, secured payroll based lending, and factoring – all markets historically controlled by banks and private equity firms. Technology, with LC and Prosper leading the way, have opened the door for these markets to move into new hands, especially in loan sizes that are too small for banks to underwrite profitably. Three years from now, we think our investment pool will significantly more diverse than it is today, and that many of the downstream opportunities will only be available to first movers able to pledge significant amounts of capital.

Needless to say, we are excited about the IPO. There any many skeptics of the marketplace lending space and even more people who have no idea the space exists. The LC IPO, if nothing else, brings publicity and even further transparency to the space. To us at Blue Elephant, it is an early marker of the rapid success in the space, and a harbinger of even bigger things to come.