After Breakout Year, Peer-To-Peer Lending Still Evolving

Jan 23 2014 | 2:17pm ET

Peer-to-peer lending—a form of financing that allows lenders and borrowers to bypass traditional banks—has come of age.

According to Ron Suber of P2P lender Prosper Marketplace, 2013 will go down as “the year that peer-to-peer finance established itself as a trusted alternative to traditional methods of borrowing and lending money and as an important new asset class for both institutional and retail investors around the world.”

It's been a rapid maturation process and P2P has “grown up in a hurry,” according to Brendan Ross, president of Direct Lending Investments, a Los Angeles-based hedge fund that buys online peer-to-peer loans. By Ross' reckoning, P2P lending was born in 2005 and had its coming out party in June 2013, at the inaugural LendIt.co conference in New York City.

At that event, Renaud LaPlanche, CEO of the dominant player in the P2P space, Lending Club, which was also the conferences sponsor, announced the firm had passed $2 billion in loan originations. Since then, LaPlanche told FINalternatives' Mary Campbell, it has gone from strength to strength.

“Lending Club continued to lead the continued development of an entire industry in the last 12 months,” he said. “Increased public awareness and credibility derived from a series of milestones, including the appointment of Larry Summers to the Lending Club board in December of 2012.”

In addition to hiring President Bill Clinton's Treasury Secretary, Lending Club also received Google backing to the tune of $125 million, surpassed $100 million in annual revenue, became the first company in the space to reach profitability and surpassed $3 billion in total loan origination—$2 billion of that in 2013 alone.

Lending Club, said LaPlanche, was also behind “the first industry securitization with Eaglewood Capital, and finally, the first Congressional hearing involving a testimony from a peer lending company earlier this month, with Lending Club’s testimony on the state of small business lending in America and how peer lending can help.”

But Lending Club was not the only P2P player to have a good year. Its chief rival, Prosper, was taken over last January by Suber, Steven Vermut and Aaron Vermut, seasoned Wall Street executives who, with the aid of a $20 million investment led by Sequoia Capital, increased loan originations by 500%, with more than $700 million on the platform since inception. In September, Prosper announced a second, $25 million financing round led again by Sequoia, with a new investment from BlackRock, the world's largest investment manager.

Consumer Credit

Lenders like Prosper and Lending Club, aiming to tap the $1 trillion consumer credit market, dominated peer-to-peer headlines in 2013. Both platforms target borrowers seeking up to $35,000 to “pay off credit card debt, or consumer finance debt, or they may want to buy a nicer wedding dress, or need cash to pay their taxes or to do home improvements,” Suber told FINalternatives. “They're not being served by their banks or credit unions, they're being turned down or they're paying too high of a rate with a credit card company or bank.”

Such requests are vetted by the lending platform (Prosper, for example, demands a minimum credit score of 660) and, if approved, are assigned an interest rate and listed on the site. Once sufficient lenders have been found, a loan is originated and serviced. Platforms generally make their money by charging borrowers a one-time origination fee and lenders a monthly service fee.

Roots and Shoots

But if P2P lending has matured quickly, it is evolving even more quickly, expanding beyond the consumer space. “Keen-eyed observers,” said Ross, “saw shoots emerge in small business and real estate lending."

Jilliene Helman launched RealtyMogul in 2013, making a splash with billboards asking motorists if they had ever wanted to own a shopping center. Sequorum launched with its eyes on peer-to-peer ownership of single-family homes.

Hellman, who acknowledges Prosper and LendingClub as influences, said what those firms demonstrated to her was that “profitable financial sub-markets" like credit card re-finance "still exist.”

“In real estate, the homeowner lending market has become more regulated, but there plenty of sub-markets that remain underserved by traditional financial institutions,” she told FINalternatives. “'Hard money' lending to companies or individuals needing only short-term financing for renovation projects remains an attractive arena, and 'crowdlending' is beginning to change the dynamics of that sector.”

Hellman's key realization was that, although credit markets are continually evolving, “a significant amount of credit still requires some collateral, like a house.”

