Marketplace Lenders: Why Retail Funding Matters

At Lendit[i] Dan Ciporin of Canaan Partners presented a cogent analysis of the issues for US marketplace lenders and looked beyond current practice to where the industry needs to go. As he noted, institutional funding dominates in the US (to a much greater degree than, e.g., in the UK). More specifically, intermediaries such as hedge funds play a major role in the US funding base — an irony given the industry’s aspiration to dis-intermediate the credit cycle.

Is there a structural weakness in the funding mix of many marketplace lenders today? I believe so.

My own belief is that the long-term health and perhaps even the viability of marketplace lending depend on changing this balance. Achieving a funding mix with a significant retail component should be a strategic goal for each platform. This means trading off the costs and benefits of institutional (efficient but volatile) versus retail funds (more expensive to attract but highly stable). Crucially, experience demonstrates the stability of retail funding even in very volatile markets.

Dan’s numbers suggested a payback period about three times as long for retail funds as for institutional (i.e., twelve vs four months). Nevertheless, the reliability of retail funding will be a key strategic advantage when (and that is when, not if) there is a disruption of wholesale markets. Those of us in the UK remember Northern Rock where a combination of duration risk and dependence on wholesale markets killed the business.

Further progress will be made with ‘slow’, stickier institutional money as deal sizes grow if the FinTech lending ecosystem develops to provide:

  • Benchmarking / indexation
  • Data, analytics, pricing
  • Regulatory conformity
  • Liquidity

What should platforms do to succeed with retail? What does the retail savings market (made up of owners and advisors) require for FinTech funding to become mainstream? Time — but time alone won’t do it.

I see developments in the following as essential:

  • The investor interface is crucial –
    → each lending platform has to optimize the interface for clarity and ease of use
    → in each market a couple of aggregator type firms are needed which provide individual investors with access to the underlying platforms as well as model portfolios (consumer / SME / residential mortgage etc) within and across platforms as well as structured products
    → the same firms will serve investment advisors (IFAs in the UK) who will need their own ecosystem (research etc) and incentives to be built in.
  • The user journey from selection and investment through monitoring to maturity or sale
    → must be smooth
    → must include a functioning secondary market.

Without this evolution even recent and much-touted tax changes in the UK (for ISAs) — which incentivize individuals to invest in platform loans — will probably achieve little in any useful time frame. We believe these changes are coming — it is on this basis that Assembly is watching developments at LendingWell with great interest.

In short, the developments outlined above are part and parcel of an evolution without which FinTech lenders will not succeed at scale in business models that are sustainable.

[i] Lendit (San Francisco April 11th-12th) was the largest-ever forum for marketplace lenders, its debt and equity providers (investors) and other system participants to learn, exchange and connect. Unsurprisingly, the mood this year was self-congratulatory (though the abrupt slowdown of VC investment and public exits cast a shadow). Marketplace lending is now an established feature of the financial landscape — though not yet mainstream. In the last three years the conference has grown from a few hundred pioneers to several thousand participants coming from startups and major institutions. A number of posts on this blog will pick up on some key themes for the industry.