The market views peer-to-peer lending as having great promise.
And, some banks are buying these loans in earnest.
Should your bank look closely at doing the same?
Since the financial crisis, a new generation of non-bank lenders has grown up to serve markets that banks either retreated from or have not been able to serve effectively. Lending Club is the best known example. Prosper is a company that pioneered the term “peer-to-peer” lending and originally saw its role as facilitating the loan of money from ordinary people to ordinary people.
Change happened quickly. Now, the more fashionable name for companies in this sector is “marketplace lender.” This term better describes the economics in which a wide array of non-bank lenders make loans in a multiplying array of asset classes and then sell those loans to professional investors. The share of these loans sold to professional investors is estimated at 80% and growing. Buyers include asset managers like BlackRock, hedge funds, business development companies, banks and even a specialized mutual fund. To feed investors’ voracious appetite for these loans, marketplace lenders have expanded beyond their original focus on unsecured personal loans into small-business loans, student loans, real estate loans and an array of other niche loan products, such as financing weddings (and divorces) and point of sale loans, including loans for cars and elective medical procedures. Most of these lenders rely heavily on technology in the underwriting, documentation and closing of these loans. Most operate almost exclusively online.
While marketplace lenders pose an immediate threat to some banks, most community banks are not affected from a competitive perspective. Smaller banks rarely have the ability to make these sorts of loans in a cost-effective manner. The CRE and C&I loans on which community banks depend are still largely unaffected. It still requires significant human involvement to underwrite and structure a large commercial loan.
However, it is a mistake to ignore marketplace lending. Banks should be studying this industry carefully and find ways to stay ahead or partner effectively. There are three primary ways to participate.
First, your bank can buy whole loans that these online lending platforms originate. Start with a clear-eyed view of the risks inherent in these loans. The large marketplace lenders generally make most of their money from origination fees. The originator usually has little “skin in the game” after the loan is sold and is incentivized to close as many loans as possible. And, there exists the risk that the originator will retain the best loans for itself and sell the rest. In mitigation of these risks, the established marketplace lenders usually have rich data about performance history and trends that allow for a more complete picture of the loans than most other assets a community bank might purchase. The yield on these loans can be well into the double digits, which makes it worth the analysis.
Second, you can spread your risk over a pool of loans. There are several structures available, including traditional-looking secured lines of credit to the marketplace lender, as well as more complicated structured finance transactions. (These non-bank lenders have significant credit needs because they cannot obtain funding through their own low cost deposits.) Your bank can also invest in securitizations of these loans. The established players like Prosper Marketplace, CommonBond and Social Finance now have a track record in securitization markets that assist in understanding and underwriting such loans / investments. Particularly if your bank plans to start small, loaning against or investing in a pool of loans can reduce risk as compared to whole loan purchases. Of course, yields are lower in a securitization with the best established securitizers garnering the lowest yields.
Third, your bank can actively partner with companies that offer “white label” programs, such as those that offer traditional community banks the capability of profitably making small dollar SBA loans. Or, your bank might, if it thoroughly understands a particular loan product, act as an originating platform and generate fees in addition to or instead of taking on credit risk. This strategy appeals to banks with an appetite for strong, hands-on management and a need for fee income. There are a handful of small community banks such as the tiny Utah-based WebBank that have taken this approach and appear to be very well-compensated for the significant work involved in overseeing such a program. The fees paid to the bank range from 30-100 basis points per loan. Other banks, typically the large banks, are outright buying loan origination platforms and taking the entire operation in-house. However, given the rich valuations of marketplace lenders, acquisitions are probably not realistic for most community banks.
A sure way to lose ground in the competitive world of banking is to ignore marketplace lending and hope it goes away. Every bank should be engaged in some fashion with marketplace lending. There is a way to engage that will fit with your bank’s risk tolerance and substantive expertise.
A version of this post previously appeared in the Western Independent Bankers Lending & Credit Digest.