Goldman Sachs Faces Doubts About Loss Rates at New Online LenderBy and
Marcus is targeting consumers as many brace for a downturn
Bank aims to produce $1 billion of revenue growth from push
As Goldman Sachs Group Inc. lends more money to Main Street, one question won’t go away: How many borrowers will pay them back?
Goldman’s fledgling online lender Marcus, named after the company’s founder, is targeting consumers at a time when many are bracing for a downturn after eight years of economic expansion. A recent example it gave suggests the firm expects loan losses to be lower than what some rivals are seeing, and half of what many credit-card lenders experienced the last time the economy went south.
The bank is counting on its consumer push to deliver $1 billion in revenue growth over the next three years. While the firm looks to attract borrowers with better credit than many rivals, others think it may be underestimating the risks of a business where it’s the upstart.
“This is Goldman getting into unsecured lending, which can have very high losses over the cycle,” Guy Moszkowski, a banking analyst at Autonomous LP, said in an interview. “They are very cognizant of risk, but for all that awareness, there is a lot of history of companies coming into consumer lending fresh that find that they get adverse selection.”
At a conference last week in New York, Chief Financial Officer Marty Chavez was short on details about the $2 billion portfolio. He did say that the 133,000 loans have an average annual percentage rate of 12 percent and a life of four years. The month before, he said they were performing better than expected.
His presentation included an illustrative industry portfolio which suggested annual losses of just 4 percent through the cycle for a business built to scale. Coupled with a net interest margin of 10 percent, that would produce a return on equity in the mid- to high teens, according to the slides.
“We are fully aware of where we are in the credit cycle,” Chavez said, adding that underwriting and pricing policies build cushions to protect returns from higher losses. “We are building this business to deliver strong risk-adjusted returns through the cycle.”
Andrew Williams, a spokesman for Goldman Sachs, said “we believe our estimates are appropriate for the segment of the market we are serving.”
Chavez’s hypothetical portfolio was solely a benchmark, leaving analysts wanting. Bank of America Corp.’s Michael Carrier and JPMorgan Chase & Co.’s Steve Wharton asked about future losses at the event, and Morgan Stanley’s Betsy Graseck previously called for more transparency on performance metrics.
To see a full credit cycle, Goldman Sachs must stick with the business even if losses spike in the near term. JPMorgan and Citigroup Inc., two of the world’s largest credit-card lenders, faced loss rates approaching 10 percent in 2010, when the U.S. was emerging from a severe recession.
Estimates for loan losses from other online lenders have increased. LendingClub Corp. delinquencies exceeded expectations over the past couple of years, and it’s too early to tell if efforts to adjust its model have worked, Kroll Bond Rating Agency Inc. said in a Sept. 28 report. Moody’s Investors Service threatened a possible downgrade of three bonds backed by Prosper Marketplace Inc. last year after the debt soured at a faster pace than expected.
Industry immaturity is part of the problem. Prosper began in 2005, and LendingClub joined the market the next year. When the financial crisis hit, the amount of loans outstanding was small and both platforms were still calibrating their underwriting models, like Goldman is now.
“I don’t think we have enough data on the new online loan product yet, to come up with an answer,” Michael Tarkan, an analyst at Compass Point Research & Trading, said in an interview. “The only online lender that was actually active back in the day was LendingClub in 2007, and the volume they were doing then versus what these platforms are doing now is de minimus.”
Goldman’s model may yet be accurate. LendingClub projects the highest-rated, 36-month loans -- those with an A, B or C grade -- will have annual charge-off rates ranging from 1.84 percent to 6.79 percent, according to a performance update posted to the company’s website.
Underlying credit quality is a key factor. Chavez said last month that average FICO scores are above 700. Harit Talwar, the head of digital finance, said last week the firm’s conservative credit policy would turn down 40 percent of current industrywide loans. That said, a look at Credit Karma Inc., a top lead generator for the industry, shows Marcus is marketing to lower-rated borrowers -- some with scores below 639.
With all the uncertainty, it’s too soon to judge the bank’s early efforts, Moszkowski said.
“Overall, we thought the net credit spread figures implied by revenue targets were low,” Moszkowski said. “Time will tell.”