Last week, the Structured Finance Industry Group presented a panel discussion on marketplace lending in New York. The panel included representatives of marketplace platforms (including Lending Club, the market leader), an institutional purchaser (a fund), a rating agency and a lawyer specializing in the area. Here are a few key takeaways:
1. The sector is growing, both in loan volume and the number of new platforms, but:
- a. this growth has put pressure on both rates and underwriting standards
- b. proliferation of platforms will lead to shake-out and consolidation
2. The basic product remains the three- to five-year unsecured loan. Small-business loans and other sectors are growing, but more slowly.
3. Emphasis is on financial technology to automate the underwriting. Both platforms (which use automated processes to generate data on potential borrowers) and purchasers (who develop proprietary algorithms to identify “good” borrowers whose loans are perceived as underpriced) rely on big data capabilities to mitigate risk.
4. For platforms, the originate-to-sell model is still dominant. However, some are moving in the direction of being balance-sheet lenders who hold their own loans.
5. Although there have been and will continue to be securitizations, the dominant players are still buy-hold yield-seeking funds. Retail (the original “peer-to-peer” model) is of diminishing importance.
6. Strong preference at Lending Club and other established players for borrowers coming through origination channels (vs. “walk-ups”). Alliances with other vendors (e.g., solar panel vendors, etc.) are a big focus.
7. There is warehouse capacity and appetite: banks want to provide warehousing to fund buyers of this product.
8. On the ratings front, the focus is on:
- a. robustness and transparency of the process at the platform level
- b. servicing considerations (not yet tested in an economic downturn)
9. The Madden decision and associated usury risk is causing purchasers to exclude loans that have this risk. Loans from New York, Connecticut or Vermont that have interest rates in excess of the applicable usury rates in those states are being rejected by purchasers and excluded from securitization pools.
Overall, it appears likely that continued growth of marketplace lending platforms will hinge on the kind of data-handling capabilities needed to expand both the availability of individual credit and increase the efficiency of pricing. However, in doing so the platforms are pushing an entire sector of credit into a less heavily regulated environment (since Dodd-Frank there is no such thing as an unregulated environment involving credit) with an interesting mix of incentives that resembles the mortgage lending environment of the early 2000’s. That said, there are several notable differences:
- There is no asset bubble to drive “irrational exuberance”
- These are very short duration assets so problems (and there will be problems) will surface much more quickly
- The size of the market is a small fraction of the size of the mortgage market – thus “systemic risk” is much less likely to be a factor
Successful platforms will be those that can bring together technological capabilities, analytic rigor and deep understanding of risk and credit.