Globally, lending via P2P platforms reached around US$50 billion in 2015, according to Morgan Stanley. It forecasts this will reached more than US$290 billion by 2020.
The best known platformscome from Britain and the US.However, Chinahas by far the most lending. Official figures out in Januaryput the number of P2P lenders thereat an astonishing 2612, with estimates they areturning over more than $US18 billion a month.
However,thatnumber is being culled fast as many are now failing in anticipation of tough new licensing restrictions due to be introduced by the countrys central bank in 2016.
SocietyOnesoon wasfollowed by RateSetter, which chose Australia as its first market outside Britain,where it was founded in 2010, andThinCats, aBritish business lending platform.
In May, Sydney-basedDirectMoneybecame the only listed player. However,itcalls itself a hybrid of marketplace and traditional balance sheet lender.
Melbourne-based MoneyPlacestarted lending in early December andNew Zealand outfitHarmoneywas launchedabout 18 months ago. It isis due to start matchingloans in Australiain January.
To varying degrees, all replace banks with individualor, increasingly, with other institutionallenders.
Alloffer rates of return well above cash depositsbut they should because theyare riskier. IWhats the risk?
Someofthe new loan platformsliketocomparethemselvestobank termdepositrates.
RateSetter,which is one of only two so far that can accept retail investments,calls its lenders savers. However,itis not that simple.
SocietyOneco-founder Matt Symonsstresses that becoming a P2P lender should notbe equated to puttingmoney in the bank.
This is an interesting alternative fixed income category that should have a small allocation,he says.
That is why most have started outonlyaccepting investments from sophisticated investors.
Thatdoesnt disqualify self-managed super funds, if they fit the sophisticateddefinition:net assets of $2.5 million or gross income for each of the past two financial years of at least $250,000.
In fact, SMSFs make up a large proportion of investors on the new platforms.
SocietyOne and Harmoneyalsoplanto go through the onerous process ofgetting aretail licence in future.
A risk mitigant peculiar to P2P lending is that each loan is fractionalised,or split, sometimes among hundreds of borrowers,similar to the way equitycrowdfundingonly requires small amounts from many investors.
However, RateSetter Australia chief executiveDaniel Foggo expects thepresentreturns will be as high as they getbecause their novelty makesinvestors demanda premium.
Returns on RateSetter in Britainare reaching5.9 per cent compared with9.9 per cent in Australia.Comparison to other investments
Assessing the risk and likely return in company shares andproperty is more complex than a headline fixed rate on aloan. The gross returns available are, therefore, better than P2P on the riskier of thoseasset classes.
Research houseChantWest figures showaverage gross three-year returns are about18.4 per cent in public and private equity and 14 per cent for listed and unlisted property, but just 4.8 per cent on the more comparable investment of athree-year bond.
However,the yields, including the costs in each investment class, dont look so rosy.
In a recent note, AMP economist Shane Oliver said yields from a three-year bank term deposit get2.7 per cent, gross residential property yields about 3 per centand dividend yields were about6 per cent for Australian shares (with franking credits) and2.5 per cent for global shares.
However, amajor in-built costfor most of the P2P platforms is that the investor is lending to an individual, not a government orbig corporation, so the risk of default must be higher in the long run.
However, RateSetter underwrites thiswith a provision fund.This is fed by alevy on borrowers which varies according to an assessment oftherisk they will default.
There is just under $1 million, or about 5.5per cent of outstanding loans, inRateSetter Australiasprovision fund. It doesnt guarantee it can cover big losses, but in five years its British parent has not had to draw on its fund, which is close topound;1 billion.
However, rivals arguethis means the returns to lenders will be lower and it, obviously, adds borrowers costs.Cost cuts shared
The removal of people and bricks and mortarappearsto be a major reasonP2P lenders can offer high net returns.
To earn the present one-month annualisedrate of about3.8per cent at RateSetter,cash in a term deposit would have to be locked up for at least five years andthe best rates would struggleto reach 3.5 per cent.
