Why This Lending Club Co-Founder Thinks the Market Is Wrong About Online Lenders

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In late May, I sat down with John Donovan, co-founder and former Chief Operating Officer of LendingClub Corp. (LC -2.08%). Lending Club, an online marketplace lender, has been in the news a lot over the past few months for all the wrong reasons. Over the past 12 weeks, the company has fired its CEO, repurchased several million dollars of securitized loans, been forced to reschedule its annual meeting amid the turmoil, and has generally lost the confidence of Wall Street. Lending Club's stock is down nearly 50% over just the past 90 days.

In this interview, Donovan gives investors a rare look behind the curtains of a marketplace lender, based on his experience at the company and his current role at another marketplace lender, CircleBack Lending. In his view, the markets misunderstand how these lenders operate and, as such, are overreacting to the perceived risks driving the stock price lower.

If you are an investor in Lending Club, OnDeck Capital (ONDK), or another marketplace lender, this is a discussion you can't afford to miss.  Click the play button below to listen now.

Transcript:

Jay Jenkins: Today we have John Donovan, who from 2007 to 2012 filled a number of high-level roles at the online lender Lending Club, which has been in the news quite a bit lately; we'll dig into the reasons why in just a minute. John was a co-founder; he was formerly a board member, chief operating officer and executive vice president of the company. He played an important role building out the company's credit risk, finance, and just overall operational teams. He helped with the product development, corporate development, and he had an active role supporting key institutional investors, which is a big question mark for the company now. We're really looking forward to hearing John's input on that angle in particular. Currently he's an active advisor and board member on a number of different fintech start-ups.

An entrepreneur through and through, he's helping these companies with crowdfunding to other marketplace lenders, both here in the U.S. and abroad. I saw on your resume at least one in China, which is pretty interesting to me. John's also the chief strategy officer and a board member at CircleBack Lending, an online lending marketplace focusing on consumer installment loans. That's CircleBackLending.com, if you're interested in checking out John's current main focus. John, thanks for being here, we're really excited to have you, and I can't wait to dive into the details.

John Donovan: I look forward to the discussion; thanks a lot, Jay.

Jenkins: No problem. Lending Club: the stock's down 81% since the company's IPO in December of 2014. It's down almost 40% this month alone, although it has bounced back about 12% since it hit its bottom maybe a week and a half, two weeks ago. [This interview was conducted in late May, 2016.]

Two things: First, the company disclosed in its first-quarter earnings report and conference call that certain employees had altered application dates on about $3 million of loans that were ultimately sold to an institutional investor. That deal was part of a $22 million loan package that didn't meet the terms that that investor had agreed to, so the company had to buy it back and deal with the whole rigmarole. It was just kind of a bad PR situation. Second, the company's CEO at the time failed to disclose his interest in a fund that Lending Club was considering investing in. So these two events together, the board was kind of like, "We have to make a change at the top."

They fired the CEO, or I guess forced his resignation, along with three other high-level company executives. The market sent the stock tumbling on all that news, questioning the company's internal controls and its loan review processes. Kind of the question is: are they adequate, have they lost their focus, what's going on? John, as a co-founder, as a former executive board member, what's your take on all this? Is the market overreacting, should investors be worried?

John Donovan: There is a lot in there. Let's talk about recent events, and then separately we can talk about what happens when a company IPOs, and typically the first year -- and why the stock price, independent of how the company is operating, oftentimes comes down. I think if you look at this most recent event, and certainly why I had reached out to you earlier, is that this $3 million alone, it didn't meet investors' requirements: but not for underwriting, not for pricing, none of those things. It was basically a disclosure. And again, so, I worked at Lending Club but I have no relationship with them anymore; I don't have any proprietary information on them. I still am a stockholder from when I worked there; I don't have any nonpublic information on them. Coming back to that, basically, this was Lending Club's first securitization.

