potential areas of enhancement. More consistent oversight of issuing bank partners would ensure maintenance of prudent underwriting standards and compliance requirements across marketplace lenders. We believe there is an opportunity for the industry to fully adopt the practices and principles enumerated in the Small Business Borrowers' Bill of Rights, and for the appropriate regulatory agencies to continue to monitor the industry’s progress in that respect.
12. What factors do investors consider when: (i) investing in Notes funding loans being made through online marketplace lenders, (ii) doing business with particular entities, or (iii)
determining the characteristics of the Notes investors are willing to purchase? What are the operational arrangements? What are the various methods through which investors may finance online platform assets, including purchase of securities, and what are the
advantages and disadvantages of using them? Who are the end investors? How prevalent is the use of financial leverage for investors? How is leverage typically obtained and deployed?
We believe that investors first consider the following “macro” benefits of investing through a credit marketplace:
1. Marketplace lending is providing access to asset classes (consumer and small business loans) that were previously unavailable to most investors. The only way for investors to access the asset classes previously was through highly structured and fee heavy securities or riskier investments in financial stocks.
2. Marketplace investing returns appear to be uncorrelated with equity market investments, and thus provide investors with attractive diversification within their overall portfolio.
3. Marketplace lending is delivering attractive risk-adjusted returns, across all grades of loans offered via the marketplace. The median adjusted net annualized returns for Lending Club investors with 100+ Notes have been 7.3%23vs. returns from alternative assets:
23For Retail investors with at least 100 Notes and 100 different borrowers and no Note accounting for more than 2.5% of the portfolio assuming 24 to 30 months of average age of portfolio as of September 15, 2015.
Sources: SIFMA, US Bond Market Issuance and Outstanding as of May 2015. Board of Governors of the Federal Reserve System, “Consumer Credit - G.19” as of December 2014.
Bond market yields as of June 2015 from Barclays, S&P, and BlackRock.
4. Marketplaces provide greater transparency for investors. Lending Club enables investors to examine key credit characteristics of each standard program personal loan at a
granular level prior to investing in it and allows investors to continue to monitor ongoing performance of the loans they have selected to invest in by providing investors with daily servicing and collection information on the loans. We provide investors with more than 40 unique loan level credit and financial characteristics and monthly performance information for every loan that has been facilitated through our platform since inception.
We also provide the performance data in a format for investors to build their own models and perform their own historical analysis.
5. Marketplace investing provides tools that allow investors to easily build or modify customized and diversified portfolios by selecting loans tailored to their investment objectives and to assess the returns on their portfolios and, if desired, to enroll in automated investing (for retail investors) or invest in a passive form (institutional investors and high net worth individuals).
($B)
In choosing a credit marketplace, we believe that investors consider the following factors:
Description Brand and Reputation of
Marketplace Lending Scale of marketplace platform
Experience of management team
Regulatory compliance standards
Diversity and scalability of investor base Potential Risk Adjusted
Return Current and expected interest rates and losses on the platform
Predictability of historical returns by risk band Length and
Comprehensiveness of Historical Data
Availability of performance data and length of track history
Sophistication of credit modeling
Significance of historical volume that allows for meaningful performance analysis and risk management
Easy to Use Reporting
Tools Ease of access to information including portfolio holdings and performance by asset class
Ability to view and analyze data in simple to understand and use user interface
Diversity of Investment
Opportunity Diversity of borrower product types depending on type, size, and objectives of investor
Diversity of investment structures depending on type, size, and objectives of investor
Products to satisfy a broad range of risk / return investor appetites
Sizable investment opportunity to attract strategic capital (e.g., insurance companies, pension funds) Fees and Other Costs
Associated with Investment
Servicing / access fee to investors
No management fee vs. asset managers who typically collect fees of 2% on AUM and have built additional incentive fees based on performance
There are a number of investment options to satisfy a variety of different investor preferences.
