Coverage: Alternative lending on the rise

It looks like banks have more competition than just each other these days. The Internet is changing the way people loan money and now those with ideas can directly connect to those with money.

Writing for The New York Times, Michael J. de la Merced reported on the initial public offering of the Lending Club, the newest way to loan money:

Obtaining a loan was once a matter of heading down to the bank and applying. But the technology boom of the last decade has given rise to a new way, where web-savvy investors can connect directly with would-be borrowers.

Now, by filing to go public on Wednesday, the leader in the so-called peer-to-peer lending industry, Lending Club, plans to test how popular and durable the business model can be.

Though companies like Twitter and Uber draw a huge amount of attention in the consumer technology universe, the nearly eight-year-old Lending Club has carved out a special niche online: lending. And in the process, it has garnered fans across Wall Street and Silicon Valley.

Together with competitors like Prosper Marketplace, the company functions largely as an intermediary connecting those with money with those who want it. It is an industry that supporters say is becoming a robust alternative to traditional bank lending and largely sky-high credit-card interest rates.

In other news, Joe Light’s story for The Wall Street Journal also highlighted the way alternative lenders are going after the home lending market:

As some banks retreat from the home-loan market, specialized mortgage companies are stepping in to fill the void.

In the first half of the year, lenders that aren’t banks made almost a quarter of all mortgage loans, the highest level since at least the financial crisis, according to data on the top-30 mortgage originators from industry newsletter Inside Mortgage Finance.

Mortgage lending at big banks such as Wells Fargo & Co. and J.P. Morgan Chase has dropped more quickly than the rest of the industry in the wake of large mortgage-related legal settlements, new banking standards that require lenders to carry more capital, and increased scrutiny from regulators.

“Banks are just taking a break. This is an opportunity for us.…The race is very early,” said Anthony Hsieh, chief executive of loanDepot.com LLC, a nonbank lender based in Foothill Ranch, Calif., and Plano, Texas.

Quicken Loans Inc., the largest mortgage lender outside traditional banks, made $24.3 billion of loans in the first half, putting it on a par with Bank of America Corp. and ahead of Citigroup Inc., according to Inside Mortgage Finance.

Nonbank lenders’ rise is good news for some consumers who otherwise might not be able to get a bank loan in the current environment. For banks, this marks a retreat from a business that used to be very profitable but has turned into a legal and financial headache since the crisis.

While banks continue to struggle with how exactly to make mortgage loans, investors are flocking to Lending Club, Fortune’s Laura Lorenzetti said:

Lending Club had been valued at about $4 billion after a fundraising round earlier this summer.

The company is looking to raise funds amid the growing success of the peer-to-peer lending market, which includes competitors such as Prosper and Upstart. Lending Club has risen to the top of that market and is now the world’s largest online connector of borrowers and investors.

The company has originated over $5 billion in loans as of the end of June. In the six months through June 30, it originated about $1.8 billion of that total, 125% more than over the same period a year earlier, according to its filing with the Securities and Exchange Commission

Bloomberg View’s Matt Levine pointed out that Lending Club does a good job of disclosure:

Lending Club does not conceal risk — it gives its investors all the information it has — and so it cannot serve the social function of banking. It doesn’t claim to, and there’s no reason that it should. But while it is a perfect equity-funded bank, it does show the limits of equity-funded banks. Banks — real banks — are in the business of producing loans, sure, but they’re really in the business of producing money-like claims. Equity-funded banks can’t do that.

There’s another point that’s a flip side of this one, which is: Equity-funded banks are great at lending. Lending Club is perfectly able to make loans, and apparently at cheaper rates than banks. So while I think Lending Club does not make an unambiguous case that equity funding is the way to go for banks, it is a good data point for the proposition that increasing bank capital would not hurt lending.⁸Lending Club, with 100 percent capital (ish), is growing its lending business — although that business is still much smaller than the lending business of any big bank.

But the real issue is whether these companies are helping consumers. It’s unclear what regulatory oversight these alternative lenders have to undergo. That could be good in the sense that some who need credit can get it. But it can be bad if these companies have the ability to abuse their power. What’s clear is that those who can afford to invest will make some money in the end.