When online lending opportunity knocks, better to open that door fast!
On March 11th in London, the alternative finance (AltFi) in-crowd gathered at the first European focused event, examining the space, including P2P Lending, Crowd Funding, and Invoice Funding. The 200+ attendees consisted of investors, wealth managers, hedge funds, family offices, VC’s, consultants and a number of other interested parties. One of these is Liberum, a London-based boutique broker/dealer and investment firm, recently having turned a focus towards P2P and Online Lending. Liberum has been an early mover in the space, as they prepared for the launch of a first publicly listed captive vehicle back in September 2013. During the premarketing though, along comes Marshall Wace buying a controlling interest in the venture, leaving Liberum as a minority shareholder, and a most likely “sponsor” of a still planned for public offering in the very near future. Liberum therefore being in the forefront of industry developments and well placed to help frame the discussion.
I’m discussing with Mr. Cormac Leech, one of the keynote speakers of the day from Liberum, and his team some of the highlights of his overview and their findings.
We’re clearly passed the hockey stick moment, where we’re looking at accelerating growth for the sector, primarily driven be the US and the UK volumes, with a CAGR of 136% since 2009. While these numbers include both consumer and small business loans, confined to the top 5 platforms, I’m asking Mr. Leech to expand on this.
Cormac: “Since 2009 we have seen tremendous growth and we forecast this growth is set to continue into 2014, where indeed we estimate that the top 5 will do $8 billion of volume in 2014. Awareness of the P2P Lending sector is rising, with Google trends showing a 70% increase in awareness of peer to peer lending since 2012. We anticipate that awareness will increase in 2014 with the expected Lending Club IPO in H2 2014. In the past few weeks we have seen banks buying stakes in the platforms. Barclays Africa bought a 49% stake in Rainfin, a South African P2P Platform. Australia's first Peer-to-Peer platform, Society One, has just closed an $8.5 million funding round, with WestPac Banking Corp's new venture capital fund investing $5 million. In our view these transactions add credibility to the sector. P2P is becoming a global phenomenon with the US being the largest market ($2.4 billion volume in 2013), however we are seeing rapid growth in China with $1.9 billion volume in 2013 and $1.4 billion in the UK.”
Structural advantages / sustainable model:
We know from earlier presentations from the likes of Lending Club and Prosper the basic premise of the P2P Lending model. Bringing together buyers and sellers of consumer credit, through a marketplace (i.e. the “Ebay” of consumer lending), enables you to eliminate the middle man (aka banks). In doing so, you save a big spread, which you can return to both borrowers (lower rate) and lenders/investors (higher yield). Help us understand the context in which this has been happening, and expand on the pro and cons where possible.
Cormac: “To understand P2P’s competitiveness we need to understand the financial plumbing. Banks are about as efficient today as they were in 1900 despite increased scale and IT investment – this leaves them vulnerable to innovation. Examining a paper by Thomas Philippon (a finance professor at NYU), he illustrates that the unit cost of financial intermediation has been relatively constant for the last 30 years at 2%. For other intermediation sectors such as wholesale and Retail Trade, investment in IT improves the efficiency and drives down the share of national income. However banks share of income has risen with increased IT spend. Currently banks share of GDP is at an all-time high of 9% - the sector therefore is ripe for disruption.
Bank inefficiency means that P2P Lending has the potential to be the low cost “Wal-Mart” of financial services – not incurring the costs of expensive branches or overly burdensome regulatory capital.
P2P platforms typically charge a 2-5% upfront fee and then a 1% fee to borrowers and lenders over the lifetime of the loan – thus making 2% per annum on balances.
Some critics argue that P2P Lending platforms are only doing well currently due to the low interest rate environment and that they will struggle as rates increase. We disagree, and have done a simple yet intuitive calculation to illustrate this. Currently banks are charging circa 7% to borrowers and paying 2.8% to depositors making 4.2% on balances vs. 2% with P2P Lending. When base rates rise, banks will lend at 10.5% and pay depositors 6.3% or less and maintain their 4.2% margin while P2P will still charge 2%. Currently P2P Lending rates are meaningfully better for both savers and borrowers. In the US they offer savers a 6-9% yield pickup compared to deposit accounts. While for borrowers rates are up to 25% lower. It is also worth noting that P2P is enjoying a macro tailwind as credit card delinquencies are trending down, with debt consolidation as a main use of funds for both Prosper and Lending Club.
Despite its increasing popularity P2P Lending has its critics. One of the valid issues is that platforms don’t take any risk, and it is our view they should take on some of the risk, with CEO’s compensation that could be linked to the credit performance of the platform. However there are also some invalid issues such as a liquidity run which is impossible since loans match funds.”