Lending Club believes that having multiple investment structures allows us to be relevant to more investors. It also gives more flexibility to investors to design and implement an investment strategy that meets their financial goals. Investors can implement a variety of investment strategies through all offered structures. Additionally, Lending Club investors can significantly diversify their portfolios by investing as little as $25 per Note and can build diversified portfolios across various credit grades and loan terms.
Investors can invest through the marketplace through three types of investment channels that we believe meet investors' varying objectives and requirements for their portfolio (e.g., fractional vs. whole loan purchases, bankruptcy remoteness or liquidity):
1. Notes on platform: A Member Payment Dependent Note corresponds to a fraction of a single consumer loan facilitated through our platform to one of our borrower members.
Investors do not make loans directly to our borrower members; instead, pursuant to an effective shelf registration statement, investors may purchase unsecured, borrower payment dependent Notes issued by us that correspond to payments received on an underlying loan selected by the investor. Lending Club is obligated to make payments to investors for an amount equal to the investor’s pro rata share of amounts we receive with respect to the corresponding member loan for that Note. Notes investors are individuals and organizations.
2. Trust Certificate: Bankruptcy-remote vehicle where qualified investors (which include individuals and pooled investment vehicles such as funds managed by LC Advisors, a subsidiary of LC), can purchase a trust certificate. The trust certificates are settled with cash flows from underlying loans selected by investors in a manner similar to the Notes.
3. Whole loan purchase: Certain investors, including banks and financial institutions, seek to hold the actual loan on their balance sheet. To meet this need, loans selected by investors are sold to investors and serviced by Lending Club.
Standard personal loan investment opportunities are equally available to all investors, irrespective of investor type, and measures are put in place to ensure that all investors have equal access. For newer types of loans with shorter historical performance records, investment is limited to more sophisticated investors who can better assess and bear the risk.
Lending Club has built a diversified investor base consisting of 20% self-directed individual investors, 50% individual investors investing through a fund or managed account, and 30%
institutional investors as of Q2 2015 for the standard loan program. Lending Club's diversified institutional investor base, which includes foundations, endowments, insurance companies, banks, finance companies, asset management firms, and corporate pension funds, continues to provide the platform with the flexibility to broaden the scope of originations and expand credit offering into very high credit quality super prime loans as well as lower credit quality in near prime. We believe this diversity of risk appetite ultimately provides more consumers with access to affordable credit.
The vast majority of investors do not rely on leverage. However, when leverage is used
responsibly, it can allow for long-term strategic capital from insurance companies that require a credit rating to invest in marketplace lending products, which ultimately lowers rates for
borrowers. Lending Club has taken a proactive approach in educating and establishing relationships with banks in order to create a diverse and sustainable network of potential leverage providers for investors.
13. What is the current availability of secondary liquidity for loan assets originated in this manner? What are the advantages and disadvantages of an active secondary market?
Describe the efforts to develop such a market, including any hurdles (regulatory or otherwise). Is this market likely to grow and what advantages and disadvantages might a larger securitization market, including derivatives and benchmarks, present?
The breadth of Lending Club’s investor base (retail investors, high net worth individuals,
endowments, pension funds, insurance companies, asset managers, banks, finance companies, etc.) allows us to deliver the most efficient capital to the platform to fund borrowers.The vast majority of investors intend to retain their positions through to maturity, but we recognize that some investors might need access to liquidity at times.
Retail investors have access to Folio Investing, a registered broker dealer with which we partner, who makes available a secondary market platform (an alternative trading system or
“ATS”) to existing holders of Notes and investors interested in purchasing Notes in the secondary market instead of on origination. While the volume of activity as measured by the number of trades on the ATS of individual Notes has grown, in relation to the current aggregate outstanding principal, the dollar volume is small. The ATS provides benefits to holders and potential investors in Notes, but it generally is not essential to investing in Lending Club Notes, as the vast majority of Note holders are long-term investors.
