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Marketplace Lending: Disruptors and the New Credit Paradigm Marketplace Lending: Disruptors and the New Credit Paradigm

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Marketplace Lending: Disruptors and the New Credit Paradigm Marketplace Lending: Disruptors and the New Credit Paradigm Marketplace lending: disruptors and the new credit paradigm Marketplace lending: disruptors and the new credit paradigm Marketplace lending: disruptors and the new credit paradigm Transformative Contents technology Executive summary page 3 Aided by regulatory changes, a Silicon Valley is coming page 5 Partner-bank model page 5 low interest rate environment and Bank engagement page 6 new data-driven technologies, Partnerships page 7 marketplace lenders are Customer acquisition page 7 transforming global credit markets Regulatory risks page 8 Madden ruling page 9 and reinvigorating the securitisation True lender issues page 10 industry. This SCI research report* Risk retention page 10 examines the factors behind the Credit risk page 11 Securitisations page 12 rapid growth of these platforms, the Loan servicing page 12 regulatory scrutiny they’re attracting, Liquidity page 14 the proliferation of bank partnerships Market evolution page 15 and investor demand, and the The UK page 16 China page 17 emergence of financial products Box: Institutional investors polled page 10 linked to the underlying loans. Box: Treasury RFI underway page 11 Box: Developing derivatives page 15 Box: Borrowers’ bill of rights page 16 Box: Retail investment opportunities page 17 *This report was written by freelance journalist Jean Haggerty and edited by SCI editor Corinne Smith Structured Credit Investor | 2015 Guide to Marketplace Lending 2 Marketplace lending: disruptors and the new credit paradigm Executive summary Exhibit 1: 92% Of Investors in Lending Club Have Earned 6-18% Annual Yields Since Marketplace lenders, formerly known as its Inception peer-to-peer (P2P) lenders, are internet- based non-bank financial institutions that Distribution of Lending Club monthly returns, from inception to December 2013 rely on technology to match prospective 25% borrowers directly to interested lenders/ investors. Marketplace lenders generate 20% revenue by servicing and originating unsecured loans. Current interest rates available on 15% marketplace lending platforms in the US imply a source of yield that is hard 10% to match (see exhibit 1). Rates on three- to five-year Prosper and Lending Club 5% debt tend to be in the teens or 20s, for instance, while OnDeck Capital – which Adjusted Net Annualised Return 0% focuses on small business lending – can offer returns of up to 100% on three- to -5% five-year debt. Marketplace loans usually Jun 07 Dec 07 Jun 08 Dec 08 Jun 09 Dec 09 Jun 10 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12 Jun 13 Dec 13 carry a roughly 1% servicing fee. Source: Foundation Capital A US interest rate increase appears imminent and that may render other, more familiar debt capital more appealing. But According to Morgan Stanley, the and diversification offered by marketplace rates have some way to go before the industry might reach as much as lending securitisation is appealing to comparable attractiveness of marketplace US$290bn in global marketplace loan institutional investors (see box on survey, loan yields are impaired. issuance by 2020 (see exhibit 5). Outside page 10). Because many marketplace lending the US, China, the UK and at some For hedge funds acting as sponsors, services are largely automated, platforms point Australia are pegged as markets securitisation can help them target risk/ can operate with a lower overhead than to watch. return levels to suit their needs. For traditional brick-and-mortar financial Interest in tapping the rated ABS banks, securitisation offers a further institutions (see exhibit 2). The ability of market is growing among some source of revenue while providing market these technology start-ups to provide marketplace lending platforms because intelligence in a sector of the loan market services more cheaply than traditional securitisation offers a way for them – as that is at risk of moving away from them. banks often means that borrowers can originators of cashflow assets – to finance Meanwhile, plans to launch derivative borrow at lower interest rates and lenders/ their assets and attract a new class of products referencing marketplace loans investors can earn high returns. investors. At the same time, the yields are also underway. The aim is to facilitate Nearly every sub-sector on the lending spectrum – consumer, small business, student loans, real estate, equipment finance Exhibit 2: Marketplace Lending Could Generate >400bp Cost Advantage vs Banks and factoring loans – either already has a thriving marketplace lending market or Opex / total balance outstanding, basis points is being examined for whether it has the Lending Club Typical Bank Lending Club’s potential to be revolutionised by marketplace in 2015 Competitor Cost Advantage lending (see exhibit 3). And the industry is not just a US phenomenon (see exhibit 4). Branch 220 220 FDIC 10 10 CS / Collection Because many 