In mid-July,
we reported that the United
States Treasury is seeking public comment from the marketplace
lending industry. As part of their
request for information, there
were 14 questions that were asked. Over the past few weeks
here at Lend Academy and LendIt we have been compiling our
responses and we filed them with the US Treasury yesterday which
was the deadline.
A total of 79 responses were received and most are
available for viewing online.
Pretty much all the major players in the industry submitted a
response including Lending Club who did a
full press releaseabout
it. Our responses are below. A word of warning, this is the
longest post ever published on Lend Academy, at just under 7,000
words, so I also uploaded a
PDF of our full response
here.
Q1: There are many different models for online marketplace
lending including platform lenders (also referred to as
“peer-to-peer”), balance sheet lenders, and bank-affiliated
lenders. In what ways should policymakers be thinking about market
segmentation; and in what ways do different models raise different
policy or regulatory concerns?
The term marketplace lending is too narrow and not inclusive of
the innovation taking place in the lending category. For the
purpose of this inquiry, we suggest using the term online lending
since we believe that the Internet is the key driver of the
innovation taking place in our industry. Marketplace lending is one
category within online lending.
We run a global conference called LendIt, which is focused on
the online lending industry, and we are in search of companies that
have incorporated the Internet into their business models,
resulting in improvements to traditional lending. The key is to
find companies that have
improvedthe traditional process and avoid companies that
may have a website but have not improved the traditional model.
There are two different types of online lending models:
marketplace lenders and balance sheet lenders. In some cases we see
hybrids of the two models.
Marketplace Lenders
The very first online lender was Zopa in the UK, which launched
in 2005 and was soon followed by Prosper in 2006, then Lending Club
in 2007 in the US. Today, this model has been replicated by
hundreds of companies all around the world. In the US we call it
marketplace lending, in the UK they call it peer-to-peer lending,
and in China they call it Internet Finance. The business model is
an
agency modelthat connects lenders (we use the terms
lenders and investors interchangeably) and borrowers. These
businesses typically include credit underwriting and loan servicing
divisions in addition to traditional operating divisions.
They are compensated through a one-time loan origination fee
paid by the borrower and, since they service the loans, they
typically charge the investors an annual servicing fee.
In 2014 Lending Club and Prosper changed the way they referred
to themselves from “ Peer-to-peer marketplaces” to “Marketplace
lenders.” The issue was that p2p lending only refers to the retail
market and these platforms are accessed by both retail and
institutional investors. We estimate that the Lending Club and
Prosper marketplaces are currently 75-80% institutional and 20-25%
retail. It’s important to note that Prosper and Lending Club are
the only platforms available for non-accredited investors.
The defining characteristic of a marketplace is that it connects
a pool of investors with borrowers. Some marketplaces provide only
whole loans to investors, these investors are typically
institutions, and some provide a mixture of whole loans and
fractional loans. In the latter case the primary investors are
individuals with loans being funded by dozens or even hundreds of
investors.
Balance Sheet Lenders
There are many online lenders that are balance sheet lenders.
They may source borrowers in a similar way to the true marketplaces
but they fund these loans from their own balance sheet.
Balance sheet lenders either use their own cash on hand (Paypal,
Amazon, etc) or they secure a warehouse line of credit (Kabbage,
CAN Capital, etc) or some other source of debt capital that is held
on their own balance sheet. Once they secure a borrower, the money
is funded immediately and the loan becomes an asset on their
balance sheet.
With this kind of model platforms will typically earn money in
the interest rate spread between the returns from the loans (net of
any losses from defaults) and the cost of their credit facility.
Some platforms charge an origination fee to borrowers, while some
do not.
Balance sheet lenders often compete directly with marketplace
lenders for borrowers and their acquisition strategies can be very
similar. It is on the funding side of the equation where they
differ.
Hybrids
Several balance sheet lenders have started marketplaces. The
advantage of having a marketplace is it allows for a diversified
investor base. Balance sheet lenders typically have a very small
number (typically less then five) of institutions providing
funding. When a balance sheet lender adds a marketplace they will
bring on dozens of investors.
