71 Stevenson Street San Francisco, CA 94105

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1 Marketplace Lending RFI Document ID: 80 FR Stevenson Street San Francisco, CA September 30, 2015 Laura Temel Attention: Marketplace Lending RFI U.S. Department of the Treasury 1500 Pennsylvania Avenue NW, Room 1325 Washington, DC Dear Ms. Temel, On behalf of Lending Club Corporation (Lending Club), thank you for the opportunity to contribute to the Department of the Treasury s Request for Information concerning Marketplace Lending. We also appreciate your hosting the Treasury Marketplace Lending Forum held on August 5, which we attended and found very valuable. Lending Club (NYSE:LC) is the world s largest online marketplace connecting borrowers and investors. Our mission is to transform the banking system to make credit more affordable and investing more rewarding. Our platform has facilitated over $11 billion in loans to more than one million individual and small business borrowers since launching in 2007, and is continuing its rapid and deliberate growth, fueled by the value we deliver to borrowers and investors and by their high level of satisfaction with our products. As important and sophisticated as our technology is, we start from a set of values that prioritize acting in the customer s best interests. For borrowers, our platform offers responsible credit products with standard program loans offering a fixed rate, fixed term, and no hidden fees. Our platform s products are generally offered at a lower interest rate than prevailing alternatives, and we disclose all terms upfront in a manner that is easy for borrowers to understand and plan for. For investors, we provide full transparency by posting on our website the performance of every loan offered publicly since inception, as well as equal access and a level playing field with the same tools, data, and access for all investors, small and large. Lending Club s Response to Marketplace Lending RFI, September 2015 Page 1 of 51

2 We use technology to automate processes and reduce costs, and pass on these cost reductions to borrowers in the form of lower interest rates and to investors in the form of better returns. Technology-led cost reductions include many process improvements, the ability to operate without a branch network, and the automation of tasks that remain highly manual at most traditional banks. Our ability to collect and analyze data, process and service loans in a highly automated fashion, and simplify processes for our customers has fueled our growth and the growth of marketplace lending over the last eight years. As a two-sided technology-enabled marketplace, we deliver unique benefits to both borrowers and investors. We believe that we also deliver strong benefits to the U.S. financial system as a whole by bringing more transparency, removing friction, reducing systemic risk by requiring a match between assets and liabilities, and offering traditional banks, including many local community banks, the opportunity to participate on our platform and benefit from the same cost reductions from which our other borrowers and investors benefit. Borrower Benefits We believe our platform s low cost operating model enables it to make credit more affordable and available for consumers and small business owners and helps community banks reach more of their borrowers: For consumers: o Significant cost savings: Over 70% of borrowers on our platform report using their loan to pay off an existing loan or credit card balance and report that the interest rate on their Lending Club loan was an average of 7 percentage points lower than they were paying on their outstanding debt or credit cards. 1 o Responsible credit: Customers who use Lending Club to refinance their credit card balance are replacing revolving, non-amortizing, variable rate debt with a fully amortizing, fixed rate installment loan. This product provides for a more responsible way to manage their credit, and helps improve the customer s credit score by reducing the amount of open-ended credit. In fact, 77% of these customers experienced a FICO score increase within three months of obtaining their loan through Lending Club, with an average score increase of 21 points. 2 o Predictable payments: Our platform s personal loan customers benefit from a fixed interest rate and fixed monthly payments that help them better budget their monthly payments and plan ahead, and protects them against the risk of rising interest rates. For small business owners: 1 Based on responses from 14,986 borrowers in a survey of 70,150 randomly selected borrowers conducted from July 1, 2014 July 1, 2015, borrowers who received a loan to consolidate existing debt or pay off their credit card balance reported that the interest rate on outstanding debt or credit cards was 21.8% and average interest rate on loans via Lending Club is 14.8%. 2 Average credit score change of all borrowers who took out a loan via Lending Club between January 1, 2013 and January 31, 2015 with a stated loan purpose of debt consolidation or pay off credit cards. Lending Club s Response to Marketplace Lending RFI, September 2015 Page 2 of 51

