After the stock market crash in September 2008, peer-to-peer lenders, marketplace lenders (MPLs) and other digital lending companies began to emerge as distrust and uncertainty surrounded the banking industry.
Over the past decade, the digital-lending industry has evolved to become more sophisticated. For example, companies are integrating big data and proprietary algorithms to analyze a borrower’s credit risk score in a matter of seconds, according to Juniper Research. The ability to scale and analyze this data provides dramatic cost efficiencies. In comparison, traditional loans can take several months to be approved.
According to the firm, MPLs are projected to generate US$588 billion in loan origination value annually by 2023. This is estimated to account for 41 percent of SME funding around the world.
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The research firm further reports that revenue from MPLs are predicted to grow at a 48 percent CAGR. This brings MPL platform revenue to US$137 billion annually by 2023, a 400 percent return from the estimated US$30 billion in revenue in 2019.
On Sunday (April 14), Reuters reported that a number of digital lending companies are taking steps to position themselves for the first economic downturn to face this industry. The Federal Reserve put a hold on interest rate rises, as Fed Chair Jerome Powell cited dampening global growth and tighter credit conditions behind its reasonings. Digital lenders are taking note.
According to a Forbes report from March, 2019 marks the longest bull-run in history as it enters its tenth year. Meanwhile, digital-lending companies are reporting that they are considering stricter credit-approval processes while cutting costs in business operations, Reuters reported last March.
Economists surveyed by the company in March put a 25 percent chance of a recession happening in the US within the next 12 month months.
“We were seeing economists bringing up some warning signs, and we were following the Fed signals and that they were becoming more dovish,” Bhanu Arora, head of consumer lending at digital lender Avant, told Reuters.
Digital lending companies are preparing accordingly. For example, SoFi, an online student-loan company, has been focused less on profitability and originating loan volume and instead on growth, Bloomberg notes.
Recently digital lender Kabbage raised a record US$700 million in securitization financing in April. Despite the notable funding achievement, its executive sentiment remains cautious.
“We have been waiting for the next recession to happen for the past five years…More people feel confident that it’s imminent,”Kabbage co-founder Kathryn Petralia, told Reuters. According to Techcrunch, Kabbage said the funds are planned to be used for “an existing asset-backed securitization transaction.”
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Peer-to-peer lending company, LendingClub (NYSE:LC) is the foremost of its kind in the US, connecting borrowers and lenders on its platform. LendingClub released its fourth-quarter and year-end financial results in February, where it reported record net revenue figures of US$694.8 million and record loan origination volumes increasing 21 percent year-over-year.
Even as it reported stellar financial results, the company reported lower growth expectations moving into 2019. CEO Scott Sanborn told Reuters that it is seeking more risky-hungry investors to shelter from the potential loss of investors who are more risk-averse. Sanborn further noted that LendingClub credit standards are tightening in lieu of the current market environment.
Year-to-date, LendingClub shares have risen over 22 percent. Digital lending companies such as North Carolina-based Lendingtree (NASDAQ:TREE) have seen share price increases of over 66 percent and GreenSky (NASDAQ:GSKY), a company that provides online loans for home-improvement and healthcare, among others is up over 53 percent as of Wednesday, April 17.
Overall, digital lending companies provide investors exposure to a new asset class in the lending sector. Morgan Stanley reports that digital lending can provide investors with higher yields and lower durations, low correlation to fixed income asset classes, and absolute returns. It reported that between 2011-2017, returns from the Orchard US Consumer Marketplace Lending Index (which tracks online lending platforms with over US$250 million in aggregate loans) showed superior returns to both US REITs and traditional fixed income assets.
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Securities Disclosure: I, Dorothy Neufeld, hold no direct investment interest in any company mentioned in this article.