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Why Web lending is getting shunned by investors

LendingClub banners hang on the facade of the New York Stock Exchange, Dec. 11, 2014.
Don Emmert | AFP | Getty Images
LendingClub banners hang on the facade of the New York Stock Exchange, Dec. 11, 2014.

Their public stocks may be cratering, but the online lending industry they're a part of is booming.

That's the backdrop for this week's LendIt conference, an annual gathering of emerging technology-powered financial institutions. Far from the inaugural event in 2013 held for a few hundred people in a stuffy mid-Manhattan conference room, LendIt's attendance has surged to about 3,500 and fills out much of downtown San Francisco's Marriott Marquis Hotel.

The mood, however, is very different from last year.

LendingClub, which pioneered peer-to-peer consumer loans, and On Deck Capital, an online business lender, are the flagship publicly-traded companies at the conference. Shares of each plunged by more than half over the past 12 months and are among the 10 worst performing tech stocks that debuted in the U.S. since the beginning of 2014, according to FactSet.

Investor skepticism

For the dozen or so financial tech companies valued at $1 billion or more in the private markets, the IPO window is currently closed, and there's certainly no reason to rush to the exits. Not with small-cap Internet companies getting hammered, interest rates on the rise and these new credit models facing their first real sustainability tests.

It's a lot for money managers to digest.

"Public investors are confused at how to value fin-tech companies," said Anthony Hsieh, CEO of loanDepot, a southern California mortgage lender that's expanding into personal loans.

Hsieh has some credibility on the topic. LoanDepot filed to go public late last year and even went on its investor roadshow before withdrawing the offering in November on the heels of Square's troubled debut and LendingClub's plummeting stock.

"There was such a headwind against LendingClub," he said. "No matter how much we say we're different from LendingClub, we were going to be grouped against that sector."

LendingClub and smaller rival Prosper are marketplace lenders — they connect borrowers with investors who double as lenders — and generate revenue from originating and servicing loans. On Deck issues small business loans with capital supplied mostly by institutions. LoanDepot provides mortgages online and also has more than 150 retail branches across the country. Elevate Credit, which withdrew its IPO filing in January, issues non-prime loans.

While the companies serve different segments of the market and have varying business models, they've all benefited from a sustained period of economic growth, falling unemployment and record low interest rates. Investors now have to see how this new class of loans, underwritten with the aid of Silicon Valley algorithms, performs in a potentially troublesome environment.

"There's some skepticism of the staying power of the model," said LendingClub CEO Renaud Laplanche, who delivered the conference keynote for the fourth straight year. Investors are saying "show me the model works through different economic cycles," he said.

For now, investors are valuing these businesses more like traditional lenders than high-growth tech companies. Those that are still private and have enough capital to stay afloat are using the pullback to strengthen their financials.

Venture capital investing in financial services companies almost tripled last year to $3.05 billion, the most since 2000, according to the National Venture Capital Association. Much of that money is visible at LendIt, where more than 130 companies have exhibits and about two-dozen are sponsors.

Hsieh said quite simply that public investors want to see earnings, even if that means reeling in some investments on the technology side.

At China Rapid Finance, a Shanghai-based lender trying to reach the hundreds of millions of Chinese consumers who lack a credit profile, the key is efficiency in marketing.

As far back as 2014, China Rapid Finance was exploring a U.S. IPO and last year the company raised private capital at a $1 billion valuation.

CEO Zane Wang said that before going public investors want to see that the company can attract massive numbers of borrowers and do so profitably.

"No matter what you do, you have to pay some customer acquisition costs," Wang said. "You have to demonstrate you can get your money back."

Few newly-public companies anywhere in tech have been punished as badly as On Deck. The stock has plunged 65 percent since the New York-based company's IPO in December 2014.

Even with a market value that sits at less than half a billion dollars, On Deck CEO Noah Breslow sees a silver lining. The seizing up of the capital markets means some of On Deck's rivals won't go public and others will see lower private market valuations, thus spending less on marketing and hiring.

"Ultimately, there will be a flight to quality," he said.

Laplanche recognizes another bright spot: Recruiting

LendingClub is valued at about 25 percent less than it was in a private financing two years ago, even though it's since quadrupled in size. For prospective employees who are bullish on the market, they can get options at a significant discount, Laplanche said.

"It's a great argument for hiring people," he said. "Coming in now, you essentially benefit from a low strike price."