Although, as long as you deposit your salary every month, some online savings accounts are offering comparable interest rates. But banks have notmatched the P2P lenders longer term rates.
The ever-falling cost of software and internet bandwidth, allied with the exponential growth of publicly availablepersonal information, means it is possible for machines to automate muchof the bank risk assessmentprocesses at much lower costs.
More importantly, P2P lenders are not using their own balance sheet. Not only do they remove all the brokerand fund manager costs, which reducereturns and add to borrowing rates, they dontearn a margin on the loan.
Instead, they charge fees, whichvary from flat, one-off fees, toa few per cent of the amount. However, thesecan mount up.
Harmoney, for example, charges borrowers $NZ375 and another $NZ375 for each top up of a loan. It also charges 1.5 per cent to lenders and a combined 35 per cent sales commissionand management fee on payment protection insurance it sells to borrowers.
So far, OBrien has lentup to$450,000 via SocietyOne, including $150,000 to agribusinesses,and believesitcompares favourably with property as an investment.
I have managed funds, including property, and I have obviously done OK out of property. But you dont get the same yield because there are lots of risks and costs in property.
Like all the new lenders, Foggo makes much of RateSetterstransparency.
Itswebsite showsdata such asaverage returns, loan rates, total amount lentcompared to applications, average loan sizes, default rates and what loans are used for.
We have just released our full loan book. For all the large platforms in the UK and the US, you can see the lending returns since inception, he says
SocietyOnestarted doingthe same in December.
It is said time is money and one important cost ofmarketplace lenders is that it can take some time forborrowers to be matched with lenders.
OBrien saysit took about three months to get his money invested viaSocietyOne, althoughthat can now take a matter of hours.
However,on average, it still can be a few days.Lending to business
ThinCatsisoneofthe few P2P lenders serving business, although severallendersthat have started withpersonal loans nowoffer business loans as well.
ThinCats Australian chiefSunilAranha, says the businessdoesnt claim to be quick.
Ittakes uptofive weeks forinvestments,butthis is quickerthan many banks.
ThinCats targetsinvestments of between $50,000 and $2 million andrequires security via a fixed and floating chargeover company assets and personal guarantees by directors. Itdoesntneed borrowerstoputuptheir family home as security, as all banks doin Australia, butitwill accepta second mortgage.
We are lending fortwotofive yearsfor growthfinance for smalltomedium-sized businesses, Aranhasays. We are quite differenttothe new SME balance sheetlenders. We dontearn a spread [interest margin], we charge a fee and we aretheonly guys notlookingtoprovide moneytomorrow.Hybridclaims to be the future
Theonly listed marketplace lender in Australia,DirectMoney,which was floated in July,says ithas chosentobe a hybridofthe established andthe newtoavoid whatitsees as a big P2P flaw:uncertaintyover matching borrowers and lenders and, just as happens in sharemarkets,the crowdingout of retail investors.
Chief executivePeter Beaumont,a formerbanker whohas worked atCiti, UBS and ABN Amro,arguesthe big P2P lenders inthe US -LendingClub,Prosper and Avant -havemovedtoDirectMoneysmodel because itguarantees quick loans and sets up separate funds for institutional and retail investorstobuy intothose loans.
The pure P2P modelof retail lendstoretail;the problem is you never know whenthatdeal willoccur, he says.
The wayDirectMoneygotaroundthatwastocreate a loan warehouse.
The main difference is the speed of the warehouse turnover. A small numberof loans are builtuptoabout$10 millionandsoldtooneoftwoinvestmentfunds.Investors canthen buy intothose funds, withinterestpayabletothe investor.
The warehouseisontheDirectMoneybalance sheetfor a shortperiod, during which it gets theinterestbeing paid.
However, competitors dont agree.
DirectMoneyhaventbeen clear around whatthey are;as abalance sheetlender you are very differenttoa marketplace lender, MoneyPlace founder Stuart Stoyan says.They have been holdingloanson balance sheetfor morethan a month.The risk is, atsome pointyou are competing withyour investors.
