Marketplace Lending: Liquidity Lessons (being) learned

So much doom and gloom this week for the Marketplace Lending space.  ONDK reports lower than expected earnings growth, and higher retention of originated loans.  Prosper cutting a significant part of their workforce.  Speculation around bad news to come from Lending Club's earnings next week?

Having attended the LenditUSA conference recently in San Francisco, I was  struck by the contrast in mood between this year's Lendit, and last year's Lendit in New York.  Whereas the mood last year could have been described as one of euphoria (with some, perhaps correctly, drawing parallels to the 2005/2006 ASF conferences in Las Vegas), the mood this year certainly seemed one characterized by despair (more like the ASF conference in Washington in '09??).  OK, not that bad!

Why such a change in mood?  The mood swing seems to mirror the change in sentiment (and liquidity) for equity and debt financing for Marketplace Lenders.  Equity market (public and private ) valuations for technology companies, finance companies, and companies that are versions of both, have taken significant haircuts over the past year.  Funding availability has shrunk for startups, and some existing platforms will likely fold this year b/c of their inability to continue to finance a "long-term liftoff" plan.  On the debt side, global credit market gyrations caused by a variety of on-going macroeconomic uncertainties, has caused a re-pricing of credit across the board, including Marketplace Lending assets.  The result of which has been a diminished interest in these assets, or at least decreased demand for the assets at the price being offered by Marketplace Lenders.  

None of this is earth-shattering, nor unexpected.  Why?  Liquidity matters.  It does today, and it always has.

Credit markets move faster than Treasury managers.  It's a fact of life, and one that I personally have dealt with for a large part of my 20+ years in credit markets while advising and structuring funding solutions for banks, corporations and governments.  (Credit) market volatility, and the resulting sudden and severe gaps in liquidity availability, are increasingly becoming the norm.  The key is to accept the fact that credit markets move quickly, liquidity can change in a moment, and to be prepared for it.  Being prepared means understanding the benefits of, and being able to create, diversification and term to the funding base.  It works in portfolio management (with assets) and it also works with balance sheet management (with liabilities).  

I've worked with many bank/corporate/government treasurers and liability managers in my career.  One of the traits that separated the really successful ones from the others, was their focus on diversification and creating a long-term funding base. This required an investment in time and travel to build relationships and educate investors on their story, as well as investments in not always choosing the best price for every deal, if there was an opportunity to build new investor relationships, particularly those that were diverse from their existing investor base.  I saw anecdotally over a 20-year period, the long-term value of investor diversification created by choosing to fund with another investor market, even if the cost was marginally higher than the best cost (usually in the home market).  Equally, the Corporate/Bank/Government issuer that left a few scraps (basis points) on the table was always greeted more receptively by investors the next time around, or when that issuer wanted their help in changing a bond covenant, or rounding up interest in a buy-back.  Focus on the long-term matters.  

The Marketplace Lending sector is now learning these lessons.  While some (few) had this figured out all along, many are now receiving this painful lesson.  To have a homogeneous investor base that can move very quickly (away) at any moment, is not the way to build long term resiliency of funding and enterprise value, no matter what the immediate size and price.  Diversification by investor type, by geography, by funding structure is important for long-term resiliency of any company that needs to access to debt investors, including Marketplace Lenders. 

While I don't consider this to be a watershed moment for the sector, it is fortunate that these lessons are coming at a relatively benign time for the credit performance of the loans themselves.  The combination of rapidly deteriorating credit performance and a reliance on a "high-velocity" homogenous funding base, would surely be a ruinous combination for some in the sector.

Given the tough lessons being learned by many today, we will likely see far more Marketplace Lenders prepared for future bouts of credit market volatility, and liquidity gaps.    

The sector, and the long-term potential of it, will be better for it.

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David A. Fry is Co-Founder and CEO of Aspire Financial Technologies Inc. ("Aspire").  Aspire is a Toronto-based financial technology company focused on providing technology infrastructure solutions to the global financial services arena.  Aspire's inaugural product, the Aspire Gateway, is a cloud-based data and technology infrastructure solution that provides a high-value connective interface between Alternative Lending Originators and Institutional Capital Providers.  David is a CFA, MBA and former Portfolio Manager, with over 20 years of credit and fixed income expertise working for global banks in London, New York and Toronto.