After underwriting loans at Citigroup just after the 200809 recession, David Snitkof concluded that even in a healthy economy there had to be a better way to lend. Banks were pulling back from making loans of all kinds, and the market seemed increasingly unattractive to everyone but distressed-debt investors. Many institutional investors werent comfortable with that kind of risk, so opportunities to buy debt dried up.
Snitkof and several colleagues from the tech world soon discovered a new way to conduct a lending business. The first generation of peer-to-peer lenders firms such as Prosper and Lending Club that lent money to individuals without a traditional financial institution, like a bank, as an intermediary had been operating for several years. These pioneers made the data they had gathered accessible to investors. Snitkof, along with Angela Ceresnie, Jonathan Kelfer and Matt Burton, realized that they could gather and analyze that data, much of it related to small consumer loans, and create a lending and investment marketplace they called Orchard Platform Advisors. New Yorkbased Orchard was officially founded in 2013 and has since tried to bring so-called marketplace lending (the term preferred now over peer-to-peer lending) to institutional investors.
Marketplace lending allows nonbank institutions to lend to individuals and small businesses online, without a traditional financial middleman but usually with some sort of credit-checking apparatus. Most marketplace loans are unsecured, though the market also includes student, small-business and real estate loans.
When it was called peer-to-peer lending, the only product being offered was unsecured consumer loans, and they were all being funded by retail investors, says Snitkof. This didnt provide many attractive opportunities for institutional investors looking for secure, low-risk investments. But as time went on, he adds, institutional investors started applying sophisticated credit strategies to buying these loans, using leverage and doing some innovation. Now a number of institutions look to Orchard to be educated about the best way to invest in consumer loans in a market that has grown with hardly any bank presence.
In fact, consumer lending has attracted a number of new players. Even Goldman Sachs Group is reportedly planning an online consumer loan program next year, which some analysts believe is a major risk. The reason: Goldman, the epitome of a wholesale financial institution, has little experience in consumer finance and developed an unfavorable public reputation during the financial crisis. But as a sort of validation of the concept, the bank apparently wants to be part of the trend, according to a memo Goldman sent to employees and obtained in May by Bloomberg.
The financial crisis actually made this type of lending possible for Wall Street firms like Goldman and Morgan Stanley that, at the height of the financial crisis, became banks. Regulations enacted in the backwash of the crisis required them to behave more like conventional banks, which were facing increasing regulation, including higher capital ratios that caused them to rethink their businesses. Marketplace competitors vary quite a bit, but their customers are largely the same: consumers and businesses that might not qualify for more than a few thousand dollars and whose options for borrowing are limited. Specialty finance companies that have generally used the balance-sheet approach to fund loans, including auto lenders, equipment lenders and other small-business lenders, are getting into distribution with the marketplace model too, as are hedge funds.
Princeton, New Jerseybased Princeton Alternative Funding launched a direct-lending fund earlier this year the Princeton Alternative Income Fund aiming to raise $50 million by year-end. PAF is focused on lending to small nonbank financing operations, such as retail furniture chains and auto lenders that have anywhere from $50 million to $100 million in outstanding loans, most of which are classified as subprime.
A lot of platforms out there their strength is originating loans for those with high credit scores. We feel theres a big gaping hole in the market in that below-700 range, says Bert Szostak, one of PAFs founders. We dont want to compete with Lending Club or Prosper. We see an opportunity to provide funding for those with FICO scores at a level where Lending Club and Prosper are not comfortable making loans.
So why should investors feel comfortable with those loans? PAFs secret sauce is MicroBilt Corp., a credit data company that owns a majority stake in the fund and gives it an edge with regard to collecting and analyzing data about consumers payments and eligibility that the Big Three credit data companies Experian, TransUnion and EquiFax do not provide. PAFs anchor client is Dallas-based Ranger Capital Group, which included PAF in its portfolio for a direct-lending fund that it launched in May.
Subprime became a bad word during the financial crisis, but its always been a very important part of the overall economy, says Szostak, noting that subprime borrowers represent about $3.4 billion of earned income in the U.S. But still, he admits, we wouldnt even invest in that space without having the data [from] MicroBilt.
If some investors feel subprime is too risky, they can consider student loans, which marketplace lending has also tackled. One New Yorkbased lender, CommonBond, is focused on that class of loans. CommonBond has funded $200 million in student loans and closed its first securitization of graduate loans at the end of June. The deal earned a Baa2 rating from Moodys Investors Services the highest investment-grade rating for a first-time issuing marketplace lender. Purchasers of the $100 million securitization included insurance companies, banks, asset managers and hedge fundsthat is, institutions.