Some marketplaces hold loans on their own balance sheets. This
is typically a small percentage of the loans but it can provide
assurances, particularly for newer platforms, that they believe in
their credit model enough to take loans on to their own balance
sheet.
The revenue model for a hybrid lender will often have a mix of
borrower origination fees and interest rate spread revenue.
Regulatory thoughts/concerns
Regulators should keep in mind that on the borrower side of the
marketplace most platforms are working under the exact same
regulations as banks. This is because most platforms partner with a
bank to originate the loan. The bank will hold the loan on their
balance sheet for a short time (less than a week) and then sell the
loan to the marketplace.
With that said there are many things that regulators can focus
on:
Lending Club and Prosper have to register each loan with the
SEC as a security. This is a cumbersome and wasteful process that
benefits nobody. Loans are being funded so quickly today that
literally no one reads these filings.
Non-accredited investors are excluded from participating in
this asset class except people who live in certain states that have
approved Lending Club and/or Prosper.
Regulators should be concerned about the maintenance of a level
playing field between individual and institutional investors. So
far, there have been no incidences of any investors being given
preferential treatment but this is one area that concerns some
investors.
Most platforms don’t offer investing to retail customers due to
regulations that make it cost prohibitive.
Platforms will often service the loans themselves. Strong
standards are needed to be in compliance with all debt collection
laws.
Backup servicing should be mandatory for all platforms who do
their own servicing. This will reduce platform risk for
investors.
We would like to see greater access to this asset class for
non-accredited and retail investors, since it is a relatively safe
and appealing fixed income product that could be included in
retirement accounts. It provides access to capital to underserved
borrowers, it empowers the investor, and it strengthens the fabric
of the US society. From the platform’s perspective, it diversifies
the investor base, which provides for increased stability.
We believe that the trend will continue to shift from Balance
Sheet to Marketplaces and we hope that the trend shifts from an
environment that is dominated by institutional investors to a
balance with retail investors. We would like to see policy and
regulation focus on opening this market to retail investors,
similar to the other two major online lending markets in the world:
UK and China.
Q2: According to a survey by the National Small Business
Association, 85 percent of small businesses purchase supplies
online, 83 percent manage bank accounts online, 82 percent maintain
their own website, 72 percent pay bills online, and 41 percent use
tablets for their businesses. Small businesses are also
increasingly using online bookkeeping and operations management
tools. As such, there is now an unprecedented amount of online data
available on the activities of these small businesses. What role
are electronic data sources playing in enabling marketplace
lending? For instance, how do they affect traditionally manual
processes or evaluation of identity, fraud, and credit risk for
lenders? Are there new opportunities or risks arising from these
data
?
based processes relative to those used in traditional
lending?
These platforms have created the technology to make an
online loan from start to finish a possibility. It also has
made loan origination a much more efficient process resulting in
funds being posted to a borrowers account in just a few days or
even quicker. There are several ways that big data and
technology are impacting marketplace lending today.
Loan underwriting
Technology, big data and the transparency of that data is one of
the major reasons this industry has been a success. By using big
data, lenders are able to create linear regression models and
machine-learning algorithms in conjunction with their own credit
models to better underwrite their customers. They use many of the
same data points that traditional lenders use but they have also
added new data sources. And as the marketplaces have
exponentially increased loan volume, over time they have been able
to improve underwriting and better price risk based on this data.
This better underwriting and increasingly longer track record
has resulted in lower rates for borrowers, while still continuing
to attract new investors.
One of the true innovations that marketplace lending has brought
are the new data sets that until very recently were not considered
in traditional underwriting. Platforms can connect with the APIs
from all kinds of companies in real time: ADP for payroll
information to verify income, Yodlee for personal finances,
Facebook or Twitter for identity verification. For small businesses
the dataset is even more extensive: Quickbooks for financial data,
UPS for shipping data, Yelp for review data, eBay, Amazon or Etsy
for online store data and much more.
The biggest two marketplaces in the U.S. update their loan data
quarterly, and at least with Lending Club potential investors are
able to download this data. Although they have restricted some
fields to lessen the ability of competitors to reverse engineer
their credit models, this transparency is what gave new investors
the confidence to invest in this new asset class from the very
beginning. Other marketplaces will offer their loan data under an
NDA to potential institutional investors.