As they were putting together the loans to sell into that securitization, they were asked by Jefferies [Group] (JEF) to put a disclosure in front of the form on these loans. What ended up happening, I guess, is they sold some of those loans, $22 million of those loans, that didn't have the disclosure. It seems like maybe they ran reports that were based on issue date versus application date, because if you think about it, right, when somebody's applying for the loan, that's when they would see this certain disclosure. Someone internally -- stupidly, clearly -- went and changed some dates on $3 million worth of those loans. That was uncovered internally; they said "Hey, what's up?", did an investigation. Seems like they figured out that there were $22 million in loans; they bought them back from Jefferies at par and sold them to someone else.

When you go in and look: to me, from the outside, I just look at the stupidity of individuals to go in and say, "Okay, we screwed up here. We're not taking responsibility for it, we're going to try to change some dates and hide it," on something that isn't related to the quality of the loans -- it was related to a disclosure. That's my understanding of at least that part of this incident, and certainly from there, investigation ensues. There's another conflict that they find with Renaud [former Lending Club CEO Renaud Laplanche], who owned a piece of a company that Lending Club had subsequently made an investment in, and whether those disclosures were out there properly. All that together with kind of a rock-star board, says, "Hey, we don't want the smell of anything improper." They force Renaud's resignation, that's my take on it.

Jenkins: It sounds like your view is that this very much appears as an isolated incident, and not representative of a culture or anything like that that could have deeper, longer-term repercussions for a stock investor going forward?

Donovan: Right. I forget the name of the accounting firm, but they had an accounting firm go do a deep dive into all the different loans. They didn't find any other issues or substantial issues. What I look at from the outside is...look, this was the first securitization. I can certainly see the mindset of somebody going -- I'm not justifying it in any way, it's wrong, they should not have changed those dates, they should have just manned up at the point that, "Hey, Jefferies, sorry, we screwed up, we sold you these loans based on issue date not application date, let us buy them back." They didn't do that. The fact that that could exist, right -- I think are what the control issues that they're getting toward -- is that, if you're looking at a larger entity, do the products people talk to the technology people? Where are those Chinese walls? I think those are some of the issues that I'm sure they'll address.

No, I don't have concerns that this is a rampant culture there. This is something that happened with literally their first securitization, and the first pool of loans selling into that securitization.

Jenkins: There's certainly a learning curve there. We've said you're no longer with the company day to day, but you do have pretty good intimate knowledge of what Lending Club was like, at least a couple years ago -- a couple, four years ago. Speaking with this kind of loan review topic, can you describe for us, generally, maybe 30,000-foot level: what does the loan review process likely look like at Lending Club today? Just to give potential stock investors an idea of how should this look, where is the crack potentially, how hard is this going to be to correct going forward?

Donovan: From the standpoint of going forward and correcting, it's pretty straightforward in terms of what they need to do, which is related to the securitization process; it's not related to the underwriting or anything else about how the basic business operates. It was, "Hey, we were going to try this method of securitization, and it seems like that whole team is now gone." When you look at the basic business model, and you say, "Okay, what do they do?" You have an applicant, a borrower comes in to apply for a loan. They're giving their different details, name, address -- Lending Club, and really all marketplace lenders, operate in this way, where they go in, they're pulling the information from the bureau, and they're able to make an instant risk-based price. Typically, the marketplace lenders, because they do instant risk-based pricing, offer an interest rate that is lower than what that same consumer would have on their credit card.

The reason for that is that, within a lending club, a Prosper or a CircleBack, you've got 30 different [risk] grades. You've got a lot of different grades, five, 10, 20, whatever that number is, you've got a lot of different interest rates that are being offered to consumers -- versus credit cards, where they tend to, if there is more than one, maybe there's three, they're not offering competitive rates, unless it's really a flip-your-balance type card. When a person with a credit card balance applies, let's say they have an interest rate of 17%, which appears to be the average rate, they go and apply on a platform, they instantly get an offer at 15%. Typically it's got to be 200 basis points lower for somebody to move their balance, but they say, "Hey, you know what, this makes sense." The product is very different in that it's an installment loan. They're going to pay 36 to 60 months, the exact same amount.

