Peer-to-peer/marketplace lending is a disintermediating force, one that allows customers to cut out the banks – which have stood for centuries as the lending and saving institutions of choice. P2P platforms forge direct connections between borrowers and investors using the power of the internet. By matchmaking between these two groups online, the platforms are able to provide a more attractive deal to both parties. Better returns for investors, swifter and more flexible access to finance for borrowers.
The banks and other types of traditional financial institution operate as intermediaries. Money comes in one end, and leaves the other, and nobody on the outside can be quite sure of where and how that money will be distributed. Traditional financial intermediaries have high fixed costs (such as branch networks), which means that they often have to charge more for their services.
How is this different to an alternative finance platform? Platforms (generally speaking) veer wholly away from the “black box” approach. Their lenders have a great deal of clarity as to where and how their money is being put to work. Indeed, in many cases the lenders themselves will choose how to allocate their funds, by hand-selecting lending opportunities. Another crucial distinction is the number of layers involved in each business model. The banks may take a pool of depositor money, extend a facility to a hedge fund, which may then invest elsewhere, and so on, and on. Bank depositors do not hold a direct relationship with their debtors. P2P investors do.
And yet certain business models have sprung up within the past few years that have introduced an extra rung into the P2P ladder – in effect, reintermediating a famously disintermediated sector. While the platforms themselves are often rather wary of such business propositions, there are a number of reintermediators that are thriving. And make no mistake, they’d struggle to thrive without the platforms’ collective support.
So onto the central question: when and why do the platforms find value in reintermediation?
Let’s take a closer look at three intermediaries that have to date met with tangible success.
P2PGI is the alternative finance sector's foremost investment trust, investing across multiple geographies and asset classes. The Marshall Wace-backed, LSE listed fund has to date raised £870m, well over half of which has already been deployed.
High net worth individuals, asset managers, hedge funds, pension funds and insurance firms channel money into the P2PGI fund by purchasing shares in the company. That money is then used to fund whole loans on P2P/marketplace lending platforms all over the world.
It’s reintermediation in that the direct relationship between end borrower and investor is lost. Institutional investment is itself a reintermediation of the P2P process, in that investors are accessing debt through a specialist vehicle, rather than directly. And by doing so, those investors are likely to incur an added layer of fees.
Why accept those added fees? Because P2PGI is a passive investment medium (for investors), providing sector wide diversification, and the promise of “outperformance” (via a sophisticated loan selection process). The fund is also able to attract leverage of up to 1.5x the value of its assets under management.
It’s easy enough to see the lure for investors, but what benefit do the originators – the platforms – gain in selling their loans to a fund, rather than direct to retail investors?
These days, most of the platforms accept that institutional money is at the very least a useful complement to retail capital. It helps the P2P lenders to balance out supply and demand. But that doesn’t mean that the platforms aren’t cautious when it comes to working with institutional partners. One common concern is that institutional capital is by nature flighty, and therefore likely to disappear in a hurry in the event of a sudden souring of the market.
P2PGI, as a Closed End Fund (CEF), goes some way towards calming these fears. CEO Simon Champ has often spoken of the advantages of “permanent capital”. All of the money raised by P2PGI to date has been accumulated via the issue of shares in the company. In other words, the company has no money to repay to creditors (excluding its leverage providers), and thus stands as a stickier source of capital than other forms.
Furthermore, the fact that P2PGI packages up P2P loan portfolios into an equity product opens the asset class up to pension funds and insurance firms, which cannot, by law, invest directly in the platforms themselves.
There is clear value-added to the CEF model, and platforms all over the world appear to have bought in.
I reached out to Mr. Champ for an explanation of the benefits of permanent capital. He said:
"From a platform's point of view permanent capital equals transparency of funding and lower redemption risk. It also means platforms can spend more of their marketing time and budget on acquiring borrowers knowing the lending side is in place. Lastly It means the platform can have a dialogue with the permanent capital provider about planning the future and knowing he will be there, that is hard to do with a crowd."