3 o o o o o Access to capital: Many small business owners cannot get the credit they need to finance their business expansion and create jobs. In particular commercial loans under $250,000 are underserved by traditional lenders, largely due to the high fixed costs of underwriting these loans through traditional methods. Bank loans from $100k to $250k have fallen 22% since 2007, during a period when bank loans of $1 million or greater increased by 56%. 3 Our platform s automated processes allow us to provide smaller commercial loans that are less available more economically than traditional banks can. Transparency: Lending Club s platform offers a more transparent process to small business owners looking for credit. We clearly disclose the interest rate being charged to the borrower and all fees. We also offer a simpler application process, faster credit decision, and faster funding than most traditional banks. Affordability: The same low operating cost model that powers our consumer lending marketplace also enables a lower cost of funding for small businesses. Small business owners looking for small loans often resort to merchant cash advances that have implied annual interest rates of as much as 100%. Lending Club s platform can help small businesses access capital at longer terms and larger amounts with lower rates than typical credit cards or alternative business loans or cash advances. Responsible products: Our platform s use of 1-5 year terms and no prepayment penalties keeps borrowers from over-levering or getting into cycles of unnecessary repeat borrowing. Small Business Borrowers Bill of Rights: Lending Club joined with leading Community Development Financial Institutions (CDFIs), think tanks, nonprofit small business advocates, and other responsible small business lenders, brokers, and marketplaces in the Responsible Business Lending Coalition and unveiled the Small Business Borrowers Bill of Rights on August 5, 2015 ( It is the first-ever consensus set of principles and practices for responsible small business lending. Lending Club has signed on to these principles and has committed to operate its business within them. For community banks: o Lower cost of operations: Over the last 30 years, community banks have lost significant market share to larger banks because of their inability to compete with the scale of large financial institutions. By partnering with Lending Club, community banks can offer loans to their customers using the Lending Club platform s lower cost of operations to more effectively compete with these larger financial institutions and their products. To strengthen these relationships, we recently announced a partnership with BancAlliance, a national consortium of over 200 community banks, to support this segment. o Saying yes to more customers: Community banks can offer more approvals to more of their customers by partnering with Lending Club and accessing our breadth of investor risk appetites. Additionally, community banks can define their 3 FDIC March 31, 2015 Call Report Data, C&I Loans and Nonfarm Nonresidential loans Lending Club s Response to Marketplace Lending RFI, September 2015 Page 3 of 51

4 investment criteria and invest in loans that meet their specific criteria allowing these banks to expand their offerings to their borrowers while diversifying their own exposure. Providing their customers with access to loans also helps community banks to retain and attract customers. Regulatory Framework Our borrowers benefit from the same regulatory protection as any bank customer as all loans issued through our platform are issued by federally regulated banks. Working in partnership with issuing banks has tremendous value to Lending Club and borrowers as it holds us to the highest compliance and regulatory standard. As a result, borrowers benefit from all consumer protection regulations including equal access to credit, fair lending, truth in lending disclosure requirements, fair credit reporting, and fair debt collection. Our compliance with these rules and regulations is monitored by daily oversight and review as well as quarterly and annual audits by the issuing bank, monthly and annual audits by our internal audit and compliance teams, and an annual audit by an independent auditor. This oversight is further supplemented by the diverse investor base (federal and state chartered banks, insurance companies, pension funds, etc.) that operate through Lending Club s platform and bring with them not only their internal audit review and oversight process but also the review and oversight of their regulators, such as the FTC, FDIC, and OCC (For example see: OCC bulletin Third Party Relationships), which come together to create a robust compliance program that benefits all users of the platform. Investor Benefits Our marketplace has attracted both individual and institutional investors who participate through a variety of programs that generally present the same overall benefits: Access to credit asset classes that individual investors did not have access to before and institutional investors only had limited access to on a pool basis. Steady cash flow and net annual returns averaging between 6%-9% 4 since inception. Full control over investment decisions: individual investors can build their own portfolio of standard program loans or Notes based on their investment objectives and risk appetite. Investors can use 32 different filters to build their portfolio (including FICO score, debt-to-income ratio, job tenure, home ownership, etc.) and review credit loss forecasts for the specific portfolio they selected before making their investment decision; Maximum transparency: investors can review statistics on credit performance by grade and by credit attribute for every single loan that was made publicly available to invest in since inception in 2007, as well as summary statistics by vintage of origination. 4 For Retail investors with at least 100 Notes and 100 different borrowers and no Note accounting for more than 2.5% of the portfolio assuming 24 to 30 months of average age of portfolio as of September 15, Lending Club s Response to Marketplace Lending RFI, September 2015 Page 4 of 51

5 Our investment programs available to investors are regulated by the SEC under the Securities Act of 1933 and the Exchange Act of 1934 and the rules and regulations thereunder. Terminology The term marketplace or credit marketplace is best used to refer to two-sided marketplaces that facilitate lending between borrowers and investors, and do not take balance sheet risk by investing in the loans they facilitate. We believe that companies that use their balance sheets to make loans are not marketplace lenders, and may be better described simply as balance sheet lenders. Throughout this response, we use marketplace to refer only to two-sided marketplaces that do not predominately self-fund loans. The term platform may describe a marketplace or other technology made accessible to third parties. Recommendations to Enhance Marketplace and Other Online Lending We have included in our response to the RFI a number of recommendations for legislative or regulatory consideration that Lending Club believes would enhance or clarify the development and operation of online credit marketplaces to the benefit of consumers, small businesses, and the financial system more broadly. For ease of reference, we have listed these below, along with the particular questions where the recommendation is discussed in this submission. 1. Small business lending protections We believe existing regulations adequately protect consumers borrowing through online credit marketplaces. However, we are concerned that small business owners may not benefit from the right level of protections and transparency. We believe there is an opportunity for the industry to fully adopt the practices and principles enumerated in the Small Business Borrowers' Bill of Rights, and for the appropriate regulatory agencies to continue to monitor the industry s progress in that respect. (Q11) 2. Alignment of interest and disclosure requirements Lending Club has a tremendous amount of skin in the game (starting with over 20% of our revenue from each loan being subject to loan performance over time) and an ongoing alignment of interests with investors. Therefore, we believe that any mandated capital-based risk retention requirement for marketplaces would be misguided and detrimental to both borrowers and investors. To ensure investors have all the necessary information to make informed investment decisions and continue to exercise full control over the quality of loans being issued through marketplaces, we are proposing additional mandatory disclosure requirements. (Q10) 3. Tax incentives to increase access to credit in underserved segments We propose that investors who provide capital in defined underserved areas and to low- to moderateincome small business borrowers be taxed at the capital gains tax rate, rather than the current marginal income tax rate, if the loan is held for over 12 months. Additionally, we propose, similar to the UK framework, that all investors be able to offset losses directly against interest income and gains and have returns on the first $5,000 of investments made tax-free. (Q9) Lending Club s Response to Marketplace Lending RFI, September 2015 Page 5 of 51