It's going to be automatically pulled from their credit card...excuse me, from their bank account. These are very consumer-friendly, very responsible methods of credit that help consumers get out of debt. From the standpoint of regulatory or anything else, the regulars historically have looked at this favorably, because you're giving the consumer better product at lower interest rate.

Jenkins: Sure, getting out of the revolving debt and moving to non-revolving is, especially credit card, where people get stuck, it's a positive thing in general. More specifically, to the loan review process, so internally, operationally I guess, at Lending Club, other marketplace lenders -- we can speak very generally here, like again, and I know you're not there. The loan will be funded...

Donovan: Let's go into that review process. The person comes in and applies, and basically, the credit bureau data and other data is pulled and they're approved. In addition, there's a bunch of third-party data that's looked at, because it's monochannel, because basically it's an online application. It can be done much more efficiently than the banks do it, supporting credit card -- because that may come in based on a written application, it may come in online, it may come in through the telephone. Typically if you go to your bank branch and you apply, they're going to say, "Hey, call this number to go through." Because it's monochannel, it tends to be more efficiently managed.

There's also a lot more data, so when a person's coming in and applying on their computer, from an antifraud standpoint, marketplace lenders can go in and say, "Okay, hey, John's applying for a loan. His credit passes, the IP address on his computer says Chicago but we can see on his LinkedIn profile that he works in San Francisco. Hmm, might this be fraud? Do we need to do some additional verification?" There's a lot of ... I think from the standpoint of safety and security, that marketplace lenders are actually safer from the standpoint of antifraud than, I think, credit card issuers.

Jenkins: Would you say there's an actual human being at some point in the process? Say, after the user experience is finished, the loan's funded, the customer's happy, they have their money. After that point, is there ever a human hand that goes in and touches, beyond the automation, just to make sure i's are dotted and t's are crossed?

Donovan: Absolutely. If you look at the process, let's say 85% of applicants are declined automatically, and there is no human intervention. What's interesting is, from a regulatory standpoint, when these platforms go through audits, the regulators are used to going into the banks and saying, "Hey, let me see your overrides. Let me see where a manager might have said, 'You know what, I know Phil, he lives down the street from me. I'm going to sign and give him this loan.'" That's kind of ripe for issues of, who are the types of people that you're doing overrides for? It raises a lot of other issues. That doesn't exist in marketplace lending; from that standpoint, the 85% of people who don't meet credit requirements are declined automatically.

At that point, you end up with, let's say, 15%, and there you're going in and saying, "Hey, do we need to do additional income verification? Do we need to do employment verification, do we want to get this person on the phone and make a phone call?" What are the other types of verification that are necessary? It's interesting, as I read a lot of things, people say, "You should verify 100%." Guess what: The banks don't do much income verification at all from the standpoint of credit card applications.

Jenkins: To be clear, it's this low-dollar, unsecured consumer loans, $3,000, $4,000, $5,000, $10,000, give or take -- obviously not with a mortgage loan, you're required to sell it to Fannie [Mae] or Freddie [Mac].

Donovan: You look at it from the mortgage side, and you can say, "Well, OK, that makes sense." Even from a bank issuing a credit card with a $10,000 balance, it's doubtful they're going to go through and do income verification. From the standpoint of marketplace lenders, when you start to look at who you should verify and who you shouldn't verify, there was data the Lending Club put out a few years ago, which said, "Hey look, our losses on loans where we income-verify are actually higher than the losses on loans that we didn't income-verify." If you think about that, it actually makes sense, because what they're saying is, "Hey, we're only going to verify people where we see an additional level of risk, and if you don't..."

Jenkins: It's correlation, not causation. It's just, it's a fact of the policy, I guess, that drives it, as opposed to some false conclusion that not verifying is safer.

Donovan: When you look at it from that standpoint, the ability to have data, the ability to look at how you handle these applications makes this process more efficient. A person comes in, applies, they get approved; there's a decision whether they're going to income-verify, employment-verify, whatever that might be. The loan gets listed. At the same time, on the other side of it, these platforms started purely as individuals funding other individuals. You've got an investor who comes in, who's signed up, who's put money on the platform, and they're choosing to allocate funds to a given loan. You basically have those two parties where the loan gets funded, and then it gets issued by a bank -- so in the instance of Lending Club and Prosper, that's WebBank -- WebBank issues a loan. A couple days later, they sell it to Lending Club or Prosper to service, so that's effectively how it ends up the model and how it ends up working.

