This article describes how some of the p2p lending spaces are trying to preserve a more equal distribution of their loans, to avoid cherrypicking of the best loans by the big banks and institutional investors.
Excerpted from Amy Cortese:
“Lending Club and Prosper focus on prime and near-prime borrowers, that is, consumers with FICO scores higher than 640. The platforms apply their own credit models and assign borrowers to categories reflecting their level of risk. In the case of traditional loans, banks pocket the profit. On P2P sites, the individual lenders do. “The difference is who’s benefiting from it,” says Renaud Laplanche, the founder and chief executive of Lending Club. Prosper and Lending Club take a small origination fee from the borrower and 1 percent of interest payments to the lenders.
The sites’ business model relies on scale: Lending Club, the market leader, earned $7 million on revenue of $98 million in 2013, its first full year of profitability after seven years. That was on loan volume of $2 billion.
The fastest, and some say only, way to reach the kind of scale needed is to turn to institutions with boatloads of money to lend. Attracted by peer-to-peer’s relatively high and predictable yields in a low-interest environment, big investors have jumped at the opportunity.
The first in were hedge funds, like Eaglewood Capital Management and Arcadia Funds, which borrow money to amplify their returns and use their own algorithms to increase yields into the midteens or more. Soon, pension funds, asset managers, community banks and even sovereign wealth funds joined in. Santander Consumer USA, the United States arm of the Spanish bank, has an agreement to buy up to 25 percent of Lending Club’s loans.
Today, P2P loans that once took days or weeks to finance are snapped up in minutes, particularly those with higher yields. “There is at least twice as much demand as there is supply today,” says Matt Burton, the C.E.O. of Orchard, a firm that helps institutions invest in peer-to-peer loans. Lending Club and Prosper now set aside a randomly selected pool of loans for institutions, which prefer to swallow up whole loans rather than finance a piece of them. To eke out better returns, many fund managers then use their own credit algorithms to identify loans that may be underpriced or overpriced, and cherry-pick the ones they want.
Continue reading the main story For example, the Ranger Capital Group, a Dallas-based investment group that raised a $15 million P2P fund last fall, deploys a proprietary algorithm it calls TruSight to exploit variances in credit models. “Everyone’s got their own secret sauce on how they evaluate loans,” says Bill Kassul, a partner in the Ranger Specialty Income fund.
The loans not taken by these sophisticated investors go back to a fractional lending pool that is open to both individual investors and institutions. That doesn’t sit well with some. “The institutional investors are snapping up all the worthwhile loans,” one investor wrote on Prosper’s blog, echoing many comments.
“By cherry-picking, almost by definition what they leave behind is not as good,” says Giles Andrews, founder and chief executive of Zopa, a British peer-to-peer lender that so far has dealt only with individual lenders.
Like high-frequency trading, P2P lending has become a game of speed. Much of the investing done by institutions these days is automated, and some hedge funds have installed computer servers close to Lending Club and Prosper to gain an edge. “The fastest computer right now is getting the most loans,” says Peter Renton, the founder of Lend Academy, a site that follows the P2P market and co-hosts the annual LendIt conference, which runs through Tuesday in San Francisco.
Prosper and Lending Club have created speed limits, known as governors, to counter these moves, and they have instituted purchase limits to ensure that big buyers don’t hog all the loans. “It’s kind of an arms race,” Mr. Kassul says. “They put a governor on, but then everyone tries to trick the governor.”
Lending Club and Prosper say they are trying to balance their lender mix among individuals, institutions and active fund managers. “We want to be extremely careful and not let a handful of investors drive our expansion,” Mr. Laplanche of Lending Club says.
And Mr. Suber of Prosper says, “We’re making sure we stay true to our original business of P2P finance.”
Still, to meet demand, P2P executives are pushing into new, higher-yield markets.”