theworldismine13
God Emperor of SOHH
Loans That Avoid Banks? Maybe Not
http://www.nytimes.com/2014/05/04/business/loans-that-avoid-banks-maybe-not.html?hp
http://www.nytimes.com/2014/05/04/business/loans-that-avoid-banks-maybe-not.html?hp
It was that rare thing, scarcely seen in the financial world since the debut of the A.T.M. or microfinancing: an innovation to help regular people. When peer-to-peer, or P2P, lending began in the middle of the last decade, it offered an easy way for people to lend money to each other over the Internet.
On sites like Prosper Marketplace and Lending Club, prospective borrowers could list their requests, often alongside their personal stories, and people with spare cash could decide whether to finance them.
By cutting banks out of the process, borrowers typically got a lower interest rate than they would have paid on a credit card or a loan without collateral. And individual lenders earned higher returns — averaging in the high single digits — than they would have received by parking their money in a savings account or a certificate of deposit.
That blend of altruism and yield attracted many individual investors, particularly in the wake of the financial crisis, when interest rates, and trust in banks, hit historic lows.
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Len Kendall, a founder of CentUp Industries in Chicago, took out a peer-to-peer loan in 2012. “It was a pretty simple decision,” he said. “Why should I pay more in interest than I have to?” Credit Nathan Weber for The New York Times
Now, as the industry matures, a new class of investors is storming the P2P gates, and they include the very institutions that P2P had set out to bypass. Today, big financial firms, not small investors, dominate lending on the two platforms. At Prosper, which has been courting institutional lenders over the past year, more than 80 percent of the loans issued in March went to those firms. More than a dozen investment funds have been formed with the sole purpose of investing in peer-to-peer loans.
P2P sites are also attracting some of Wall Street’s biggest names as board members and investors, and investment banks are vying to manage Lending Club’s hotly anticipated initial public offering.
The influx of institutional money has supercharged the sector, allowing Prosper and Lending Club and a host of newcomers to extend more loans to more borrowers. Lending Club figures that it has saved borrowers $250 million in interest charges. The two platforms say they have made more than $5 billion in loans to date and have been doubling in growth every year.
But investor demand is now outstripping the loan supply, spurring fierce competition among investors to snatch the best loans first. And the original P2P investors — the dentists, dabblers and stay-at-home moms who helped establish the market — are finding themselves outgunned by the cash-rich, algorithm-wielding arrivistes.
P2P insiders say the new institutional investors benefit the industry. “It will drive competition, drive down rates and allow us to serve customers better,” says Alex Tonelli, a founder and managing director at Funding Circle, a San Francisco-based P2P market for small-business loans.
Still, the Wall Street makeover — some would say takeover — of P2P lending is raising concerns as the new players begin securitizing loans and clamoring for more. Insiders predict a day when the loans are regularly sliced, diced and securitized, hedged, traded on secondary markets and tracked by exchange-traded funds.
At the very least, the big players’ entry runs counter to the original notion of P2P lending as a populist alternative to the high stakes world of Wall Street. The term “peer to peer” has become something of a misnomer. Some of the latest lending platforms are ditching individual investors altogether to focus on big lenders.
Acknowledging the growing role of institutions, Ron Suber, the president of Prosper, says the industry as a whole is better described as “online consumer finance.”
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Jeremiah Owyang, the founder of Crowd Companies, an organization that helps corporations navigate the so-called sharing economy to which P2P belongs, was more blunt. “It won’t be P2P for long,” he said.
Algorithmic Cherry-Picking
When Len Kendall, a digital-marketing executive in Chicago, was considering striking out on his own in 2012, he knew that he would have to live leaner. One place to cut back was his credit cards. Despite having an excellent credit score, over 700, he was paying 17 percent interest on about $10,000 in credit card debt. That was when he heard about Prosper.
He applied for a loan and within days was approved for $10,000 to be paid back over three years at 7.5 percent interest. This loan was funded by dozens of small investors, who typically split investments over a large number of loans to diversify their risk. “It was a pretty simple decision,” Mr. Kendall says. “Why should I pay more in interest than I have to?”
Lending Club and Prosper focus on prime and near-prime borrowers, that is, consumers with FICO scores higher than 640. The platforms apply their own credit models and assign borrowers to categories reflecting their level of risk. In the case of traditional loans, banks pocket the profit. On P2P sites, the individual lenders do. “The difference is who’s benefiting from it,” says Renaud Laplanche, the founder and chief executive of Lending Club. Prosper and Lending Club take a small origination fee from the borrower and 1 percent of interest payments to the lenders.
The sites’ business model relies on scale: Lending Club, the market leader, earned $7 million on revenue of $98 million in 2013, its first full year of profitability after seven years. That was on loan volume of $2 billion.
The fastest, and some say only, way to reach the kind of scale needed is to turn to institutions with boatloads of money to lend. Attracted by peer-to-peer’s relatively high and predictable yields in a low-interest environment, big investors have jumped at the opportunity.
The first in were hedge funds, like Eaglewood Capital Management and Arcadia Capital Advisors, which borrow money to amplify their returns and use their own algorithms to increase yields into the midteens or more. Soon, pension funds, asset managers, community banks and even sovereign wealth funds joined in. Santander Consumer USA, the United States arm of the Spanish bank, has an agreement to buy up to 25 percent of Lending Club’s loans.
Today, P2P loans that once took days or weeks to finance are snapped up in minutes, particularly those with higher yields. “There is at least twice as much demand as there is supply today,” says Matt Burton, the C.E.O. of Orchard, a firm that helps institutions invest in peer-to-peer loans. Lending Club and Prosper now set aside a randomly selected pool of loans for institutions, which prefer to swallow up whole loans rather than finance a piece of them. To eke out better returns, many fund managers then use their own credit algorithms to identify loans that may be underpriced or overpriced, and cherry-pick the ones they want.
For example, the Ranger Capital Group, a Dallas-based investment group that raised a $15 million P2P fund last fall, deploys a proprietary algorithm it calls TruSight to exploit variances in credit models. “Everyone’s got their own secret sauce on how they evaluate loans,” says Bill Kassul, a partner in the Ranger Specialty Income fund.