6 4. More efficient income verification We urge that the IRS create an application programming interface (API) for its 4506t tax return transcript process. This would make it easier for consumers and small business owners to give lenders access to their tax information voluntarily. We believe this relatively simple improvement to the current 4506t process would make a meaningful difference in lenders ability to offer lower cost, faster, easier, safer, and greater access to credit, across consumer and small business lending. (Q2 and Q9) Please find below answers to the specific questions asked in the RFI and thank you again for the opportunity to offer input. Renaud Laplanche Founder and CEO Lending Club Lending Club s Response to Marketplace Lending RFI, September 2015 Page 6 of 51

7 1. There are many different models for online marketplace lending including platform lenders (also referred to as peer-to-peer ), balance sheet lenders, and bank-affiliated lenders. In what ways should policymakers be thinking about market segmentation; and in what ways do different models raise different policy or regulatory concerns? There are many ways to segment the market, and each segmentation has its own positive and negative aspects. We believe the three lines of partition below, which differ from the Treasury s proposed scheme and definitions, draw key distinctions and more accurately describe the regulatory framework and control environment in which online lenders operate. A. Balance sheet lenders vs. marketplace lenders Many online lenders finance loans with their own equity and/or borrowed capital before reselling these loans to investors either privately or through the securitization markets. We refer to these lenders as non-bank balance sheet lenders and not as marketplace lenders, as they do not facilitate a marketplace (as defined above). While this method has its merits, it is different in nature from the business model of true marketplaces such as those operated by Lending Club or Prosper. The marketplace operator lists loan applications that meet certain underwriting standards, established by a banking partner in some cases. These approved applications are shown to investors along with risk ratings, and investors decide which loans to invest in. The structure of a marketplace with an issuing bank brings with it regulatory scrutiny at the federal level (SEC, OCC, FDIC, CFPB, FTC) and state level through applicable state agencies and the issuing bank itself, as well as daily acceptance testing by thousands of users. In addition, each category of institutional investor brings a layer of additional due diligence, scrutiny, and controls. These investors include banks, investment advisors, hedge funds, endowments, and pension funds, which bring the following additional levels of oversight: a. Large institutional investors perform significant investment, credit, and legal due diligence before making an investment. They also generally employ investment and credit professionals to monitor the marketplace s credit performance and servicing quality as well as portfolio performance. b. As a vendor or third party partner to banks, we are subject to strict vendor management compliance requirements. Bank investors on the platform like Union Bank bring an additional layer of audit and control requirements, particularly in areas such as Bank Secrecy Act and Anti-Money Laundering, in order to satisfy their own compliance and regulatory requirements. c. Investment advisory firms offer an additional and different type of oversight to satisfy the fiduciary duty they have to their clients. The satisfaction of that duty includes an initial due diligence often involving an accounting and process audit as well as a traditional investment and legal review, and ongoing monitoring of performance. B. Marketplaces that offer private vs. public investments Lending Club s Response to Marketplace Lending RFI, September 2015 Page 7 of 51