To better appreciate the massive growth opportunity still ahead, just sit back and take in these 3 numbers (in $billions): 5/650/3000.
$3 trillion equals the total outstanding US consumer credit pool (not including real estate).
$650 billion equals the total US outstanding credit card debt / receivables (a key metric as 80%+ of all P2P Loans are used to refinance some sort of credit card debt)
$5 billion equals the amount of loans funded to date in the US by the 2 main players.
Today, the US P2P Lending market is less than 1% of total outstanding CC debt, and less than 0.2% of total outstanding US consumer credit. Growth opportunity anyone?
Cormac: "To date the P2P Lending industry has grown at a CAGR of more than 130%, and we suggest that the industry can continue to grow circa 50-60% annually for the next decade. The 2024 P2P Lending platform revenue pool is likely to be at least a $20-40 billion market (US and UK consumer finance and UK SME combined). For banks it is not just P2P Lending that is a threat; they are also vulnerable to other sources of disintermediation, such as Square (payment systems) which processed $20 billion last year or the Digital Wallet with both Apple and Google creating their own version. P2P Lending is also disrupting money transfer and FX markets, with platforms such as Xoom and Transferwise which are 70-90% cheaper than the average bank.
P2P Lending is clearly negative for the overall bank sector, and while this is a story we have seen before, it is easy to see banks getting “Blockbustered” over the next 10 years. We refer to an interesting chart that was published in the New York Times illustrating that the pace of technological adoption has been accelerating over the last 100 years. Disruption is happening faster and at an accelerating pace. Even the BoE’s head of Financial Stability Mr. Haldane expects bankers may ultimately become “surplus links in the chain.”
In a ZIRP environment (aka zero interest rate policy), where financial repression is “de rigeur”, it’s increasingly difficult for investors to find any yield to speak of. As the current baby boomer generation has started to retire (in the US, for the next 15 years, 10,000+ people a day turn 65 !), they will be looking to move from capital appreciation (stocks) towards more bond like investments. However, with IG rates below inflation rates, there is an urgent and obvious need for a higher yielding fixed income investment class. P2P Lending to the rescue! The main attractiveness of the asset class is high credit quality, high yield and short duration. What other qualities do we see in the asset class?
Cormac: “P2P loans as a new asset class provides useful diversification for investors. Furthermore P2P Lending net yields compare favourably with other asset classes, with platforms in the US offering circa 8%+. They offer investors attractive risk adjusted returns. We recently analysed the Sharpe ratio of one of the large US platforms, giving us a ratio of 4.4 over the last 5 years vs. 1.12 for the SPDR.
There are an increasing number of P2P Lending funds emerging both in the US and in Europe, of both the open and closed end variety. Many of these funds are enhancing returns through the use of leverage; these funds are delivering returns of 10%+ per annum.
The P2P Lending - equity opportunity is also interesting. Currently there is only one listed P2P platform globally. However, we anticipate an IPO in the US in Q2, which will drive awareness of the industry in 2014.”
Conclusions & Predictions:
It’s important to highlight the fact that the above considerations have been made primarily from a UK perspective and background. Some of the statements at times seem too harsh. For instance, arguing that there have been no efficiency gains in banking since 1900 fails to highlight developments like credit cards, ATM’s, student loans, arbitrage, forex, etc. They also do not make a distinction between the US and UK tax environment, which has a sizable impact on after tax returns. The equity play they are referring to is less a P2P Lending, but more a payday loan play. And regarding the lack of skin in the game, I would argue that the reputational risk (of failure) is substantial enough to partly cover the lack thereof.
Cormac concludes with:
“P2P is the “Walmart/Ryanair” of financial disintermediation, with one study showing that by 2015 Lending Club will be circa 60% more efficient than the equivalent banking business on costs, as % of loan balances. Liberum having conducted their own study of the platform efficiency in order to back this theory up, they have concluded that in 2013 (estimate) P2P platform costs are 420bps of loan balances vs. 695bps for comparable banking business – circa 40% more efficient. Over time and with increased economies of scale, we anticipate a further increase in P2P’s relative efficiency. This story is highly credible as P2P platforms do not have the expense of branches, expensive regulatory capital or the outdated systems.”
I would like to thank Mr. Cormac Leech and the Liberum team for their insights and look forward to further interaction with them.
Yvan De Munck is a Managing Director at R.W. Pressprich & Co., a NY based broker dealer and investment firm. The views expressed herewith are his personal views, and in no way reflect those of R.W. Pressprich & Co.
He can be reached @yvandemunck.
DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer