Marketplace lending surely had its day in the sun in 2014. Peer-to-peer lending, which now goes by the term marketplace lending, took a big step forward last year. We saw the IPO of Lending Club rocket in its first day of trading on December 11, 2014 by first pricing above the range at $15 per share and then touching a high mark of 67% that day. Lending Club has been the leader in this field and its IPO highlighted the importance and the emergence of this new lending alternative. Despite this surge, however, not everyone attended the party in 2014. Noticeably, the SEC still has not finalized its crowdfunding rules, which are an important next step for the marketplace lending industry.
So what exactly is marketplace lending? Put simply, it is an Internet based lending market that is created by connecting borrowers with lenders or investors. There are various companies with different approaches to the concept. In Lending Club’s case, potential borrowers fill out online loan applications. The company (and its bank behind the scenes) then uses online data and technology to evaluate the credit risks, set interest rates and make loans. On the other side of the equation, Investors are offered notes for investment that correspond to portions of the loans and can earn monthly returns on their notes that are backed by borrower payments. As a result, marketplace lending effectively offers secondary market trading for loans.
On the positive side, marketplace lending can be good for borrowers because the lower cost structure of an online platform can be passed along to borrowers in the form of lower interest rates. The use of the Internet and online credit resources can also speed up the credit approval process so that borrowers can get funds faster. In addition, some borrowers may get access to loans that they could not get from traditional banks. In other words, the marketplace could help individuals with lower credit scores or negative credit histories find loans. Thus, despite its critics, marketplace lending can help serve a niche that has historically been underserved by the banking industry.
Marketplace lending, however, at least when it comes to Lending Club and those like it, still has a bank at its core. So some borrowers will still not be able to get loans through this marketplace model. Also, the investors are buying registered securities with interests in the loans made in the marketplace. Lending Club turned to registering their notes with the SEC when they were unable to get their original more direct peer-to-peer model of connecting lenders with borrowers to work under the securities laws. Registration, however, adds additional costs to the structure and is more like a loan securitization model. In addition, since there is a bank at the core of the Lending Club type model, this structure is similar to other credit finance models. The investors here are simply taking less return than other credit providers so the investors may not be receiving enough for the risk they are taking on. All in all, there are some concerns with the various structures that make up marketplace lending, despite the benefits.
So how would the SEC finalizing its rules on crowdfunding help marketplace lending? Despite the JOBS Act becoming law in 2012 and proposed rules being issued by the SEC in October 2013 with a 90-day comment period, the final rules on crowdfunding continue to be delayed at this point. However, the head of the SEC, Mary Jo White, recently indicated that “Completion of these rulemakings remains an important priority and the staff is working hard on the recommendations for the final rules.”
The final rules should allow marketplace lending without the need to register securities (like Lending Club ultimately did) to comply with the securities laws. The ability to crowdfund could also get the marketplace lenders back to something closer to their peer-to-peer roots. In other words, investors and borrowers could be more directly linked through crowdfunding than through the current process that more resembles the loan securitization process. This should further reduce the costs of the loans to borrowers as cost savings are passed along. Lenders should also benefit as the fees they pay the marketplace lender could be reduced as well.
Until the crowdfunding rules are finalized, I would anticipate the existing marketplace lending structure to continue to grow. It may be a modern spin on loan securitization, but it does have its benefits and serves some borrowers’ needs. As we move forward and this niche grows, banks themselves may even decide to buy their way into this industry. Since Millennials are generally thought to be more comfortable with online services and have tended to be wary of traditional banks, this may be a ripe area for banks to expand and the release of final crowdfunding rules may help.
Still, the SEC is certainly looking to protect less sophisticated investors (or lenders in this context). With crowdfunding specifically aimed at the general public, I am sure the SEC is being cautious here. Hopefully, the final rules will get the balance right between protecting the public from itself and allowing more investors to diversify their investments.