8 Some marketplaces are financed mostly or exclusively through private placements, while other marketplaces like Lending Club offer investments only through a public offering, which began in October In 2011, Lending Club s wholly-owned subsidiary LC Advisors (an SEC registered investment advisor) began making available private offerings to accredited investors and qualified purchasers only in investment funds. At the same time, a separate business entity, LC Trust I, was created to provide certain, qualified investors the ability to purchase trust certificates in a vehicle that holds loans facilitated by the Lending Club platform. We believe that a public offering of securities offers transparency to investors and the public at large in terms of the risk factors associated with the investment, performance of the Notes and underlying loans, and the issuer s financial standing and financial performance. A public offering of securities entails periodic disclosure and reporting requirements (on Forms 8-K, 10-Q, and 10-K), audited financials, accounting controls (SOX), and strong corporate governance. As a publicly traded company, Lending Club is now also subject to additional public scrutiny and has expanded its obligations under the 33 and 34 Acts and taken on the requirements of the NYSE. Private investors through LC Advisors receive the same level of data and transparency as Lending Club s public investors and are not advantaged or disadvantaged in any material way. The purpose of the private offerings was to increase the efficiency of investing larger sums of capital as opposed to investing in $25 increments via the public offering. In addition to the disclosure requirements required with a continuous public offering, Lending Club and other leading marketplaces have elected to provide additional loan-level credit attributes and performance data publicly on their websites for the publicly available Notes (and underlying loans) so anyone can monitor underwriting and servicing quality, without making any investment through or even signing up for the platform. In contrast to this loan level transparency, certain other platforms and lenders finance loans with their own equity or borrowed capital and then subsequently issue securities publicly through the securitization market to create additional capacity on their balance sheet. While this structure brings some level of transparency into the underwriting and servicing performance, this transparency is limited to the performance of loans at a pool level, rather than an individual loan level, which can mask individual loan performance. C. Marketplaces that issue loans under states licenses vs. marketplaces that partner with issuing banks The two most common regulatory frameworks for issuing loans are the use of state lender licenses and partnerships with issuing banks. Both of these models are well established and have been relied upon for many years by many lenders. Under the latter framework, used by Lending Club and others, Lending Club acts as a third-party vendor under the direct oversight and control of the issuing bank that originates and issues loans to borrowers. Later the bank then sells these loans to the marketplace operator, who may, in the case of Lending Club or its affiliate, issue securities to investors to raise the capital needed to acquire the loan from the bank or may subsequently sell the loan to an investor who is looking to hold the assets, such as a community bank. These securities are special, limited obligations of the issuer that require the issuer to make payments to investors if the borrower makes a payment to the marketplace, Lending Club s Response to Marketplace Lending RFI, September 2015 Page 8 of 51

9 thereby matching the asset (the borrower promissory note) with the liability (the obligation of the issuer to pay the investor). We believe that this perfect matching, combined with the spreading of any such risk over thousands of investors, greatly reduces systemic market level risk related to defaults. This matching materially differs from banks, which typically make loans at 10x the value of equity held on their balance sheet. As noted above, a marketplace that partners with an issuing bank is subject to an additional level of regulatory oversight as it performs a number of tasks on behalf of the bank: applying the bank s credit policy, underwriting loans on behalf of the bank, conducting identity and credit verifications - all at the bank s daily direction, oversight, and control. In essence, the marketplace is acting almost as part of the issuing bank and that program is subject to supervision by the issuing bank s prudential regulator and held to the standard of regulatory compliance and consumer protections of the bank itself. We believe that extremely robust and highly efficient compliance management and consumer protections result from the model of: (i) acting as a two-sided marketplace with a wide variety of investor types, each of which brings with it an additional level of diligence, oversight, and scrutiny, (ii) conducting a public offering of securities that provides additional controls, transparency, and disclosure and publicly disclosing loan-level data on our website beyond the requirements of our securities offering, and (iii) partnering with a federally regulated issuing bank to directly oversee and audit the loan program (along with its prudential regulators). Lending Club s Response to Marketplace Lending RFI, September 2015 Page 9 of 51

10 2. According to a survey by the National Small Business Association, 85 percent of small businesses purchase supplies online, 83 percent manage bank accounts online, 82 percent maintain their own website, 72 percent pay bills online, and 41 percent use tablets for their businesses. Small businesses are also increasingly using online bookkeeping and operations management tools. As such, there is now an unprecedented amount of online data available on the activities of these small businesses. What role are electronic data sources playing in enabling marketplace lending? For instance, how do they affect traditionally manual processes or evaluation of identity, fraud, and credit risk for lenders? Are there new opportunities or risks arising from these data-based processes relative to those used in traditional lending? As electronic credit data has increased in availability, particularly on small businesses, it has been critical to the development of Lending Club s marketplace and that of other innovative firms that utilize data-driven underwriting models to provide nearly instant credit offers with an experience that is substantially better and more efficient than traditional small business bank lending. Newer types of electronic data sources are useful when traditional small business credit data is less predictive, but they introduce privacy and fair lending issues issues that many lenders within and outside of marketplace programs are now addressing. Electronic data access creates the opportunity to increase the convenience of and access to affordable and responsible financing for borrowers underserved by traditional lending systems, and makes borrowing a faster and simpler process for everyone while reducing the potential risk of fraud. Specific benefits include: More convenient access to credit A traditional business loan requires an overly burdensome amount of documentation that can take hours to prepare. 5 The recent Federal Reserve Bank of New York surveys have found that the average credit-seeking small business owner spends about 24 hours just getting ready to initially apply for credit 6. In contrast, with online applications and the use of electronic credit data, applications can be submitted faster and completed at the convenience of the borrower as electronic credit data sources quickly provide technology platforms with the required information, replacing the reams of information used by traditional lending decisions. This speed and convenience allows small business owners to focus on running their businesses and also makes it easier to comparison shop, driving down the cost of credit. Faster access to credit By using electronic data, the platform leverages automated credit decisioning that removes problematic discretionary credit decisions while allowing a quicker decision that enables loan proceeds to be delivered to small businesses faster than traditional lenders, typically five business days or less. Reduced identity fraud Without a face-to-face relationship, online lenders use various electronic data sources to prevent fraud and to protect both borrowers and investors. By using electronic data and highly trained fraud reduction professionals, Lending Club has developed excellent fraud detection capabilities across small business Lending Club s Response to Marketplace Lending RFI, September 2015 Page 10 of 51

