A revolving credit card loan from a traditional lender would typically involve an average interest rate of 15% to 20% for example, but the typical average interest rate paid out on savings accounts was less than 0.5%. The online platforms have transformed those metrics, offering borrowers lower average interest rates of around 12% to 15% while boosting the target return for investors to 7%.
Abhai Rajguru, co-founder of Nava Finance, who plans to launch a UK-focused institutional consumer loans vehicle in April, says: “We are able to offer better priced loans for consumers, better yields for investors and at lower margins than banks need. This is the key to the longevity of this offering. Retail banking has gone past its peak. We are able to provide this service at a fraction of the cost and with deeper analytics than a bank.”
Transparency and the availability of information on borrowers are also key aspects to what makes markets like the US, UK and continental Europe attractive. These factors provide comfort to investors, allowing for diversification as well as in-depth analysis of credit worthiness and cherry-picking using modern computing power to collect and analyse the vast amount of data available on each lender.
The ability of process data has become a competitive point between providers of institutional access to marketplace lending. Although they are largely reliant on the platform to do the initial round of loan selection, once those loans are then made available to institutions, the ability to rapidly and robustly select the cream of the crop of loans focusing on the very top end of prime and super-prime borrowers is critical.
According to Himanshu Chaturvedi, managing director at Cambridge Associates: “This is a strategy where we have seen a lot of managers competing for capital based on their ability to do better credit analysis based on their data processing capability.”
Markets like the US, UK and Europe also benefit from stabilised, clear regulatory frameworks. However, in a young and yet untested market, where much of the technology and tools are still being developed, the market remains fluid and consumer lending is not without its risks.
As Chaturvedi says: “In the credit world, anything that brings diversification to portfolios is welcome. This is a well-developed sector, but the instruments keep changing.”
WHAT’S NOT TO LIKE?
Cambridge University’s research on the European market suggests the main perceived risks in the sector are: the collapse of one or more well-known platforms due to malpractice (46% saw this as a high or very high risk); notable increase in default rates (42% high or very high); fraud involving one or more high-profile campaigns/ deals/loans (40%); and changes to regulation at the national level (39%).
The US is not immune from the threats either, which makes platform choice and the route to investment very important.
Investors are highly reliant on the credit scoring capability of the platforms to generate the underlying pool of loans from which institutional investors choose their takings. “Institutions are investing passively at that point in the process,” Jullia says.
There are typically three ways an investor can access consumer loans: firstly, by buying whole loans, picking and choosing from the pool generated by the platform by applying a second scoring system to that pool; secondly, fractionalised loans, whereby loans are broken into smaller chunks – $15,000 might be split into $25 segments, for example – and investors buy a selection of partial loans; thirdly, they can invest passively by allocating to funds operated by the platforms, which randomly select a certain percentage of all the loans they write.
“Many institutions prefer to own whole loans,” Jullia says. “The passive route relies on the selection of an intermediary who is paid purely on volume, which could present an important conflict of interest. Further, in a relatively young market where many of the platforms are ultimately still tech startups, the counterparty risk inherent in a structure like fractional lending, which leaves the investor exposed to the platform itself, is an important consideration. There will be consolidation in the market as it matures and not all the current operators will make it, which is why we don’t want exposure to those platforms.”
