Eisman Assails ‘Clueless’ Silicon Valley Over Online Lending

  • Too small to be next ‘Big Short,’ still cause for concern
  • Loans treated like sales, he tells conference in film echo

A money manager who famously predicted the collapse of subprime mortgage securities, Steve Eisman, has turned his sights on the internet loan industry.

While the loans these companies make are small on average and don’t portend to be the next "Big Short" -- the title of the book and film that detailed Eisman’s bet against the debt central to the 2008 financial crisis -- there is reason for investors to be cautious, he said.

Steve Eisman
Steve Eisman
Photographer: Daniel Acker/Bloomberg

The central problem is that these lending startups, their founders and backers in particular, don’t have a lot of experience making loans to consumers, and some of them approach loan-making as they would retail sales, Eisman said in opening remarks at a conference of investment bankers and investors in Miami Beach, Florida, on Sunday.

"When you go to Amazon and buy a book, you buy it and the transaction is over," he said. "But when you take out a loan, that is just the beginning of the transaction -- it’s like a relationship."

"Silicon Valley, I think, is clueless" to this, Eisman said. 

Industry Gathering

The remarks were given inside a large conference hall of the beachfront Fontainebleau Hotel, where several thousand Wall Street securitization professionals are convening this week for their 22nd annual ABS East Conference. It’s the same gathering where, in one scene of the film "The Big Short," the character based on Eisman bursts into outrage at a mortgage executive giving a talk.

As risky private mortgage lending has faded, Wall Street firms looking for outsize returns have turned to other types of consumer loans, with online lending sprouting as a hot new trade. It started with substantial support from venture capitalists who poured money into developing software and algorithms meant to make the process of underwriting loan applicants more efficient. Startups employing this technology find investors to finance the loans, rather than directly funding borrowers themselves. 

Startup Firms

More than 160 startup firms of this kind have emerged since 2009. The biggest include LendingClub Corp., Prosper Marketplace Inc. and Social Finance Inc. Together these companies arranged more than $36 billion of financing in 2015, mainly for consumers, up from $11 billion the year before, according to a report from KPMG.

LendingClub shares declined as much as 5.4 percent on Monday, the biggest drop in more than a month, before falling 3.7 percent to close at $6.19 in New York.

A representative for LendingClub didn’t return messages seeking comment about Eisman’s remarks. Spokeswomen for SoFi and Prosper declined to comment.

Delinquencies Spike

“We have seen loans underperform from their expected loss estimate at the time of underwriting,” Stephanie Yeh, a director at Credit Suisse Group AG, said on a Monday morning panel discussion. “There still isn’t a lot of data.”

Earlier this year, a spike in delinquencies and defaults from some lenders rippled through the community of investors who buy these securitizations. Investors demanded that lenders raise their rates to protect the high returns that they’ve come to expect from the debt. In an audience poll on the same panel, more than 50 percent of the crowd said in a live electronic survey that there is not sufficient data for investors to assess risk tied to unsecured consumer loan securitizations.

Benefits of this technology, lenders and their backers say, include faster approval times, cheaper transaction costs, and more availability of credit to borrowers who may otherwise not qualify for traditional consumer loans, typically of several thousand dollars and with higher interest rates. Big banks, money managers, hedge funds, insurers, trustees, law firms and credit ratings firms are all competing for the online lenders’ business.

Track Record

“Traditional Wall Street occasionally forgets that online lending has a long track record and that these platforms have been built by people with deep financial markets experience," Nat Hoopes, executive director of the Marketplace Lending Association, a trade group, wrote in an e-mail. "Borrowers and investors are turning to these online products because they are delivering enormous value compared to the traditional alternatives.”

But these lenders and their wares are relatively new, and they haven’t been tested in an economic downturn yet. This has drawn concern from skeptics like Eisman, who say there’s no telling how the loans will perform long-term. He said Sunday night the business will never scale to the proportions that its proponents claim.

This month, a top U.S. banking regulator, Thomas Curry, warned the startup lenders about the potential for unintended biases in their underwriting that could lead to violations of federal law. Bond graders have also noted that these startups have varying degrees of underwriting sophistication and that regulatory and legal risks abound.

Regulation of securities other than those tied to the mortgages is appropriate, Eisman said Sunday.

"Tough," Eisman told an audience member who raised a question about whether regulations from the Dodd-Frank Act should be forced upon companies that specialize in other kinds of consumer debt aside from mortgages. "You live in a bad neighborhood, you blew up planet Earth, so shut up, and move on."

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