P2P Lending: Industry Overview
Originally published on the Wharton FinTech blog on October 29, 2014.
An overview of the peer-to-peer lending industry, including advice for prospective investors and an outlook on the future of the sector.
On campus, in the office and on the Street, Peer-to-Peer (P2P) lending has soared in popularity over the last few years. I became professionally and financially engaged with the P2P lending space while working for American Express’s OPEN Small Business team and it has been thrilling to watch the industry grow and develop. I recently hosted a seminar on P2P lending on behalf of Wharton FinTech and wanted to highlight a few insights and analyses.
P2P lending is the practice of loaning money to individuals through a simple online platform. These online platforms connect lenders (also known as investors) to borrowers and cut out traditional financial institutions. Borrowers each seek to receive a lump-sum loan from investors, which is then typically used to refinance credit card debt, consolidate loans or meet other financial obligations. Though loan sizes can vary from as little as $5,000 to as much as $250,000 (depending on the borrower’s creditworthiness and desired use of capital), the average loan size is roughly $15,000. Annual Percentage Rates (APR) range from seven to thirty-six percent, and loan terms are generally for either three or five years. The actual loan product is cut up into small fragments (e.g. a $10,000 loan can be cut up into $25 “notes”), which are then purchased by investors. The P2P lending platform facilitates interest and principal payments from borrowers to investors and makes money by taking a small percentage of the payment, usually in addition to an origination fee off the loan. It’s clear that the P2P lending model is a proven and effective alternative to borrowing money directly from a bank and appeals to participants by offering a streamlined application and rapid credit decisioning process.
Landscape: Who’s Who in P2P Lending?
In order to properly assess the P2P lending landscape, it is important to recognize the key players. Prosper and Lending Club are the largest and most well-established incumbents in the US market. Founded in 2005 and 2006, respectively, these two platforms have issued over $6B in loans to date and own the lion’s share of the current P2P market; however, Lending Club is substantially larger than Prosper in terms of overall loan issuance volume. Lending Club is also the first P2P platform to announce that it intends to go public and was valued at roughly $4B earlier this year after acquiring Springstone, a patient financing company. However, Lending Club has yet to show consistent profitability (posting a net loss for the first half of 2014), and this valuation feels very much dependent on the company’s ability to continue growing at a rapid pace. Outside the US, UK-based Zopa is the largest P2P lending platform, having facilitated over £650M in loans.
Over the past few years, we’ve seen a rapid increase in the number of new competitors and product offerings. Some entrants, such as Funding Circle, have established themselves in the small business loan space while CommonBond and SoFi have targeted student loans — specifically those offered to MBA students. However, these platforms have largely restricted investment opportunities to accredited investors. Other new players, such as Pave and Upstart, are looking to break into the P2P space by underwriting loan applicants with sparser credit histories. Wharton FinTech had the chance to speak with Pave’s co-founder, Oren Bass, and head of Business Development, Kathryn Ebner:
”P2P lending is evolving — everyone’s been focused on pricing and rates, which are key components, but what we haven’t yet seen is a holistic approach. At Pave, we believe that the rate is just one part of the experience. We want to provide a funding product that enables the success of the future generation.
Our underwriting model goes beyond FICO to help us better understand each borrower’s financial situation so that we can personalize each loan decision. Our borrowers often use the funds in a way to further their education or enhance their career or financial stability — you can use the funds to take a course at a coding bootcamp, relocate to a new city for an exciting job offer or even refinance your credit card debt at better rates. To empower our borrowers even further, our loans have a flexible payment structure where you can choose when to begin making payments, either 3 or 6 months after receiving funds, which is especially important for those taking educational courses. Ultimately, we believe our users want their money from a brand they trust and that understands their needs beyond just a financial relationship. We’re more than just a loan.”
We also spoke with Brigitte Bradford of Upstart’s marketing team:
“Upstart is a marketplace lending platform that goes beyond the FICO score to finance people based on signals of their potential, including schools attended, area of study, academic performance and work history. Our proprietary underwriting model identifies high quality borrowers despite limited credit and employment experience.
While Lending Club and Prosper’s innovation has focused on offering better rates by saving on operation costs, we’ve taken what they’ve learned and built a better, smarter product. On the borrower side, our dynamic, data-driven underwriting enables us to continually improve and expand our ability to find and serve people who have the ability and propensity to repay loans. On the investor side, unlike Lending Club and Prosper we don’t charge investors any fees, and we’re the first platform to offer auto-invest to all investors and origination fee refunds on any loan that defaults.”
Benefits and Risks of Investing
Should you invest in a P2P loan? Ultimately, that decision comes down to your personal risk tolerance and your existing assets and investment portfolio. The P2P lending industry has the potential to offer attractive return on investment despite uncertainty about this new asset class. First-time investors should always be aware of the benefits and risks of investing.
P2P lending offers a new asset class that may help diversify an existing investment portfolio. Recent returns have been solidly positive (anywhere between 5–15%) and default rates have been low. Additionally, platforms such as Lending Club give investors the flexibility to “cherry-pick” investments notes and provides fairly robust details on a prospective borrower. Conversely, institutional investors may sometimes have right of first refusal for the most attractive loans; this means that retail investors have less variety and potentially less attractive loan candidates to fund, thereby increasing the chance for default and reducing overall returns.
Most importantly, investors should be aware that P2P loans are not collateralized, meaning they are not tied to physical property such as a house or car. If a borrower runs into financial trouble, a P2P loan is likely the last in line for repayment. Loan performance can also be highly volatile and has been shown to be correlated with overall economic conditions. Finally, the P2P space is sparsely regulated and could be negatively affected by future financial regulation. Investors should carefully weigh all the risk factors prior to investing into P2P lending and apply the same level of due diligence as for any other asset class.
Impact and Future
Given the increasing number of entrants and growing general awareness of the space, it’s likely that P2P lending will have a significant impact on the US and international credit industry. What started as a way for individuals to refinance credit card debt has grown into a multi-billion dollar industry that is rippling into student and small business loans. Auto loans and mortgages, though more challenging and competitive, may be next. However, hedge funds and other institutional investors are starting to replace retail investors as the target source of capital for the larger P2P platforms, challenging the notion that P2P lending will truly remain “peer-to-peer.” It’s also unclear how the large, traditional lenders —i.e. JPMorgan Chase, Wells Fargo, Bank of America — will respond, but it’s a safe bet that these banks will act in the near future to stave off further disintermediation. What is clear is that, barring a sudden economic downturn or strong regulation, P2P lending will continue gaining momentum and disrupting the credit industry — it’s a fascinating time to be involved.
