If you want to find examples of people making really ill-advised decisions that not only seem silly in retrospect, but also at the exact moment they’re made, the stock market is a great place to start looking.
We got a perfect example last week in shares of LendingClub, the beleaguered marketplace lender that’s suffered through what can only be described as a hellish month.
Just to recap:
1) former CEO Renaud Laplanche was ousted after it was revealed that i) the company had misrepresented some of the loans in a batch they sold to Jefferies and, ii) it became apparent that he hadn’t informed the board that he was an investor in a company he was trying to convince LendingClub to invest in.
2) Wells Fargo announced they would be launching a product designed specifically to compete with the P2P players.
3) Goldman and several others said they were putting a pause on plans to buy loans from the company. Shares plunged, the retail crowd was mad, and those who had been skeptical of the model from the start laughed.
Then, on Friday, this happened:
But shares skyrocketed nearly 20% on Friday before closing up over 10% at $4.81. The catalyst: Citi. And I don’t mean an analyst upgrade.
As I’ve explained at length with digital ink and more times than I care to remember in discussions with investors, this is not a “future of finance” story. There are (or at least there “were”) far too many people who thought this was a play on some kind of FinTech revolution whereby P2P lenders were set to supplant banks if not entirely, at least for personal and small- to medium-sized business lending.
And trust me, these companies didn’t do anything to dispel that idea.
In reality, these are just poorly capitalized lenders with no branches and untested underwriting algorithms substituting for loan officers. So you kind of have to think about that and then consider that in a pinch, they can’t access capital markets with the ease banks can and try to imagine LendingClub being able to tap the Fed’s discount window in an emergency. Now that’s comedy gold.
To be fair that’s a stylized characterization that’s not totally correct, but the point is that these companies can’t retain a lot of credit risk on their balance sheets because if the loans start to go sour it’s not 100% clear what their capacity to raise capital would be.
So, the loans they make must be sold. That way, the marketplace lenders can make more loans. Up until this year, demand for these loans has been solid (although because this model hasn’t even been through a whole credit cycle yet, we really don’t know what “solid” means). Some of the first cracks emerged when Moody’s got nervous about some paper backed by Prosper loans and the entire thing kind of fell to pieces when Goldman, Jefferies, and others put the brakes on with regard to LendingClub’s loans.
Here’s how the company itself put it in an SEC filing disclosing a grand jury subpoena from the U.S. Department of Justice: “Historically, the Company's overall business model has not been premised on using its balance sheet and assuming credit risk for loans facilitated by our marketplace.”
See what I mean? I think a lot of investors didn’t understand that while the “originate to sell” model was certainly a big part of the housing bubble and is also prevalent in the subprime auto space, the marketplace lenders live and die by it.
That brings us to Friday’s rally. The euphoria was touched off by reports that Citi is in talks to either buy loans directly from the company or, to use Bloomberg’s words, “provide financing for others to do so.”
Underscoring what I’ve been saying for months is BTIG’s Mark Palmer: “Those [DoJ and SEC] inquiries are much less important to the prospects of the company and its stock than are indications that it will have sustainable sources of funding going forward.”
A word to the wise: one bank’s willingness to step in here isn’t going to keep this model alive. It’s flawed and there is perhaps no better example of how desperate the situation truly is than the fact that peers like SoFi are creating hedge funds to buy loans from themselves in what is truly one of the most absurd circular funding schemes in the market today.
Also on Friday, we got a further glimpse into the trials and travails of LendingClub’s former CEO when Bloomberg reported that Laplanche once took out a loan to cover what amounted to a margin call on a previous loan collateralized by the company’s plunging shares. He could have sold other shares to raise money but that would have only exacerbated the problem by driving the share price still lower.
But here’s the punchline: the loan Laplanche got was a personal loan from board member and former Morgan Stanley chief John Mack.
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