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Innovation of the Year: Online Marketplace Lending

When gold was discovered on the remote Klondike River in northwest Canada in 1897, people got excited. "STACKS OF YELLOW METAL!" one newspaper headline screamed.

An estimated 70,000 prospectors headed to the Yukon territory. Along the way, tens of thousands of them stopped in Seattle, the nearest city of much note, to buy the gear they would need. The city's population surged, as merchants popped up to sell tents, warm clothing and stores of food.

Pardon the well-worn metaphor, but 2014 was a Gold Rush year for online marketplace lending.

The sector's undisputed leader, Lending Club, more than doubled its quarterly loan volume on its way to a lucrative initial public offering. A flood of new capital from hedge funds and other institutional investors entered the market. Bankers sat up and took notice. New asset classes including small-business loans, real estate loans, and even loans for the purchase of solar panels were pioneered. An ecosystem of ancillary firms matured. By December, roughly 100 different online platforms were operating in the U.S., according to one estimate.

As a result of the industry's rapid growth and evolution, American Banker has named marketplace lending its Innovation of the Year.

Here's one sign of dizzying change in this industry: American Banker's editorial staff recently had an internal debate over what moniker to use to describe it. Until recently, "peer-to-peer lending" was the preferred term for the business activity of companies like Lending Club and Prosper.

Then, after individual investors in the loans began to be elbowed out by hedge funds and other institutional investors, the industry rebranded under the "marketplace lending" name. There's also the "alternative lending" label, which is often used to describe nonbank balance-sheet lenders, such as OnDeck, that rely on Web-based loan origination platforms.

In the end, we decided that "marketplace lending" best describes the many fast-growing firms using technology to build online platforms that stand between borrowers and lenders. Fortunately, unlike the investing public, we're not required to make a judgment about how big marketplace lending will eventually become.

Today, there's certainly no shortage of excitement or hype.

Lending Club's share price shot up by 56% on the first day of trading in December, resulting in a market capitalization roughly equal to those of midsized banks like Huntington Bancshares and Comerica Inc.

The sheer variety of investors piling into marketplace lending speaks to the perceived size of the opportunity. An estimated 80% of the industry's loan originations are now going to institutional buyers.

The massive asset manager BlackRock may be the company that's currently most heavily invested in marketplace lending. But the spectrum of participants also includes hedge funds, business development companies, banks and, soon, life insurance companies, according to advisers. It's a far cry from the days when the online marketplaces were geared primarily toward individual investors.

Former Pimco CEO Mohamed El-Erian was the most recent high-profile investor to formally enter marketplace lending. He took a $12 million equity stake in online platform Payoff, which is setting up an infrastructure to originate its own loans. Another famous investor, the billionaire George Soros, is also preparing to back the industry, American Banker reported in November.

A recent report by a California venture capital firm predicted that marketplace lenders will originate $1 trillion of loans annually by 2025. That'd be more than a 100-fold increase from the estimated $8.8 billion in marketplace loans made this year.

"For the first time in banking, the online marketplace makes it possible for a third party to match idle supply and demand," argues the report, written by Foundation Capital, which has investments in both Lending Club and OnDeck. "As a result, lenders and borrowers can now find one another and agree to terms all without the involvement of retail banks or credit card companies."

But there are reasons to be cautious, at least for now, about starry-eyed predictionsfrom the industry's boosters. Among the concerns are interest rate risks, the patience of investors, the ability of the loans to weather the next economic downturn and possible competitive threats from traditional banks as well as more established technology companies.

In this article, we profile some of the players a mix of startups and more established firms that are emblematic of the new industry and its underlying technological and social infrastructures. And we offer an outlook on the challenges ahead that could add up to marketplace lending's first wakeup call or worse.

The Pacesetter

Lending Club, which launched its website in 2007 and started growing rapidly in the wake of the Great Recession, maintained its sharp upward trajectory this year.

In March, the San Francisco-based company extended past its roots in consumer lending and started originating small-business loans. In April, Lending Club paid $140 million in cash and stock to buy Springstone Financial, which offers private student loans and financing for elective medical procedures. In the second quarter, Lending Club topped $1 billion in quarterly loan originations for the first time.

In December, the company became the first marketplace lender to sell stock to the public. And on the first day of trading, its stock price popped.

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Interesting. We got surprised with power of P2P when we worked with a NZ based P2P in building a entire technology stack. P2P is going to be a disruptive model and will change way people will manage their money.
Posted by a.prabhu | Sunday, December 21 2014 at 12:57AM ET
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