Fraud Detection
With no face-to-face interaction it is critically important for
platforms to have sophisticated fraud detection. Many of the same
data sets that are used in loan underwriting are optimized
specifically for fraud detection with a borrower’s online footprint
being carefully validated. For most platforms any borrower that
does not pass all the automated fraud detection tests will be
flagged and investigated manually. Although at least one company in
the small business space, Kabbage, has a 100% automated
underwriting process with no human intervention and has succeeded
in keeping fraud to a tiny fraction of their loan book.
These advances in online fraud detection have resulted in a
surprisingly low rate of fraud at most platforms.
Borrower acquisition
In this new age of data borrowers can be targeted much more
intelligently than ever before. While marketplace lending platforms
use traditional media such as television, radio and direct mail to
attract borrowers they are increasingly using partnerships with
lead generation companies to send them pre-vetted borrowers.
On the consumer side the two leading providers are Credit Karma
and LendingTree and on the small business side there is Lendio,
Fundera, Biz2Credit, and Connect Lending. These lead generation
companies will select the best platform based on the criteria the
prospective borrower enters. This leads to a very high percentage
of borrowers obtaining loans from the online lenders thereby
providing a much better customer experience.
Q3: How are online marketplace lenders designing their
business models and products for different borrower segments, such
as:?
Small business and consumer borrowers;?
Subprime borrowers;
Borrowers who are “un
?
scoreable” or have no or thin files;
Depending on borrower needs (e.g., new small businesses,
mature small businesses, consumers seeking to consolidate existing
debt, consumers seeking to take out new credit) and other
segmentations?
There are many market segments in online lending today:
1. Consumers
Prime
Near prime
Sub prime
Student
Asset backed lending
Auto (direct)
Online pawn shops
Healthcare
Cosmetic & elective health
Hospital services
2. Small businesses
Long term
Short term
Merchant Cash Advance
Accounts Receivable
Point of Sale
Equipment finance
Asset backed lending
Auto (indirect)
Aviation
Construction
3. Real Estate
Short term bridge loans
Buy to rent
Non-qualifying mortgages
Commercial
Retail
Lending Club and Prosper focus on
unsecured consumer loansfor prime or near-prime
borrowers. Their average borrower has a FICO of around 700
and, for the most part, they don’t accept borrowers with less than
a score of 640. Since the inception of these lenders, there have
been many new entrants who focus on different segments and now it
seems there is a platform for every niche.
For borrowers who have a
thin filethere are some unique approaches being
taken. A company like Upstart focuses on young borrowers who have
recently graduated college. They collect additional data points
including the college they attended, standardized test scores, and
academic history. Using their unique algorithm, they try to
determine the future earning potential of a borrower. They are
looking to identify borrowers who will be considered prime in
the future but who may not qualify for a loan today from
traditional lenders.
Student lendingis a unique subset of consumer
lending. The platforms here have focused primarily on refinancing
existing student loans. There is a “one-size fits all” approach to
traditional student lending and many new graduates have excellent
credit. These people are able to refinance their loan at a lower
rate, particularly in the case of private student loans, saving
students often tens of thousands of dollars. Like Upstart,
platforms here such as SoFi and CommonBond look at future earning
potential.
Small business lendingrequires a very different
approach than consumer lending. In the case of very young companies
the only option for lenders is to underwrite based primarily on the
personal credit of the company owners. More established companies
have the luxury of a financial track record and so the health of
the business is the primary factor considered during the loan
application.
There is a huge variety of loan products available today for
small business owners. Not that long ago small businesses had two
choices: a bank loan or fund their business on credit cards using
their personal credit. Now, there are many different loan products
available to small business owners. What is important for small
business owners is considering the total cost of the loan.
Transparent pricing is a real issue for small business lending
because the products are often so different. This is why some
platforms have grouped together to create the Small Business
Borrowers Bill of Rights. More on that in the response to Question
11.
Online platforms for
real estatelending (typically called real estate
crowdfunding) have exploded in just the last 18 months. This
industry barely existed three years ago and today there are over
100 platforms offering real estate loans. Most platforms focus on
short-term loans of less than 12 months for small developers
looking to do a “fix ‘n’ flip” where they purchase a home, do some
renovations and then sell. Other kinds of loans, such as
buy-to-rent and commercial real estate loans are becoming more
common today.
