For years I’ve kept a watchful eye on the evolving world of marketplace lending. For much of my career I was responsible for overseeing underwriting for traditional banking organizations — first for consumer loans at American Express and then small business loans at Citibank. The data available from borrowers in those situations was deep and detailed and allowed rules to be created and performance to be analyzed.
In 2011, I discovered Lending Club, the then-largest peer-to-peer (P2P) marketplace lender in the U.S. I became fascinated while looking at this company. Here was a lender that distributed 100% of the loans offered at the loan level, which meant a lender could be selective in the types of loans funded. The most fascinating aspect was that historical loan performance data was available to any investor that wanted to analyze the information.
For someone who had spent her career building and testing credit models, the ability to do this as an individual — well, it was like being a kid in a candy store. For the first time ever, as a retail investor, I was able to invest in a loan while applying the analytics that were core to my professional life. Peer-to-peer lending provided full transparency into a borrower’s credit and financial data, the same data that was available to me when I ran a bank’s underwriting department.
This was an exciting discovery. My first instinct was to build a credit model that would provide a nice return. I appreciated the yield and diversity that P2P lending brought to my personal investment portfolio, and I wasn’t alone. A number of my acquaintances were also investing and we were all fascinated by the novelty and potential of this new market. It’s hard to express how revolutionary it was.
As with any emerging market, there was a lot of curiosity and excitement but not always a great deal of understanding. At an early industry event, I led a presentation with Matt Burton — co-founder and CEO of Orchard — on consumer credit and how it could be used to research and facilitate investments in this new market. Investors who were interested in marketplace lending needed some guidance on how to actually make an investment.
Like Matt and I, these investors appreciated the yield and the diversification these products could bring to their portfolios. They also appreciated the fact that a marketplace enabled them to invest only in those loans that matched their specific risk/return criteria. The control provided was a unique and valuable feature, but also a good deal more complex given the relatively small value of each loan, which meant investing in a large number of loans.
For individual investors it might be possible to manage investments in a few dozen individual loans, but for institutional investors a manual approach simply could never scale. It was these investors who were quickly recognizing that marketplace lending could be an attractive asset class. However, for marketplace lending to be viable, institutional investors required a different model than what was used in the past.
The first technologies for marketplace lending were back-end reporting and order management systems that allowed investors to deploy capital across the origination platforms like Lending Club and Prosper, which that had enabled automated buying. It was an important first step and it was one that differed from the technology models typically used by institutional investors.
The world of the institutional investor was one with securitized bonds backed by loans. These products flowed into broker dealers and then through managers — hedge funds, asset managers and wealth managers — to institutional investors. It was a fairly contained closed-loop system that had worked for decades. The financial crisis of 2008 interrupted that flow, as the stream of capital— particularly to individuals and small businesses — dried up. That change led to the rise of P2P and the sudden interest of institutional capital in participating in this market.
The topography of marketplace lending was radically different. Rather than being able to invest in securities, one was investing in individual borrowers. These borrowers weren’t working with a handful of big banks but, rather, with a constellation of online loan originators — each of which had their own reporting models and APIs. Individual and institutional investors might be vying for the same pool of loans. It was a complicated environment and technology became critical to making it function effectively.
As marketplace lending — and the technology that supports it — has evolved, the opportunity goes far beyond being an attractive niche segment.
The excitement around marketplace lending is based not only on what has happened or where the industry stands today, but, most importantly, its potential for the future. The global debt market is enormous and the opportunity for disruption is huge. This potential will be realized if the firms involved in powering the industry continue to invest in their technology. Technology will give those participating in marketplace lending three clear advantages over traditional banks:
Billions of dollars have been lent to people and businesses all over the world and these loans have been directly distributed to investors interested in owning those specific assets. Exponential growth has occurred, both in terms of the dollars lent and the diversity of investors. Today some of the world’s largest global investment firms are investing in lending assets by buying them directly from the originator. This is no longer a niche industry.
This expansion of investors and originators has been supported by a maturing ecosystem of service providers. To help put the industry in context, Orchard has created the “Lendscape,” a graphical depiction of marketplace lending (See graphic on next page). It shows the ecosystem with examples of the players as they exist today. Capital is on the left, borrowers on the right and the firms that make it happen are in between. These companies include data providers, banks, software companies, custodians, servicers and administrators — just to name a few. Many of the firms depicted are established financial services companies that recognize the potential of marketplace lending to drive industry growth.
While I have described the origin and evolution of marketplace lending and touched on where we are today, the real excitement is where the industry is going.
Because Orchard’s technology sits between loan originators and investors — and has access to the individual loan data — it provides a unique view into how the various market participants are evolving. On the investor side, there has been not only a massive increase in the number of investors, but also a significant diversification of investor types participating in this market. In the early days, the leading originators had relatively short track records — around 3 years — and the typical investor was a hedge fund or family office that had a specific focus dedicated to understanding and taking a risk on this new asset class.
Today, many other types of investors are entering the market, including large banks and multi-sector asset managers. This diversification is a great signal for marketplace lending. It provides validation but, more importantly, it means that a greater diversity of loan types and borrower segments can obtain funding. The introduction of institutional capital has enabled the exponential growth of global originations. The trends witnessed in the US over the last few years will be replicated in markets around the world.
Technology is allowing originators to distribute loans at scale. Loan originators fall into three broad groups:
Each of these types of originators brings unique value to the market, and each has the opportunity for rapid growth. The rise of firms whose focus is on acquiring, underwriting and servicing borrowers is new to most of the mature global financial markets. Borrowers benefit from more options and generally enjoy better service given that these companies are competing on that front.
No one should doubt the potential of marketplace lending. The global addressable market is, by many estimates, in the trillions of dollars. This market has matured in a very short time. The focus on technology has lead to a more informed and empowered investor base. This has created opportunities for investors of every size, from individual retail investors to the largest global asset managers. In turn, this has led to a decentralization of power from the chosen few to the many. The result is improved stability, fairness and greater resiliency.
Technology plays a central role in every aspect of marketplace lending. Borrowers benefit from advanced underwriting models that truly understand their creditworthiness and can make a lending decision in a short period. Originators are able to distribute their loans to a large set of investors and as a result, the capital base is more diverse and stable. Finally, because investors have access to each loan, lenders are accountable for the decisions they make and investors are aware of the assets they are buying.
Marketplace lending is a radical new model that offers unique benefits to all market participants. Proven to be effective, scalable and resilient, its core consists of the trifecta of technology, data and services that can function in concert to deliver value to all.
