Peer-to-peer lending is popping up a lot in banking circles all of a sudden, and reactions run the gamut.
At Wells Fargo, some employees received an email late last year saying they cannot participate in P2P lending because companies in that space are considered part of the competition. At the other extreme, tiny Titan Bank in Mineral Wells, Texas, is buying P2P loans for its own portfolio in an unusual alliance with the largest originator in this niche.
But even as more bankers take sides on what some see as a newly emerging battleground, it's fair to say that most have given little thought to the P2P sector so far. Websites such as Lending Club and Prosper, which match up consumers seeking to borrow money with other consumers willing to use their own money to fund those loans, are just not on their radar.
That's about to change.
Though still a microscopic part of the estimated $11 trillion consumer lending market, P2P is going to matter in a big way sooner than you think, say those familiar with the sector. The pioneers in this space are moving past the early losses and regulatory hiccups that held them back for years. They are growing fast, mostly through loans to consolidate credit card debt, and taking some of banks' best customers in the process.
Thanks to their success, more P2P startups are proliferating. Some, like Funding Circle, are using the same model to offer small-business loans.
Now P2P lenders are starting to recruit traditional players in financial services—banks like Titan and institutional investors—to help fund their loans and fuel their growth. A few also are paying banks for customer referrals.
And some online direct lending startups, though still considered part of the P2P sector, do not use "peers" at all in the funding part of the equation. Instead of having individual mom-and-pop contributors risk small amounts, they line up big investors like hedge funds to buy their loans in bulk.
Brendan Ross, president and portfolio manager at the hedge fund Direct Lending Investments, buys small-business loans from online lenders such as IOU Central and QuarterSpot for his fund. The way he sees it, P2P has created an entirely new bank model. It may not be fueled by "peers" as once envisioned. But it is all the more powerful in this new incarnation.
"People think of P2P lending as an Internet phenomenon, but it's not," Ross says. "It's a banking phenomenon."
He says P2P players do almost everything that banks do—market products, evaluate borrowers, underwrite and service loans. "The only thing they're not doing that a bank does is lending their own capital. They're lending other people's capital," he says. "They're like a bank without a balance sheet."
Unlike the spread lending done by traditional banks, this platform lending model, as Ross calls it, makes starting a new bank—or at least the functional equivalent of one—easier than ever, he says. Partly because they don't have the same regulatory burdens as traditional banks, the players in this space can use technology to evaluate risk in new ways and help borrowers that banks reject.
P2P makes sense for sophisticated investors as well. Ross says he generally buys loans that mature in a year or less, with interest rates ranging from 15% to 40%. Default rates usually run from 6% to 8%.
Ross predicts P2P is going to become a major force in lending and he says traditional banks need to figure out how they fit into the new paradigm.
"I believe this decade will see platform lending emerge to rival spread lending," he says.
In his view, the opportunity for banks is in "monetizing their declines," by vetting these new types of lenders, partnering with reputable ones, and referring customers who get turned down for bank loans. QuarterSpot recently began working with banks in this way, paying an origination fee for the referrals.
If bankers are skeptical, the peer-to-peer sector's bumpy start could be partly to blame. But those familiar with P2P say it is now in its "2.0" stage.
Companies like Lending Club and Prosper, which helped create this niche, look much different than they used to. Over the past year, they have been making headlines that illustrate as much.
Lending Club, for example, received a $125 million investment from Google and added Larry Summers, the former U.S. Treasurer, to an already substantial board that includes former Morgan Stanley titans John Mack and Mary Meeker. It has plans to do an initial public offering sometime this year.
Prosper received a $20 million investment from Sequoia Capital upon bringing in a new management team in early 2013. The team quickly made changes to improve the borrowing and lending experience. Just as significantly, it settled a longstanding class-action lawsuit by Prosper "1.0" investors for $10 million, putting a close to a problematic first stage in which defaults soared above 36%. The company also has high-profile board members of its own, including the Consumer Financial Protection Bureau's former deputy director, Raj Date.