Real estate is a unique asset class with a very different
underwriting process to other types of lending. This is
asset-backed lending so here the platform will assess the
underlying asset as well as the borrower.
There is a mix of debt and equity platforms, many offer both
types of investments. Almost all platforms only allow accredited or
institutional investors and there is a usually a high minimum
($5,000 or $10,000) per loan.
Regulatory Thoughts
From an investor’s perspective, regulators should pay attention
to style drift and credit underwriting standards. The marketplace
lending platforms are incented to originate as many loans as
possible, thereby generating fees, so it important to monitor that
the types of loans for the stated strategy are the actual loans
that are being originated. So far, Lending Club and Prosper have
established best practices including platform transparency and
making the historical loan data files available for download.
From a borrower’s perspective, all forms of lending are
potentially exposed to online lending alternatives. It is very
difficult to cut through the clutter to find trustworthy options.
We were encouraged to see the creation of the Small Business
Borrower’s Bill of Rights. We hope that this frameworks gain
tractions in the small business category and we hope that similar
frameworks emerge in other categories.
Q4. Is marketplace lending expanding access to credit to
historically underserved market segments?
While many platforms focus primarily on providing a better
option for people who can already get credit some are expanding
access to credit for people who have been excluded until now.
Examples of some online lending platforms expanding access to
credit:
Upstart focusing on young people with a good education who are
just starting out and have little or no credit history.
Avant targets the “middle class” borrower who has fewer options
than prime borrowers.
Freedom Financial is an example of a company who works with
borrowers who have had some financial distress, a group that most
platforms ignore.
Oportun, formerly Progresso Financiero, targets the Hispanic
market, a notoriously underserved market by traditional financial
services.
LendUp helps sub-prime borrowers transition from payday lending
through education and a system that will actually improve the
borrowers credit score.
Lenddo is establishing an alternative credit score for people
without a credit score.
Kiva Zip is an impact investment platform to help customers and
brand ambassadors support their local business.
We are seeing the most innovative forms of inclusive finance
emerge outside of the US, typically through the use of alternative
sources of data including telco data, ecommerce data, search data,
and social media data. China in particular has granted credit
bureau licenses to the leading consumer Internet companies (Baidu,
Alibaba, and Tencent) and we are seeing promising early results of
combining alternative data with traditional credit data.
Q5: Describe the customer acquisition process for online
marketplace lenders. What kinds of marketing channels are used to
reach new customers? What kinds of partnerships do online
marketplace lenders have with traditional financial institutions,
community development financial institutions (CDFIs), or other
types of businesses to reach new customers?
We covered some of this in question 2 but here is a more
complete list of the kinds of marketing channels used by online
marketplaces:
Traditional advertising: television, radio and print, usually
with a direct response component.
Online: paid search, SEO (search engine optimization), display
advertising, affiliate, social media
Partnerships: largest referrers to marketplace lenders are
Credit Karma and LendingTree. Banks and credit unions are also
becoming an important source of borrowers for some platforms.
Direct mail: many platforms start with this because it is very
easy to target geographically and allows borrowers to receive a
pre-approved loan offer.
Email: all platforms utilize email extensively.
Loan brokers: most prevalent in the small business and real
estate spaces.
Repeat customers: many customers will borrow a second or third
time.
Acquisitions: this has just started happening, platforms will
buy a company because they have a desirable borrower pool.
There are some newer platforms focused on working directly with
community banks and even some larger regional banks. This is
expected to be a major growth area in the future as more banks
partner with online lending platforms.
Of special mention is the Lending Club-Citi deal that was
announced at LendIt in April. This is a mutually beneficial deal
whereby Lending Club provided their service to Citi so that Citi
could satisfy its CRA requirements. Lending Club enabled them to do
this for borrowers who live in remote geographic areas for very
little cost.
Regulatory Thoughts
We suggest that regulators pay particularly close attention to
the lead generation category, which is on the front lines of
borrower education and acquisition.