Orchard leads the field amongst those companies vying to streamline access to the marketplace lending industry. Institutional investors and investment managers use the Orchard platform to allocate funds on a passive basis to marketplace lending platforms, in accordance with pre-set criteria. For originators, the site offers simplified access to a broad range of potential investors.
But Orchard isn’t alone in its efforts to own the middle ground between investors and originators. NSR Invest – a splicing of Lend Academy Holdings and Nickel Steamroller – delivers a not-dissimilar service, but with a greater focus on the retail investor. In the UK, a number of companies – such as InvestUP and BusinessAgent – are chasing a similar opportunity.
And yet Orchard has to date streaked away from the competition. So much so that Forbes recently named the company on a list of potential billion dollar startups. Orchard has raised $14.7m to date. Is it simply that Orchard got the jump on the competition – having launched into an increasingly institutional market at just the right time? Or is Orchard offering something that the platforms can’t say no to?
I’d say it’s a mixture of the two. Orchard is the first mover in this space, and we know that the platform works with a high quality range of investment managers and institutional investors. For early stage platforms in particular, the lure of gaining access to these capital sources is worth the price of involvement in the Orchard ecosystem.
But Orchard, which is fundamentally an aggregator – albeit a highly sophisticated one, in terms of its order management and portfolio reporting capacity – does nothing to alter the nature of the underlying asset into which its investors buy. The very largest platforms, which are capable of attracting more than enough capital directly, might therefore decide that exposure on the Orchard platform isn’t worth the cost. This very point was voiced at a recent gathering of UK platform CEOs.
Nevertheless, the Orchard proposition is clearly resonating with a broad range of market participants.
There is a healthy crop of borrower acquisition intermediaries in the UK. However, their success – to my mind – hinges on which of them is designated by the Treasury as a point of referral for small businesses that have been denied credit by the banks. We’ve just entered the “Request for Proposal” phase of the designation process, and I don’t expect the lucky few “finance platforms” to be announced until 2016. That’s not to say that the UK players haven’t met with some success already. Funding Options, for instance, recently secured a £1.25m investment from GLI Finance. But these online credit brokerages sprung up in anticipation of a state-backed system of SME referral, and only upon the advent of that system will we be able to properly judge their effectiveness.
The most successful borrower acquisition business that I’ve come across in fact hails from the other side of the pond. Lendio is on a mission to speed up and simplify the process of perusing small business loan options. The platform boasts a “Q&A” style interface, where SME owners are required to state how much money they require, number of years in business, average monthly sales, a credit worthiness estimate, and so on. Upon completion, Lendio will identify a range of potential funding options, and it will be for the business owner to sift between them.
So far, so familiar.
But Lendio also comes equipped with a couple of powerful distinguishers. Most crucial among these, as Founder Brock Blake told me when I met him in the Big Apple, is the company’s strategic partnership with Staples – one of the world’s leading vendors of office supplies. Staples refers its millions of SME clients to the Lendio site to help them with access to credit.
Generally speaking, the major alternative lenders are inundated with cash, and don’t have enough borrowers. The online credit brokerages have a window of opportunity to help the platforms to maintain an equilibrium of supply and demand. But to achieve sustainable success, these matchmakers need to become more than just the bucket into which unsuitable loan applicants are dropped. To be truly successful, they need to take on an active role in the origination process – whether it be through strategic partnerships like Lendio’s tie-up with Staples, or through advertising, or events, or via some other strategy.
Lendio’s value to the platforms as an active originator of loans is aptly reflected in the amount of VC money attracted by the platform to date. Bloomberg reported in March this year that Lendio had secured a $20.5m investment from Napier Park Global Capital LLC, bringing the amount raised by the company to a grand total of $31m – dwarfing the amounts raised by its competitors.
Is there a magic formula?
What then do these three most successful of intermediaries have in common?
The combination of these three factors is why so many major alternative finance platforms have elected to work with P2PGI, Orchard and Lendio, in spite of the added layer of fees that such alignments entail.