The following is a guest post by Dawn Papandrea. It originally appeared in Personal Loan Reports.
FIRST, SOME BACKGROUND
Although the first P2P lenders brought together individuals who wanted to invest some of their money with consumers who needed an alternative way to borrow, it has evolved into a multi-billion dollar entity. “P2P is almost a misnomer,” says Tony Zerucha, managing editor of BanklessTimes.com. That’s because nowadays, there are big financial institutions involved in some aspect of the process, which is why Zerucha says you’ll hear the term “marketplace lending” used interchangeably.
Essentially, as the P2P lending companies grew and needed more capital, they couldn’t rely solely on individual investors, so they took a shortcut, says George Alex Popescu, editor-in-chief and founder ofLending Times. “They went straight to hedge funds to borrow money from. They went to large banks, retirement funds, insurance companies and sold loans to them,” he says.
The result was a new market that helped consumers get loans with lower interest rates than credit card products, gave investors a chance to make money via lending, and helped large funds get better returns. “The industry grew explosively, doubling every year for the last seven years,” says Popescu.
That is, until 2016 rolled in.
One of the things happening now is that P2P companies are starting to run into the issue where there’s big institutional capital waiting to be deployed, but they are struggling to successfully deploy it, says Zerucha. “There is a lot more access to capital than they can lend out. A lot of the early success was based on using algorithms that identified pockets of borrowers that were lower risk than others. One of the things that concerns me is these institutions are so hungry to maintain deal flow that it wouldn’t surprise me if there’s a strong temptation to relax standards to give more loans,” he says. And we all know how that turned out for the mortgage lending industry several years ago.
As such, Zerucha predicts that this is the year when you’re going to start seeing some market consolidation. “Some companies aren’t going to make it. Those whose lending standards are better, and whose algorithms are better will survive,” he says. Others, he says, jumped on the train at the peak trying to make as much money as possible, and they will look to get out.
Popescu says this leveling off was bound to happen, especially in light of the dreadful stock market performance at the beginning of the year.
For one thing, the large funds that are fueling the industry began asking questions and showing more concern. “We saw in the past that big banks can make mistakes. If you look at the numbers, you do see that the amount of default on P2P loans inched up over the last few months. Funds are wondering if it’s the normal cycle, or if this is a sign that some of these loans are worthless,” says Popescu.
This domino effect in which the demand for loans is still up, but the investors aren’t as confident, could be what led to the current situation at Prosper. As Popescu explains, it’s harder to find more investors while losing money, so they decided to cut expenses by reducing payroll and marketing by 30 percent each.
With LendingClub, there’s a whole different situation. “Their results for the Q1 2016 were amazing. They are profitable, the revenue is growing 80 percent a year. On paper, they’re perfect,” says Popescu. The problem is their stock has gone down. Then came the shock of founder and CEO Renaud Laplanche resigning over some issues with some of the loans that were sold.
“That’s very much like firing the CEO of McDonald’s because one of the stores had rotten meat.”
But Popescu speculates there is likely more to the story. “That’s very much like firing the CEO of McDonald’s because one of the stores had rotten meat,” he says. Regardless of the reason, you’re probably wondering how this will affect you, the borrower.
WHAT IT ALL MEANS
The big picture is as a consumer, you should be happy this is happening, says Popescu. “This industry has offered you another way to access debt when you need it. As the market starts competing with each other, it’s forcing the banks to also start offering online loans,” he says. In other words, there are more options for alternative loan products than ever before.
Zerucha agrees, noting that the big banks are already getting involved. “Dozens are partnering with companies to do offshoot websites,” he says. He cites the letter that Jamie Dimon, CEO of JPMorgan Chase, wrote to his shareholders this year that basically told them to prepare for partnerships with fintech companies. “It rang a lot of bells in the industry,” says Zerucha.
The other big factor in play is that the Fed may raise the interest rate. “That systematically affects this market and drives the price that a financial institution lends or borrows money. As Fed increases rates, it will increase the amount of interest that they have to pay to their lenders or equity investors,” says Popescu. And that cost will trickle down to the borrower.
So what’s the big takeaway from all this? If you are considering applying for a P2P loan, Popescu’s advice is to either act now, or plan to wait out the temporary turmoil that is coming down the pike. “Now that Prosper and Lending Club have management and profitability issues, they will probably raise their rates sometime in the next six to 12 months to assure investors and increase profits. You’re probably better off borrowing now than later.”