We believe that the stock price charts of Lending Club and
LendingTree over the past year provide insight into the increasing
value of customer acquisitions in the lending industry. LendingTree
is a lead generation company and its stock us up 100% while Lending
Club’s stock is down 50%. The lead gen companies are the downstream
beneficiaries of customer acquisition dollars spent by the
marketplaces. The investment community has recognized that the
borrower community is the scarce commodity that can either
constrain or drive the growth of a marketplace.
From a regulator’s perspective, the practices of the lead gen
companies should be closely monitored. The marketplaces could pay
increasing amounts per borrower lead as competition increases and
their operations scale. The lead gen companies are incented to use
aggressive tactics to acquire borrowers and should be closely
watched.
Q6: How are borrowers assessed for their creditworthiness
and repayment ability? How accurate are these models in predicting
credit risk? How does the assessment of small?business borrowers
differ from consumer borrowers? Does the borrower’s stated use of
proceeds affect underwriting for the loan?
Every marketplace lending platform creates their own proprietary
credit model based on their own analysis of credit bureau data.
Most platforms hire experienced credit experts who have created
these models at traditional lenders.
For those platforms with an established credit history these
models have been very accurate in predicting credit risk. Large,
sophisticated investors with a history of investing in consumer
credit continue to invest in Lending Club, Prosper, SoFi and other
platforms precisely because they have done a good job at evaluating
risk.
The one proviso that we need to mention is that most of these
platforms began after 2009 and so have not experienced an economic
downturn. Lending Club, Prosper and OnDeck did all experience the
economic downturn in 2008-09 and managed to come through ok
although their loan books were much smaller then.
Small business underwriting is very different to consumer
underwriting. Consumers are much more homogenous than small
businesses. A group of borrowers with a 720 FICO score and a
$75,000/year income will all tend to perform in a similar way.
Every small business is different, even franchise businesses. So
more data is needed to underwrite these businesses accurately.
Some platforms have begun to use borrower purpose to evaluate
risk, although it is far from universal and results are not
proven.?Most platforms, will not take loan purpose into
consideration when underwriting a consumer loan.
Q7: Describe whether and how marketplace lending relies on
services or relationships provided by traditional lending
institutions or insured depository institutions. What steps have
been taken toward regulatory compliance with the new lending model
by the various industry participants throughout the lending
process? What issues are raised with online marketplace lending
across state lines? ?
Most platforms work with an FDIC insured institution to offer
loans nationally. These banks will originate the loan and then hold
on their balance sheet for a short time before selling to the
platforms.
These banks, and there are only a small number of them, all work
within the established regulatory framework. They undergo regular
audits and internal reviews to ensure adherence to all applicable
regulations. These banks assume most of the risk for monitoring the
activities of the platforms as it relates to compliance and are
subject to routine examinations.
While platforms could go state by state and apply for lending
licenses themselves, most choose to partner with a bank that can
then export the interest rate of that bank nationwide. Now, there
is a case before the courts (Madden vs Midland) that is challenging
the law for exporting interest rates across state lines and it will
likely go to the Supreme Court so a final decision on this is not
expected for quite some time.
One issue being raised by platforms is the burden of these state
regulatory requirements that are often inconsistent with federal
regulatory requirements.
Banks are also involved in the online lending process in other
ways:
On marketplaces, investor money is kept on deposit in a
bank.
For borrowers, loaned money is usually sent via ACH from the
platforms bank to the borrowers bank account.
Banks are partnering with platforms to obtain borrowers.
Banks are buying loans on the platforms
Securitizations, both rated and unrated, are underwritten by
banks.
Warehouse lines and leverage facilities for institutional
investors are mostly provided by banks.
Many employees at platforms come from traditional financial
services.
Regulatory Thoughts
We are not the experts in bank compliance and regulation. We
suggest that you pay particularly close attention to a few
different constituents:
Cross River Bank: Cross River Bank has been the most active
origination bank and is trying to instill best practices for our
industry.
American Bankers Association: the ABA focuses on regulatory
arbitrage, they want a level playing field where banks and non-bank
lenders are regulated equally. They wrote this opinion piece after
our LendIt Conference:
“Banks Don’t Need Protection from
Startups – But Consumers Sure Do.”
