Fintech is an emerging industry in which companies leverage the cloud, mobile, big data and other innovations to remake (and even disrupt) traditional financial systems.
But lately, fintech has been the industry suffering from disruption — of a sort.
Growth is slowing for operators like LendingClub Corp (LC), On Deck Capital Inc (ONDK) and Square Inc (SQ), and regulatory burdens are starting to stack up. And investors flat-out don’t like it.
And today, we’re learning that there might be a lack of overall discipline. Today, LendingClub released a shocking announcement that CEO and co-founder Renaud Laplanche resigned, and other senior managers were let go as well.
The news sent LC stock plunging more than 25% to all-time lows just above $5.
According to a recent internal review, the company apparently failed to conform to its own rules with the sales of $22 million in near-prime loans to one third-party investor. LC apparently did not follow up with a request for some type review for a noncredit and nonpricing element, and there reportedly is evidence that employees altered data to process the loan.
What’s more, the internal review uncovered something else: some type of personal financial interest in a fund unrelated to the aforementioned loan sales.
In the wake of this massive upheaval, here are five things that LC stock holders — and anyone interested in the fintech space — should know:
Lesson #1: Trust Is Paramount
In the company’s press release, new executive chairman Hans Morris — former president of Visa Inc (V) — said: “A key principle of the Company is maintaining the highest levels of trust with borrowers, investors, regulators, stockholders and employees. While the financial impact of this $22 million in loan sales was minor, a violation of the Company’s business practices along with a lack of full disclosure during the review was unacceptable to the board.”
A financial company is a steward of other people’s money, so a breach of trust can do irreparable harm. However, customers want higher returns and protections, and failure to give in can send them packing to competitors. And a financial company’s own investors and lenders can get antsy, which can lead to higher costs.
The worst-case scenario (obviously) is what we saw during the financial crisis, when scores of financial institutions lost their credibility, resulting in “bank runs” of massive withdrawals.
Will the same happen to LC? No … but there will be damage, and that’s why Laplanche had to go.
Lesson #2: You Need Stable Leadership
Investors in tech operators have had a tough go at it over the past few years. Wall STreet has become increasingly circumspect about business models, as well as the sustainability of growth and profitability.
But leadership stability is crucial, too, and whenever CEOs or senior managers depart, risk levels rise.
If history is any indication, this could be just the start of LC’s problems. Other high-profile IPOs like Groupon Inc (GRPN), Twitter Inc (TWTR) and Zynga Inc (ZNGA) had similar issues with unstable management.
When LC came public in December 2014, Laplanche was looked upon as one of the pioneers of fintech. He was a former securities attorney and used his expertise to develop a sophisticated platform.
But it appears he wasn’t an effective leader in building a culture of compliance, and that could come back to bite LC on more than just today’s occasion. Investors are worried, and LendingClub could institute more restructuring ahead.
Lesson #3: There WILL Be Growing Pains
As a public company, LendingClub has beat earnings expectations every quarter — until this quarter. During the three months ended March 31, revenues came to $152.3 million, producing an adjusted profit of 5 cents per share.
While the top line beat the consensus mark, the bottom line was merely in line with expectations. And in light of the issues with the company’s compliance, LC has provided no guidance.
The immediate future could be rough. Keep in mind that other fintech players, including Prosper, Square and On Deck Capital, have experienced deceleration. The problem for the fintech lenders is finding willing buyers of loan portfolios. After all, if the U.S. economy is slowing down, those portfolios will suffer more losses.
It also doesn’t help that fintech algorithms and data models have not really been tested during challenging times.
Lesson #4: The Regulators Will Weigh on Fintech
Regulatory and legal requirements are often slow to catch up with new technologies, and the fintech space is no different. The industry actually has been able to capitalize on this so far, while traditional financial institutions have been weighed down by onerous requirements that have come from the financial crisis.
But that advantage could be going away soon.
For example, the lawsuit of Madden v. Midland Funding, LLC, may require companies like LC to comply with state usury laws (which put limits on interest rates for consumers) and has been appealed to the point where it has reached the Supreme Court. LendingClub, for its part, has already restructured to get ahead of this particular change.
Also, the presidential election is taking on a heavily anti-Wall Street vibe, which could result in more financial services regulations.
Not to mention that today’s news out of LendingClub could spur more scrutiny on the industry.
Lesson #5: Investors Are Getting Killed
The losses in the fintech sector have been stunning. LC is off about 75% from its 52-week high, and On Deck has shed about the same from its market cap.
It’s just plain tough to be bullish in this kind of environment, and will relegate many investors to a wait-and-see approach.
That mindset will no doubt be even more aggravated thanks to sell-side analysts doling out downgrades. Stifel has noted a loss of “faith and trust” with LC stock, and Sterne Agee has reduced its price target from $8 to $5. William Blair isn’t even rating the stock anymore.
And the shorts are showing their teeth. Even before today, a hefty 21% of LendingClub’s float was sold short — and while many investors might lock in their gains, a new set of shorts might dive in for a possible follow-through selloff.
Long story short: The already substantial pain in fintech might not be over yet.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