Jenkins: That is a nice transition into the very back end, and that's the funding end, as you say. There's an intermediary bank, that sort of provides some bridge capital to facilitate the funding of the loan. After that, it goes through a third party, like you said. It could be another individual, if it's through that channel, or it could be some institutional money, which is what prompted this whole spike in interest in Lending Club stock and why it dropped. While at Lending Club, one of your responsibilities, among so many others, was managing the relationships with some of these institutional folks. Based on your experience, do you think these buyers, these funding partners, are reacting the same way the stock market did to all this turmoil, the CEO's firing, all these concerns?

Donovan: Part of it is, let's go into the transition of how it went from this pure model of individuals funding other individuals -- and how it's gotten to where, I think, on Lending Club, half the money or 32% of the money, I think, is what Scott Sanborn, the acting CEO, has said is institutional money that's on the platform. How did it transition over? I think part of that is looking at other models, right? If you look at eBay, what did eBay start out at, but people who wanted to buy Pez dispensers from other people? Where did it evolve to? It evolved to, kind of, larger small businesses that are using it as a distribution platform to lots of individuals who may want to purchase. I would say that the same thing has happened from the marketplace lending standpoint, so I originally built the financial services side of it. When the company got to a certain size, I hired my replacement on the risk side, which was a woman, Chaomei Chen, who took over, who has experience at Chase.

From an underwriting standpoint, within these platforms, it's not like it's a bunch of start-up kids who are managing underwriting. These are people who had managed multibillion-dollar portfolios previously, and know how to do that. Certainly that would be the case with the board also.

Jenkins: Internally you feel like the company's very well suited to handle -- you feel like foundationally, the company's fine in terms of what they're trying to do and what they're executing on?

Donovan: Absolutely.

Jenkins: To me the question is just, and this is speculation and I realize that, but from the institutional...we'll talk a little bit more about Jefferies in a minute, but if you're Morgan Stanley (MS -1.38%) or Jefferies or someone on that side looking at buying these loans, do you see material internal control issues? Is this something that's going to make you second-guess buying a loan from Lending Club?

Donovan:It depends on the type of entity that you are, right? If you're a bank or an insurance company, then you're looking and you're saying, "There's a control issue, I need to understand that before I put additional funds on it." I think that was the effort more recently with, "Hey, we had a review, and here's the way that we're going through and addressing that." I think once they get that stamp for approval, bank and insurance money, which I think is a significantly smaller percentage, will come back in. From the standpoint of hedge funds, other funds, other institutional equity, I don't think they have the same constraints. From everything I've read -- PureIQ is a company that kind of looks at this stuff, there's a few others who have done different surveys -- it seems like that money is still available. There was an article, I think in The [Wall Street] Journal today, that was talking about how there are constraints on some of the bank lenders.

I think it relates more to the warehouse lines that are used to securitize than it is the actual debt that's going on the platform. I'd say it's still a turbulent period; I think you're certainly going to see slowdowns with the platforms in terms of Lending Club to $2.7 billion in the first quarter. I don't think they're going to be at that number for the second quarter, but I think the question is whether they're down 10%, whether they're down 30%, whatever that number is.

Jenkins: That drop could just as easily come from a drop in demand on the consumer side than a drop in supply on the funding side.

Donovan: Except at the same time, the Fed just put up new revolving credit data. We're talking about record levels of revolving debt, so they expect that to go over a trillion dollars this quarter. It's not that consumers aren't borrowing more, and it's certainly not that the banks are offering a better product. I worked at MasterCard for much of my career: 17 years. When I started there, there were 50 banks that represented less than half of all the credit debt in the United States, the revolving debt. Right now there's five banks that represent more than half. Effectively it becomes an oligopoly, and this is a new form of competition. I don't think you're going to see consumers aren't borrowing; they are. They're certainly looking for more responsible ways of paying that back, and whether it's the solution or something else, there will be something.

