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Will the Real Marketplace Lender Please Stand Up?

Understanding the hidden consumer regulatory risk for hedge funds

January 20, 2016 By Ryan Lichtenwald 1 Comment

Views: 964

Regulation of peer to peer lending

[Editor’s Note: This is a guest post from Michael Mann and Margot Laporte. Michael Mann is a partner in the Washington, D.C. office of Richards Kibbe & Orbe LLP. Margot Laporte is an associate in the Washington, D.C. office of Richards Kibbe & Orbe LLP.]

The recent growth of marketplace lending platforms has resulted in non-bank entities, such as hedge funds, engaging in activities that could conceivably be construed as consumer lending transactions. The Consumer Financial Protection Bureau (the “CFPB”) was established by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 as an independent agency within the Board of Governors of the Federal Reserve System to regulate the offering and provision of consumer financial products and services and to enforce federal consumer financial laws against banks and other covered entities. Currently, the CFPB does not have authority over non-bank entities that engage in activities such as marketplace lending that do not constitute the offering or provision of financial products or services directly to consumers. However, as marketplace lending becomes more sophisticated, the line will continue to blur between the regulated consumer lending activities of banks and other covered entities, which include the origination, brokerage, and servicing of mortgage, student, and payday loans, and the unregulated marketplace lending activities of non-bank entities, which includes the provision of liquidity to online lending platforms that originate loans to consumers.

While marketplace lenders historically have partnered with originating banks that are subject to regulation by the CFPB and other banking regulators, as the marketplace lending space expands, we expect that the sources of funding will expand as well. In this article, we outline the potential risks and theories of regulation for non-bank entities engaged in funding and other activities related to marketplace lending and suggest several areas where proactive policies and procedures implementing best practices in advance of specific regulatory guidance would benefit non-banks engaged, directly or indirectly, in the fast evolving marketplace lending industry. [Read more…]

Filed Under: Guest Post Tagged With: hedge funds, marketplace lending, regulation, risk

Views: 964

An Updated Look at the Risks of Marketplace Lending

This financial advisor thinks the risks of marketplace lending have changed over the years in part due to lower interest rates offered by the platforms.

July 30, 2015 By Peter Renton 3 Comments

Views: 43

[Editor’s note: This is a guest post from Matt Shibata, a Portfolio Manager at Morling Financial Advisors, where he provides investment advice and allocates to variety of asset classes, including marketplace lending. He also writes on investment topics at his blog ThoughtfulFinance.com.]

Several years ago, I wrote a two-part guest post about marketplace lending as an investment asset class. It has been truly amazing to watch the industry’s growth and see how widely marketplace lending is now accepted as a bona fide asset class. The industry’s maturation has mitigated many risks, but I also believe that the rapid growth and increasing competition has increased other risks.

The primary risks today, in my opinion, stem from the decline in lending rates. Although rates were declining in 2013 (when I first invested in and wrote about marketplace loans), rates were much higher then. Today, rates have already come down significantly and continue to decline. Lower projected returns translate to a narrower margin of safety. Many, if not all, of the below risks have existed for quite some time and have been widely expected at some point, but they warrant more caution now due to today’s lower and still-declining rates.

Loan Refinancing

One factor that has been driving down returns has been loan refinancings, which represent a conflict of interest between investors and the platforms. Investors would generally prefer to hold performing loans to maturity in order to maximize returns, whereas the platforms are incentivized to originate as many loans as possible in order to maximize revenue. These are not mutually exclusive interests, but the platforms have been actively soliciting existing borrowers to refinance their loans at lower rates for the past several years. This is not inherently wrong (it’s great for borrowers), but investors should realize that a conflict of interest exists and that their loans are callable at any time (which is detrimental during a period of declining rates, since reinvestment returns will be lower). Orchard Platform recently posted a good summary of this issue here.

Loan Quality Questions

As more platforms go public, the pressure to grow continues to increase. Growing loan volume needs to be carefully weighed against maintaining loan quality. My observation is that both the pressure to grow and the huge demand for loans has led to a loosening of underwriting standards. We are seeing explicit examples, such as “high yield” offerings and euphemistically named “near prime” loans. But several sources have also confirmed that at least some platforms are now accepting less borrower documentation than they have in the past. My hope is that the technology used in place of traditional underwriting methods is robust enough to make up for the weaker verification processes. Only time will tell.

Questionable Practices in the Corners of Business Lending

The 2015 LendIt conference in New York (highly recommended!) was a great showcase of the industry and I met a ton of interesting people and learned about many marketplace lending platforms that focus on business lending. However, a few of the business lending platforms and funds were extremely aggressive. I am not trying to be moralistic, but it was honesty difficult to tell whether some of the platforms were helping or exploiting borrowers. A more economic concern is that several claimed that their high-degree of collateralization mitigated a lot of risk, but further questioning about recovery rates called many of these claims into question. This certainly does not apply to the entire business lending segment, but I would encourage investors to research any platform and/or manager that they are considering.

