Slowdown in marketplace lending? Maybe, but digitization is on fire

marketplace lending securitization

There’s been a lot of talk about a slowdown in online lending and an overall weakening in demand for consumer loans.

Technology providers that service the industry aren’t seeing any of it, though. Online lenders are busy growing the securitization side of their businesses, where they package their loans together into investable securities and sell them to institutional investors. To do this, they’re turning to third party service providers.

“Startup online lenders typically start with good technology, user experience, and customer service but they have to feel their way through the financial regulatory world, adjusting as they go,” said Stephen Bisbee, CEO and President of eOriginal, a technology provider active in the Digital Transaction Management (DTM) space. “When they get to the securitization phase of their businesses, they turn for help.”

Securitization is the next stage of online lending

Securitization of online loans is a more complicated process than simply originating loans. Because of the massive increase in scale needed — an individual loan on an online marketplace may only be $10 thousand dollars, but a securitization can be in the hundreds of millions or billions of dollars — it’s imperative that the entire lifecycle of the transaction be digitized.

Take the auto loan industry. The auto loan industry experienced massive growth by creating 2 industry portals that enabled fully electronic auto loans — from dealership to secondary market — in mid 2000. Nissan did its first securitization in 2005 and now, Toyota and Ford both complete over 80% of their transactions electronically.

Marketplace lending is undergoing its own maturation process, too. “As marketplace lending moved from p2p to institutional capital sources, leading platforms began to look at how they were going to take electronic originations and sell them out into market,” recalled Bisbee. eOriginal counts 10 online lenders as clients including Funding Circle, Earnest, SoFi, Upstart, Apple Pie Capital and Borrower’s First.

Online lenders branching out

eOriginal’s Bisbee expects online lenders to continue expanding their product lines, requiring different levels of digitization. “SoFi began with student loan refis but it’s getting into auto finance and more,” he said. “It’s now offering mortgages. Mortgage is where we started 20 years ago, creating the first fully electronic mortgage for online lenders. We can enable everything on a mortgage after origination. In the time share world, with one customer, our firm enabled 180 thousand mortgages in 18 months.”

Based on demand from online lending clients, eOriginal, which charges a yearly platform fee plus transaction fees, has never been busier. The private company recently doubled its sales and revenue estimates for 2016, as its customer base has grown by more than 70%. And CEO Bisbee just isn’t seeing a slowdown: “In our world — when you focus on the securitization side, it’s just a pricing issue. Once you can get out to the secondary market, there’s always a buyer — it’s just a matter of what they’re willing to pay for debt.”

Regulations cometh

For its part, Digital Transaction Management, as an industry, is set to be a $30 billion market by 2020, according to Aragon Research’s Jim Lundy. For this whole online lending experiment to work, it’s not just about digital signatures: like the auto loan industry, it’s about finding a way to create industry-wide alliances between distributors, originators, investors, and technology providers.

The move towards fully digitzed transactions is also being fueled by the concern that regulation is on its way to the online lending industry. eOriginal has the ability to provide real-time audit and data analytics at the document, transaction, and portfolio level. “The world is moving away from a document-centric perspective to the trusted-data perspective,” Bisbee explain. “In this world of financial services, whether you’re a lender or investor, you should never need to look at a document. You should make decisions based on data and that data needs to be trusted and auditable.”


Funding Circle securitizes first portfolio

fintech M&A 2013

Funding Circle will become Europe’s first online lender to have loans from its platform securitized, setting a precedent that could attract additional funding to the fast-growing industry. The deal, arranged by Deutsche Bank and announced on April 14, will secure loans that originated through the platform by KLS, a U.S. asset manager.

The announcement of the deal was the latest in a series of indications that European investors view Funding Circle, and the entire online lending space, as a maturing member of the continent’s lending ecosystem. At first glance, the securitization, to be backed by £130m of loans and marketed by the end of April, looks like a strong vote of confidence in the upstart, which was founded in 2010.

For the company, of course, it is hard to see any downside stemming from the move. Indeed, it is the latest in a series of milestones for the firm: Last December, Funding Circle announced it had crossed the £1 billion threshold in loans in 2015, and is poised to exceed that number again in 2016. Also in December, the Bank of England declared the firm to be the third largest net lender to small businesses in the UK, following RBS and Lloyds Banking Group.

An industry matures

Looking at the securitization deal, which was inked to back loans that originated via the platform by KLS and arranged by Germany’s Deutsche Bank, the Financial Times said it “underscores rapid growth in alternative platforms as traditional lending continues to stagnate across Europe, despite efforts from policymakers to boost the flow of loans to small and medium sized businesses.”

And Cormac Leech, an analyst at investment bank Liberum, told FT that the involvement of Deutsche Bank was “a strong endorsement for P2P credit quality.”

Online lenders aggressively lending

Others, however, say that while the current move is certainly a net positive at this stage for Funding Circle, it is not clear just what the long term impact of growing levels of securitization will have, either on the company or on Europe’s online lending sector in general.

As early as last summer, Australia’s Sydney Morning Herald described the current wave of infatuation with online lending companies as “a flashback to the subprime mortgage boom” that derailed the US and much of the world economy in 2008. To demonstrate growth, online lenders have significantly ramped their volume of originations by tapping mostly institutional sources of capital. Institutional interest, which has helped provide liquidity for the expanding industry, appears to be waning and underwriting growth rates are indeed slowing. Some platforms have seen loan volume drop over 20% just from Q3 to Q4 of 2015.

Canaan Partners General Partner Dan Ciporin warned last week at the LendIt 2016 conference that introducing professional capital into the marketplace lending world is not without risks.

“Institutional capital is very fickle. Retail capital is quite sticky, on the other hand, and it is enormous,” Ciporin said.

Fintech’s growting sweet spot: Below-prime

Also at LendIt, TransUnion’s financial services head, Steve Chaouki, told conference attendees that new online lenders have led a large expansion in below-prime loans since 2010: Such loans were virtually nonexistent in the online space six years ago; today, the $10 billion the sector has funded for these loans far outstrips similar loans made by banks, finance companies or credit unions.

Chaouki also noted that fintech loans made in 2014 reached four percent delinquency rate in about nine months, in contrast to about 17 months for similar loans made in 2011.

None of which necessarily indicates fundamental holes in the online lending sector, or in the marketplace lending in particular. Ultimately, there is little question that, like across the Atlantic, online lending is here to stay in Europe. It is no exaggeration to say that P2P and marketplace lenders have attracted borrowers by creating simple, easy-to-understand loans that make credit available to ordinary, workaday individuals quickly and painlessly.

Seen through this lens, there is certainly reason for optimism: Funding Circle’s current round of securitization seems to indicate that the industry as a whole is maturing and will continue to do so into the future. And although companies such as Funding Circle, Lending Club and Prosper command less than 1 percent of the lending market today, they are likely to continue to grow, and it is clear that finance’s incumbents have taken note of the disruption they have sought to sow.

All of which means that online lenders find themselves today at a crossroads: Will the sector use the coming years to focus on careful, honest growth, the pursuit of ambitious goals and strong earnings and a commitment to maintain healthy loan books? Will online lenders manage to avoid the traps often associated with the traditional lending industry which reverberated around the globe a decade ago?

Photo credit: royal_broil via / CC BY-SA