Is peer-to-peer lending out of control?
There’s certainly some cause for concern. Consider these facts: P2P loan volume is poised to hit $77 billion this year, a 15-fold increase from just three years ago. LendingClub, the No. 1 player worldwide, is trading at a market value of about $7 billion even though it lost $33 million last year. And in a flashback to the subprime mortgage boom, P2P startups have begun bundling and selling off loans through securitizations.
The business of matching lenders with borrowers online—which still amounts to only 0.08 percent of the $96 trillion in global corporate and household outstanding debt—may truly be an innovative way to distribute capital. But is P2P a revolution or just another bubble?
Money managers are betting it’s the former as they pile into one of the fastest-growing asset classes in finance, Bloomberg Markets reports in its June issue. Some are taking equity stakes in P2P startups. In February, Third Point, the hedge fund founded by Daniel Loeb, led a $200 million investment round in Social Finance, which refinances student loans.
The deal valued the three-year-old San Francisco company, known as SoFi, at $1.2 billion. Others are investing in the loans themselves. In April, Victory Park Capital, a private equity shop in Chicago that backs a number of P2P platforms, announced it was increasing its funding pipeline for one-year-old Upstart Network to $500 million from $100 million.
Third Point and Victory Park are hardly outliers in pursuing loans that are generating 5 to 12 percent annual returns in an era of nonexistent interest rates. Goldman Sachs, BlackRock, Alibaba, and even Google are making deals in the space.
In the U.K., holders of tax-free savings accounts known as ISAs may even soon be allowed to invest in P2P loans, a move that could draw Britain’s top asset management houses and provide £150 billion ($220 billion) in fresh cash by 2020, according to Liberum Capital, a London investment bank. “Every single lending product that a bank provides is vulnerable to this model,” says Cormac Leech, a senior analyst at Liberum.
And now Wall Street is cranking up the volume by running these loans through its securitization machine. In November, Morgan Stanley and Goldman led the sale of securities backed by $303 million in student loans originated by SoFi. In February, BlackRock unveiled the first investment-grade-rated package of P2P consumer loans with a $281 million offering of notes from Prosper Marketplace, a site that lets users apply for loans as well as back them.
Such deals will help P2P platforms spread risk and multiply loan volume, which isn’t necessarily a bad thing. Growth is good, right? Still, the specter of the subprime-mortgage bust looms over this nascent market.
“Yes, these platforms are low-cost distributors of loans, and investors are frantically chasing yield,” says Tania Modic, the head of Western Investments Capital, a family office based in Lake Tahoe, Nevada. “But loans take time to season and go bad, and Wall Street loves to package and pass along risk. The music will stop—it always does—and this will not end well.”
Peer-to-peer stalwarts counter that their industry doesn’t look like the toxic mortgage market of the 2000s. Many platforms in the U.S. and the U.K. post their loan books online so investors can analyze the quality and performance of their debt on a loan-by-loan basis. London-based RateSetter maintains a “provision fund,” which stood at £13 million as of May 14, to make lenders whole should borrowers default, a feature other sites are now imitating.
Most P2P firms also shun subprime borrowers. Zopa, a 10-year-old British firm that’s issued more than £800 million in consumer loans, approves only one out of five applicants. Both Zopa and RateSetter have default rates of less than 1 percent, while bad loans at LendingClub and Prosper are below 3 percent.
“There’s always tension in any credit business between how fast you grow and the quality of your loan book,” says Giles Andrew, Zopa’s co-founder and CEO. “We publish data on every loan. So any signals that bad debt had started rising would be very visible.”
But as institutions pour money into P2P, some platforms may relax their credit criteria and welcome riskier borrowers to accommodate the flow, especially if they can offload risk through securitizations, says Michael Tarkan, an equities analyst at Compass Point Research & Trading in Washington who covers P2P companies.
In the U.S. market, LendingClub and its brethren have enabled consumers to pay off pricey credit card balances with cheaper P2P term loans. So what’s to stop consumers from levering their credit cards back up? Such behavior could spell bad news for investors in P2P loans if an interest rate hike or an unforeseen shock pressures borrowers, Tarkan says.
“We’ve created a mechanism to refinance a credit card into an unsecured personal loan,” says Tarkan, who’s rated LendingClub a sell. “This may prove to be a superior model, but we just don’t know because it hasn’t been tested yet through a full credit cycle.”
Renaud Laplanche, the founder and CEO of LendingClub, says borrowers may indeed max out their cards again. But so far, he says, they’re boosting their creditworthiness after converting card debt into P2P loans by paying lower interest rates. Moreover, Laplanche says, the global lending market is so vast that platforms like his, which is multiplying its volume by 20 percent a quarter, won’t have to take on riskier borrowers for years.
“There’s no need to loosen standards,” Laplanche says. “It’s all growing very fast, but it’s a controlled growth.”
It may well be that the speed and efficiency of the Web fundamentally changes the business of lending. Institutional investors are certainly betting that way. The P2P boom won’t just test a new business model. It will also show whether Wall Street has learned its lesson.
This story appears in the June 2015 issue of Bloomberg Markets.