LendingClub uses technology that banks don't have, to offer what they can't.
LendingClub is the world’s largest peer-to-peer lending company. Between its founding in 2006 by Renaud Laplanche and Q2-15, it has made $11.1bn in loans to consumers and small businesses. The company is fascinating not only to industry observers as the largest U.S. tech IPO in 2014 with an initial market capitalisation of $8.5bn, partly inspiring J.P. Morgan’s CEO, Jamie Dimon, to warn investors that “Silicon Valley is coming” in his annual letter to shareholders this year. It is also an inspiration to the discerning HBS Technology and Operations Management student as an example of an operating model which is closely aligned with its business model. (1) (2)
LendingClub (“LC”) connects consumers seeking to borrow money with investors seeking to lend money.
From a user experience perspective, consumers apply for loans via a simple application form. The submitted information, together with 3rd party information such as the customer’s FICO scores, are entered into LC’s proprietary risk models. If they pass muster, consumers are then offered a fixed-rate loan with a 3-5 year maturity at a tailored interest rate which is typically lower than the rates charged on credit cards. If they accept, the loan will be made available to investors on LC’s marketplace platform. Once funded by investors (usually within one week), the loans are funded into the consumers’ bank accounts and repayments are automatically debited on a monthly basis.
The value proposition to consumers has several components. Firstly, interest rates are lower than credit card rates (average interest rates in Q3-14 were 14.8%). Secondly, the loans are more transparent – they have fixed interest rates, no prepayment charges, and no hidden fees. Finally, the application process is much faster and easier than it would be with traditional banks.
From a user experience perspective, investors have access to an online portal on which they can set the parameters for their lending activity (e.g. select targeted credit scores, interest rates, loan maturities, etc. to suit their needs).
LC’s platform is flexible with regards to the degree of automation it offers investors. Investors can select the loans in which they would like to invest entirely on their own, they can participate programatically based on parameters of their own choosing, or they can leave the allocation decision up to LendingClub and invest automatically.
Another advantage for investors using the platform is the large amount of information available, both at the level of individual loans (LC submits a filing to the SEC for each loan issued) and in terms of historic performance of all loans issued.
A final key advantage is that the platform allows investors to allocate funds in $25 increments, allowing a high level of diversification even with only modest amounts of capital invested on the platform.
In addition to the platforms flexibility and transparency mentioned above, the value proposition to investors consists in LendingClub’s risk management capabilities. Having issued hundreds of thousands of loans since 2007 over the entirety of an economic cycle, the company argues that it has developed proprietary risk models based both 3rd-party, user-provided and behavioural data which allow for attractive risk-adjusted returns. (3)
The value proposition to consumers and lenders laid out above has a number of implications LC’s operating model and the required capabilities of its tech platform.
In order to deliver low interest rates to consumers and high returns to investors, it needs to be able to be able to charge low spreads in comparison with traditional banks.
- LC achieves this through its highly automated origination process, which eliminates many of the manual and paper-based processes prevalent at traditional banks and lowers its variable cost.
- By being an online lender, it also does not need a physical branch network, further saving considerable fixed costs.
In order to make loan applications faster and easier for consumers than they would be with traditional banks, the process needs to be as frictionless as possible.
- LC has re-designed the process to be fully digital, and relying only on information which can easily be provided within 20 minutes, or automatically pulled from 3rd party sources.
- It has also developed behavioural tests (e.g. consumers typing in ALL CAPS tend to be higher-risk borrowers). (4)
In order to offer investors the ability to choose between varying degrees of automation, large sets of highly granular information, and the ability to invest in small $25 increments, LC needs a highly-integrated and scalable IT platform.
- LC has spent more than $30m to develop its technology stack from the ground up. This is highly uncommon in the financial services industry, where many banks’ IT systems consist of a patchwork of discrete legacy systems which have been accumulated as a result of M&A activity and which would be too costly to integrate in most cases.
- I believe that this point is an example of value proposition following operating model: Because LC was started as a technology company with an integrated technology stack, it was able to offer investors a level of granularity which was unprecedented in the banking industry. (5)
LendingClub represents a classic example of a company which is unburdened by legacy systems and is leveraging state-of-the-art technology to develop operational capabilities not previously seen in the financial services industry. As a result, the company is able to offer a distinct value proposition to both consumers interested in borrowing money, and investors interested in exposure to consumer credit. That said, the market in which is operates is highly dynamic, and time will tell whether its competitive advantage over the incumbent banks turns out to be sustainable.
(1) Wikipedia: https://en.wikipedia.org/wiki/Lending_Club
(2) Mashable: http://mashable.com/2015/04/10/jp-morgan-ceo-letter/#u_rLluSDZZq4
(3) Goldman Sachs Global Investment Research: “LendingClub Corp. (LC) – Premium marketplace with premium valuation; initiate at Neutral”, January 20, 2015
(4) Interview with Jakob Schwarz, Chief Credit Officer at Lendable, a UK-based competitor
(5) Lending Club IPO Prospectus: http://www.sec.gov/Archives/edgar/data/1409970/000119312514323136/d766811ds1.htm
Student comments on LendingClub
Great post! LendingClub is a fascinating company. I am especially impressed by their level of transparency, which you mention briefly above, that is in my view unparalleled across both established financial institutions and burgeoning fintech startups. Not only do they provide access to the raw data of their entire loan book, but they also offer a suite of helpful analytics online. This is clearly a distinctive marketing advantage, but do you think it leaves the door open to competitors? Obviously they are not sharing their underlying algorithm, but a sophisticated enough analyst might be able to find patterns. In short, do you think they have a sustainable edge (specifically, versus newer fintech players)?
Lending club has proven to be a leader in this space but it can be argued that many of the online players have grown to their current levels because of the positive benefits of not being regulated. Do you have a sense of what LC is doing to better prepare itself to go head to head with banks once regulation hits the sector?
LC is one of the quintessential examples of digital transformation in financial services. Great example. Thank you for the post!