Title IV of the JOBS Act “Regulation A+”: Title IV of the JOBS
Act recognized that the overhead of establishing and maintaining
the regulatory framework for large public companies is too
cumbersome for small business and it stifles access to capital and
innovation. Reg A+ is a lightweight version of an IPO that provides
a regulatory framework for smaller businesses. While focused on
equity raises, Reg A+ is a good example of a two tier regulatory
system for small and large companies.
P2PFA/FCA: In the UK, the P2P Financial Association is the
industry association that created a regulatory framework that was
ultimately adopted by the FCA. They classified P2P lending as a
“lower risk” investment (more risk than bank deposits, less risk
than equities). Their basic premise is that P2P lending offers
significant economic and customer benefit, a regulatory framework
is needed, but the framework must balance the benefits of
innovation and efficiency against full consumer protection. We
believe that the P2PFA/FCA solution is the best public-private
regulatory approach to P2P lending in the world and we would
support the implementation of a similar model in the US.
Q8: Describe how marketplace lenders manage operational
practices such as loan servicing, fraud detection, credit
reporting, and collections. How are these practices handled
differently than by traditional lending institutions? What, if
anything, do marketplace lenders outsource to third party service
providers? Are there provisions for back-up services? ?
Loan servicing is done in house at many platforms. To satisfy
investors these platforms typically also have backup servicers in
place. These servicers can step in if there is ever a problem at
the platforms.
Fraud detection is a major focus of all platforms. There are
some very sophisticated automated systems that have been built to
flag incidences of possible fraud.
Credit reporting and collections are done in a very similar way
to traditional financial institutions. Collections are typically
outsourced after a set period, often 30 days.
Regulatory Thoughts
What happens to the total cost of operations when delinquencies
spike? How much of the operational efficiency of online lending is
the direct result of underinvestment in their servicing and
collections groups during a benign borrower delinquency period. The
platforms say that they are fully prepared. Perhaps regulators
could require a stress test or audit on platforms to ensure that
they can scale their operations properly?
Q9: What roles, if any, can the federal government play to
facilitate positive innovation in lending, such as making it easier
for borrowers to share their own government-held data with lenders?
What are the competitive advantages and, if any, disadvantages for
non- banks and banks to participate in and grow in this market
segment? How can policymakers address any disadvantages for each?
How might changes in the credit environment affect online
marketplace lenders?
There are many things the federal government can do to
facilitate positive innovation in lending. We are at a critical
time in history right now with lending going through a
transformation, so it is crucial that the government acts
thoughtfully and not stifle innovation. Other countries such as the
United Kingdom and New Zealand already have sensible regulations in
place that has been embraced by the platforms, the borrowers as
well as large investors and these countries are attracting a lot of
overseas capital because of that.
It should be pointed out that all marketplace lending platforms
are heavily regulated already on both sides of their marketplaces.
A myriad of federal fair credit laws already apply for borrowers
and on the investor side federal securities laws apply to all
platforms.
Having said that here are some thoughts on regulation:
For any changes work with the marketplace lending community in
a collaborative way to create a robust but welcoming environment
for innovation.
Work within, and help enhance, the current regulatory
framework.
Remove the necessity to file every loan with the SEC as a
separate security for platforms who want to allow non-accredited
investors.
Foster partnerships with marketplace lending platforms and the
banks, encouraging banks to offer the advantages that come with
technology and product innovation.
Help expand or facilitate the expansion of the secondary market
to generate liquidity to market participants and loans to
borrowers.
Allow home state interest rates to be exported nationally.
Allow more efficient access to IRS data for both consumers and
small business.
Expand the SBA budget to work with marketplace lending
platforms as well as banks.
Collect loan level data and apply it to FRED – give us
aggregated and anonymized insight.
We believe that online platforms:
Provide access to capital to creditworthy borrowers, some of
who do not have access to an alternative source of capital
Provide a sense of empowerment for lenders who have made the
choice to directly invest (and impact) the lives of others.
Strengthen the fabric of our society by leveling the playing
fields and providing lower cost access to capital to underserved
categories.
For any regulatory enhancements we should consider those
premises so that regulation can further strengthen the
industry.
