Are the Ills at Lending Club Contagious to the Crowdfunding Industry?

Real estate crowdfunding firms are keeping close tabs on the troubles impacting The Lending Club and possible implications they may have on the broader industry.

Lending Club was an early success story among peer-to-peer lenders. The company made a big splash when its December 2014 IPO succeeded in raising more than $1 billion. But after reaching highs of nearly $26 per share, the company has seen its stock drop to less than $4.50 amid investigations into their business practices by the U.S. Department of Justice and the New York Department of Financial Services. Those investigations came on the heels of reports that founder and CEO Renaud Laplanche left the firm after an internal probe determined the company had falsified documentation when selling a package of loans.

Although The Lending Club does not provide real estate loans specifically, the business model is similar to real estate crowdfunding platforms that do online fundraising for debt and equity positions in commercial real estate deals. “Most of us think that it does have implications, not just for peer-to-peer lending, but also for (financial) tech broadly,” says Dave “DJ” Paul, co-chair of the Crowdfund Intermediary Regulatory Advocates (CFIRA). “How significant those implications are might be an open question, but there is no doubt that it will have some reverberations,” adds Paul.

Problems at The Lending Club have landed the company in the headlines at a time when the broader crowdfunding industry is celebrating the implementation of Title III of the Jumpstart Our Business Startups (JOBS) Act. Title III, which went into effect May 16th, allows firms to directly market debt and equity investment opportunities to non-accredited investors. Title II of the JOBS Act opened online fundraising to accredited investors in September 2013 and effectively launched a rapidly growing real estate crowdfunding industry. Research firm Massolution estimated that real estate crowdfunding platforms would raise $2.5 billion globally in 2015.

Investigators are still working out what happened at The Lending Club and whether the problem was caused by an isolated incident or individual. Or, if it was caused by a bigger systemic problem within the company or even the peer-to-peer lending industry. However, it does feel as though there might be some sort of “niggling problem” with the peer-to-peer space, Paul says.

The situation is reminiscent of the S&L banking crisis in the late 1980s and the more recent subprime housing mortgage debacle in a couple of ways, notes Paul. One, there is massive demand for the product. It is awfully hard for any company to not look at that appetite and keep “feeding the beast,” because they get paid to originate loans, he says. Part of the problem that caused the housing crisis is that lenders loosened underwriting standards to do deals. “I’m not saying that that is what has happened, but it sure feels like that could happen if it hasn’t already, and that is a problem for the industry broadly,” says Paul.

The turmoil at The Lending Club is casting a shadow on the real estate crowdfunding space, notably weakening interest from investors. Institutional investors particularly are taking pause and placing more emphasis on due diligence. “I think the dating period if you will between institutional investors and platforms is going to get even lengthier,” says Jilliene Helman, CEO of real estate crowdfunding firm Institutional investors are going to want to see a longer performance history before they invest, and there also are likely to be fewer new platforms created, notes Helman.

Investors and borrowers are going to be more selective in choosing with whom they do business, agrees Paul. This goes to show that not all platforms are the same. There are those who are doing it right and those who aren’t, he adds. Investors are going to look more closely at a platform’s underwriting criteria, as well as its experience in doing loan workouts. If the real estate market dips, investors want to know who is going to work out problem loans. That is a very different skillset than originating loans, and there are a lot of inexperienced people who haven’t gone through a down real estate cycle, says Paul.

The Lending Club problem is creating a “rough patch” for other real estate crowdfunding and peer-to-peer lending platforms that may take some time to fully work out. But, it is not going to bring down the entire industry, says Helman. There are some advantages for real estate crowdfunding and real estate peer-to-peer platforms in that there are tangible assets backing debt and equity transactions. One of the lessons from this also may be for firms to make sure they have the financial, legal and compliance infrastructure in place before scaling up too quickly, adds Helman.

Certainly, the industry has regulations and oversight in place. CFIRA has spent the last four-plus years working with the Securities & Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) regarding regulations related to the JOBS Act and industry best practices. However, the investigation underway at The Lending Club may signal that the “honeymoon is over,” says Paul. This is the sort of thing that forces regulators to pay more attention. “I welcome that additional scrutiny, because that validates the industry and it validates the operators who are doing it right,” he says. It ought not to be a Wild West. Operators should be held accountable, he adds. 

TAGS: Lending News
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