11 and consumer lending, enabling our marketplace to lower pricing and prevent harmful identity theft. In the first nine months of 2014, the net identify fraud loss of the top credit card issuers in the ID Analytics network was 10-15bps of portfolio outstanding. For LC during the same time period, identity fraud losses were less than 1bp of loan principal issued. Broader access to credit By leveraging electronic data and in partnership with community banks and CDFIs, Lending Club s marketplace is broadening access to small business financing. For example: Lending Club's partnership with Opportunity Fund (described in Q5) combines the benefits of a technology-based platform and CDFI approaches to small business lending. This type of partnership builds CDFI capacity and increases access to thousands of potential borrowers that the CDFI might otherwise be unable to reach. As electronic data types expand and electronic data generally is made more accessible, it must be used thoughtfully with continued testing and oversight to prove it is effective and stable, and limit the risks inherent in blindly using and trusting new data. As a result, credit models based on electronic data should be applied for less critical purposes initially, such as improving fraud verification procedures. As electronic data is used for less critical procedures, users can test the quality of the data to make sure that it performs as expected from a credit perspective. Once electronic data is used for determining credit risk, users must also continually invest, test, and refresh these models as electronic data can quickly change and its efficacy diminish. For example, the Department of Justice noted that a model used by a major ratings agency to rate mortgage backed securities failed to take into account new data as the mortgage products and economic environment changed. 7 As this example illustrates, while electronic data can make credit more affordable and accessible, its use comes with a requirement of continual, responsible, and diligent review and oversight. 7 Lending Club s Response to Marketplace Lending RFI, September 2015 Page 11 of 51

12 3. How are online marketplace lenders designing their business models and products for different borrower segments, such as: Small business and consumer borrowers; Subprime borrowers; Borrowers who are unscoreable or have no or thin files; Depending on borrower needs (e.g., new small businesses, mature small businesses, consumers seeking to consolidate existing debt, consumers seeking to take out new credit) and other segmentations? Like other marketplaces, Lending Club s approach is to use a single technology platform that can serve many markets. Lending Club s marketplace started in prime consumer credit, then expanded to custom consumer credit programs for both super- and near-prime borrowers, specialized consumer lending (Springstone acquisition), and small business lending; we are also continually assessing other markets. While each lending product has specific requirements that are unique, the business model and platform used is consistent. Marketplaces are building their platforms to leverage technology in order to: (i) reduce operating costs, (ii) improve user experience, (iii) increase access to and affordability of credit, and (iv) provide investor access to a new and attractive asset class. The application of these benefits may differ by market. For example, in mortgage origination and issuance, user experience and funding timelines are likely to be the main drivers of improvements to the process. The technological sophistication of Lending Club s marketplace enables it to leverage a broad investor base with varying risk-return requirements. These varying risk-return requirements then enable Lending Club s marketplace to efficiently serve a variety of borrower segments matched to these risk-return levels. These include some market segments currently underserved by traditional bank lending, such as: Credit card payoff personal loans: where traditional banks may not lend because of concerns about cannibalizing their profitable credit card businesses Small business loans under $300,000: where banks are hindered by legacy systems and do not have the robust and scalable technology to efficiently and profitably underwrite and process these loans (and alternative business finance companies are not as affordable or transparent in their terms as most credit marketplaces). Additionally, Lending Club s diverse acquisition channels enable it to cost-efficiently acquire borrowers in different segments. Partnerships are a major acquisition channel for small business loans, while direct marketing channels are primarily used to acquire personal loan borrowers. Marketplaces have built technology platforms designed to be flexible around the needs of different products and borrowers and to manage a diverse set of investors with a variety of risk tolerances. As a result, marketplaces have efficiently delivered affordable credit to underserved markets including small businesses and low- to moderate-income borrowers while offering investors access to a new and attractive asset class. Lending Club s Response to Marketplace Lending RFI, September 2015 Page 12 of 51

13 4. Is marketplace lending expanding access to credit to historically underserved market segments? Marketplaces are providing increased access to credit to historically underserved market segments, particularly to small business owners and low- to moderate-income individuals. We believe that this trend is likely to increase as the industry develops because marketplaces have structural advantages in serving underserved market segments, including lower cost of operations, diverse capital sources with a breadth of risk-return tolerances, and technology and data expertise. Drivers of expanded access: Structural advantages Marketplaces can bring structural advantages to serving underserved borrowers, by use of their lower cost structure, expanded capital sources, no legacy systems, and core competencies in data innovation. Lending Club, as an example, has an operating ratio estimated to be 2%, when holding monthly originations constant, in contrast to the 5-7% operating ratios of traditional bank lenders. 8 This lower operating cost ratio enables the Lending Club platform to facilitate loans to borrowers that a traditional bank may deem to be unprofitable, such as smaller sized loans that underserved borrowers more often require. The minimum loan through the Lending Club platform is $1,000 for consumer loans (in most states), and $15,000 for business loans. Additionally, a diversity of capital sources enables marketplaces to serve borrowers that a traditional bank lender may not. The risk tolerance of Lending Club investors varies significantly, and therefore the platform is able to facilitate loans to a broader risk/return profile in contrast to the more narrowly focused risk appetite of a balance sheet lender, including traditional banks. The technology and data expertise of many marketplaces is a third important advantage. Marketplaces have typically built their own technology and are not inhibited by a traditional bank s complex, legacy systems. This purpose built technology base, when coupled with a core competency in data innovation, allows Lending Club and other marketplaces to efficiently serve creditworthy borrowers with lower credit scores by discovering alternative indicators of creditworthiness and effectively utilizing them in an automated underwriting process. By leveraging these advantages of lower cost structure, expanded capital sources, and technology and data expertise, marketplaces can serve more customers than traditional lenders, and we believe marketplaces will increasingly serve the historically underserved over time. In practice As a result of these structural advantages, marketplace lending delivers a significant amount of affordable credit across the country to low- to moderate-income families and individuals. Over 8 Operating ratio is expressed as expenses as a percentage of outstanding loan balance. To adjust for rapid growth, Lending Club s estimated operating ratio is estimated on a run rate basis, assuming no growth in monthly rate of origination volumes. Lending Club s Response to Marketplace Lending RFI, September 2015 Page 13 of 51

