WHITE PAPER The Marketplace Lending Revolution Vicky Costello www.lafferty.com
Introduction: Marketplace Lending: The next revolution? In 2012, Patrick Molineux, in his book Connected Consumer and the Future of Financial Services* suggested that the banking and insurance industries might prove too complex to construct as P2P commodities. The question for P2P lending, Molineux suggested, is whether there is a sufficiently deep well of consumer trust to transform the market. That trust is rooted in the ability of other consumers to pay and the longevity of the P2P platform. At that time, Molineux felt that if both of these criteria were satisfactorily met, the credit industry could be changed forever by peer-to-peer lending. Molineux went on to suggest that, for this alternative form of lending to really change the face of the credit industry, it must engage the wealthy in placing significant sums on loan as part of mainstream wealth management portfolios, and grow the size of loans expanding into P2P mortgages. A question remained over whether the nascent industry could enter the mainstream and really offer competition to banks. Writing a year later in a guest article for Forbes magazine, Molineux acknowledges that, not only was peer-to-peer lending on the rise, but that a form of peer-to-peer insurance had even become reality. Indeed, this is a good indicator of the rapid growth of peer-to-peer lending: in the last two years alone, it has grown from a position of potential disruptor to significant threat. The global growth rates illustrate both the huge public appetite for an alternative form of finance and the potential for this industry if these growth rates continue. Marketplace mortgages are now a reality, with a number of buy-to-let mortgage providers operating in the marketplace space, and many other variations on the model have emerged in the interim period (see the case studies section of this report for details). In fact, the dominance of institutional capital on US platforms, in particular, has begun to cause concern among some early supporters of the industry. Growth Marketplace lending is growing exponentially. US platform Lending Club s recent IPO marketing material welcomed backers and the uninitiated alike to the We re Just Getting Started Club and this kind of bold statement of intent does not seem incongruous given the industry s enormous success thus far. From inception in 2007, it took Lending Club until Q4 2012 to reach its first billion in loan originations. By the end of 2013, originations stood at three billion, and, as of Q3 2014, they stood at six billion. Its main rival in the US market, Prosper, passed the one billion mark in April 2014, and six months later had originated another billion to end Q3 with two billion in cumulative originations. London-based brokerage Liberum estimates global compound annual growth rates of 136 percent between 2009 and 2014(E) and these rates are even higher in the key markets where marketplace lending has taken strongest hold. In the UK market, the fastest growing segment, business lending is growing at a rate of well over 200 percent year-onyear. Well established platforms are frequently doubling their loan volumes annually, while new entrants are constantly appearing to provide diversity and competition in the market. * Patrick Molineux, Connected Consumer and the Future of Financial Services (Computer Sciences Corporation, 2012) Patrick Molineux, How tech can help financial firms reach the underbanked, Forbes, 2013. Web. http://www.forbes.com/sites/ ciocentral/2013/02/11/how-tech-can-help-financial-firms-reach-the-underbanked/ 2
Uneven global distribution While the marketplace lending industry globally now accounts for around $8 billion, according to research carried out by Liberum, in fact the industry is concentrated into a small number of very active markets. Economic conditions, regulation, technological development and consumer appetites all play important roles in determining the suitability of a market for this finance model. Currently, the US and the UK dominate the global marketplace lending scene (the Chinese market is substantial, but it is a very different model and the absence of regulation has made it very volatile, with little transparency and even well-known platforms disappearing overnight. China is covered in more detail in the case studies section of this report.) margins for the platforms themselves. On this point, very few of the top platforms are actually posting a profit, focusing on growing the business to achieve scale, but this is something that is likely to change as more borrowers and investors adopt the marketplace model. Revolution or evolution? Marketplace lending is often described as a revolutionary innovation, and it is certainly true that the model appeals to entrepreneurs and the technologically savvy, in particular. However, it might be said that marketplace lending is in fact evolutionary, rather than revolutionary it is doing essentially what banks were established to do but using the tools and methods that have become part of everyday life in developed economies worldwide over the last two decades. It is no secret (or surprise) that these platforms have been established by innovators entrepreneurial thinkers certainly but also former employees of the very banks and financial services agencies these new platforms are attempting to displace. In fact, Charles Moldow, CEO of Foundation Capital, one of the key investors in Lending Club, explains that marketplace lending is not a radical concept it s a more efficient one.* At its core, marketplace lending is a simple concept whereby the savings from greater levels of efficiency are used to fund better interest rates for borrowers and investors, while these efficiencies allow for healthy profit * Charles Moldow, A Trillion Dollar Market By the People, For the People: How Marketplace Lending Will Remake Banking As We Know It (Foundation Capital, 2014) 3