Jenkins: A good question from the consumer side, too, is just how quickly will the public, I guess, forgive and forget all the headlines?

Donovan: From a borrowing standpoint, all the research shows borrowers make decisions based on rate, how quickly they get the money, convenience, and maybe No. 4 is brand. I don't think this'll impact borrower demand or borrowers' willingness to borrow money. I know when I worked at MasterCard, we did a lot of research, and people's feelings on credit cards are very different than debit cards. Whether it's someone else's money that they're borrowing, they're much more comfortable with security with other things -- versus debit, which they consider to be their money, then they're much more on top of it. I don't think it'll hurt from a consumers' borrowing standpoint, I think it's how quickly they get the money back on the lenders' side.

Jenkins: That's really interesting. Lending Club stock has bounced back over the last seven to 10 days. Part of that, I think, is driven by an announcement last week that Jefferies, which is the bank that was sold the $22 million in loans that was not quite right, they're back and they've announced a plan to increase the relationship with Lending Club, increase their loan purchases and get a little bit more intertwined. That's noteworthy: I, a cynic -- and maybe I'm in this camp a little too much sometimes -- but a cynic could see this as maybe a PR move, this announcement, more so than subsequent change. What do you think, having been someone who's on the other side of the fence? Is there real meaning to this, or is this just trying to rally the troops and come home and kind of calm the market?

Donovan: No clue. It would be foolish to do PR now, I think there's got to be meat to it. Part of it will come with, "What does this deliver?" I go back to the numbers, and Lending Club issued $2.7 billion. This securitization was for like $100 million, so not significant at all. It was certainly an area for growth for them in the future, but not significant. What that's going to go for and replace, whatever, I'm sure they'd get a bunch of deals done. It wasn't something that was desperately needed at the time. The same thing was, there was a partnership that was put on hold with banks, I think it was called BancAlliance; it was 100 different regional banks. That was all of $25 million, so from the standpoint of significance, I don't think it was significant.

What I thought was really interesting is, I read the press release in the BancAlliance one. They ask the CEO of BancAlliance, was he going to continue the program? He said, "You know it's on hold for..." Sorry, was he going to do it himself? He said, "Unfortunately, we can't afford to do it ourselves, because we can't bring the efficiencies that we need." What he's basically saying is: He can either bring a great product to his community and regional bank customers, through a partnership with a marketplace lender, or he can't do it. It isn't a choice of him doing it himself, because he just doesn't have the efficiencies or the capabilities to drive that type of website and functionality.

Jenkins: That's a common thread when you look at other fintech companies, and different ways that the financial services is kind of merging with the technology side of things. It's just, banks are banks, they're not technology companies.

Donovan: That's where I think Jamie Dimon has been really interesting to me, in his comments more recently. One: going back in that, these guys can issue loans and do review much faster than we can, and we're going to watch that. We don't think we can compete with it right now, so we're going to partner, and JPMorgan [Chase] partnered with OnDeck from the standpoint of small business loans, to take into account some of their underwriting capabilities. I think you are going to see some cooperation between the banks, and the banks are looking for these services because they haven't invested in R&D in the same way.

Jenkins: In addition to institutional money, and the kind of individual, there is the option to use Lending Club or OnDeck or whomever to use their own capital. Do you see a place for this in the business model? And then kind of a followup is: If they do go that route, could that be an early indication that some of these companies will end up with bank charters that'll gather deposits, and try to lower their cost of funds through that route?

Donovan: It's interesting. You've already seen with Goldman Sachs (GS -0.71%) -- bought GE's deposit book of $17 billion in deposits, and they're planning to launch their own marketplace lending platform. I think that's certainly showing how others are seeing that type of opportunity. From the standpoint of whether people are balance-sheeting or not, I think you're certainly seeing investors saying, "We want you to eat your own cooking." And whether that's something that happens through Dodd-Frank, in that there are certain expectations that they would do that, or whether it happens through something -- Lending Club changed the relationship that they had with WebBank, to put more of the fees earned longer-term for WebBank, so that WebBank has skin in the payments being paid back.