Holders of Trust Certificates do not currently have a secondary market option while institutional investors in loans are able to access a secondary market through securitization.Currently, all of Lending Club’s institutional investors purchase loans or trust certificates with the intention to hold the loans to maturity. The secondary market is not critical for the institutional investors on Lending Club’s platform but could ultimately lower return thresholds for investors and allow for further savings to borrowers.
Unlike specialty finance companies, the Lending Club platform does not need to rely on the securitization market as the primary avenue for funding and purchases with leverage constitute only a small subset of total purchases on the platform. However, Lending Club supports the responsible use of securitization as a way for long-term strategic capital providers such as insurance companies to participate in the marketplace lending space, as we believe that their participation will ultimately allow us to deliver more affordable credit for borrowers.
Advantages of Secondary Market (independent of investment vehicle):
Transparency through price discovery
Liquidity allows for lower return thresholds, which deliver savings to borrowers
Lower cost barrier to entry for investors (legal fees, account set up timeframe, etc.)
Greater diversity of investors; improves ability of investors to get access to consumer loan credit
Larger appetite and capacity for the asset classes given liquidity
Disadvantages of Secondary Market:
Lending Club has less control over who ultimately owns the Notes. However, as a servicer, Lending Club will always know who owns its portfolios and continue direct dialogue with the investor
Pricing is subject to macro volatility and investor sentiment as with all securities traded on a secondary market. However, Lending Club can mitigate potential volatility by continuing to provide performance and credit information for all loans Securitization
The vast majority of Lending Club investors do not rely on securitization as a source of funding.
However, if executed responsibly and with a minimal number of intermediaries and control over the process, the securitization of marketplace loans could help drive down the cost of funds for investors. These savings could then be passed on to borrowers, allowing even greater savings.
Additionally, securitization allows non-bank investors with a higher cost of funds to invest efficiently in asset classes that are currently underserved by banks. This ultimately allows Lending Club to extend credit to a broader set of customers in these segments.
Also, unlike securitization issuers, Lending Club has been providing loan-level granularity and transparency around all issued loans on the platform to all investors (direct purchasers or securitization investors), which allows all parties to do extensive diligence and monitor changes in underwriting standards on an ongoing basis. The transparency and breadth of data allows investors to do multi-year diligence on Lending Club’s underwriting practices before making an investment decision. Over 100,000 investors have the ability to monitor daily any changes to Lending Club’s underwriting practices.
14. What are other key trends and issues that policymakers should be monitoring as this market continues to develop?
We have identified a few key trends that we believe the Treasury should be monitoring as this market continues to develop:
Marketplace lending is becoming mainstream: We are seeing marketplace lending reach a broader segment of the U.S. economy through partnerships with large banks, a broader mix of borrowers affected and expanding types of asset classes impacted. For example, Lending Club partnered with a number of community banks in 2013, Union Bank in 2014, and Citi in 2015.
Marketplace loans are reaching a broader mix of borrowers. Lending Club’s borrower mix has shifted from primarily millennials to a mix more representative of the overall U.S. population.
Market participants are moving into larger lending verticals that have had little online lending to date (e.g., mortgage), leading to increased transparency for borrowers and investors in these markets, which have traditionally been less transparent.
Continued focus on responsible lending practices and innovation: As noted in the
response to question 11, Lending Club identified the need for responsible lending standards in small business lending and joined with organizations across the industry to launch the Small Business Borrower’s Bill of Rights (www.ResponsibleBusinessLending.org).
Marketplaces are increasingly using partnerships to expand access: Marketplaces are increasingly working with banks, for the greater benefit of consumers and small business owners – the best of both worlds: marketplaces have a low cost of operations and banks a low cost of capital, with the combination of the two allowing an even lower cost of credit.
Marketplaces are working with partners to provide financing to borrowers and communities that are typically hard to reach. Lending Club has partnered with Citi to provide financing to low- and moderate-income families. Lending Club has partnered with Opportunity Fund to provide loans to small business in underserved areas of California. Marketplaces are increasingly partnering with companies to offer their customers and partners small business financing at low interest and fees. As just one example, Lending Club has partnered with Google to enable Google to invest its own capital in the growth of its partners and drive business growth, while giving Google’s partners access to financing with low interest and no fees.