The Marketplace Lending Industry Key competitive advantage The key competitive advantage that these companies have is their efficiency while banks spend up to 30 percent of their operating costs on resource-draining branch networks, marketplace lending platforms operate fully online. The major platforms all carry out some degree of in-house underwriting and risk assessment, but the very nature of this online model means that they can use a much wider array of data than the incumbents generally do. Meanwhile, debt collection procedures vary from platform to platform with some outsourcing part or all of this to external agencies. Some critics of marketplace lending see the model as unlikely to pose a significant risk in the near future due to the fact that the product offering is too narrow but it is interesting to view this debate against the backdrop of the November 2014 Future of Retail Banking forum in London, where the emphasis was on specialist, rather than universal banking. In the future, traditional banks that refuse to (or are incapable of) changing their lending models may find themselves priced out of the lending market by marketplace lenders that can offer a more competitive product, and, having gained extensive experience and expertise building and scaling their businesses, marketplace lenders may come to be seen as the lending industry specialists, and the natural choice for retail investors willing to take on modest risk levels. Meanwhile, the platforms themselves are beginning to diversify as they grow with many of the largest marketplace lenders adding new asset classes in 2014. Another common hesitancy industry analysts have is in relation to interest rates, which have been at historic lows for the last number of years. While few analysts expect imminent rate hikes, many correctly point out that marketplace lending has grown so rapidly thanks in large part to these low interest rates, which have meant that banks have been offering very poor returns on investments while borrowers are still charged high rates. The question of what will happen in a higher rate environment remains to be seen. However, the marketplace industry is staunch in its collective response that platforms will retain their competitive advantage over banks, as their spreads are significantly tighter. Data, data everywhere Part of the key to this efficiency is in the greater levels of access to and more innovative use of data by the marketplace lending platforms (compared to the banks more cumbersome systems). Many within the finance industry stress the need for new sources of consumer data, and this is part of the reason for marketplace lending s advantage over banks. While many of those sceptical of the marketplace lending model suggest that the platforms underwriting methods are not sufficiently robust, a substantial part of our everyday working lives is now spent entirely online, and it is folly not to mine the trove of data that produces. The incumbents are only beginning to establish systems to analyse this data and make decisions based on it, but this is precisely what marketplace lending platforms already have in abundance these are start-up companies with very small staff numbers in all but the largest companies, but technology is not a distinct department in any of these platforms it is an integral part of their fabric. The CTO is very often part of the senior management of the company, and 4
many of the CEOs have their backgrounds in technology and computer science. In his discussion on data and using heuristics in underwriting, Charles Moldow suggests that FICO data is inadequate at assessing a customer s ability to and intention of repaying a loan something that he says new data sources are much more proficient at. Moldow notes that some marketplace lenders use sliders on their sites so that would-be borrowers can indicate how much money they want to borrow. The online platforms can measure the length of time a customer spends using the slider, moving between different amounts and they have found that the longer a potential borrower spends sliding the scale, the better the predicted rate of payback. He highlights the many other forms of online data that can be used to help assess the creditworthiness of a potential borrower for example, the length of time a person has used one email address, or the number of friends or followers a business has on Facebook or Twitter. Moldow suggests that, not only do Retail banks lack access to this data; they also lack the analytics and organizational focus to lead or even keep up with this growing field. And of course, due to their very nature, marketplace lenders have access to vast amounts of their own data, by assessing borrowers loan repayment rates, they can offer lower rates to them for subsequent loans, thus creating a selfperpetuating business model the lower rates attract more customers, and happy customers return repeatedly. In a keynote speech at industry conference LendIt in San Francisco in April 2014, analyst Peter Renton suggested that Big Data will become part of the online lending ecosystem.* As platforms grow and service more customers, this data trove will increase and become an integral part of the marketplace lending industry s competitive advantage over banks that use more outdated data systems. Promotion and awareness initiatives The industry is a largely self-promoted one some of the leading reports and studies into marketplace lending in the last number of years have all been undertaken by champions (ie, investors or brokers) of this lending model and as such it is often difficult to obtain an unbiased, clear picture of the industry. But as the industry is run by technology-savvy people, it is very well placed to use newer marketing tools like social media to promote the individual platforms, and, even more importantly, the marketplace lending industry more generally. Foundation Capital, a shareholder in Lending Club, and Liberum, a London-based brokerage firm with a particular interest in marketplace lending, is behind two of the most influential reports on the industry in recent years. Several websites, such as altfi.com, lendacademy.com and p2pbanking.com have been established in recent years to track the industry with a clear emphasis on telling the good news stories, highlighting the industry s success and promoting it among the uninitiated. Lending Club s IPO in December 2014 proved that there is significant appetite among institutional investors, and the media attention it garnered for the industry has done a great deal to increase awareness among borrowers and retail investors. In the UK, the top platforms began mainstream advertising campaigns late in 2014, with RateSetter, Funding Circle and Wellesley taking out advertisement space on UK television as well as high visibility static advertising such as billboards and London Underground banner ads. Consumer preferences In the UK, innovation charity NESTA has taken a strong interest in marketplace lending over the last number of years publishing two substantial reports on the area since April 2013. In its 2013 report into peer-to-peer business finance in the UK, Banking On Each Other: NESTA profiled * The speech can be viewed online at: www.youtube.com/watch?v=zvogvcdq53y&list=pldq2kqy 5
