For the US peer-to-peer market, 2015 was a year of progress. Loan origination volume doubled again last year, as it has every year since 2010. Total origination volume in 2015 was estimated to be around $15bn.
The fourth quarter also saw the launch of a marketplace loan index by Orchard Platform with the aim to provide heightened transparency, in addition to giving investors a benchmark to gauge the performance of loans originated via online lenders. Investors have long complained about the lack of data and transparency in marketplace loans, and a concrete benchmark by which to measure performance is another step towards developing a mature, functioning market.
The impressive volumes and structural progress means banks are paying more attention. “[In 2014], banks wouldn’t get anywhere near us — P2P was still a novelty,” says Jason Fritton, chief executive of online real estate platform Patch of Land. “Now there’s so much capital flow from traditional financial institutions to lending platforms. Just one year ago, that would’ve been unthinkable.”
However, the legal implications of the Second Circuit court ruling in last May’s Madden vs Midland Funding case cast a shadow over the industry throughout much of the year, dampening liquidity for loans originated in New York, Connecticut and Vermont. The ruling, which the Second Circuit Court of Appeals decided in August not to rehear, restricts the ability of marketplace lenders to bypass state usury laws by partnering with out of state banks. Irate industry players called for the Supreme Court to review the case and a petition for review was filed by Midland Funding in November.
“I think that there’s some reason to think that the case might be overturned. It’s a big enough issue that disrupts the financial markets, and if this doesn’t get resolved by the Supreme Court, Congress will fix it,” says Oliver Ireland, partner at law firm Morrison Foerster in Washington, DC.
Under the Madden ruling, a non-bank entity could be subject to applicable state usury limits and the loan buyers might not be able to charge and collect interest at the contracted rate, according to a September report by Moody’s. However, the US Supreme Court could reverse the ruling.
Heightened scrutiny from US regulators was also a running theme. In mid-2015, the US Treasury published a Request for Information (RFI) as policymakers tried to gain a better understanding of the market and its risks. In November, the Federal Deposit Insurance Corporation (FDIC) issued a letter expressing concern over the growing risk associated with banks purchasing loans from platforms.
In a response to new scrutiny, there has been talk of self-regulation by the industry in a bid to educate regulators and soothe their fears over reckless lending practices. However, some observers remain divided over the efficacy of such an effort.
“Self-regulatory bodies work best where parties in the industry are on opposite sides of the transactions,” explains Jerry Marlatt, senior counsel at Morrison Foerster in New York. “Certainly, you can have a body that helps with education and lobbying, but in this context, it would forestall or substitute some form of government regulation.”
Bigger players jumping in
The space became ever more crowded in 2015, with the entrance of traditional financial institutions on both the loan origination and whole loan and ABS investment sides.
Goldman Sachs announced plans to enter the market, while Blackstone Group rebranded its B2R Holdings unit as Lending.com with the goal of originating $10bn of loans over three years. The private equity giant’s entrance into P2P may disrupt the plans of smaller fintech companies that had themselves set out to disrupt the consumer and small business finance industries.
Jason Hogg, CEO of Lending.com in New York, confirms that securitization may be a possibility in 2016. “Relative to Lending.com, securitization could play a role, but we [also] want to provide other solutions,” he says, adding that the company will also consider whole loan and direct sourcing relationships.
Moving forward, consolidation could emerge as a dominant theme as larger players look to scale up through acquisitions of smaller platforms. “Competitive advantages are not easy to come by to secure real, deep and diverse capital, and ultimately to have a robust pricing engine where you’re actually leveraging big data to price risk,” says Varun Pathria, chief investment officer of Los Angeles-based Asset Avenue. “I don’t think these are easier barriers [for smaller players] to overcome.”
This year may also see more platforms taking the rated route for P2P ABS. “I think a triple-A rating is helpful for pricing and drawing investors into the space,” says Chuck Weilamann, a senior vice president at DBRS in New York. “SoFi, for example, already had a lot of demand when they were still at single-A and that’s seemed to increase since they’ve been able to get higher ratings.”
Where are the European deals?
