Peer-to-peer (P2P) lending, also known as online lending or marketplace lending, has seen skyrocketing popularity in various countries over the last decade. According to Bloomberg Markets estimates, global online loans have soared from about $5 billion in 2012 to more than $60 billion in 2015, and Morgan Stanley predicts the volume could jump to some $290 billion by 2020. This is huge growth, but could it be too much growth too fast?
Peer-to-peer lending companies bypass banks’ intermediary role, and their operational cost savings incentivize them to absorb greater risks. This translates into accepting a wider (and riskier) pool of borrowers who get access to credit lines at more favorable terms, as compared to traditional banking institutions. According to California-based Lending Club, a 2016 survey revealed that refinancing debt from high interest credit cards (through Lending Club’s personal loans) helped borrowers reduce interest cost by 32% on average. On the other side of the equation, lenders on these platforms are rewarded for assuming higher risks with yields greater than interest rates on bank deposits.
Online Lending Catches Big Players’ Attention
These high-yield investments have also caught Wall Street’s eye. Hedge funds, asset managers and even banks, including Citigroup Inc. and Jefferies Group LLC, are buying P2P loans and bundling them into bonds to sell to other investors. Such securitizations appeal to funds/banks looking for quick gains, while also serving as a diversified, potentially high-yielding asset pool for investors.
Furthermore, some financial behemoths are partnering with marketplace lenders while others are even introducing their own in-house online lending platforms. Wells Fargo will begin operating its ‘FastFlex’ program this year to provide online loans with maturities as short as one day mainly to small businesses. JPMorgan had announced in December its plans to extend loans to New York-based online lender On Deck’s 4 million small business customers.
Is this Burgeoning Online Lending Revolution About to Collapse?
High yield P2P loans and their securitizations should emerge as potentially lucrative investments for buyers and lenders—as long as the loans are repaid. It would be foolish to overlook the vulnerabilities inherent in these loans’ characteristics—short-term maturities requiring monthly/weekly interest payments from borrowers who have probably been denied credit lines by traditional banks. Recent data suggests some cracks are starting to form.
In February, Moody’s expressed a possible downgrade of three bonds backed by Prosper Marketplace P2P loans and sold by Citigroup, owing to unexpected delays in repayments and rising charge-offs. In another instance, a $126 million deal involving the securitization of CircleBack Lending Inc.’s loans by Jefferies Group LLC has unraveled driving cumulative losses edging past trigger value.
Additionally, Lending Club, the world’s biggest online lending platform, is under the ‘microscope’ for apparent improprieties related to sale of some of its loans, followed by the resignation of its CEO, Renaud Laplanche, in May 2016.
Given these events, it’s reasonable, if not wise, to start drawing parallels to the 2008 subprime crisis. Some of the same factors are at play: the securitization frenzy, risky loans, the shadow banking chain and quick riches. The irony here is that the enhanced regulatory framework on brick-and-mortar banks in the aftermath of the financial meltdown (designed to curb their excessive/indiscriminate risk taking) could actually play a major role in fueling the growth of the online lending market. Return-hungry and risk loving lenders are targeting subprime borrowers once again.
Although the losses, so far, in marketplace lending may not have reached the lows of a crisis, they have served as warnings for regulators to take a closer look into the industry’s books and practices. Earlier this month, the Treasury stated its plan to gain greater transparency, including a public database of loans made from marketplace lenders. It also expressed the need to subject firms lending to small businesses to Federal Consumer Protection Laws.
Bottom Line for Investors
The online lending market has prospered by offering lucrative returns to investors, but at what risk? Recent reports of losses and anomalies on these ‘new’ online lending platforms bring to the fore a rather default-prone image of the industry.
However, broadly speaking, the key for investors is almost always to think about the impact on a relative basis. Given the relatively small size of the online lending market, a crisis here is not likely to impact the broader economy and/or stock market. This is provided that the “too big to fail” institutions do not divert too large a share of their investments into the online lending marketplace in the future, which does not seem likely.
Disclosure