What's really interesting to me with that is the U.S. Solicitor General just announced today that he feels the Second [Circuit] Court was incorrect on the Madden case [Madden v. Midland Funding, LLC], and that it probably shouldn't be heard from the Supreme Court. I think from a regulatory standpoint, from an environmental standpoint, you're looking at marketplace lenders who are very compliant. I was at Lending Club at the time; Lending Club went to the SEC and said, "We would like to register with you. We're going to go through this process to seek additional oversight." You don't typically hear that from other entities in the financial industry; to a certain extent it bites them in the ass with what just happened, right, in that I think this was not a public company that had as much visibility. It would be probably more of a wrist slap of, "Hey guys, you can't do that type of thing." Except for someone who lied, there would have been one termination.

Some of the other types of thing that happened, I don't think would happen if it wasn't a company that was really saying, "We want to be held to the highest standard possible."

Jenkins: I'm going to change gears here slightly, and we're kind of on the theme of traditional banks. In our previous conversations and earlier in this talk today, you've said that you think Lending Club and other marketplace lenders probably, if not definitely, are better at credit underwriting than, say, a typical community bank or regional bank. Real quick, I've got just a couple of headlines I'm going to run by you, just to see: How would you respond if you were as a shareholder? How does it kind of make you feel? Earlier this year I saw a presentation from Lending Club specifically, that reported that a certain tranche of their debt was defaulting at 7% to 8%, versus what they originally thought was going to be 4% to 6%. A couple hundred basis points higher default rate than expected -- and I should be really upfront about this, that presentation was really limited in the data that was provided.

I don't know the volume, I don't know what the risk tranche was on those, or any kind of pricing, there was none of that provided. You see these headlines elsewhere in the industry: Moody's recently downgraded some securities issued by another online lender, and the reason was, again, higher than expected default rates. You see the different examples, it's a problem that people are paying attention to in the industry. Are these credit underwriting models working the way we thought they would, or we think they are? How do those reports make you feel? How do you respond to these things?

Donovan: No, and maybe it's because I've worked in credit and I understand what happens. It's not a process of, "Hey, we're going to go issue these loans and believe that the climate is going to stay exactly the same." Things change over time, so you're always going in and looking at your book. An example from the early days is, when you buy loans from a given channel, there may be risks that...negative selection that takes place based on the way you're getting loans from a given channel. There are a bunch of things that may drive losses slightly higher for a certain book, and there are a bunch of ways that you go through and you address that. And you address that through changing your underwriting; you address that through what you do with given channels, if there's channels that carry greater risk; you address that through changing your pricing.

Certainly what we've seen in the case of all marketplace lenders more recently -- I think Prosper just announced in the last day they were raising rates. What you do is you go through and you raise rates. And I think if you look at what happened with Lending Club a few years ago, there was excess supply and they were lowering rates. More recently, if you look at the past year, they've raised rates. What you do over time is, you're saying, "Hey, what is the expected investor return, and then how do I manage the book of business to deliver those objectives?" If we see losses going up in a certain segment, do we raise prices, raise interest rates? Do we modify the underwriting to get rid of the negatives? That's the process; it's a live, vibrant process, it's not something that's really a static environment.

Jenkins: I guess another way of thinking about it is that the fact that the company can essentially in real time -- if not real time, pretty darn close to real time -- identify where something's askew and then tweak it immediately. It's a mathematical thing, it's not...other banks could be accused of redlining, or some of these other no-nos. If it's a number and a model, that's about as unbiased as can be.

Donovan: Even more than that, Jay, they all put the data out and they sell files on their websites. This stuff has been studied by universities around the world, it's been studied by competitors, it's been studied by the government, it's been looked at by everybody. The data's out there, it's completely transparent, to the low level. Go look at the financial issues that we had in the past with the mortgage crisis. I thought The Big Short was really an amazing book; you go and read the...hey, it's people who have high FICO scores but no meat. How challenging was it for them to actually figure out who the people were? In the case of marketplace lenders, just pull the files off the website, all the data's right there. You don't know who it is individually, but you're seeing the credit data, you're seeing other information related to it. It's not an industry that's not transparent, that doesn't allow people to go in and make up their own mind.

