PLATFORM (Peer-to-Peer) LENDING
Peer-to-peer (P2P) or platform lending offers something that other fixed income vehicles currently don’t: low risk investments that consistently deliver stable returns significantly higher than those found in the traditional fixed income markets. Thanks to regulatory pressures on traditional banks, platform or peer-to-peer (P2P) is rapidly making inroads into the $850 billion unsecured consumer loan industry, with some predicting that today’s $3 billion niche could grow to $50 billion by 2020, including small business lending. The sector’s high, stable yields, low default risk, and lack of correlation to other fixed income assets has also caught the attention of yield-starved institutional players and begun to crowd out mom-and-pop investors.
Online platform lending, also known as peer-to-peer lending, is a cottage industry that most agree started in 2006. Online platforms facilitate transactions between borrowers seeking loans financed by individuals or institutions, eliminating the need for traditional banks. The platforms are upending the old bank model, using technology to capitalize on structural inefficiencies, and are compressing the costs of originating, servicing and funding loans. Online lending markets have emerged globally for personal loans, student loans, small business loans, and auto loans.
Though disruptive to bank balance sheets, online lenders meet borrower and investor needs in a way that banks simply can’t. Borrowers typically receive lower interest rates than they would with a traditional loan, and investors are repaid with healthy rates of return, through monthly automatic payments, minimizing default risk. For example, investors with well-diversified loan portfolios of unsecured, short-term consumer loans can expect returns of between eight to 10 percent. That’s greater yield than typical fixed income investments, and with lower risk – default rates for online loans average around three percent annually, below the five percent average default rate for traditional unsecured consumer loans. Yields are based on borrower interest rates and credit characteristics, providing an alternative that is uncorrelated to the bond market.
With interest rates at all-time lows and banks facing increased regulatory pressures, platform lenders have moved beyond individual investors and are gaining traction with large pension funds and other high profile institutional investors. The sector is led by two major online platforms in the United States – Prosper Marketplace and Lending Club. Prosper launched the first P2P lending site in 2005, and in September 2013, raised $25 million from Sequoia Capital, BlackRock and others following a $20 million capital raise in January 2013. Lending Club supported a secondary capital raise of $125 million from Google and Foundation Capital in May 2013, valuing the company at $1.55 billion.
2013 was a headline-making year for the world of peer-to-peer / platform lending. In addition to hosting its first industry conference – Lendit 2013 in San Francisco, CA – the sector welcomed Vikram Pandit, Tom Glocer, Google, Guggenheim Partners and BlackRock as new converts.