“For individuals, whose house is often their largest single asset, real-estate credit markets offer a familiar appeal,” said Hellman. “Even when mortgages are securitized and bundled in multiple ways, most individuals can grasp the concept of a house, commercial building or raw land as 'real' collateral—something tangible that has a real (though still somewhat fluctuating) store of value. This familiarity makes 'crowdfunding' particularly viable as a financing source for real estate.”

Expansion Abroad

Proving the P2P phenomenon is not limited to the North American continent, Christian Faes has co-founded a similar business across the pond. LendInvest, his Britsh-based peer-to-peer lending platform, also focuses on loans secured against residential and commercial property, and he expects this expansion of P2P beyond consumer lending to continue.

“We think that there will likely be variations on the P2P concept, with different platforms establishing certain expertise in their respective niches. Moving forward, as the different P2P platforms continue to gain momentum, there will be a few clear leaders in each part of the market. Peer-to-peer lenders that focus on unsecured personal loans are fairly established. The more exciting development will likely be in the area where investors can obtain superior risk-adjusted returns through secured peer-to-peer lending.”

And while acknowledging that 2013 was a big year for P2P, Faes believes that 2014, especially in the U.K., will be even bigger as the Financial Conduct Authority formalizes its regulatory regime for the platforms.

“The importance of this is that investors will be able to have confidence that the platforms they are investing through are run by experienced professionals, backed by adequate capital. We believe that this will transform peer-to-peer lending into the mainstream, and allow for significant additional investment to flow into the asset class. There is a lot of pent-up investor demand for yield, and P2P can provide the perfect solution. However, many investors are understandably waiting for the industry to become regulated. We welcome this, and look forward to becoming one of the first platforms to become regulated in 2014.”

Regulation is an issue in the U.S., too, where Lending Club actually closed for a month in 2008 to hammer out an agreement with the Securities and Exchange Commission. Currently, residents of any U.S. state can borrow via P2P platforms, but it's only legal to lend in 26 of them. LaPlanche told Forbes magazine in November that he has more investor interest than he can handle and that regulatory approval in the remaining states will come over time.

Institutionalization

While both the type of financing targeted by P2P lending and the rules governing it are evolving, perhaps the biggest change in the space is the entry of institutional-class lenders. Faes' business, for example, targets pension funds, hedge funds and family offices. Ross estimates that half the capital invested in P2P lending now comes from institutions.

In fact, Ross' predictions for 2014 include “catch-phrase fatigue” that will see the term "peer-to-peer lending" replaced by "online lending."

“Institutional investors are taking over the peer-to-peer space, and the newest online lenders, like IOU Central, are directly lending their own money to small businesses that meet their requirements," he said.

Online lending is “nothing less than the vanguard of Silicon Valley’s attack on New York, Charlotte and other bastions of retail lending. Silicon Valley has created a bank without a balance sheet. Online lenders market financial products, underwrite borrowers and service loans, all without taking a penny of balance-sheet risk.”

For Ross, who expects a Lending Club IPO in 2014 and the takeover of Prosper by “a major U.S. retail bank” (a prediction dismissed by a Prosper spokesperson as “pure speculation”), the big story in 2014 will be the “huge growth in the number of players that take up niche positions in the lending value chain: brokers who find borrowers, underwriters who deliver credit models, hedge funds who provide balance sheets, and servicers and collection agencies who keep the payments flowing.”

Suber predicts that in 2014 demand from borrowers, as well as retail and institutional lenders will continue to accelerate. His firm, he said, is on track to originate in excess of $1 billion of loans in 2014 and the industry as a whole will “continue to see significant global expansion as borrowers have caught on to the fact that there is an alternative to traditional banks for competitively-priced loans, and investors now have access to a new asset class that offers a high-yield, short-duration, fixed-rate, uncorrelated, monthly-paying investment.”

Laplanche also expects “continuing mainstream adoption of the model, with peer lending becoming an increasingly popular way to obtain affordable credit. We believe the public will see extensions of the model to new asset classes including commercial loans, auto loans and possibly mortgages, and we expect the Lending Club platform to become the largest issuer of personal loans in America. We also expect the banking system to continue to transform itself and increasingly embrace peer lending in 2014.”

But Ross goes a step further: The emergence of online lending, he said, “marks the start of the 'Decade of Private Debt,' during which a fragmented lending value chain will unleash a huge amount of creativity, changing the face of lending for every type of borrower and investor.”


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