14 the last 12 months, Lending Club s platform, for example, has facilitated more than $200 million in loans to low- and moderate-income individuals 9 across the United States. Lending Club believes it will continue to expand its platform s reach to this underserved population, through partnerships like the innovative partnership announced this year with Citi and Varadero Capital, which is designed to deliver $150 million of affordable credit to underserved, low- to moderateincome borrowers. These platforms also facilitate loans to other underserved constituencies such as smaller businesses. The underserved nature of these smaller businesses is evidenced in the Federal Reserve's Joint Small Business Credit Survey, which shows microbusinesses (those with revenue of less than $250,000) only succeed in obtaining credit 25% of the time 10 while large firms with annual revenues of $10 million or more succeed in accessing credit 70% of the time. Moreover, this survey also notes 86% of microbusinesses are seeking credit for an amount of $250,000 or less. Lending balances for smaller loans ($100,000 to $250,000) are down 22% since 2007, while booked commercial loans of greater than $1 million have increased 56% in the same period. 11 To meet this emerging need, our platform is focused on serving the segment seeking loan sizes less than $300,000 with an average loan size of $55,000. Our partnership with Opportunity Fund, one of the largest Community Development Financial Institutions (CDFIs), is structured to provide credit access to small businesses in underserved parts of California in order to leverage our platform and deepen its access to and broaden the benefit for this underserved population. Successfully serving underserved populations, however, requires more than simply making credit accessible to them. To truly serve these populations effectively, the credit product must be designed to provide for the timely and successful repayment of the loan and allow the borrower to end the cycle of debt that many currently available products encourage. The Lending Club platform focuses on providing access to loans whose terms are fair, transparent, and responsible for all borrowers with features for standard program loans such as a fixed term, fixed monthly payments, and no prepayment penalty, in amounts that do not unduly burden the borrower, which overall reflect responsible borrowing principles. Our position on these principles is further reflected in the Small Business Borrowers' Bill of Rights ( BBOR ) that was created by a coalition of lenders, brokers, nonprofits, and industry participants. (See Question 11 for further detail on the BBOR). We believe that our marketplace s structural advantages, continued focus on fair and transparent terms, and innovative partnerships will aid in broadening access to responsible credit for these historically underserved populations. 9 Borrowers who have reported adjusted household income is less than 80% of the median income of their zip code and live in majority or greater low to moderate income (LMI) census tracts as of June 30, Federal Reserve Banks of New York, Atlanta, Cleveland, and Philadelphia, Joint Small Business Credit Survey Report, FDIC March 31, 2015 Call Report Data, C&I Loans + Nonfarm Nonresidential loans Lending Club s Response to Marketplace Lending RFI, September 2015 Page 14 of 51

15 5. Describe the customer acquisition process for online marketplace lenders. What kinds of marketing channels are used to reach new customers? What kinds of partnerships do online marketplace lenders have with traditional financial institutions, community development financial institutions (CDFIs), or other types of businesses to reach new customers? Lending Club uses a diverse array of direct and partnership marketing channels to attract borrowers to our platform, including: Online Partnerships: We work with companies that sell products or services that are suitable for financing or that help potential borrowers manage their finances, manage their credit, or find the best lending options. Search Engine Optimization: We seek to ensure that our marketplace is optimized to achieve meaningful organic traffic from search engines. Search Engine Marketing: We also use paid placement on major online search engines. Social Media and Press: We leverage social media outlets and the press to help drive brand awareness. Offline Partnerships: We work with companies that sell products offline that often require affordable financing, such as swimming pools, home improvements, and furniture. Mail-to-Web: We have developed a highly targeted direct marketing program that selects from a given population of consumers and small business owners who would benefit from our products. Radio and Television Advertising: We utilize radio and television advertising to enhance the impact of our other marketing channels. Other Partnerships Traditional Financial Institutions: We work with a large number of traditional financial institutions that invest directly on the platform and / or partner with us to facilitate personal loans to their customers. Banks are a natural partner for marketplaces as their strong relationships with their customers and low cost of capital, combined with the efficient and cost-effective technology offered by marketplaces, creates a best of both worlds advantage for banks and their customers. These partnerships enable banks to provide their existing customer base with access to credit products other than traditional credit cards, which are an efficient payment solution but a poor long-term financing option. These partnerships also enable banks to invest in these new loans that the bank would not otherwise be able to procure, underwrite, and fund as efficiently, resulting in a stronger borrower relationship and a more diverse bank balance sheet. Examples of Lending Club s banking partnerships include: o BancAlliance: In February 2015 Lending Club announced a partnership with BancAlliance, a national consortium of 200 community banks in 39 states, to offer access to co-branded personal loans to their customers through the Lending Club Lending Club s Response to Marketplace Lending RFI, September 2015 Page 15 of 51

