Fitch: Marketplace Lender Enthusiasm Confronts Market Realities
The challenges underscore the unproven nature of the marketplace lender business model - which was originally premised on funding loans primarily via retail investor demand - through the economic cycle. The extent to which marketplace lenders can navigate these challenges without adversely impacting their risk profiles and profitability will determine the sector's long-term success.
A sustained period of historically low interest rates prompted an increased funding appetite among banks and other institutional investors for marketplace loans. As institutional demand waned in recent months, marketplace lenders began to seek alternative funding sources to sustain loan originations. For example, Social Finance (SoFi) recently launched a quasi-captive hedge fund purposed with investing in loans originated by SoFi as well as other marketplace lenders.
Some marketplace lenders also responded to reduced funding availability by raising loan pricing to attract funding; however, this reduces the competiveness of marketplace lenders' lending rate (if the cost is passed to the borrower) or adversely impacts profitability (if the lender absorbs the cost). Passing higher funding costs through to borrowers is also harder to implement for lenders targeting higher quality borrowers.
The marketplace lender business model has yet to endure either a full interest rate cycle or credit cycle, so the resilience of current models under rising interest rates and/or rising credit losses is uncertain. Pockets of recent credit underperformance beyond initial expectations have likely contributed to the ongoing refinement of underwriting models, including further de-emphasizing of the use of traditional FICO scores in certain instances. Marketplace lenders are also exploring product expansion into adjacent lending products such as mortgages, small business loans, and autos, which Fitch views as tacit acknowledgement that business models, as currently constituted, may not have the diversity to flourish if core product growth is constrained.
Marketplace lenders' rapid growth has attracted heightened regulation and legal risk (Madden v. Midland), which may force changes to loan pricing and risk sharing, as evidenced by recent changes implemented at Lending Club with respect to its relationship with WebBank. In this case, LendingClub gave up a portion of its revenue to WebBank in an effort to preserve its exemption from state-specific usury rate caps.
Fitch considers greater regulatory oversight to be inevitable with the distinctions between marketplace lenders and traditional lenders continuing to blur as marketplace lenders adapt their funding models to economic realities.
Several US federal and state regulators have begun to seek more information about the marketplace lending industry with the expectation of producing a more formal regulatory framework. LendingClub, Prosper Marketplace and Funding Circle established an industry trade group, the Marketplace Lending Association, to respond to regulatory scrutiny and establish certain industry operating standards.
Likewise, the regulatory environment has begun to evolve outside of the US. For example, regulators in China seem poised to tighten oversight of the industry given the rapid growth in loans originated in that region over the past few years and the degradation in credit performance that has ensued, driving some lenders out of business.