Recent news and commentary have been anything but optimistic on the future of marketplace lending. But are the negative projections simply drummed up by traditional banks or is there real reason to be concerned?
After exponential growth starting in 2010, the marketplace lending industry has come back to earth. Lending Club had its first quarterly drop in originations, in the second quarter of this year, since it went public. Other marketplace lending platforms like Prosper have been cutting staff and reducing costs. Are we seeing the beginning of the end of the industry or is this simply a reversion to a more realistic growth rate?
According to Morgan Stanley, global marketplace lending grew at a compounded annual growth rate of 123% from 2010 to 2014 and is expected to grow at a CAGR of 51% from 2014 to 2020. Given that real global economic growth is closer to 3%, what explains marketplace lending’s more pronounced growth? The answer is partly in the types of loans made by the sector. Many banks consider personal, unsecured loans – like those issued by Lending Club and Prosper – to be unprofitable. So a portion of the growth is, in many ways, the result of untapped demand.
To continue the speed of growth, marketplace lending will need to branch out into other areas of lending. But on the flip side, it is premature to say marketplace lending is endangered. Let me explain why.
When pondering this subject, I find it interesting to see how other industries have fared as technology and investment have brought the end user greater value and transparency. The sector of the economy which has seen the most visible change has been that of retail where the consumer is shopping less at stores and malls while spending more online. The trend is rapidly affecting many of the largest retail chains and malls around the country. The change in consumer behavior is all too clear to retailers like Macy’s, which recently announced the closure of 15% (100 of 668) of its stores. The bottom line is that technology combined with forward-thinking investment by some of the larger online sellers has significantly changed consumer behavior.
How is fintech changing investor and borrower behavior? According to a Gallup poll last year, customers using bank branches dropped by 50% between 2011 and 2014. One function that kept many customers going into bank branches was to deposit checks. Since 2014, many banks have rolled out mobile deposit apps, further accentuating the fall in foot traffic to branches. And how does this impact lending? Traditionally, lending was one of the banking roles always done in person, whether it was a personal line of credit or a mortgage. But as mobile banking has taken off, we are all increasingly aware that lending can also be done online. I believe that this trend will continue and marketplace lending will be one of the larger beneficiaries of the digitization of banking.
What about investors who are doing the lending in place of the banks? This can be a touchy subject for banks that have traditionally provided the capital and taken the risk. Banks have learned how to compete with nonbanks that simply offer better technology. Many banks now offer loan products online with fully automated underwriting for some products. But banks are still learning to deal with the concept of investors stepping in to put up the capital for the loans.
There are reasons for marketplace lending investors to still be encouraged. Investor returns on the main platforms have been strong, with historical yields between 5.20% and 8.37%, depending on the grade of loan. With U.S. interest rates at or close to zero, we have seen investors searching for alternatives to equities that offer both yield and diversification and for many, they are finding this in marketplace loans. We have yet to see how this asset class will perform in a recession but increasingly, investors appear to be getting comfortable with the risk. At the larger marketplace lending platforms, the proportion of lending backed by individuals has ticked higher relative to overall lending. (For Lending Club, it has risen two percentage points in each of the past two quarters.) And while many investors may be unfamiliar with marketplace lending as an asset class, the growth in advisers and analytics companies in this space is giving the investment community much greater support and understanding of this asset class.
Additionally, assuming that online lenders stay clear of overly leveraged securitization, which we saw accentuate the financial crisis, marketplace lending has the potential to reduce systemic risk by spreading exposure across many investors rather than having it sit with a small number of big banks.
So while we see growth at some of the larger platforms slowing, the marketplace lending model looks like it is here to stay. The digitization of banking is in its early stages but the trend is clear. The changes in behavior we see in finance can potentially be as dramatic we have already seen in retail.
Tom Grant is a managing partner with Intelligent Lending Advisers, a Boston-based adviser for investors in marketplace loans. He was previously a managing director with BBVA in global markets. He can be contacted on Twitter @thomaslgrant.