Marketplace Lenders Fight Decline, Seek Answers
Marketplace loans are a unique form of credit where investment capital is funneled through online platforms to consumers and small businesses. What originally began as peer-to-peer financing has now grown into a multibillion dollar sector in FinTech with millions in venture capital funding.
Like tribal online installment loans, marketplace consumers prefer quick and convenient access to capital provided by online lenders. Similar to tribal lending entities (TLEs), marketplace lenders also rely heavily on alternative data in underwriting, viewing real-time personal and business data to collect an accurate reflection of the borrower’s current financial position and needs. With such demand for marketplace loan products, why are so many marketplace lenders struggling to turn a profit?
Marketplace lending began as an online middleman connecting individuals seeking modest investment opportunities with other individuals searching for short-term business funding or access to capital for personal needs unmet by traditional bank products. As companies like Lending Club, Prosper and On Deck grew the space beyond the limited capacity of small peer investors, banks, venture capitalists, hedge funds and large-scale investors partnered with different lending platforms. In 2015 alone, marketplace lenders secured $2.7 billion in venture capital investment. An IPO by Lending Club in 2014 netted the company another $1 billion. However, in just a few short years, Lending Club’s stock price has gone from a high of over $25 per share to less than $6.
Recent missed earnings expectations have not helped marketplace lenders. Prosper announced last week that a glitch in the formula it used was overstating returns to its investors. For an industry reliant on the sophistication of its data-crunching algorithms, system errors like this one are worrying. Prosper’s loan algorithms did not appear to operate any better in 2016: the company posted a loss last year of $118.7 million. Prosper is not alone though, as returns are down across the entire marketplace sector. Lending Club, once the darling of the marketplace revolution, continues to see quarter-over-quarter loan origination declines. Once the posterchild for growth and capitalization in FinTech, Lending Club’s recent fortunes are actually scaring away fellow marketplace lenders from going public as well.
Despite a growing demographic of financially underserved Americans, a number of causes are limiting marketplace lenders from serving this group effectively. High customer acquisition costs plague the industry and add considerable cost to an otherwise low-overhead venture. Scandals, like the document alteration scheme uncovered at Lending Club last year, have eroded investor and consumer confidence in the industry. Banks, previously blind to this financial segment, are joining the marketplace and increasing competition. Other factors like poor underwriting, lack of transparency, falling interest rates, and rising charge offs are also inhibiting profitability for marketplace lenders.
There are some fixes marketplace lenders can make to arrest decline and return to profitability. First, marketplace lenders must diversify marketing strategies to reduce customer acquisition costs. Corporate partnerships with banks might also provide an opportunity to share costs and give lenders access to a customer base without the use of costly direct mailers and other campaigns. Diversification into other financial products could help marketplace lenders weather downturns in borrowing or shifts in regulatory scrutiny. Changes will likely need to made for marketplace lenders to remain competitive in FinTech.
Marketplace lending is still big business. Prosper recently signed a deal to sell off $5 billion worth of loans to a group of large investment firms. Banks are also investing again in loan portfolios, and some lenders are even raising millions to start their own investment funds. While it is still too early to tell if marketplace lenders will dominate non-prime lending in the next decade, it is premature to label them dying relics of online lending.