An investor’s guide to marketplace lending
Learn what investors should consider to succeed and position themselves for attractive returns in this rapidly expanding investment space.
A brief history
In the wake of the 2008 recession, banks — out of necessity — became more restrictive with their lending in certain sectors, driving borrowers to seek options elsewhere. Entrepreneurs recognized this demand as an opportunity. They responded by creating online lending markets separate from banks, and marketplace lending was born. Marketplace lending, also called peer-to-peer (P2P) lending, refers to private and public companies attracting external investors to facilitate the origination of online loans to multi-sector borrowers outside traditional banking channels.
Marketplace lending grew out of the startup boom in Silicon Valley with high aspirations. Websites sponsored by the likes of Lendingclub.com and Prosper.com began connecting investors with consumer borrowers. They then scaled up the business model to include different sectors and platforms as awareness and demand grew. Borrowing rates were often low compared to traditional banks, yet attractive to investors. Since then, technology and big data analytics have advanced, bringing in a constant influx of new institutional investors (e.g. hedge funds) to the market — and the evolution continues.
Competition continues to drive marketplace lending platforms to refine operations, transparency and safety, and establish specialties, such as personal, auto, medical or real estate lending. As such, this type of lending now asserts institutional-level credibility and has established a strong, permanent presence within the financial market. By best global estimates, marketplace lending is a more than $300 billion industry, having grown nearly 150 percent on a compound annual basis for the last six years.
As a credible lending opportunity, it is important for investors to understand the benefits of marketplace lending and considerations as the industry moves toward even greater transparency and specificity.
Benefits for borrowers and investors
Marketplace platforms offer numerous benefits over traditional lending, both to borrowers and investors. As previously mentioned, they enable borrowers to secure loans outside traditional banking channels. This provides flexibility for borrowers to find better interest rates and shop for preferable terms and conditions.
By opening the door to large segments of previously inaccessible borrowers, marketplace lending presents an obvious attraction to investors. Its breadth of opportunities includes:
The function of P2P trading operates independently of stock exchanges, creating a buffer against market volatility. This non-correlation makes marketplace lending an excellent channel for investment portfolio diversification and for finding attractive returns with relatively low to moderate risk. It’s not uncommon to expect returns of five to 10 percent or greater. According to the platform Lendingclub.com, “99% of portfolios with 100+ Notes see positive returns.”
Another advantage for investors (and borrowers) is that marketplace lending circumvents much of the rigidity of banks in terms of restrictions, regulations and governance. Although it’s uncertain whether this autonomy will attract more aggressive oversight in the future, for the time being, the industry is doing a commendable job achieving balance and security for all parties.
It’s no surprise that, with its many advantages, the marketplace lending space continues to draw growing interest from individuals, retail brokerage, family offices and institutional investor communities. The simplicity of these platforms makes it easy for almost anyone to participate. In addition, hedge funds and registered closed-end fund managers have established programs with a proactive, bespoke approach to investing in the market. These programs are attracting a number of high-net-worth individuals and institutional investors. As such, there are a few things savvy investment managers, and their investors, should consider to cultivate success and position themselves for attractive returns in this sphere.
Starting off, it’s important to weigh the benefit of partnering with outside service providers, such as a custodian and an administrator. These parties can provide the talent, resources and expertise to support specific operational needs and help foster security and peace of mind.
Custodians, as a whole, have been slow to enter the marketplace lending space. Their hesitancy is understandable given the conflicting interests P2P seemed to pose to the banking industry when it first came on the scene. Now that the maturity and credibility of these platforms has been vetted over time, more custodians are finding ways to expand their services to support them.
Administrators, on the other hand, have a long history of helping investment managers navigate marketplace lending. Over that time, the technology and services they offer have improved considerably. In fact, there are many marketplace lending administrative offerings available today that were unheard of even two or three years ago. Because of this pace of technology, it’s a good idea for investors to familiarize themselves with all services currently available and ensure they’re getting the level of detail and transparency they need.
As a best practice, fund managers, along with experienced operational professionals, should look for an administrator that invests heavily in technology to ensure comprehensive and reliable service delivery. Flexible portfolio position reporting is preferable so data can be aggregated and drilled down according to specific criteria for analysis. The best administrators will spend time learning what you need and craft customized solutions that make transparency paramount.
Enhanced technology increases transparency
Because of a lack of better options, many managers and their administrators have come to rely on the marketplace lending platforms themselves to provide aggregation data — usually totals of principal and interest received, write-offs, adjustments, etc. These generalized statistics are helpful in a broad sense, but the lack of detail presents many limitations for full transparency and for fully understanding current, and potentially future, performance.
As the investor side of P2P lending becomes more institutionalized, managers are seeking more look-through into the lending platforms. To meet this need, some administrators have implemented technology only recently available to support independent tracking and analysis of each fractional loan interest. With it, managers are able to convey confidence in a fund’s performance.
New technology also enables some administrators to offer loan data dissection that goes well beyond mere aggregate-level accounting. These administrative teams use modelling and tracking algorithms, often aided by artificial intelligence and autonomous processing, to offer full visibility, cross-referencing and predictive analytics into all levels of a portfolio. They can independently calculate loan amortization schedules, identify expectations and track those projections against a platform’s aggregate numbers. With line-to-line detail, they’re able to scrutinize the principal and interest collection of each individual loan. (E.g., Is the loan in arrears? Has it exceeded its grace period? Is it in REO?)
Independently calculating a loan amortization schedule to a granular level of detail — a process referred to as portfolio accounting or loan ledger accounting — enables the administrator to identify any potential discrepancies and make adjustments. It provides another level of security for the investor, as well as the confidence of knowing each individual loan in their portfolio is being carefully monitored.
Marketplace lending is thriving, and it offers many benefits to borrowers and lenders alike. For investors, it’s easy to get started — especially with the partnership of an experienced, tech-forward administrator. With the pace of progress, it’s important to stay aware of the options available to you. But no matter how the industry evolves, you can rely on this fact: transparency will be your key to success in this space.
Learn more about the administration and accounting services we offer or contact an expert for additional information.
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