The year 2014 is seeing important milestones in peer finance. Lending Club has reached $5 billion in loans originated to date. Prosper Marketplace is now hitting its stride at $369 million in originations for Q2 and the rating agencies are inching closer to developing methodologies to create more traditional-style securitizations. It appears as though the industry has hit a point of inflection, and the groundwork laid by Lending Club and Prosper offers great potential for scaling this quantum leap in banking efficiency.
Peer finance is shaping up to be the next evolution of traditional banking into a more efficient method of capital formation and investment through the leveraging of technological innovation. Let’s explore the main benefits of peer finance and the prospects for the future growth of this promising new industry.
Peer finance — here to stay
Peer finance has been growing rapidly over the past five years, quickly becoming a major global investment class. The industry leader, Lending Club, is widely expected to go public in 2014 and is currently valued at $3.8 billion. Its investors include such prominent firms as BlackRock, Google Ventures, T. Rowe Price and Union Square Ventures. Prosper has ramped up its volume significantly and features its own list of impressive investors such as BlackRock and Sequoia Capital.
Peer finance is not only a U.S. phenomenon. In the U.K., Ratesetter and Zopa are approaching a decade of history and the government gave a strong endorsement to Funding Circle by investing £75 million in small business loans through the platform. Furthermore, the Funding Circle platform is now enjoying early success in the U.S. and will be issuing fractional loans to unaccredited investors shortly, which will further deepen the range of financing and investing options for U.S. businesses and investors.
Source: Lending Club, Prosper, Funding Circle, Ratesetter and Zopa.
Plain vanilla loans offered more efficiently
Peer financing offers a relatively easy application and approval process that is done completely online. Borrowers choose the type of loan they would like to receive and apply to the appropriate platform. The application process is quick and borrowers can receive a loan offer in a matter of minutes. Loans are then posted on an online marketplace where lenders can view detailed borrower information. Depending upon the platform, both accredited and unaccredited investors have access to peer finance (although some restrictions apply to unaccredited investors). Once a loan is approved and investor interest is beyond a certain threshold, the loan is funded and the financing portal collects payments and distributes them to lenders over time.
Peer finance advantages
Yield to investors
Yields of traditional investments are low and not expected to rise any time soon. Although the Fed is expected to end its bond purchases in October as part of its quantitative easing program, Fed Chair Janet Yellen also signaled that there is no change in its plan to keep short term interest rates low until at least next June. In this type of environment, investors are tempted to reach down in credit quality or add substantial leverage to portfolios in order to increase yield. However, peer finance offers loss-adjusted expected yields in excess of 9%.
Advantages for borrowers
From a borrower’s perspective, peer finance offers a better financing option than that of alternatives, as they pay significantly lower interest rates and receive better terms.
Source: Argus Q3 2013, Lending Club, Prosper.
Lending Club and Prosper rates are as of June 13, 2014 and represent the 1-year average.
Lending Club and Prosper rates were averaged across both platforms.
Just the beginning
The peer finance model is adopting all major traditional banking products and new platforms are being added on what seems like a daily basis.
Note: This is a small subset of the many platforms currently available to illustrate the diversity of options available to both borrowers and investors.
As the market for peer finance expands rapidly, there are many things to consider as investors and borrowers learn how to leverage this nascent industry to its true potential. Some of the themes to look for in the near future are:
• Growth of differentiated platforms that expand into more diverse areas of finance such as factoring, secured lending and real estate.
• Development of “Kayak” type platforms that serve to normalize and aggregate data across the diverse landscape such as the Lendvious.com platform created by Crowdnetic.
• Exchanges and marketplaces that function as unbiased forums for borrowers and investors to leverage in order to increase liquidity and bring consistency to the industry.
Further down the road, we could also see platforms that integrate across the different areas of crowdfinance, especially as the JOBS Act continues to democratize equity crowdfunding with similar impact. As the marketplace evolves, we could see the adoption of truly virtual banks that connect borrowers, lenders, venture capitalists, business owners, entrepreneurs and consumers. Until then, we will continue to watch the light-speed development of this exciting new industry.