The Evolving Nature of P2P Lending

by Alex Johnson 0

Person-to-person (P2P) lending has seen extraordinary growth in the last ten years. Along the way, the concept of P2P lending has also evolved significantly…to the point where most industry observers don’t even call it P2P anymore:

“While the earliest lending platforms (e.g., Prosper, LendingClub) began with true “peer-to-peer” models, the majority of lending capital is now provided by institutional investors, such as hedge funds, insurance companies and, yes, even banks. Institutional investors have been drawn to the asset class by strong unlevered yields and highly predictable credit performance across a large portfolio of loans. In 2014, 81 percent of LendingClub’s loan originations came from institutional and managed investors.”

“This shift explains why many participants now refer to the space as “marketplace lending,” reflecting the wider range of investors. As the capital supply is now more concentrated with institutional investors, the two-sided “network effects” boasted in the early years of P2P lending may not be as important today.”

The shift to institutional investors as the primary source of funds is significant. Perhaps more significant is the success of the underlying lending technology developed by these platforms, regardless of how they fund their loans.

“The term “marketplace lending” implies a meeting place where investors and borrowers can be freely matched. But new lending platforms actually employ two new business models: technology-enabled lending (a new distribution and underwriting model) and 100 percent off-balance-sheet financing through a “marketplace” (a new funding model).”

“These two models are often conflated, and many new lenders actually have traditional sources of capital, but use the Internet as a distribution channel to issue new loans. While platforms such as LendingClub, Prosper, Peerform and CircleBack are actual marketplaces, other platforms coined as marketplace lenders, such as SoFi, Earnest and Avant, are for the most part traditional lenders using their balance sheets or similar credit facilities.”

“The success of those businesses using traditional funding models points to the fact that the explosive growth is due more to the strength of the new distribution and underwriting models. Originating installment loans (a much better product than credit cards for long-term, higher-balance lending) through an online channel (a much more convenient option that traditional lenders offer) has meant a much stronger value proposition to the consumer versus existing unsecured consumer finance products.”

Looking forward, the greatest opportunity in marketplace lending may be in point-of-sale finance.

“Most marketplace lending today, at least on the major platforms, is for refinancing old loans, not issuing new ones. For example, about 70 percent of origination volume on LendingClub is for refinancing or paying off credit card debt.”

“With most consumer lending platforms addressing refinancing, an enormous opportunity exists for emerging platforms to focus on the even larger market for purchase finance (i.e., directly helping consumers to finance new spending), where today, credit cards are the status quo.”

“Startups have begun to emerge to address this opportunity across many verticals of consumer spending: e-commerce (Affirm, Bread), elective medical procedures (PrimaHealth Credit), coding academy tuition (Climb, Earnest, LendLayer), automotive financing (AutoFi) and weddings (Promise Financial — in which I am an investor).”

“The point-of-sale opportunity is also specifically suited to marketplace lending in a way that refinancing is not; retailers need high approval rates, which the marketplace lending model is uniquely suited to offer because of its ability to find investors for a broad range of borrower credit profiles. “Purchase financing is a logical evolution of marketplace lending,” says Brad Vanderstarren, co-founder of Promise Financial.”

Overview by Alex Johnson, Director, Credit Advisory Service at Mercator Advisory Group

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