AnAlysis & insight

despite a slowdown in securitization rates and warnings of contraction in marketplace lending, survey responses from institutional investors show increasing investment in and optimism about the sector. While there is no clear explanation for this disparity in perception, it may be that the sector’s explosive growth in 2014-15 generated expectations that are not sustainable for any industry. Continued growth at a slower rate may be generating concerns among observers that are not shared by actual investors.

2016 SURVEY OF U.S.

MARKETPLACE LENDING

one year ago, Richards Kibbe & orbe LLP and Wharton Fintech released the inaugural survey on this emerging industry, which connects borrowers and lenders of capital directly through internet-based platforms, challenging the traditional bank lending model. We undertook the survey to answer questions raised by institutional investors’ involvement in this still-maturing field. how well do institutional investors know marketplace lending? What is their level of participation in it? how do they assess the risks and rewards that lie ahead for the industry?

We now have two years of data on these and related questions. the answers from our polling of more than 300 institutional investors have evolved significantly in just 12 months. Respondents expressed greater optimism, different sources of concern and markedly less uncertainty about marketplace lending in 2016. it is apparent that in the past year, institutional investors have developed a deeper understanding of the industry.

Awareness of and optimism about marketplace lending, both substantial in 2015, reached new heights in 2016. that positive outlook may explain the survey’s most dramatic finding—a sharp uptick in the percentage of respondents actually invested in the sector.

the emergence of regulatory risk as an area of concern surrounding marketplace lending offers another big takeaway from this year’s survey. Yet, respondents claimed little knowledge of the industry’s regulatory framework. As institutional investors continue to sharpen their focus on marketplace lending over the next year, this is an area that will likely receive special attention.

the world of marketplace lending is changing quickly—and that includes its perception among institutional investors.

Respondents

• Approximately 15% of those who responded work at funds with $10 billion or more in assets under management, and 36% work at funds with more than $1 billion in AuM. 47% work at funds with less than $200 million in AuM.

• the dominant investment strategies used by the respondents’ firms were credit, multi-strategy and event-driven/special situations. (Respondents could select multiple responses.)

• Among respondents whose funds invest in whole loans or borrower payment dependent notes through a marketplace lending platform, most (73%) have less than 10% of their portfolios invested in such assets, while 15% have more than 90% of their portfolios invested in such assets.

KEY FINDINGS

AwAReness of & InteRest In MARketplAce lendIng

• Although still a nascent industry, marketplace lending is familiar to a large and growing percentage of respondents. 82% characterized themselves as somewhat or very familiar with marketplace lending, up from 75% last year.

• optimism about the industry’s future is also growing: more than 80% indicated high or medium levels of optimism for continued growth of marketplace lending, compared to 71% last year.

• Perhaps the strongest evidence of optimism is that 50% of respondents have capital allocated to the marketplace lending space. in 2015, only 29% of respondents were invested in this industry.

• the types of loans in which investors showed the greatest current interest in 2016 were consumer (unsecured) (52%), small business (46%) and real estate (37%). Additionally, interest increased in all loan categories surveyed in 2015 among investors interested in purchasing whole loans or notes from marketplace lending platforms.

investment Professional

other C-suite Position

other Legal/Compliance

Portfolio Manager

General Counsel

Chief Compliance officer

investor Relations

other

who took part in the survey

24%

3%3%

9%12% 13%

17%

19%

Most targeted loan types

85%

52%Consumer (unsecured)

small business

Real estate

education/student debt

Auto

Merchant Cash Advance

46%

37%

24%

17%

15%

level of familiarity

Very Familiar

somewhat Familiar

Just a Little Familiar

Not at All Familiar

5%

45%

13%

37%

12%

Investment strategy type

Value

distressed

Private equity

Long/short

Venture Capital

Credit

Multi-strategy

event-driven

32%

19%

15%

13%

8%

9%

8%

21%

RIsk fActoRs & RegUlAtoRY conceRns

• Presented with risk factors associated with marketplace lending, respondents expressed the greatest concern over market-wide credit events, with 85% of respondents somewhat or very concerned. the greatest source of concern in 2015, the threat of adverse selection/borrower quality, remained third this year and had the highest level (38%) of respondents who were very concerned. the risk factor that placed last in 2015, regulatory risk/uncertainty, leaped to second in 2016.

• Respondents indicated significant levels of current investment and interest across a broad range of investment possibilities in the marketplace lending space:

• 72% of respondents believe the consolidation of

marketplace lending platforms is somewhat (40%) or very (32%) likely.

