Marketplace Lending and Fintech Growth
Financial technology, or Fintech, has upended the once staid financial and banking industry by providing consumers alternative ways to access credit, make or receive payments, and many other banking and investment related activities. One area where Fintech has had great success disrupting incumbents is in lending, by enabling investors to fund loans directly to borrowers in a process that has become known as peer-to-peer (P2P) or Marketplace Lending.
Borrowers find P2P/Marketplace Lending attractive because it provides access to loans that banks may be too risk-averse to approve. Due to the severity of the Great Recession, only consumers and small businesses with well-established credit histories have typically been able to borrow from banks, and only after submitting time consuming credit checks and exhaustive amounts of paperwork. Tight credit conditions create opportunities for borrowers and lenders to achieve better credit terms via alternative sources, such as crowdsourced P2P initiatives. Whether used for debt consolidation, home improvement, small business financing, auto loans or other purposes, P2P/Marketplace lending has created borrowing opportunities where traditional banks tightened up.
These new opportunities are equally attractive for investors looking for alternative sources of income relative to traditional fixed income markets. The ability to invest in P2P loans and loan portfolios that are priced according to terms, yield, credit quality and other criteria creates an asset class with positive net returns, low volatility, and low correlations to traditional public securities markets. Risk can be managed using credit model overlays that sit on top of marketplace lending (MPL) platforms that further filter loans on specific credit metrics. The use of technology has enhanced loan transparency, provided access to private lending, reduced operating costs and shorted the underwriting timeframe.
Advantages of P2P/Marketplace Lending (MPL)
The increasing interest in MPL arises from several benefits:
- loan interest rates often undercut those offered by banks
- investments offer high returns not correlated to other asset classes
- Investors can control the amount of risk by selecting various creditworthy borrowers
- Provides opportunities for socially conscious investors to help borrowers escape from high-interest debt
- Gives access to loans by individuals and small companies with less than good credit, often using alternate data sources instead of or in addition to credit scores
As in any market, MPL assets are subject to the ebb and flow of supply and demand. Exogenous factors such as interest rates, ease of credit, and economic activity create rewarding opportunities for investors to profit from the exponential growth in the P2P sector. Above average returns can be earned by investment in both P2P loans and in the Fintech companies that develop these solutions. Because of this, interest in Fintech startups is rising. There are more than 1,300 Fintech companies in 54 countries, resulting from almost $26 billion in total funding, or $44 million per company, on average.
Global Fintech Development
Currently, the leading Fintech hubs are found in San Francisco, New York, London, Singapore and Israel, but the future will see the growth of startups and incubators throughout the world and especially in Scandinavia, including the cities of Oslo, Amsterdam, Copenhagen, Stockholm and Helsinki. Government support is spurring growth across the globe:
- U.K.: Offers tax incentives for startups and funding for online businesses from its National Cyber Security Program
- U.S.: Investments have tripled in Fintech competitions, incubators and accelerators that create connections between startups and investors
- Singapore: Supports Fintech startups and incubators through financing and co-investment initiatives
- Hong Kong: Offer matching funds for venture capital outlays in technology companies
- Luxembourg: Its Digital Luxembourg initiative targets the Fintech sectors, and startups benefit from government support and an advanced IT infrastructure
Fintech catches the imagination of consumers, especially members of the Millennial generation. Reasons given by consumers for their interest in Fintech include:
- Ease of account setup
- Better fees and rates
- New products and services
- Improved online functionality
- Better service
- Innovative products
Financial services have become the world’s largest industry, creating better user experiences from advances from applied technology. Fintech allows all kinds of consumers to access services that were once reserved for institutions and wealthy individuals. P2P borrowers and other consumers no longer have to endure the hassles of dealing with brick and mortar commercial banks. The latest Fintech applications emphasize user-friendly interactive interfaces that work well on mobile devices.
Adapt or Die
Fintech startups are pressuring banks and other traditional financial institutions to respond by either developing their own new technology or acquiring companies. One of the liveliest markets is the one for P2P payments. Large non-bank players include Google (Google Wallet), Apple (Apple Pay), Samsung (Samsung Pay), and PayPal (Venmo). Just recently, Google Wallet introduced the ability to transfer money to recipients without requiring them to supply an email address. Visa and MasterCard are fighting back by using the clearXchange network developed by a bank consortium, composed of Wells Fargo, Capital One, Bank of America, JPMorgan Chase, and US Bank.
Marketplace Lending Unleashed
Marketplace lending in the U.S. accounted for approximately $5.5 billion of loan origination in 2014. However, the industry experienced astounding growth in 2015, reaching an estimated volume of $18 billion. The two largest U.S. marketplace P2P lenders are LendingClub and Prosper. The Orchard US Consumer Marketplace Lending Index saw an annualized gain of almost 7 percent in 2015, versus a loss in the S&P 500 and a 0.55 percent gain in the Barclays Aggregate Bond Index. Price Waterhouse Coopers predicts P2P loan volume to reach $150 billion by 2025, and cryptocurrencies and blockchain may soon boost P2P transaction volume even higher.
With this kind of explosive growth, marketplace lending investment opportunities will likely be on the rise. The antidote for this opportunity is the managed fund sector. Companies like Prime Meridian Capital Management offer funds catering to all the marketplace lending verticals. Their funds offer expert selection and management, instant diversification and increased liquidity. Prime Meridian offers four separately managed funds dedicated to:
- Consumer Income: high-yield, short duration P2P loan portfolios
- Levered Consumer Income: high-yield, short duration P2P loan portfolios with a leverage component for added yield
- Small Business Lending: small business lending loans composed of proven creditworthy small businesses owners
- Real Estate Lending: diversified marketplace lending loans spanning various property types and domestic geographic locations
Advances in Fintech have created several nontraditional banking sectors, including marketplace/P2P lending, mobile payments and electronic wallets. P2P lending offers retail investors an alternative asset class with high, non-correlated returns traditionally only reserved for large commercial banking institutions. Investors can focus on the risk/return characteristics they favor. Professionally managed funds offer several advantages ranging from loan diversification/selection, expertise of portfolio construction/management, and increased liquidity.
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