16 platform, as well as purchase certain of these consumer loans and others for their portfolios o Union Bank: In May 2014 Lending Club announced a strategic alliance with Union Bank, a $100B+ asset bank, to have Union Bank purchase assets through the Lending Club platform, with the potential to create unique credit products together for Union Bank and many other banks customers. Non-profits: We have partnered with several non-profits such as the U.S. Women s Chamber of Commerce and SCORE to expand access to credit to their networks. CDFIs: We are developing relationships with CDFIs to broaden access to financing for underserved borrowers, including: o Opportunity Fund: Lending Club has partnered with Opportunity Fund, a leading CDFI business lender, and the largest nonprofit lender to small businesses in California, to provide a compelling combination of approaches to small business lending to leverage the strengths of each model. Lending Club can help the Opportunity Fund improve their efficiency and scale by providing them with the Lending Club platform s automated credit model, fast, simple application process, and access to thousands of potential borrowers that a CDFI such as Opportunity Fund may otherwise be unable to reach. Through this new partnership, businesses that would not satisfy the credit criteria of the issuing bank for Lending Club s platform may now be offered a loan to be acquired by Opportunity Fund. The pilot phase of this partnership plans to facilitate up to $10M in loans to small businesses in underserved areas of California, helping an estimated 400 businesses create 1,000 jobs. If the pilot is successful, the parties intend to expand the effort nationally. Beyond utilizing the marketing channels identified above, Lending Club s strengths in consumer acquisition lie in its ability to use a simple online experience for borrowers who come through any channel and its relentless focus to measure performance and optimize the process to further enhance the overall borrower experience. Lending Club s Response to Marketplace Lending RFI, September 2015 Page 16 of 51

17 6. How are borrowers assessed for their creditworthiness and repayment ability? How accurate are these models in predicting credit risk? Lending Club and its issuing bank partners have developed sophisticated systems to assess creditworthiness (which should take into account, through a variety of assessments, the probability of a borrower s successful on-time repayment of the loan) and prevent fraud. As a result, the Lending Club platform s risk model is currently twice as effective as generic bureau risk scores, and our fraud prevention systems minimize fraud losses to rates currently much lower than industry standards. Effective Assessment of Creditworthiness All lenders should assess a borrower s creditworthiness that focuses on a borrower s ability to successfully repay the loan in full and on time, consistent with responsible lending practices. The foundation of the Lending Club s platform s loan decisioning is automated credit models that provide borrowers with instant loan offers. These models draw on current and past credit behavior data provided by credit bureaus, application information provided by the applicant, and credit and payment data from other third parties. We believe that these models are strong predictors of credit risk, with actual losses generally tracking forecast losses. Lending Club has invested significantly in its credit expertise and continuously enhanced the risk models. To develop these risk models, Lending Club s risk team, data scientists, and credit modelers work in close partnership with our issuing bank partners credit and risk teams to develop and deploy risk assessment systems at a pace and scope that exceeds that of most traditional lenders. The platform s risk models are regularly reassessed and rebuilt to incorporate recent and additional data and any changes to electronic data. The teams collectively examine thousands of potential credit attributes to enhance the risk prediction capabilities of the credit model and sub-models. Lending Club is not only able to deploy credit model improvements on the platform more frequently, but also can respond more quickly to changes in the portfolio or economic environment. After design, review and internal testing, and validation of new models, independent third parties are engaged to validate these new custom risk models. Once this independent validation is complete, new models are moved onto the platform and into production in approximately eight weeks. Updates to these new models can be developed and placed into production in as little as two to three weeks. In contrast, a traditional bank loan program may require months to complete similar processes needed to develop, validate, and implement a new model into production. Our risk infrastructure and automated Q/A systems ensure that we are able to both develop quickly and test and validate models in a comprehensive and efficient fashion. The high quality of the platform s risk assessment systems can be demonstrated in two ways: (i) the currently deployed model on the platform outperforms industry generic scores such as FICO by more than double in the Kolmogorov Smirnov test, an industry standard measure of the effectiveness of a risk model and (ii) as evidenced by declining platform losses (on a percentage basis) and increasing investor confidence, the platform s pricing has correspondingly declined Lending Club s Response to Marketplace Lending RFI, September 2015 Page 17 of 51