The bottom line is this. The U.S. has always led the world in
financial services. But lending money to consumer and small
businesses is going through rapid changes right now and it is never
going back to the way it was last century. For the U.S. to continue
to lead the world of financial services in this century it needs a
regulatory framework that will encourage innovation. Otherwise,
countries like the United Kingdom and China will likely be the
source of continued innovation.
Q10: Under the different models of marketplace lending, to
what extent, if any, should platform or “peer-to-peer” lenders be
required to have “skin in the game” for the loans they originate or
underwrite in order to align interests with investors who have
acquired debt of the marketplace lenders through the platforms?
Under the different models, is there pooling of loans that raise
issues of alignment with investors in the lenders’ debt
obligations? How would the concept of risk retention apply in a
non-securitization context for the different entities in the
distribution chain, including those in which there is no pooling of
loans? Should this concept of “risk retention” be the same for
other types of syndicated or participated loans? ?
There is no consensus in the industry on this issue. It is often
discussed as a criticism of some platforms that do not have skin in
the game, that there is some misalignment of interests between the
platform and the investor.
On the surface this seems like a valid point, particularly given
what happened during the financial crisis. But we would argue that
there is no misalignment of interests whether or not a platform has
skin in the game. These loans are relatively short term, so within
a matter of months investors can see how the loans are performing.
If there is underperformance investors can and will choose to stop
investing. When this happens the platforms will struggle whether or
not they have skin in the game.
People have been arguing for years that as the industry scales
there will be the temptation for platforms that do not have skin in
the game to loosen their underwriting standards. Even as the
largest platforms originate billions of dollars in loans we can see
that they continue to maintain their credit standards and this
loosening has not happened.
The platforms that do choose to invest in their own loans and
hold them on their own balance sheet often use that as a selling
point to investors. But it feels unnecessary to legislate skin in
the game for all platforms.
Q11: Marketplace lending potentially offers significant
benefits and value to borrowers, but what harms might online
marketplace lending also present to consumers and small businesses?
What privacy considerations, cybersecurity threats, consumer
protection concerns, and other related risks might arise out of
online marketplace lending? Do existing statutory and regulatory
regimes adequately address these issues in the context of online
marketplace lending?
Current regulations adequately protect the borrowers from risk,
particular on the consumer side where platforms must adhere to the
same lending laws as banks.
On the small business side more could be done to increase the
transparency for small business borrowers. Much of the pricing and
loan terms are difficult for business owners to understand and
there is no easy way to compare costs between loan products. The
industry has already created a
Small Business Borrowers Bill of Rightsthat has
been adopted widely so new regulation in this area would be
premature.
This Bill of Rights, specifically for small business owners, is
a very important step for this industry. Many of the largest small
business lending platforms have signed on to this Bill of Rights,
which has the following tenets:
The Right to Transparent Pricing and Terms
The Right to Non-Abusive Products
The Right to Responsible Underwriting
The Right to Fair Treatment from Brokers
The Right to Inclusive Credit Access
The Right to Fair Collection Practices
On the subject of risk there are many considerations:
Privacy risks – we need to ensure that platforms are not
sharing their data unlawfully.
Cyber Security – any business that operates online has cyber
security risk. We have seen some of the largest corporations in
this country fall prey to hackers so this risk will always be
there.
Consumer protection concerns – the current regulatory framework
is sufficient here.
Underwriting risk – recession could see large increase in
defaults. Related: pressure to grow could see platforms loosen
standards.
Bad actor risk – could be fraud or mismanagement at a newer
platform.
Risk can never be completely legislated away. While the risks
will continue existing regulations are sufficient for protecting
consumers and small businesses.
We believe that the key to long term success here is three
fold:
Platforms should provide clarity on the terms for both the
lender and the borrower
Platforms should provide historical data files of all loans
ever originated making as many variable as possible available to
analyze
Platforms should provide an open API for automated
transactions
The best platforms will encourage the participation of the
ecosystem. The creation of the ecosystem is the best path for
success, since the ecosystem provides capital and innovation. If
regulators were to push for platforms to increase transparency,
provide historical data, and open electronically, the ecosystem
will be enabled to filter for best and worst platforms.
