By Ryan Weeks on Wednesday 28 September 2016
As you might imagine, there was no shortage of things to talk about during the “In defense of online lending” panel at AltFi Global. After all, there’s plenty for the industry to defend at present. To be fair, the panellists performed admirably under pressure from The Wall Street Journal’s Telis Demos – with topics ranging from the continuing feasibility of the pure marketplace model, to increased regulatory attention.
But one question slipped somewhat under the radar.
All speakers seemed to agree that the industry’s nascent “ecosystem” will become an essential ingredient in the development of the industry. When they referred to the ecosystem, they referred specifically to companies that seek to in some way ameliorate the investment process. These include a rapidly growing cadre of gateway and data analytics firms: NSR Invest, LendingWell, Goji, InvestUp, AltFi Data, PeerIQ, dv01, Orchard, MonJa, and so on.
But of course, as Demos rightly pointed out, these firms represent just one side of the coin; there’s an equally diverse pool of “gatekeepers” on the borrower side. This section of the market features the likes of Lendio, Fundera, Bizfi and Crowdnetic in the US, and Funding Options, Funding Xchange and Rangewell in the UK. These kinds of companies – each in their own way – act as lead generation machines for a wide array of lenders, ranging from the traditional to the alternative, the offline to the online.
That makes sense. However it makes no less sense for Demos to then ask – as he did, later on in the event: what remains as the core value proposition of the marketplace lending platform itself?
Marketplace lenders are often described as disintermediating forces. They cut out the middleman in order to transmit a greater proportion of the time value of money to lenders.
Industry commentators have long suggested that the arrival of “gatekeepers” might serve to erode a level of the value that is delivered to investors and borrowers alike. It’s an extra level of fees, after all, and somebody’s got to bear it. But now the question seems to have rounded to face the platform itself. And that question is this: if you’re increasingly farming out origination duties, data analytics duties, allocation and secondary market functionality, what exactly is it that you do again?
In a scenario where each and every one of the above processes has been outsourced, what remains to the platform – and indeed what most platform representatives seem to say when posed this question – is credit analysis. There are plenty of lead generation sources in the marketplace lending space, but there’s no guarantee of every single lead being funded. The largest platforms in the space have refined their credit models and pricing over nigh on a decade in some cases, and are famed for the speed and efficiency of their underwriting. Technology plays an important role in delivering these benefits to customers, and the efficacy of platform algorithms typically improves over time. Even when the bulk of both origination and debt capital handling responsibilities are stripped from the platform, its importance as a credit selection engine remains.
However, it’s not impossible to imagine even this function becoming obsolete. As specialist origination platforms become more sophisticated, they will likely begin to develop their own credit criteria, and could in theory begin to segment their originations according to the specifications of investors. At that stage, what’s to stop an end investor from plugging directly into deal-flow at the source, as it were, rather than paying fees to a platform in the middle?
Of course, this is all theoretical. The reality is that most of the major platforms are sensitive to the risk of having their value-propositions eroded by specialist service providers. And, truth be told, the success of the “gatekeepers” is often heavily dependent on the cooperation of the platforms themselves. How, for example, could a gateway platform hope to channel investment into Prosper loans if Prosper itself chooses not to play ball?
What develops, in reality, is a balancing act. Marketplace lenders will cede some information and some responsibility to gatekeepers where necessary. They know, for example, that they stand little chance of courting traditional fixed income investors without pan-industry, independent standardisation initiatives.
But there’s a hesitancy around ceding allocation functionality to gateway platforms. The reason for this is that gateway platforms are, by definition, competing with marketplace lenders for customer relationships. Which owns the connection: the marketplace lender, or the specialist gateway platform? And which is the more valuable link in the chain? Questions fit to keep marketplace lending bosses up at night.
Anecdotally, we understand that one of the US’ largest marketplace lenders cut ties with Orchard last year, following the migration of a major investor from the former platform to the latter. For the platform in question, its worst fears had been realised. A divorce became inevitable.
Going forward, then, the question becomes: can the platforms and the gatekeepers exist in equilibrium?