• Among those who have invested through marketplace lending platforms, 42% have used a major platform (Lending Club, Prosper, ondeck, soFi), while 58% have used other established or start-up platforms. Nearly half (48%) of these respondents manage their portfolios through the originating platform.

when asked what would lessen their concerns about investing in marketplace lending, respondents said the following would have a very significant impact:

solution to ConcernPercentage of Respondents

Greater transparency and disclosure in terms of credit and interest rate risk

47%

increased standardization of data and performance reporting 39%

Liquid secondary trading market 39%

enhanced regulatory clarity from securities, banking and consumer finance regulators

33%

Mature securitization market 33%

Platforms taking steps to improve collection mechanisms in case of defaulting borrowers

29%

Platforms providing provision fund for bad debts 27%

AnAlysis & insight

47% of respondents identified real estate loans as the best future investment opportunity. this may reflect a desire for loans secured by “hard” assets that lenders expect will better weather an economic downturn. it may also signal an interest in the widening access to the nearly $17 trillion real estate market provided by large platforms like soFi expanding into the home mortgage space, which comprises the bulk of real estate lending.

Current investment

interested in Near Future

direct lending to platform

18%12%

Purchase of whole loans via negotiated arrangement with

platform

15%13%

stock investment in publicly traded platform

10%10%

Purchase of whole loans using active loan selection via APi

with platform

10%5%

investment in securitization of loans from platform

8%12%

Co-investment alongside platform

5%13%

equity investment in privately held platform

19%12%

Purchase of borrower payment dependent notes from

platform

10%10%

• Among general counsels, chief compliance officers, C-suite professionals and other legal/compliance professionals, more than 40% said they are not at all (9%) or just a little bit (32%) familiar with the regulatory framework for marketplace lending. When asked about specific regulatory actions, they expressed significant but also broad and unfocused anxiety across a wide range of government activity.

About RiChARds Kibbe & oRbe LLP

RK&o represents clients in new and disruptive financial markets. We are at the forefront of the opportunities and challenges facing marketplace lending platforms and institutional investors entering this space. our lawyers draw upon more than 25 years of experience in alternative investment strategies and secondary market trading. RK&o is based in the key financial and regulatory centers of New York, Washington, d.C. and London. For more information, visit www.rkollp.com.

Wharton Fintech is the first student-led Fintech initiative and is dedicated to connecting innovators, academics and investors with the ideas and companies that are reinventing global financial services. We are committed to education, career development and idea promotion by connecting innovative, established, disruptive and proven Fintech enterprises with students and industry professionals. For more information, visit www.whartonfintech.org.

About WhARtoN FiNteCh

WHAT’S NEXT?• We expect that platforms will continue to

explore more niche markets in an effort to avoid competition from established players in the consumer, small business, real estate and student loan spaces.

• We foresee significant platform consolidation in the coming year as major platforms build out their suite of offerings and smaller platforms face greater competitive pressures.

• We anticipate greater integration of platforms with banks to address the concerns both platforms and banks have about increased regulatory oversight of the sector. Platforms will want to address Madden and “true lender” risk, while banks will want to reassure their regulators that they are focused on the credit risk involved with loans they purchase from, or originate on behalf of, online lending platforms.

• We believe that there will also be significant regulatory developments over the next year, though the general direction of those developments at the federal level will hinge on the upcoming election.

• We expect that there will be greater interest among investors in secured consumer loans, such as home mortgage loans or refinanced auto loans. Given the heightened concern about market-wide credit events, and the continuing concern about borrower quality, investors may want to invest in consumer loans secured by collateral, which will help investors recover some portion of their losses resulting from any loan defaults.

AnAlysis & insight

It is surprising that so many respondents indicated some concern with securities laws, investment adviser regulations and broker-dealer regulations, which, while burdensome, can be navigated by making the required regulatory filings. Less surprising is the greater concern among some legal and compliance personnel about possible new federal and state regulatory challenges, including the new complications raised by the Madden decision.

Very Concerned

Somewhat Concerned

25% 50% 75% 100%

Potential federal banking regulatory actions

Potential state regulatory activities

FDIC guidance on bank purchases of marketplace

loans

SEC’s pending ABS rules

Madden v. Midland decision

Planned congressional oversight hearings

SEC reinterpretation of securities laws or

regulations

Potential CFPB oversight of platforms