Lessons from Lendy
– History of troubled lender shows the importance of independent verification of credit performance
– This is not a function the regulator can reasonably be expected to undertake
– Marketplace lending will fail to access deep pools of funding until these lessons are learned
August will herald the 2019 edition of Cowes Week – sadly this year without the support of its headline sponsor. Whilst Lendy has now entered into administration it still has a contract giving it sponsorship rights to the event until August 31st 2019.
And ‘Cowes Week Limited’ was far from the only entity to be drawn in by Lendy, with news this week that Lord Myners is calling for an independent enquiry into the regulators conduct relating to the failed lender.
I first had contact with Lendy in the summer of 2017 when their business development team accepted our offer of a demo. I was surprised by their interest but was keen to expand our coverage of UK p2p / marketplace lenders. Over a conference call we explained how lending platforms could encourage investors to purchase their loans if they could make it easier for investors to understand the risk/return characteristics, and could demonstrate that they were accountable to a widely understood performance metric, and therefore motivated to originate loans that would perform. The Lendy team liked the sound of more demand from investors and promised to feedback to management and follow up in due course.
Having heard rumours of ill disciplined lending as far back as spring 2017 I was extremely sceptical that we would ever hear back. We had made it clear that, to create credible performance metrics, we would independently interpret their loan book performance and would apply a standardised methodology to illustrate performance. If the rumours were true it seemed to me to be unlikely that they would embrace the kind of scrutiny that would reveal signs of bad lending practices. After some abortive attempts to meet we finally arranged a follow up conference call in February 2018. Whilst at that stage the rumours were spoken in whispers, and industry specific rather than main-stream news, there was still plenty of reasons to make me doubt that this call would result in an on-boarding of their data. Aside from the immediate scepticism that a business that was lending against boats could easily pivot to lending against real estate, there was also talk from other lenders that their rejected borrowers were being spotted on the Lendy platform, and some anecdotal reports of development projects getting into trouble. Nonetheless Lendy seemed keen. Up to that point the CEO had not been involved but I was even more surprised to find him to be engaged, and indeed joining the screen share demo call that we subsequently organised.
But that was when the trail went cold. After spelling out the on-boarding process, and our need to independently verify performance using raw cash flow and bank statement level data, we never heard from Lendy again. As I had expected Lendy were not open to having their lending performance scrutinised by a third party. They were interested in some kind of independent stamp of approval that might encourage demand for their loans. But, as soon as they discovered that the approval would only come after a third party had reviewed their performance, and reported it in a way that would allow comparison with peers, they disappeared.
All of this took place before Lendy achieved FCA authorisation in July 2018. Nonetheless I have sympathy for the regulator. Invariably they are being criticised for authorising an outfit that had problems, and few things in life are more certain than hindsight bias. However – some context is required. At the time there was huge pressure to approve platforms representing a model that should bring huge benefits to both borrowers and lenders, and the FCA was wrestling with the dizzying range of interpretations of the ‘peer to peer’ model that were all seeking approval. In addition, detailed loan level analysis was not part of the authorisation process, with the approval process relating more to high level principles with the aim of ensuring that the retail investor might be protected by the right governance and structures.
Sympathy for this complexity aside I hope that this sorry episode reinforces some lessons. Third party loan book scrutiny is a clear indicator that an originator is prepared to be held to account for the performance of their lending. An absence of it should raise questions. This kind of scrutiny can come in many forms but to be most effective the output should be comparable. Not only does this allow investors to understand the asset performance of one originator in the context of another but it also avoids the dilution of accountability that results from performance measures that can only be viewed in isolation. And whilst it is unrealistic to expect that the FCA should do this themselves, independent third party verification should be encouraged. The management of sensitive data and the analysis required to comparably report the performance of a range of loan types, is too resource intensive to be performed by a regulatory body. However, there are any number of private sector companies willing to provide the service themselves. In addition, the industry itself should embrace third party performance verification. Doing so would serve to protect legitimate players from bad actors. Markets thrive on trust. In turn trust is often built on self regulation and third party verification. The existence of the rating agencies in the bond market being a prime example.
To build a sustainable industry p2p and marketplace lenders need to build a diversified and deep funding base. This relies on having the widest possible audience of investors interested in purchasing loans. Achieving this relies on two things. Firstly, originators need to be trusted that they are accountable for the performance of the loans they write. i.e. they are motivated by the ongoing performance of the assets originated, not just by the fees earned at origination. Secondly, investors need to be able to perform a value discovery exercise whereby they can understand the risk/reward characteristics of different loan types, sourced by different originators. This is as relevant for institutional investors as it is for the retail investor. A failure to deliver this will result in a thin institutional investor base and a nervous regulator. And a failure to achieve diversification of funding will put the model under significant pressure in a more challenging funding environment. If these lessons are learnt trust will proliferate, a deeper pool of funding will develop, and a duly comforted regulator will not need to apply the expensive and blunt instrument of ever tighter regulation.
I wish Cowes week better luck in finding a new sponsor. And I urge investors not to rely on luck when it comes to selecting a loan originator.
Rupert Taylor, Founder and CEO of Brismo