WHO ARE INVESTORS IN MARKETPLACE LOAMS?
Most counterparties of marketplace loans are not individuals, but hedge funds and investment banks looking for yields in a sub-zero interest rate environment. Still, retail investors place 54 per cent of orders on marketplace lending platforms, with an average of $12,000 of indirect exposure, where they invest not in loans directly, but in rating classes.27 The big investors are institutional investors and funds with tens of millions of direct exposure who pick and choose individual loans and fund them fully.
Sophisticated investors, such as institutions and funds, allocate capital to marketplace loans with the prospect of earning high returns.28 They are securitizing the loan portfolios they acquire from marketplace lenders to turn an unleveraged return of around 8 percent into a leveraged return of somewhere between 16 and 24 percent. Some funds exclusively invest in marketplace loans.Professional money managers will run their own analytics before investing in a credit portfolio with the data that some marketplace lenders post on their site. Lending Club, for example, makes the raw data of its loan book available for download,29 and other platforms have announced that they will do the same. The risk appetite of hedge funds has little in common with that of private individuals, who are 100 percent risk averse. Because hedge funds are by nature risk seekers, they can tolerate higher losses than retail investors. That raises the question about misalignment of interest: the originators and servicers of loans—the platforms—have little experience dealing with market cycles. Because their balance sheets never show the loans, they have very little skin in the game. Most online lenders do not align management compensation to performance of their loan portfolios, and they have no investment in the loans on their platform alongside other investors. This leads to the impression that they have less motivation to ensure their loan portfolio performs well.
Is an investment on a marketplace lending platform the new savings account? Definitely not. Not only do savings accounts allow depositors to withdraw money at any time, they also come with a deposit guarantee from the central bank. A portfolio of marketplace loans is more akin to a portfolio of uncollateralized bonds, which may yield returns when times are good, but could incur large losses when the underlying assets come under stress. Nevertheless, when one visits the websites of marketplace lending platforms, they seem to speak almost exclusively to retail investors. Even though platforms point out that well diversified investors rarely lose money, such loans have a higher risk than anything on offer at a conventional bank. Marketplace lenders demand no collateral from borrowers, and some of their income declarations are not even verified. Before retail investors invest, they should have a clear picture of what they’re getting into. Investors may glean the expected performance of their investment, but when they wish to understand the underlying assets better, they are left to their own devices and Excel skills. The analytics provided by marketplace lenders are hardly adequate deciding factors for investors. Chapter 13 will discuss a detailed analysis and stress test of portfolios of marketplace loans under several scenarios. In the rest of this chapter, we look into more general characteristics of marketplace loans, such as borrower ratings and default rates.
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