He agrees institutional investors, like high-frequencytraders in a sharemarket, havebeen jumpingover retail investorson someofthe more established P2P loan markets inthe US because oftheir greater abilityto price risk andoffer better rates.
To fix this, the biggestP2P lender,LendingClub,which has matched more than $US11billion so far,has setuptwomarkets. One allows investment inwhole loans, which institutions favour, and anotherfractionalisesloans.Loans are randomly selectedtobe senttoeach platform basedonthe social security numberofthe borrower.
MoneyPlacedoes itby simply banning queue jumping.
The firstmoney in isthe firstmoneyoutand we allow an equal access for retail and institution investors.
However,the big question that needs to be in the back of every investors mind is: will the P2P lender you putmoney on exist when your loan expires?
Foggois convinced there are too manymarketplace lenders in Australia.
Like a sharemarket, mostneed high volumes to get the best speed and pricing.
In Britain,there are only two P2P personal lenders of significant size- RateSetter and its predecessor,Zopa. In the US, Morgan Stanley has counted 100. But there are only three of note:LendingClub, Prosper and Avant.
In Australia, there are at least six.
Jason Berry and Stuart Hecker are well-versed in the promise and the pitfalls of online lending.
In the summer of 2011, the business partners were staving off creditors and struggling to keep the doors open at their Anaheim-based auto repair chain. They asked Wells Fargo for a capital infusion but were swiftly shot down.
Desperate, they took to the Internet and easily landed a $105,000 business advance with what some would call a last-resort lender. The deal: Give us 6 percent from your credit card receipts to repay the debt.
What seemed like a fair deal ended up bleeding them dry. The interest they paid, it turned out, was 39 percent.
We regretted it within 30 days, says Berry, managing partner of Becker Tire LLC. I cant believe we spent so much money on this thing.
The once niche market of alternative, online lending popular among small businesses with brief or spotty credit histories has exploded into a multibillion-dollar industry that offers quick and easy financing to everyone from students to homeowners. It has captured the attention of deep-pocketed investors and even large banks.
The alt-loan boom has also become synonymous with vaguely worded pricing terms, ultra-high interest rates and questions about how the firms should be classified and regulated.
For those reasons, Californias Department of Business Oversight is scrutinizing more than a dozen online loan providers to get a better handle on what they do, how much business they generate and how they make their money. Many of them are headquartered in California.
The companies under the states microscope include Lending Club, Prosper Marketplace and OnDeck, industry heavyweights that have championed peer-to-peer lending the practice of people lending money to people they dont know without the participation of a financial company.
Also in the mix are players like PayPal and Kabbage, both of which issue cash advances to small businesses. PayPal is primarily an electronic payments provider. Kabbage is a financial tech company that uses algorithms to extend credit to small businesses. It recently raised $135 million in venture capital.
Officials at the Consumer Financial Protection Bureau, which regulates financial products, say they have serious concerns about these firms and want more rules in place to rein them in.
State and federal regulators are mainly concerned about how easy it is for businesses and individuals to get some types of online-based funding and their ability to repay the debts. In many cases, borrowers fill out simple forms and can get preapproved for funds in the tens of thousands of dollars, in some cases within minutes.
Such companies measure the creditworthiness of potential borrowers by checking everything from daily credit card receipts to social media presence, essentially creating their own customer-scoring models.
Were not interested in cutting off that access to financing, said Tom Dresslar, a spokesman for the California regulatory agency. California businesses and consumers have much at stake, and we have some questions about (whether) these lenders are appropriately licensed and regulated by the state.
For the owners of Becker Tire and Service Center, getting their advance was a snap. They suddenly had an influx of funds within roughly 10 days of applying, without having to dig up the reams of documentation that traditional banks expect.
