Last week British investor Fintex Capital issued the first Euro-denominated bond backed by marketplace loans. Like traditional bonds, it can trade through Euroclear and carries an International Securities Identification Number, but it is backed by a bundle of unsecured online loans to consumers, part of a rising phenomenon known as peer-to-peer, or marketplace lending.
It is the latest sign that marketplace loans are emerging as a mainstream global financial asset class driven by institutional investors.
“Marketplace lending is here to stay,” said Robert Stafler, cofounder of Fintex, which placed the first Euro bond last week with a group of institutional investors. That bond, worth up to 100 million euros, is backed by loans from auxmoney, Germany’s leading peer-to-peer marketplace. “It will have an ever growing place in the enormous credit landscape of every country, in every vertical.”
The amount of money involved in this particular Fintex deal may be relatively small, but it, and a series of wider issues of securities backed by marketplace loans on the U.S. market, show that institutional investors — who make up 80% of the capital behind marketplace loans — are increasingly active in the space. Consequently, institutional investor participation is improving the liquidity and sophistication of this rapidly growing industry that set out to be an alternative to traditional banking.
This raises the question about whether marketplace loans are an alternative to banks, giving regular folks new access to lending or borrowing money, as they set out to be; or simply another debt instrument.
“The increasing trend of securitizations from well known firms, such as Citigroup and Blackrock, may have served as the industry’s tipping point into mainstream financial institutions that are in search for yield,” said Blake Coler-Dark, who spent three years spearheading relations with institutional investors for Lending Club, a leading U.S.-based marketplace loan platform and is now chief investor relations officer at FundersClub, a San Francisco-based equity crowdfunding platform.
Along with marketplace lending’s shift to the mainstream come rising concerns about stability and regulation, especially around the liquid derivatives based on these loans. American investors demonstrated some of this squeamishness last week, when a securitization of loans originating from the marketplace lending platform Prosper, fetched a yield almost twice the size as a year ago.
Peer-to-peer lending first appeared about 10 years ago, as a fringe, democratic alternative to banks. Platforms like U.K.-based Zopa, founded in 2005, and California-based Prosper and Lending Club, both founded in 2006, utilize the power of big data and social networks to allow individuals to borrow money from other individuals. Algorithms quickly evaluate one’s credit risk, often resulting in immediate and cheaper loans for borrowers because these online platforms do not have the overhead and lending regulations that banks do.
The industry then ballooned in the wake of the 2007-2008 global financial crisis, when banks began to reduce credit prompted by a capital crunch and new regulations enacted after the collapse of mortgage-backed securities. In 2014, marketplace lenders made $24 billion in new loans, up from $1 billion in 2010, according to Morgan Stanley. By 2020, the bank has forecasted as much as $490 billion will be issued annually in such loans around the world.
With smaller returns on many assets in the current low-interest rate environment, institutional investors from big names like Goldman Sachs and BlackRock Financial Management, to boutique firms, like Chicago-based Victory Park Capital, have been scooping up marketplace loans. According to Orchard Platform’s U.S. Consumer Marketplace Lending Index, 12-month returns on these loans are running at 6.41%, compared to a 2.5% on Barclays Aggregate Bond Index.
“While borrowers created the need for these platforms, it has really been the investors — those funding the loans — who have propelled the industry forward,” Orchard Platform, a technology provider to institutional investors in marketplace lending, wrote in a recent white paper.
But the reliance on institutional money has some worried about whether this source of capital could dry up once interest rates begin to rise. Having come of age following the global financial crisis, the new industry has yet to experience monetary tightening.
“Changes in the macro economy and a rise in interest rates is a valid concern, but it’s all relative,” Coler-Dark said. “Rates are now trickling up, and as a result, the cost of capital for the lenders and hedge funds utilizing leverage facilities could lead to a margin squeeze, potentially forcing the investors to look elsewhere for higher illiquid yield.” The lending platforms have responded quickly to the changing environment, by raising the interest rates on their loans following the U.S. Federal Reserve’s interest rate hike in December.
To distribute their risk and create liquidity, investors have increasingly been selling off loans as securities, carrying out 9 such deals for a total of $2.7 billion in the U.S. market in the last three months of 2015 alone, more than five times the dollar-value of the same time period in 2014, according to PeerIQ. Since the first deal in 2103, there have been 41 issues of securities-backed marketplace loans, worth a total of $8.4 billion.
Fintex’s Stafler said he expects the first full-fledged securitization on the European market later this year. Bundling the loans into securities and bonds also makes them more accessible for institutional investors, like pension funds, who do not want the hassle of buying loans directly from platforms, Stafler said.
But recently, interest rates have been rising on issues of securities backed by marketplace loans, and this is worrying, said Ram Ahluwalia, chief executive of PeerIQ, a risk-management firm focused on marketplace lending. Ahluwalia, who is familiar with the terms in a handful of recent deals, remarked that in some cases, the interest rates demanded by investors in securities backed by marketplace loans were higher than the interest rates on the underlying loans themselves. In general, interest rates on marketplace loan-backed securities are about 500 basis points higher than a year ago, Ahluwalia said.
“The last couple of months have seen an increase in financing costs, it’s a pricing problem,” he explained. It partly stems from higher yields in general for asset-backed securities, as concerns continue over low commodity prices and economic slowdown. But it also shows that investors see risks in marketplace loans, especially as there has been a slight uptick in delinquencies, according to Ahluwalia.
Analysts who follow the industry have taken note.
Marketplace risk management and consultancy MonJa recently highlighted Lending Club’s data that show some recent loans to lower grade investors have slightly increased charge-offs. “Investors should closely monitor more recent vintages of lower grade Lending Club loans,” MonJa said. In February, Moody’s downgraded bonds issued by Citigroup that were comprised of loans made through Prosper Marketplace.
On the other side of the Atlantic, Stafler said such trends could put a damper on emerging European appetite for the development of this new asset class, but he emphasized that the underlying risks to investing in German or British marketplace are lower. Unlike in the U.S. market, in Europe there is little correlation between rising unemployment and growing consumer loan default, he said.
“Here it’s a lower risk and lower return environment,” he said.
Concerns are also mounting about increased regulation, especially in the U.S. market, where the Treasury Department, Congress and other federal agencies are in the process of gathering more information on the industry. The Consumer Financial Protection Bureau recently opened a department dedicated to marketplace lending, and a federal court case is examining if marketplace lenders should be subject to state usury laws.
“That is part of what happens when you become a successful industry,” Ahluwalia said. “But maturation is still a long way off.”