Jenkins: To be fair, I guess, there's a caveat there that we have to assume that some of the data is accurate. Because as you said before, not everything is verified, and that's, I guess, again, to be fair, a lot of banks don't verify everything either on small, consumer-type loans. The credit scores will be verified, of course; but incomes and employment, so forth, could be, I guess, flubbed a little bit.

Donovan: People lie, right?

Jenkins: Just like the low-doc loans of the subprime era, same kind of concept, I guess. The stakes are lower; the stakes are considerably lower systemically. But for an investor in the stock, that's certainly a risk you should be aware of and cognizant of.

Donovan: That should be the risk, and I think when you think of it from that context, that's why the board acted the way that they did when somebody changed data. At the end of the day, if it's about investor trust and the data we put on the site, and somebody internally's changing data, yeah, that's a problem. In terms of how that was changed, whether it was on an extract in one instance, it seems to be very isolated and it seems to be more external. You can start to put it into pieces in terms of, "Okay, that's why they reacted the way that they did, and they didn't accept anything less than full compliance and perfection."

Jenkins: Coming back to this risk, and sticking with credit, I've actually got a last little bit here: You founded the company in 2007, which is right when the financial crisis was really coming on strong. The credit cycle at that point was really contracting hard, you guys were making a lot of loans when a lot of banks were not making loans, and that was at a time when many consumers really needed the cash and couldn't get it. For you guys, truthfully, it was an amazing time to start a business like this. At the same time, from a PR perspective, people really didn't like banks; the anti-bank sentiment was so strong and so powerful at the time.

Donovan: They still don't, to be clear.

Jenkins: I think it's improved to a degree, but you're right. The hangover from that era is definitely still around. Post-crisis we've had this big expansionary period of the credit cycle, as you mentioned --credit card debt approaching, what, a trillion dollars? We all know that the credit market is cyclical; there will come a day, could be tomorrow, could be in five years, we don't know, it's going to contract again. When banks fail, that's when default rates skyrocket, that's when investors take losses. For a young company, a fairly green company, eight years old, nine years old: What happens to Lending Club and other online marketplaces, lenders, when that cycle turns? Are you concerned about this unknown? Do you think other shareholders should be? How can Lending Club and others mitigate some of this risk? Because I think it's a really important and big risk.

Donovan: I think if you look at data that's been released by others in terms of the last downturn, in general prime consumers -- the No. 1 reason why people end up defaulting is loss of job. I think after that is divorce and medical, I'm not sure which order those two are in. By far it's loss of job. You've got a down economic time, people lose their jobs. It tends to happen, believe it or not, by FICOs. When you've got your best FICOs that might be carrying a 10-basis-point loss, it might double to 20 basis points. That's not going to really hurt overall returns. You get down into, I think the average FICO on most of these platforms is about 700. You get into the 700 range, and let's say it's 4% and that's going to go up to 7%. You'll still have positive returns for investors, it's certainly not going to be as high as they have in the past. You get into subprime, where losses might now be 12%, and if those double and go up to 24% or even higher, that's why I think there are more significant issues.

It tends to be, in consumer credit at least, one of, are you talking about prime, near-prime, or subprime? Tough economic times tend to hit subprime first and foremost. How do different NDDs manage that, as you start to get into a...

Jenkins: John, I don't know if you can hear me, but I'm having a bit of a connection problem here. Let's see...All right, can you hear me OK?

Donovan: I can, yeah.

Jenkins: I'm sorry, if you don't mind rewinding about 30 seconds there, I missed that.

Donovan: What was I saying?

Jenkins: Sorry, you were just beginning talking about how subprime jumps to 24%, and where you put your money, and how you know the problems will play out.

