Eight years ago, the global financial crisis changed the way we think about debt. It shook public faith in the big banks—some of which didn’t survive the meltdown. And in the process, it made room for the rise of marketplace lending.
This financial innovation consists of online exchanges where ordinary people make unsecured high-interest loans to other ordinary people. That’s why marketplace lending is also known as peer-to-peer lending. By matching lenders directly to borrowers, it takes the bank middleman out of the debt market.
Since its inception in the late 2000s, marketplace lending has seen good and bad years. Today, an imminent interest rate hike has made its future uncertain. By learning more about the young peer-to-peer loan market, we can take a better guess about its fate.
The Case for Investing In Marketplace Lending
Peer-to-peer lending expanded rapidly in the early days of the Great Recession. Interest rates were at rock-bottom, making it hard for investors to find yield in traditional banking products.
And the ensuing credit crunch made it hard to get approved for personal loans. Thus, many borrowers couldn’t get service at banks. Instead, they went to online marketplaces for financing. Two of the most prominent are OnDeck (NYSE: ONDK) and Lending Club (NYSE: LC).
Lending Club sorts its loans into almost 40 risk grades. Annual interest rates range from 6% for high-credit borrowers to 36% for risky borrowers. That makes them very competitive with traditional debt investments. It’s no wonder that marketplace loans soared 700% between 2010 and 2014.
What’s more, the marketplace lending process is considerably faster than traditional banking. Peer-to-peer borrowers can fill out an application in minutes, and get their funds in a few days. By contrast, traditional loans often take weeks to process.
This is partially because peer-to-peer networks like Lending Club and OnDeck have managed to stay under the radar of Dodd-Frank authorities and other regulators. But as we’ll see in a moment, that may change soon.
Peer-to-peer lending is fast and easy for borrowers. And it can be very profitable for investors. It’s especially competitive in times of scarce credit or low interest rates. But that doesn’t mean it’s a panacea for every problem in the debt markets. Marketplace lending also has some significant weaknesses. And some haven’t been addressed yet.
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The Case Against Investing In Marketplace Lending
Take a quick look at the stock performance of OnDeck and Lending Club. It becomes pretty clear that there are some problems under the hood. Both companies are down almost 50% in the last year.
Why have these promising financial-tech disruptors tanked so hard? There are a few reasons. Perhaps the biggest is that marketplace loans are unsecured personal debt. The only risk management involved in the process is a brief credit check. And as Lending Club’s 36% top annual interest rate implies, some of these loans are really risky.
Back in 2008, the SEC made a foray into regulating these industries. They required them to securitize their loans, in accordance with the 1933 Securities Act. Private marketplace lender Prosper managed to …read more
Source:: Investment You
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