By: Jeff Ball, President and CEO of Visio Financial Services
Marketplace – sometimes called peer-to-peer – lending, in which retail and/or institutional investors can lend money to borrowers online without the use of a traditional intermediary like a bank, is a hot topic now in the investment world. This is particularly true following the December, 2014 IPOs of two of the largest players in the online lending space, Lending Club and OnDeck.
The reality is, what once started as a true marketplace for retail investors to connect with those in need of fast financing is now dominated by institutional investors. However, whether at the retail or institutional level, marketplace lending for various segments – including small business, personal, real estate and even student loans – is attractive to many accredited investors due to outsized returns on these fixed income assets.
Accredited investors have many questions about investing in marketplace lending, including: how much of my portfolio should I dedicate to this asset class? What sectors within marketplace lending are the most attractive for the medium- and long-term?
Why is Marketplace Lending so Popular Now?
Before addressing these questions, it’s important to step back and elucidate the reasons why marketplace lending is increasingly moving into the mainstream, even for those historically wary of alternative investments.
Many people know that during the global financial crisis and the resulting “credit crunch” that began in 2007-08, banks dramatically increased the credit requirements for consumers to obtain mortgages, auto loans, credit cards, and other loan products. Since credit is so critical to our economy, alternative lenders saw a surge in popularity, especially for personal or small business loans. And, new technologies enabled lenders to create sophisticated platforms and algorithms to expand their reach and attract more quality borrowers and investors.
Simultaneously, the Federal Reserve drastically lowered interest rates and government bonds quickly shot up in price, with a corresponding decrease in yield. To this day, the 30-year Treasury bond yield is less than three percent. Fixed income is an important part of most investors’ portfolios, but the rates of return for this asset class were dramatically cut as a result of low interest rates. Therefore, investors were incentivized to look for yield in other assets, and marketplace lending has become an attractive area for some looking for higher returns for fixed income assets through the private credit markets.
Lending Club, between 2007 and the end of 2014 before its IPO, facilitated more than $7.6 billion in almost exclusively personal loans. In fact, more than 80% of borrowers cite credit card consolidation as the purpose of these three- to five-year amortizing loans. Multiple small business-specific platforms have cropped up, like Dealstruck and IOU Central, while real estate is emerging as another potential goldmine as well.
Who is Investing in These Loans?
Many people are confused about the difference between the terms “peer-to-peer lending” and “marketplace lending.” The name shift represents nothing more than where the majority of the investment capital comes from.
More than 70% of Lending Club’s loans are sold to institutional investors. These include hedge funds, insurance companies, pension funds, and – perhaps surprisingly – banks. Starting in June of 2013, Titan Bank and Congressional Bank even beganbuying Lending Club loans.
Lending Club carries no balance sheet risk, yet is originating growing amounts of paper and selling it to investors; meanwhile, OnDeck has never been a true “peer-to-peer” platform, and instead allocates institutional money to small business loans. This new form of securitization that meets institutions’ particular needs has outgrown the “peer-to-peer” designation.
Nonetheless, many platforms still allow accredited retail investors to build their own portfolios. More than that, the marketplace lending space is one of the best examples of how finding investments is changing through the advent of new technologies.
The choices available to investors versus even a decade ago have grown exponentially. With a few clicks, an accredited investor can build a portfolio of hand-picked early-stage companies, specific real estate assets or even invest in profitable small businesses in need of a loan, from anywhere in the world. Marketplace lending is emblematic of the explosion of options available to accredited investors in the alternative assets market and could have a significant effect on their future asset allocations.
This article was originally published on Accredited Investor Markets (AIMkts). View it here.