How Bank Partnerships with Marketplace Loan Platforms <i>Really</i> Work

Gilles Gade is a popular man these days in the world of online marketplace lending.

The chief executive of Cross River Bank in Teaneck, N.J., says that since May 2014, more than 72 marketplace lending platforms have signed nondisclosure agreements with the bank to discuss possible partnerships. So far, Cross River has screened and signed on with 14 platforms.

The $295 million-asset bank is to these platforms what WebBank is to Lending Club. It originates the loans that the platforms pledge to buy. Current partners include Marlette Funding, which is rapidly catching up with Prosper Marketplace in terms of origination pace.

The number of firms that describe themselves as marketplace lenders is astonishing given that the credit segment is much smaller than traditional asset classes such as auto and student loans.

Online platforms have popped up everywhere. There are literally one-man-and-a-Bloomberg-terminal operations springing up, some that could disappear as fast as they have sprouted. For example, one startup founder, who works from his basement and has an investor presentation that touts the promise of "pier-to-pier" loans, recently shared with American Banker his loan targets in the millions of dollars.

Some analysts have zeroed in on these partnerships, describing them as vital but vulnerable joints that could be targeted by regulators in the name of consumer protection. Officials at the Federal Deposit Insurance Corp. and the Consumer Financial Protection Bureau so far have remained publicly silent on the burgeoning lending approach.

In a recent interview, Gade explains how partnerships with marketplace platforms really work, and how banks and their clients control and mitigate risks. What follows is an edited transcript.

How are you able to make these loans?

GILLES GADE: At the end of the day, we are originating traditional,nonrevolving consumer loans, which banks have been doing for a very long time. Other banks see it as a third-party relationship, while we have made it a true bank loan. We hold the loans for two to three days before transferring them back to the platforms. [Editor's note: WebBank, which originates loans for Lending Club, moved to a two-day hold last fall, also.]

We do a lot of hand-holding with the platforms, particularly on regulatory and compliance, and payment processing. Since May, more than 72 platforms have approached Cross River and have signed nondisclosure agreements. By the end of the second quarter we would have enrolled 15-20 platforms. To date, our public partners include: Marlette, Upstart, Affirm, Vouch, Peerform [and] Borrowers First, and we also serve as backup for Lending Club. We are in talks with Lending Club to be their second origination partner.

In terms of loan type and volumes, what are those like right now?

We do mostly consumer, with a small portion of small-business lending. We took on small-business-lending platforms very recently. To date our origination volume is over $1 billion. Per month, we have current originations of $125 million to $150 million. We expect to close well over $2 billion in 2015.

Does Cross River retain risk on the loans it agrees to sell?

We started putting some loans on balance sheet in the third quarter last year. We are retaining 5%-10% of monthly production of a select group of platforms that we feel comfortable with. At this stage, we are still in the middle of the cycle, so we hold them for six to nine months, and then we will probably sell loans in the private or public securitization market in the second quarter this year. The market is very efficient for this kind of paper. Investors underwrite the platforms before us as an issuer.

Describe the loan performance on the credits you've originated so far. Are lenders starting to react to competition by lowering credit standards?

Although defaults are naturally expected, we have not seen the kind of aggressive entry that has plagued other markets. Also, the product has remained somewhat vanilla, helping to keep defaults lower.

Cross River charges the platforms certain fees to make their loans. What are those numbers like, and do they vary by loan profile or by platform?

We grade platforms internally based on our own due-diligence metrics, the responsiveness of the management team, their internal policies, procedures and risk management, servicing expertise and ability to hit projections.

In terms of revenue, we charge a processing fee between 30-100 basis points per loan, depending on volume. In addition, on the loans we retain, Cross River is open to entertain a revenue-share structure with the platforms. If there is a 14% coupon, for example, we share that back with the platforms after dealing with chargeoffs and other fees, in the form of a waterfall structure.

What happens if a platform wants to work with another bank?

We have quasi-exclusive relationships. Should the platforms elect to work with other banks, they will have to pay a fee, usually 10-20 basis points per loan, until contract term.

Do you think other banks will partner with these firms in the same way that Cross River has? When will a larger bank decide the time is right to acquire a platform?

Bigger banks aren’t participating yet at the origination level. Consolidation among platforms might have to happen before a bank would buy in. Lending Club and Prosper are the two largest platforms, although Marlette is closing in rapidly [on No. 2 Prosper]. Some of our partners are working on big relationships for equity or debt.

Buying a platform now would be a very expensive proposition based on public companies such as Lending Club. It would be dilutive. I doubt any bank has an appetite or stomach to absorb a sizable platform while the market is hot. In the meantime, banks can either partner with platforms to originate loans or hold loans on balance sheet at attractive yields.

As per a Lending Club presentation a couple of years back, a loan originated through a traditional bank typically costs around 660 basis points. It costs Lending Club around 240 basis points. That's approximately 420 basis points of economy split between the consumer, the platform and the investor.

Large and small platforms are raising a lot of money from the venture capital community and hedge funds. The very same investors who bought asset-backed securities a few years back are now buying loans directly and getting better yields for similar credit exposure, tapping into the securitization market themselves with their own loan pools.

Marlette, one of your partners, has said it wants to partner with a bank to tap into deposits. Will platforms become more independent or will they always need a bank partner to provide cheaper costs of funds?

For true creditor status and exportation of interest rates, partnerships will still be needed between platforms and banks. Down the road, even if platforms want to go through the licensing exercise in all 50 states, they will be subjected to usury rates in all 50, independently, which will be very difficult to manage from an algorithm standpoint.