Investor Risk Analysis

The platforms’ risk models appear much more robust, but my guess is that many individual investors rely on some of the public commentary that compares the credit risks of marketplace lending with the credit risks of credit cards. This is an imperfect analog, at best, since revolving consumer credit (like credit cards) is fundamentally different from non-revolving personal loans (like marketplace lending) on many levels. For instance, a troubled credit card customer has an incentive to continue paying their monthly bill so that they can continue to use the card. A marketplace lending borrower does not have that incentive. This is not a prediction that marketplace loan loss rates will exceed credit card loss rates in the next economic downturn (although they may), but I would encourage investors to consider possible losses carefully.

Conclusion

As “peer-to-peer lending” matures towards “marketplace lending,” the high returns of early-adopters are now trending down towards market-driven ones. I believe marketplace lending will provide positive returns for quite some time, but the margin of safety is narrowing and its relative value to other investable markets has diminished as well. My hope is that all parties protect the integrity of the asset class, to ensure its long-term viability. Of course, hope is not a prudent investment strategy, which is why I am writing this and encourage all marketplace lending investors to recognize and weigh the risks along with the opportunity.

Full Disclosure: I advise clients on private investment vehicles dedicated to the marketplace lending asset class, as well as personally own loans on both the Lending Club and Prosper platform. I am also a client of NSR Invest.

Filed Under: Peer to Peer Lending Tagged With: interest rates, marketplace lending, p2p analysis, risk

Views: 43

Is P2P Lending A Low Risk Investment Now?

March 19, 2013 By Peter Renton 26 Comments

Views: 945

I have been thinking about this idea for some time. With Lending Club now profitable and growing like gangbusters and Prosper with a new bankruptcy remote vehicle for all investors I think it is time to revisit the idea of risk.

Despite the question in the title of this post I don’t truly believe that p2p lending is a low risk investment. I think most of us would agree that Treasury bills or an FDIC-insured investment is pretty much all we can consider as low risk.

But let’s look at the mainstream investments for a moment. The stock market is at an all time high and yet everyone remembers that it has had two major corrections in the past 13 years where values went down roughly 50%. The bond market has had a great run for many years now but at some point in the next couple of years that run will likely be over. Both those investments represent a real risk of principal loss going forward.

Lending Club in a Very Strong Financial Position

Now, let’s consider an investment in Lending Club today. In February it issued $120 million in new loans and is now running at a profit. It is safe to say that loan volume in March will be north of $130 million and increase steadily from there. Returns to investors continue to be strong and there is an IPO looming on the horizon where it will pocket a huge cash war chest.

There is very strong demand from institutional investors with new large investors coming on board all the time. But in recent conversations I have had with Lending Club management they say retail investor demand is also growing very strongly. When their IPO happens this will become even more pronounced as investors from all 50 states will become eligible to invest. Suddenly investors from large states like Texas, Ohio, Pennsylvania and New Jersey will come flooding in to Lending Club.

The future is indeed very bright for Lending Club and it would take an unforeseen calamity to alter their growth trajectory now. With a well-diversified investment there is little risk of principal loss at Lending Club and the potential return is 10% or more.

Prosper Offers Additional Protection for Investors

Taking a look at Prosper they are clearly not in as strong a position as Lending Club. In recent months they have been reduced to a tiny market share but there are early signs of a resurgence. They are going to post a better month in March (month to date volume is up 73% over last month) and all signs point towards a record month for them in April.

Even though Prosper is clearly the number two player and they are in a weaker financial position they have implemented a bankruptcy remote vehicle for all investors. This provides an added level of protection for investors that offsets the increased platform risk in my opinion. With a new management team and their recent large cash infusion they are also in a relatively good financial position.

Now, anyone who has been reading this blog for a while knows I am a big cheerleader for the industry. I do not pretend to be completely objective in my coverage; I invest a lot of my own money in Lending Club and Prosper and plan on investing a lot more. I want the industry to continue to flourish.

So, while I don’t really believe that an investment in p2p lending is a low risk investment I think we can all agree that it is a lower risk investment today than it was two or three years ago. I would also propose that today it is also a lower risk investment than an S&P 500 index fund or a total bond market index fund.

But what do you think? Am I crazy to even suggest this? As always I am very interested to hear your comments.

Filed Under: Peer to Peer Lending Tagged With: diversification, Lending Club, Prosper, risk

Views: 945

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ABOUT LENDIT FINTECH NEWS

LendIt Fintech News, Powered by Lend Academy, has been bringing you all the news and information about fintech and online lending since 2010 when it was founded by Peter Renton. We not only have the industry’s most active news site, but also the largest investor forum and the first and most popular podcast.

We are a team of fintech enthusiasts who have been covering the industry for many years. With a deep knowledge of online lending, digital banking, blockchain, artificial intelligence and more our team covers the daily news and writes in-depth editorials.

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