Meanwhile in Europe, though the market still lags behind the US in terms of scale and maturity, marketplace lending has grown sharply. According to data from the UK Peer-to-Peer Finance Association, its members lent £411m in 2015 up to October 30, compared with £279m in 2014.
Participants view 2016 as an important year in the European marketplace lending sector. Funding Circle’s global co-head of capital markets Sachin Patel says that the market will see increased differentiation between platforms in 2016.
“We’re beginning to see differentiation in the market between platforms, in terms of quality and the types of institutional capital they’re taking on board,” he says. “Investors used to see P2P as one big asset class, but now they are differentiating between asset class and model. Funding Circle originates vanilla SME loans — it’s not sexy and institutional investors quickly become comfortable, opening up the asset class to a much wider range of investors for the first time.”
Some players hope that institutional investor KLS Diversified Asset Management will issue the first P2P securitization in the first quarter. In December 2014, the US-based fixed income manager invested £132m in a portfolio of loans to small British businesses, originated by Funding Circle.
However, divergent opinions among ratings agencies suggest that it may take some time for the ABS market to warm to the new asset class.
Fitch Ratings has said it would put a ratings cap on any securitization of marketplace lending portfolios until more historical performance data becomes available. There is concern that the assets have not been through a full economic cycle yet, with marketplace lending only gaining traction after the financial crisis.
“[Marketplace lenders] only have three years of data on sizeable volumes, and our criteria usually says we want to see five years of data before we go up to double-A and triple-A ratings,” says Matthias Neugebauer, head of corporate loan securitization and structured credit products at Fitch in London. “We’ve said that for most marketplace loan securitizations this is most likely not achievable at the moment, in either consumer or SME portfolios.”
Stefan Augustin of Moody’s, however, says it is possible to extrapolate the default behaviour of a marketplace lending portfolio from existing bank-originated SME loan portfolios.
“The platforms are not originating to ‘new’ borrowers, as such,” he says. “SMEs are the backbone of any major eurozone economy. You can compare the character and portfolio of Funding Circle, for example, to bank originated and rated SME transactions. These deals will not reinvent the wheel. They’re very similar to what traditional banks already do.”
SMEs in the spotlight
Unlike the US, European marketplace lending — dominated by the UK market — has traditionally focused on SME loans. Marketplace lending in the UK consumer lending space faces competition from high street banks, unlike the same market in the US in which credit card lending prevails.
“Consumer credit is very well done already,” says Funding Circle’s Patel. “I can log in on my mobile and get a loan from a bank at 3% in seconds — there’s not much we can add over and above that. But small business loans are not done well anywhere. Even in 2015 the only place you can do it is in a bank branch, and it’s a tired and cumbersome process.
“It’s also a bigger market — banks provide £7bn a month in SME lending and around £2bn in consumer lending, so there’s a bigger opportunity on the SME side.”
More broadly, the question in the market is around whether banks are better placed to channel money to the real economy. But with their advanced IT capabilities and streamlined origination processes, many see marketplace lending platforms as a key part of channelling credit into the real economy, though some say traditional banks should not be written off in this regard.
Mark Hale, chief investment officer of Prytania Investment Advisors, appears to agree. Speaking at the DBRS Day in London event in November, which focussed on the outlook for the European markets in 2016, he said: “We have all talked about non-bank and direct lending stepping into the market for years, but the revival of SME lending in Europe in the next two years is essentially going to be about banks. The availability of credit to SMEs is finally improving according to the latest ECB survey, but a sustained revival in bank lending is a key missing part of the European recovery.”
Moody’s Augustin says that the platforms do not yet have the scale to render traditional banks irrelevant: “[The platforms] are getting bigger and bigger, but compared to the bank lending market they’re relatively small. The marketplace lending market is maturing, but it’s not yet mature. In Europe, it’s not even certain yet whether they are here to stay.”
The platforms should focus on their strengths, says Augustin: “Where they can really compete with banks is on time — they can process a small business loan in perhaps a week, when a bank would take maybe three to four months.”
The key for online lenders, he adds, “will be to maximise the speed, convenience and transparency of what they offer”.