But within a month of getting the money, Berry and Hecker immediately felt the weight of their repayment terms. The daily deductions of 6 percent by Merchant Cash amp; Capital were based on each days credit card sales, which fluctuated wildly. So while the repayment percentage was fixed, the actual payment amounts were not.
It became very difficult to pay my other bills while paying a fluctuating number to Merchant, Berry said.
It wasnt until later that they realized they paid almost 40 percent in interest, he said.
Borrowers in these types of scenarios are often in the dark about the online loans APR, which represents the true cost of the loan. Not all lenders will do the math for you.
Merchant, which now goes by Bizfi, says it assisted Becker Tire when no traditional banks would. The cash-advance firm was upfront about costs and does not disclose an APR because it does not issue loans, said company spokesman Lewis Goldberg.
This is a purchase of future receivables, he said.
Becker Tire says it received $15,000 as part of a class-action lawsuit against Merchant over its financial practices. Goldberg declined to discuss the details of that case, citing a confidentiality agreement.
An August study by the Federal Reserve Bank of Cleveland showed the average small-business owner says alt-lender websites make borrowing terms and conditions easy to understand. But when asked about specific products, the small businesses often answered questions, specifically about cost, incorrectly.
State regulations exist to govern disclosure of consumer and business loan terms. They strive to ensure borrowers get loan rates that are stated fully and clearly and are adequately vetted before being issued a loan, among other things.
WHOS A LENDER?
But many alternative finance companies dont consider themselves lenders and maintain theyre not technically subject to state lending laws.
Take Prosper and Lending Club, which contend theyre merely facilitating the online loans. They say the party responsible for issuing the loan is their contracting partner, WebBank, a financial institution in Salt Lake City.
Along the same lines, companies including PayPal and Square call themselves money transmitters. Firms like Kabbage dont issue loans, either; they give out cash advances, similar to what Berry obtained through Merchant. The companies advance the money to the business and deduct payments on a daily, weekly, monthly or bi-monthly basis to recoup the costs.
Theyre essentially skirting state regulation, said Eric Weaver, head of the nonprofit microlender Opportunity Fund.
Some of the lenders that are under state inquiry say they do disclose loan conditions. Bond Street said it provides customers both the interest rate and APR in all of its loan offers. SoFi, which refinances school loans, told the Register in a statement: Fairness and transparency are critical factors in our partnership with our members, and we strive to have an equally transparent approach with regulators.
The remaining lenders declined to comment, did not respond to requests for a comment or merely confirmed the inquiry.
Ironically, one growing line of business for traditional, brick-and-mortar small-business lenders is helping borrowers get out of problem online loans, says Kurt Chilcott, chief executive and president of CDC Small Business Finance.
In late 2012, CDC agreed to refinance Berrys loan with Merchant and roll it into a $125,000 Small Business Administration-backed loan at the prime lending rate plus 3.75 percent, which comes out to be roughly 7 percent.
NOT SLOWING DOWN
Refinancing may not be possible in all cases, especially when borrowers have dug themselves too deeply into debt by taking on a string of online loans to repay previous ones similar to the vicious cycle that victims of payday lenders experience.
Despite any glitches, theres no sign that online lending will slow soon.
Some of the top names are expanding with the backing of Silicon Valley venture capitalists. Lending Club went public in late 2014 with a valuation of $9billion.
And big, traditional banks seeing their retail branch and lending operations shrink are looking to tap into the alternative lending market.
JPMorgan Chase recently signed a partnership with OnDeck, and JPMorgan will use the online lender to offer rapid access to small-business loans. The service operates with JPMorgans name and capital.
Some of the money thats flowing into online lenders is being recycled into heavy marketing.
Berry, the auto shop owner, experienced this firsthand. Since paying off the Merchant loan, he receives regular mailings, emails and phone calls from similar cash-advance institutions.
They say, lsquo;So, youre saying you dont want the money? They try to make you feel stupid for not taking the money, says Berry.
Chris Shove, former executive director of the Montana Business Assistance Connection, has not been working for the organization since Jan. 23,hellip; Read more