Q12: What factors do investors consider when: (i) investing
in notes funding loans being made through online marketplace
lenders, (ii) doing business with particular entities, or (iii)
determining the characteristics of the notes investors are willing
to purchase? What are the operational arrangements? What are the
various methods through which investors may finance online platform
assets, including purchase of securities, and what are the
advantages and disadvantages of using them? Who are the end
investors? How prevalent is the use of financial leverage for
investors? How is leverage typically obtained and
deployed?
Marketplace lending began with individual investors at Lending
Club and Prosper. Many early adopters invested despite the risks
involved when these platforms were new. Today, many investors like
to work only with established platforms that have a long track
record.
Factors that investors consider when investing include:
Interest rate
Loan duration
Creditworthiness of the borrower
Loan purpose
How quickly the available cash can be deployed
Are there enough loans to create a diversified portfolio
The minimum investment required per loan (for fractional
loans)
The end investors fall into a number of different
categories:
Individual investors
Family offices
Hedge funds
Publicly traded closed end funds
Banks
Insurance companies
Sovereign wealth funds
Pension funds
Securitizations
Endowments
Some platforms operate their own funds.
Financial advisors are starting to put their clients money to
work.
Leverage is not a big part of the industry. While leverage is
definitely used by some of the funds it is not a majority of the
loan volume, in fact it probably represents less than 25% of the
total loan volume. Leverage is obtained from banks such as Capital
One, Silicon Valley Bank, Jefferies and many others.
Q13: What is the current availability of secondary
liquidity for loan assets originated in this manner? What are the
advantages and disadvantages of an active secondary market?
Describe the efforts to develop such a market, including any
hurdles (regulatory or otherwise). Is this market likely to grow
and what advantages and disadvantages might a larger securitization
market, including derivatives and benchmarks, present?
There has been a secondary market for retail investors for many
years. It is a fully functioning and active market, particularly at
Lending Club, with many individuals using it for liquidity just as
it was intended. The problem is that only small investors
participate, so institutional investors are left without this form
of liquidity.
For institutional investors the only option that exists today is
securitization. There have been more than a dozen securitizations
done to date, mostly unrated, although some recent issuances have
received investment grade ratings.
One of the challenges for a fully functioning secondary market
for institutional investors is that it is not a high priority for
most of the main players. The platforms have strong investor demand
so they are reluctant to devote significant resources to help
create it. Service providers who have the capability have other
priorities as everyone tries to compete in a fast growing industry.
Efforts have begun but they need buy-in from platforms.
The platforms question whether there will be enough demand today
to create a sustainable secondary market for whole loans. Most
loans issued are relatively short duration and for those investors
that want liquidity they can get it by participating in a
securitization.
There is no derivatives market yet but as the industry matures
this will likely become a reality. Some investors do want the
ability to hedge their positions in marketplace lending. Once
indices/benchmarks develop then there will be those who want to go
long and those short, and there are at least two companies working
on providing that capability but this is still in the early
stages.
Q14: What are other key trends and issues that policymakers
should be monitoring as this market continues to develop?
One of the key trends that is happening today is the
participation of banks in marketplace lending. Many banks see this
as a way for them to deploy capital in a cost efficient way in
asset classes that are complimentary to their existing
holdings.
The recent acquisition of personal finance company, BillGuard,
is also significant in that it shows that marketplace lending
platforms want to provide more than just loans to their customers.
They want to provide value added services to borrowers so that they
can develop long lasting relationships with consumers. This is also
happening on the small business side where some platforms offer
free services to small business owners.
As we have mentioned previously, we also think that policymakers
should be monitoring the regulatory environment in other countries,
in particular the United Kingdom, where marketplace lending is
thriving under a new regulatory environment.
There are several other things for policy makers to
consider:
How an interest rate rise will impact the industry.
What happens during the next economic downturn.
Are borrowers still being treated to fair pricing and
transparent loan terms.
Applying current regulation to changed product offerings
Cybersecurity is of paramount importance to all
participants
Development of secondary markets
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Response to the Treasury’s Request
for Information on Marketplace Lendingappeared first on
Lend Academy.