18 over time, resulting in a benefit to borrowers with even more affordable credit over the last three years, the risk premiums required by investors on Lending Club s platform have decreased by 270 basis points. 12 Effective Income and Employment Verification Lending Club and its issuing banks have developed and refined statistical models over the last 8 years to determine the amount of verification necessary for any given loan application. We have also developed processes to cost-efficiently verify income and/or employment when such verification is necessary and is likely to improve loan performance, yet we do this in a way that minimizes the burden on the borrower. The chart below shows that these models and processes have been effective at identifying the lowest risk loans that do not require income or employment verification. Loans that have not been subject to verification of income have on average performed better than loans that were income verified. Effective Fraud Prevention Fraud prevention is critical to reducing risk and improving loan performance. Lending Club has developed industry leading fraud prevention systems that protect investors from investing in fraudulent loans and also protect borrowers who may be subject to identity theft. Similar to creditworthiness, Lending Club s fraud detection system begins with models that analyze a wide variety of credit and other data to predict the likelihood that a loan application may be fraudulent. Our fraud team then performs additional verifications in order to proceed with the application. In the first nine months of 2014, the platform s fraud loss rate related to verified ID 12 The weighted average interest rates on 36-month loan portfolio have declined from 13.2% in June 2012 to 11.2% in June 2015, down 200 bps. Meanwhile, 3-year treasury yields have increased 70 bps over the same period, resulting in a 270 basis point spread reduction. Spread based on weighted average monthly interest rate on 36-Month loan portfolio minus monthly 3-year treasury yield. Source: FactSet, Lending Club s Response to Marketplace Lending RFI, September 2015 Page 18 of 51

19 theft was less than 0.01%. By comparison, the net identify fraud loss of top credit card issuers was generally 0.10%-0.15%. 13 How does the credit assessment of small business borrowers differ from consumer borrowers? For both consumers and small businesses, Lending Club employs a consistent approach with a data and technology-enabled highly automated process; our underwriting approach is specifically tailored to the repayment behavior of the segment. Small businesses and consumers have different credit characteristics and require different underwriting processes. The Lending Club platform loan decisioning for small businesses underwrites the business and a guarantor with available data, using a credit model designed specifically for the repayment behaviors of the types of businesses that we serve. The applicant s financial statements, credit history and behavior, additional data, and other information are analyzed to properly decision each business loan application. Does the borrower s stated use of proceeds affect underwriting for the loan? For consumer loans, the use of proceeds can influence pricing and loan amount available based upon historical risk performance, but Lending Club does not verify the actual use of the loan proceeds. For small business loan applications, the stated use of proceeds can allow us to tailor the terms of the loan to the business s need. For example, a business borrowing for expansion may be best served with a longer loan term, while a business borrowing to purchase and sell inventory may be best served with a shorter term. Additionally, when the stated use of proceeds can be verified based on the product by sending money directly to the supplier of inventory, it reduces risk and therefore can result in lower pricing. 13 Source: ID Analytics Lending Club s Response to Marketplace Lending RFI, September 2015 Page 19 of 51

20 7. Describe whether and how marketplace lending relies on services or relationships provided by traditional lending institutions or insured depository institutions. (Note: relates to the answer in Q1.) We believe that marketplace lending is a catalyst that brings together a variety of service providers and other relationships to create a more accessible and affordable lending mechanism. We also strongly believe that marketplace lending provides benefits to bank partners including: (i) an efficient lending mechanism for products essentially vacated by traditional banks due to cost and competitive product constraints and (ii) the opportunity to enhance our partners' product offerings to borrowers in a more efficient and affordable manner. In addition, the marketplace s product offerings have helped our partners grow their balance sheet with investments in the platform s high quality assets and benefited our platform through our partners guidance and feedback on enhancing compliance, controls, and risk infrastructure. The key relationships that marketplaces may have with traditional lending institutions desiring to participate as borrowers and/or investors on a marketplace platform include the following: Borrower-Side Banking Relationships Issuing bank relationships Marketplaces may rely on issuing banks to originate and issue all loans facilitated by the platform and to provide strict oversight and control over the platform s compliance and risk capabilities. Lending Club s primary issuing bank is WebBank, a FDIC-insured Utah-chartered industrial bank that handles a variety of consumer and commercial financing programs. Lending Club also partners with NBT Bank, NA and Comenity Capital Bank as the issuing banks for its K-12 education and patient finance programs. These relationships subject the marketplace to a substantial degree of regulation and regulatory oversight that does not apply to non-bank programs. Referral or Joint Marketing banks Over the last 30 years, there has been a tremendous shift in how credit is delivered to consumers. In 1990, community banks accounted for approximately 80% of the consumer lending market but they now account for less than 10% of that market. 14 This shift was driven largely by the inability of smaller banks to compete with large financial institutions given their lack of scale and resources and the move towards credit cards and away from more traditional loan products. In order to increase the accessibility of the platform s loan products, we continue to develop partner opportunities with banks and other traditional lending institutions in order to leverage the cost efficiency of our platform and make its products available to our partners customers under 14 Ryan Tracy, " Lending Club, Small U.S. Banks Plan New Consumer-Loan Program," Wall Street Journal, February 9, 2015 Lending Club s Response to Marketplace Lending RFI, September 2015 Page 20 of 51