By Efi Pylarinou

Lending marketplaces are about to get boring. From Birth of P2P loans to Maturity via securitization, the recipes and cookware are looking more and more like old-fashioned financial engineering.

“For the kind of people who think technology is all about innovation and cool new things, then, fintech is about to get even more boring”. “…startups are becoming much more like the banks they’re seeking to disrupt. That’s Lunn’s Great Convergence.” by Felix Salmon in “Financial Startups are getting an edge by growing up”

Crowd sourced lending has been going on for a while. Lending Club started before the peak of the subprime crisis. Origination from non-depositary institutions has also been going on for a while and has been tagged “Shadow Banking”.

Funding consumers, students, mortgages, SMEs; is not a need created by some innovative company like Apple. It has been there for a while, starring at us in the face and looking for a servicer to fill the gap that was created from banks pulling out of this market.

The P2P lending platforms have already become P2P marketplaces, with the heavy involvement of institutional funding (covered in: “P2P Lending” to “Lending Marketplaces”: the graceful dance has started). In December 2015, in some of the year-end articles on trends and predictions for Fintech, there was mention of potential future troubles in the P2P lending space (e.g. Crazy Fintech Predictions for 2016). Probably extrapolating from the recent troubles in high-yield and EM debt, the Fed’s rate hiking, and some macro factors; coupled with Lending marketplace Fintech valuations shrinking to more normal levels as CACs become higher for further growth.

On a more positive note, there has also been recognition of the great need-potential for funding in the real estate market. This is an area that P2P funding is expected to grow. Securitization of P2P loans is another process in its infancy.

In today’s research note, I will dissect the P2P loan space in three main stages. I will start looking behind the scenes to look for elements of old-fashioned finance:

Birth phase Adolescent phase Mature phase

Where P2P loans are Born

The myth of the stork bringing the baby, is not true in P2P lending. There is a bank behind the creation of every P2P loan. WebBank, tucked neatly in Utah and away from Silicon Valley and New York, has underwritten the majority of P2P loans. It is a lean financial institution with a niche focus. Every time a Person applies for a loan on a P2P platform, WebBank issues the loan (i.e. provides the capital) and 2 business days later the P2P platform buys the loan, to hand it over to the Persons that come in and fund it.

This fact makes it clear that the P2P online platforms look more like a match making business. They source and bring together borrowers and lenders (but there a bank involved). They do also a lot of the pre- and post- services for a loan to be issued and serviced. WebBank however is vital, same way oil is vital to an engine’s functioning. WebBank is at the top of the Triangle that is behind the scenes of a P2P loan (WebBank, Borrower, Lender).

Liquidity can dry up, if WebBank has troubles or decides to reduce capacity and take less risk. One supplier of capital, simultaneously used by Lending Club, Prosper and Paypal, is never a good thing in any market. If regulators decide to restrict P2P lending, starting from one of their supervised institutions, like WebBank that is tightly involved in the online lending process, can be a starting point. Felix Salmon emphasizes in “Financial Startups are getting an edge by growing up” that “Something that looks incredibly simple from the outside (e.g. P2P loan)…can turn out to be insanely complex behind the scenes”.

In a future research note, I will expand more on the business model of WebBank and its client base.

Where P2P loans become an asset

In the second phase , P2P marketplace are no more trendy, innovative platforms but are being seen as more traditional financial products. Lenders can directly invest in these P2P online platforms and spread their holdings across borrowers, thus reducing risk and earning interest. Algorithms running behind the scenes to facilitate the process of origination are starting to look and feel more like that of a bank, in this phase. The platforms differentiate in several ways. Credit scoring and risk profiling, is one main way that aims to offer a better risk-adjusted return to lenders. The reality is that overall, lending marketplaces have concentrated on the very high end of the credit spectrum and have 80% rejection rates (i.e. refusal rate of borrowers).

Financial advisors can offer their clients a portfolio allocation to P2P loans via NSRInvest (see research note: LendingRobot and NSRInvest, “les fiancées” of LendingClub).

Another way, to get involved indirectly in this space, is investing via investment trusts. Again this also smells like traditional old finance. There are hybrid investment vehicles, like those offered by GLI Finance (equity and debt); income trusts, like the recent LSE launch of Funding Circle income fund. This phase, is no different than the path followed by any other financial structure.

Where P2P loans become a more mature market

In this phase, P2P loans are pooled and re-packaged into tradeable securities, falling under the still “naughty” term of securitization. Such structures have been created over the last two years mostly pooling consumer loans and some with student loans. In 2015, Blackrock, a big asset manager, and Citibank, a large bank, launched two of the largest securitized P2P deals for the year. The market has still a bitter taste coming from the subprime crisis and a subconscious mistrust to the ratings associated with them. However, the explosive growth of P2P lending volume, leads institutions to re-create such vehicles that re-distribute risk and replenish capital for funding.

In another future research note, I will expand more on the securitization deals in this space (which is deja-vu financial engineering) and on the first glimpse of Fintech innovation for this complex and cumbersome process (A new Fintech platform for online P2P securitization).

Lending marketplaces have heavy elements of old-fashioned finance and are becoming less innovative and cool, as they grow up.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech. Efi Pylarinou is a Digital Wealth Management thought leader.

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