Donovan: Subprime, in a down economic time, that jumps up much more significantly. It isn't something that happens from a national standpoint. You start to handle it early on by pushing people more toward three-year loans and five-year loans. You start to look at different geographies, so if you know the auto sector is likely to be hurt first and hurt bad, and you know that there's a ton of layoffs in Detroit -- Detroit's doing great right now, I don't need to consult anyone from Detroit because I think it's probably the opposite case -- in the case of Detroit, what should we do? We should increase your income verification and employment verification, when you get job applicants from the Detroit area. You're going in and you're saying, "Okay, we know" -- again, don't need to make light of anyone's challenge. Let's say IBM had big layoffs. You know if you're getting people applying for loans that work for IBM, you're probably going to increase the level of employment verification you're doing.

It's all of those things that I think this sector is better able to manage than what had been done historically on a credit-card side, it was something else. Again, my background's in credit cards, I think they're the most amazing tools in the world. I can't imagine life without one, but from the standpoint of borrowing money, they don't make a lot of sense.

Jenkins: I guess time will tell. And I guess the other thing I think about is: With the heavier reliance on institutional money, and potentially the company's own capital, while leveraging up increases the risk to shareholders of Lending Club or whomever, funding won't dry up. If an individual investor gets burned on a few loans, they're not likely to come back. An institutional investor at Morgan Stanley or Jefferies or whoever, they would expect that. They're more sophisticated and know what to anticipate in terms of that. That'll mitigate somewhat.

Donovan: Bain did a study a few years ago, and I think it was called, "The World of Awash in Cash" [actually "A World Awash in Money"]. It talks about how there's $7 trillion in cash sitting on the sidelines, and it's looking for yield. If you look at what just happened with SoFi: SoFi just got a AAA-rated offer, so it's the highest offering of any marketplace lender, which certainly shows that it is possible for a marketplace lender to get very high rating. I think you're going to see more and more of that in the coming years, to allow it to be easier for the insurance companies, the banks, and all the people that are very long-cash to start to get more yield from that. It's not a matter of, there isn't cash looking for it; there is. There's trillions of dollars in cash looking for yield. It's just a matter of, can you match that level of risk, and rating, with what the requirements are on that cash?

Jenkins: To be clear for listeners: Companies like Lending Club generally, at this point, make their money on fees. As long as there's someone who would like a loan and there's someone on the other side who's willing to fund a loan -- regardless of who that person is, the Lending Club institutional money or another individual -- as long as that market exists, Lending Club will make money on those transactions as they happen. It's kind of like a toll collector, as opposed to what a traditional bank would do.

John, before we conclude, I wanted to ask you: As we've mentioned, you've moved on from Lending Club; I think it was 2012 was the last year you were there. Currently you're the chief strategy officer at CircleBack Lending. My question is: What drew you to CircleBack today, and how does it compare to your prior experiences? What lessons have you learned in your prior jobs at Lending Club, MasterCard and so on, that make CircleBack different and exciting to you?

Donovan: CircleBack is a medium-sized platform that's done about $450 million in loans. The difference, really, there, is much more of a focus on partnerships, so being able to support those regional banks, make it more efficient for them to be able to both fund the loans and monetize their customer base. If they've got a mortgage book that they could sell in installment loans, they can't afford to do it on their own. So how can you partner with entities such as regional banks, regional issuers, other types of businesses that have large customer groups that may need this type of responsible credit? It's still marketplace lending, it's just a slightly different angle.

Jenkins: I really like the idea of marketplace lending, particularly from, like you said, a responsible credit. It's really a fantastic avenue to get out of credit card debt. I have a couple of personal friends who have used Lending Club and others very effectively to do that. I'm a big fan of what this platform and this idea can do, and I really appreciate you taking the time to get a deeper level, help our listeners and our stock investors have a better understanding of how all this works on the back end.

I think, for me personally, I'm not going to invest in a company unless I really, truly understand what it does, how it makes money, and I think this conversation today has gone a really long way to helping people understand that for marketplace lenders -- whether it's OnDeck, Lending Club, CircleBack or anyone else.

Thank you so much for joining us; I've really enjoyed it, and maybe we can do it again some time.

Donovan: I look forward to it, Jay. Thank you very much.