Name: MarketInvoice Market share (Marketplace Lending, 18 Dec. 2014): 11.61 percent Year established: 2011 Loan type: Invoice Finance Invoices traded to date (February 2015): 330,765,916 MarketInvoice offers a variation on peer-topeer, or marketplace, lending and is an example of the kind of diversity in the UK market. Fellow invoice discounting provider Platform Black also operates in this space, with approximately one percent of the UK market. The platform grew by a substantial 195 percent in 2014 and saw the total value of invoices traded (since launching in 2011) climb from 100 million at the end of 2013 to over 300 million just a year later. MarketInvoice welcomed 5 million in investment from venture capitalists Northzone in December 2014. It had previously secured the support of the government, with state-owned British Business Bank committing to invest approximately 40 million over a 12-month period from August 2013 by buying invoices on the platform. The Greater Manchester Combined Authority also announced plans to invest 2 million in a similar manner in November 2014. This kind of official recognition and approval will only serve to further enhance the company s growth prospects over the coming year. Invoice discounting is a specialist area of finance, but it has proven lucrative for retail banks in recent years. This expansion of the scope of disintermediation is one that the banking industry needs to pay heed to in the coming months in order to react adequately to the threat it poses to the industry. While invoice discounting has traditionally been a less desirable means of finance for businesses with Invoice discounting is a specialist area of finance, but it has proven lucrative for retail banks in recent years cash-flow difficulties, due to the often large fees charged by banks or specialist providers and the complexity of the agreements involved, the marketplace model enables businesses to achieve repayment rates of up to 90 percent immediately, with fees set at an average rate of 1.5 percent and the complete pricing structure outlined in advance. Borrower/invoice issuer MarketInvoice works with companies that have been trading for at least six months, with annual revenues over 100,000, that supply goods or services to large-end customers, meaning clients with annual revenues of at least 15 million, or public sector bodies. Businesses must be registered in the UK, as either a limited company or an LLP. Invoices traded typically range between 5,000 and 1 million, with the average invoice amount currently standing at 90,000. On average, businesses using MarketInvoice trade 10 invoices per year. The platform uses Barclays Bank for its client accounts, into which debtor repayments must be paid. A crucial element of the MarketInvoice system is that it requires no debentures, and the business retains the relationship with its client/ debtor: there is no obligation to disclose the trade with MarketInvoice. In 2014, the platform 6
announced the integration of its systems with Xero and Sage software to facilitate businesses uploading company documentation in support of their funding applications. Investor MarketInvoice is open only to institutional/ high net worth investors at present. This is due in part to regulation, and in part due to the relative complexity of the model, and the higher values traded. Investors pay an average monthly fee of one percent and saw average net annualised returns of 11.62 percent for 2014, 12.7 percent for 2013 and 14.51 percent for 2012. The platform advertises a crystallised loss rate of 0.03 percent since inception, and has had some success in recovering losses, at 70 percent to date. This is a metric that many of the other platforms do not explicitly outline for their investors and there has been considerable discussion about this on the individual companies forums. Debt recovery may well be a crucial area in the marketplace lending industry in the coming years, as businesses attempt to achieve scale and are driven to attract borrowers with lower credit scores. 7
The P2P Threat to Retail Banking The marketplace lending revolution Peer-to-peer or marketplace lending has become one of the phenomena of the early 21st century, with service providers like ebay, Uber and Airbnb revolutionising the way business is done in their respective spheres. The disintermediation of industries like travel and retail forced the incumbents to rethink their own strategies to stay alive. When the financial crisis of 2008 exposed the weaknesses of the traditional banking system and destroyed consumer trust, the way was paved for new thinking and alternative finance providers seized the opportunity to enter the space. Access to credit had become increasingly expensive for a whole range of consumers and next to impossible for small businesses. These factors, together with new technological capabilities and a generation of consumers comfortable with conducting financial transactions online created the perfect conditions for disintermediation of the banking model. A new Lafferty thought leadership report, The P2P Threat to Retail Banking, undertakes a study of the state of marketplace lending globally, with case studies and analysis of conditions in key markets worldwide, including the US, the UK and China, the global leaders in marketplace lending, as well as platforms of note in Australia, Argentina, Canada, New Zealand, South Africa and other key markets in Europe and the Middle East. The report considers how the p2p lending platforms are beginning to reframe the debate somewhat, having originally positioned themselves in opposition to the banks. With the heads of the top platforms saying publicly that they expect and welcome interest in partnerships from the banks, we look at why 2015 might be the year when partnership deals between p2p platforms and banks become commonplace. To date, banks have generally done little in the face of this potential threat to their business while awareness levels within the financial sector are now growing, decisionmakers have had their attention and efforts focused elsewhere for the last few years, so that marketplace lending has slipped under their radar to a certain extent. Yet, with global growth rates of 100 percent year-on-year, it is only a matter of time before marketplace lending takes a significant portion of consumer and SME lending from the incumbents. This report looks at the growth rates, regulatory conditions and potential for expansion in marketplace lending as well as explaining the key risks, threats and opportunities for the fledgling industry and why it is so important for banks to react before it is too late. To read the full report The P2P Threat to Retail Banking: The Marketplace Lending Revolution including over 20 additional case studies, please complete and return the order form on the next page. 8
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