Foreign governments are becoming active in supporting marketplace lending:
Governments are becoming more involved in marketplace lending by supporting marketplaces through business practice changes and by investing in marketplace loans as well as providing incentives for investments. For example, the UK Government has promised to invest £100M in small businesses through alternative lending channels. They have instituted a practice requiring designated banks to refer their declined small business loan applicants to marketplace lenders and have expanded investor access to encourage investors to invest in marketplace loans through tax-advantaged Individual Savings Accounts.
Appendix: 4506t API and other valuable government data For a 4506t API to be successful, we suggest the following:
1. Add additional data points – The current 4506 transcript lacks a few necessary data points available on the actual tax forms: Ownership information including names, % owned, addresses, possibly SSN (Schedules K-1 and G), Compensation of
Officers including names (Schedule 1125-E). If this is not included, we may need to collect tax returns anyway to get this information, eliminating much of the benefit of an API. The following would also be valuable in lowering the cost of credit and increasing credit access: balance sheet detail, depreciation schedule, and the statements showing Other Depreciation and Other Income.
2. Retain multiple year access – Multiple years of data will be critical to identify borrowers whose finances are stable or improving over time.
3. Provide at an affordable cost – To be widely used, especially at the “top” of the application “funnel,” this API would need to be available at low cost, even for multiple years of data (i.e., if 1 of 3 applicants are approved, this increases the effective cost threefold of using the API to evaluate all applicants). Because of the cost savings to the IRS, zero or low cost should be feasible.
4. Integrate borrower consent – There will need to be a method for the API to obtain an individual's consent before sending their tax information to a 3rd party. The API could be built to use a token to accomplish this. This permission system would need to be
structured to take place instantly and seamlessly for the tax payer (i.e. within an online application, rather than something like a separate email chain or website). If the addition of the 4506t process adds friction to a loan application, it will not be widely adopted.
We strongly encourage the IRS to rapidly develop a 4506t API, and would gladly assist in its development. Below is ranked list of other government data that could lower the cost and increase access to credit.
Item Value Purpose
Automate the existing IRS4506t
“Request for Transcript of Tax Return”
processthat gives permission to share a summary of tax returns. Include a few additional tax data points the 4506t doesn’t currently include.
A 4506t API would allow lenders to offer faster loan decisions, lower pricing, higher approval rates, more attention to smaller loan requests, decreased fraud risk, and an easier application process. Could be transformative for consumer and small business credit.
HHS quarterly wage data in theNational
Directory of New Hires Extremely
valuable Verify consumer employment and income instantly, and include that data in loan
decisioning. Same benefits as the 4506t API listed above, for consumers only, not small businesses.
Social Security Administration benefits and earnings data
Extremely
valuable To verify consumer SS income, present and historical, and SSN.
Data overlap with Nat'l Directory of New Hires. Same benefits as the 4506t API above, for consumers.
valuable To verify business's existence, plus attributes like industry, size, and number of employees. The need for this would be partially met by the IRS 4506t API. If this data cannot be shared directly with lenders, perhaps it could it be made accessible to lenders through an intermediary organization, such as the Small Business Financial Exchange (SBFE). SBFE is a nonprofit organization of financial institutions that share information with each other in order to improve the credit decisions of all members.
SBA individual loan
performance data Helpful To see how a specific business has performed in the past to assess creditworthiness. Benefits: Better rates, more approvals, and easier process for businesses with past positive performance on SBA loans.
Payroll Tax data - firm
level Helpful Review of a firm's historical payroll tax info could help us assess the growth of a business. Use for verification and credit assessment could lead to higher approvals, lower pricing, and faster/easier application process.
Unemployment insurance programs earnings data
Helpful To verify consumer unemployment income.
(This data is owned by states, regulated by Department of Labor) SBA performance
data sets, anonymous Helpful (doesn't need to be
data sets, anonymous Helpful (doesn't need to be