39 170 130 “ Billing / Fraud marketplace lending Origination 19 100 80 services are largely G&A 20 30 10 automated, platforms Other 28 30 0 can operate with IT 29 35 0 Marketing 135 40 175 100 35 a lower overhead Total Opex 270 40 310 695 425 than traditional brick- Cost advantage drivers (in bp): • 220: Lack of branch network • 40: Online back-oce and support, outsourced collection fees and-mortar financial • 40: Automated origination and leaner operation institutions” Source: Foundation Capital Structured Credit Investor | 2015 Guide to Marketplace Lending 3 Marketplace lending: disruptors and the new credit paradigm Exhibit 3: Marketplace Lenders liquidity and provide investors with a range of hedging tools. Whether marketplace lenders will have Consumer the transformative power to reduce banks to bookstores – as Citi analysts asked in Pay Day an ABS research report in August – is a valid question, but one to which major Purchase banks resoundingly respond “no”. Credit Finance card data shows that banks are not losing Education meaningful business to marketplace Financing lenders, the analysts point out. Against this backdrop, however, several Real Estate US banks – including Goldman Sachs and Citi – are exploring ways to edge into Merchant Cash Advance the booming online loan marketplace. Strategies include buying up marketplace SMB Credit loans, partnering with marketplace lending platforms and extending warehouse credit to investors. Source: Foundation Capital Several US banks Exhibit 4: The Global P2P Landscape –“ including Goldman Sachs and Citi – are exploring ways to edge into the booming online loan marketplace ” The US Treasury Department has also taken note of the rise of the marketplace lending industry (see box on RFI, page 11). But the main source of regulatory scrutiny for the sector has arisen following the Madden vs Midland Funding ruling, which has cast doubt on the efficacy of the pre-emption of state usury laws that many Source: Fitch Ratings platforms rely on. Exhibit 5: Global Marketplace Loan Issuance ($bn) 25 300 Australia Australia China China 51% Expected CAGR 250 20 UK UK 2014-2020 USA 200 USA 15 123% CAGR 150 10 100 123% CAGR 2010-2014 5 50 0 0 2010 2011 2012 2013 2014 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Produced by Morgan Stanley Structured Credit Investor | 2015 Guide to Marketplace Lending 4 Marketplace lending: disruptors and the new credit paradigm Exhibit 6: Personal Loans Outstanding – Bank Balance Sheets Interest rates on P2P loans have been lower than those on credit cards since $700 2010. Marketplace lenders’ ability to operate quickly and from a lower cost $600 base has enabled them to price loans at lower interest rates. $500 To date, the vast majority of marketplace loans in the US have been made to $400 prime and near prime borrowers (see exhibit 8). For example, Prosper reported $300 that the average credit score of its total originations since inception was 700. For $200 Lending Club, the average credit score for all public policy loans originated since Outstanding Personal Loans ($Bn) $100 inception through 31 March 2014 was 702 (see exhibit 9). $0 Partner-bank model Dec 11 Dec 12 Dec 13 Dec 14 Dec 10 Dec 07 Dec 97 Dec 01 Dec 95 Dec 02 Dec 05 Dec 92 Dec 93 Dec 98 Dec 03 Dec 08 Dec 09 Dec 99 Dec 94 Dec 04 Dec 06 Dec 96 Dec 00 But perhaps marketplace lenders’ Produced by Wells Fargo greatest advantage over traditional banks is that they typically use a partner-bank model, which hives them off from bank Silicon Valley is coming On the consumer loan side, in regulations. In a partner-bank model, the In 1994, Bill Gates said that banking is particular, the rapid growth of the US partner bank originates the loans and the necessary, but that banks are not. This marketplace lending industry may be marketplace lender buys those loans and April, JPMorgan’s ceo Jamie Dimon offered attributable to two of the benefits it sells them on to investors (see exhibit 10). a more pointed warning to his bank’s provides. First, it can improve access to The partner-bank model shields shareholders: Silicon Valley is coming. credit for individuals who have short credit marketplace lenders from bank “There are hundreds of start-ups with histories; second, it allows consumers to regulations that require them to hold a lot of brains and money working on consolidate credit card debt and lower capital against the loans that they various alternatives to traditional banking. their interest rate more than they could by originate because the marketplace lender The ones you read about most are in the going through traditional lenders. is not assuming credit risk. Essentially, lending business, whereby the firms can A Federal Reserve Bank of Cleveland this hands a loan pricing advantage to lend to individuals and small businesses report issued last year suggests that marketplace lenders. very quickly and – these entities believe most US marketplace loans are used to Earlier this year, Goldman Sachs – effectively by using big data to enhance consolidate high-interest rate credit card estimated that marketplace lenders’ credit underwriting,” Dimon said in a letter debt.
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