A new business that thrived amid low rates will be tested as Fed moves things higher
Renaud Laplanche, CEO of Lending Club, says of the online lender: ‘We don’t think we are rate-sensitive at all.’ PHOTO: ADAM JEFFERY/NBCU PHOTO BANK/GETTY IMAGES
The online-lending industry boomed in an era of low interest rates. A new test awaits if the Federal Reserve raises short-term rates, as many expect it to do this week.
After holding short-term interest rates near zero for seven years, the Fed is widely expected to move at its two-day policy meeting that ends Wednesday.
An interest-rate increase is a scenario that many firms in this nascent industry have never confronted.
Unlike banks, online lenders don’t lend from deposits that are directly affected by the Fed’s core benchmark rates. The raise could be felt, however, in the form of investors’ expectations of higher yields on their investments, or if banks increased the rates on credit facilities the lending platforms use to buy the loans before packaging them into smaller slices and reselling them.
“Changes in rate could have an impact on our business in at least three areas: demand for loans, credit performance and supply of capital,” said Sam Hodges, co-founder and managing director at Funding Circle Ltd., an online marketplace lender for small-business loans.
While an increase in the Fed’s short-term rate will affect some of the mechanics of making loans for banks and nonbank lenders alike, a more serious test would come if rate moves come quickly enough in coming months to spook borrowers and potentially push some into default.
A small increase won’t affect Funding Circle, Mr. Hodges said, or cause it to bump up the rates it charges borrowers.
“Given the cushion we’ve already built into our loan pricing, we don’t plan to increase rates if there’s a small shift in the base rate,” he said.
Should the Fed keep raising rates over a two-year period, however, that will add up and lead to uncertainty for online lenders, said Frank Rotman, partner at startup-investment firm QED Investors.
A change in unemployment or consumer behavior that might come from a sustained increase in rates would likely test some borrowers’ ability to pay. That also could expose algorithms under which loans have been issued over the past several years, said Mr. Rotman, who is a former executive at Capital OneCOF0.36% Financial Corp.
Platforms will have to await signals from capital providers, such as hedge funds, banks, insurers and others who buy the loans. “When those institutions decide to change rates, that’s when we react,” said Yee Lee, chief executive of consumer lending startup Vouch Financial Inc.
Firms that keep the loans on their books may be insulated because some credit facilities with banks and hedge funds are based on prime rates and others on longer-term rates, which the Fed’s decision will affect differently.
Some lenders appear not to be worried about interest-rate changes.
“We don’t think we are rate-sensitive at all,” said Renaud Laplanche, chief executive of LendingClub Corp., which originates loans largely to help consumers pay off credit-card debt, at a Goldman SachsGS0.98% event last week, according to a transcript provided by Thomson Reuters.
As short-term interest rates increase, credit-card rates go up. LendingClub charges borrowers more and passes the higher rates to investors, who will seek more yield.
The impact of rate increases will also depend on factors such as whether an online-lending company underwrites loans and holds them on their books, as do companies such as OnDeck Capital Inc.,ONDK0.20% or handles the loans as “marketplaces” in which the platform originates loans and passes them along to other investors, as in the case of LendingClub and Funding Circle.
Those that hold the loans will have different agreements with their capital sources, said Julianna Balicka, an analyst at investment bank Keefe, Bruyette & Woods.
“No one really knows” what lenders would do or how the increase in rates will affect the market, Ms. Balicka said.