Interest in peer lending credit has surged with the IPOs of two large marketplace lenders but just how big could the industry get?
The successful initial public offers of shares from Lending Club and OnDeck Capital have brought a huge increase in media attention to the peer lending credit space. The two offers raised over $1 billion in capital and online originations last year totaled more than previous years combined.
As the industry moves from an alternative form of finance to the mainstream, the question is just how big could peer lending credit become?
Peer Lending Credit: An Industry Hard to Define
True definitions in the peer lending credit space seem to be blurring with a big variance in business models. Even the two pure-play peer to peer lenders, Prosper and Lending Club, have a large institutional investor base so it is not necessarily just peer investors lending to borrowers. Beyond the two peer lending credit platforms, the distinction is even more blurred. Check out my peer lending sites review for a more detailed description on the two p2p marketplace lenders.
OnDeck Capital and several other large players like SoFi allow investing in loans but only for accredited investors and institutional players. There’s also a whole industry of smaller players like Avant Credit that lend out on their own capital.
Loan types offered also vary by platform. Prosper Marketplace has remained committed to its focus on personal lines of credit while Lending Club has moved into the small business space. SoFi has made its mark in educational and mortgage loans and OnDeck Capital specializes in business loans.
The growth in the peer and online lending space is so strong that it has easily supported the many business models and investor demand has remained high. This growth is likely to continue for at least a couple of years as borrowers become more comfortable with online lending. Eventually the different business models and companies will start to consolidate once growth slows.
Peer Lending Market Potential More than 1,600 Times Larger
It took Prosper Marketplace eight years to originate its first billion in loans. The second largest marketplace lender originated its second billion in loans over just six months in 2014. In the third quarter of 2014, Lending Club saw its first quarter of one-billion in origination.
Even at this feverish growth, the peer lending credit industry is still just a fraction of the total market for consumer credit and other loans. Revolving credit, mostly balances on credit cards, topped $858 billion in the last quarter of 2013. Non-revolving consumer credit, led by the $1.2 trillion student loan market, jumped to $2.1 trillion last year.
The financial crisis choked off the $70 trillion market for small business loans and regulation under Dodd-Frank and Basel III are making it difficult for traditional banks to carry out their role as primary financiers. The Federal Reserve reports in a special paper on P2P Lending and small business credit that banks account for 60% of small business credit, followed by finance companies (15%) and other sources (25%) like brokerage and leasing companies. The median small business loan was for $20,000 which is well under the maximum allowed even for personal credit on the peer lending platforms.
The rise of peer lending credit could not have come at a better time for small businesses. According to a paper published by Harvard Business School, loans from traditional banks to small businesses in the United States have fallen by 20% since 2008 while loans to larger companies are only up 4% over the period.
While most peer lending platforms remain focused on consumer credit, the potential exists for the industry to move into the $13.3 trillion mortgage industry. In fact, at a total outstanding balance just under $10 billion, the peer lending space is less than a tenth of a percent the size of the total U.S. credit market.
The peer lending credit space holds several advantages over traditional lending that may work to its favor in grabbing market share. Costs related to operating physical branch locations account for up to 35% of a banks total operating expenses. Through cost advantages, Foundation Capital estimates that marketplace lending can reduce costs by as much as 4% compared to traditional banks. Some of those savings will be passed through to borrowers as lower rates and could help persuade people to go online for their next loan.
Moving away from the stale model of reliance on credit scores, online platforms are tapping algorithms to gauge creditworthiness and may mean greater flexibility for the industry. The returns to peer lending have been so strong and regulatory burden has gotten so great that Prosper Marketplace is seeing traditional banks invest in the platform’s loans. Ron Suber, President of Prosper, recently told me in an interview on the future of peer lending that banks have become regular investors as a way to place their capital rather than originate loans themselves.
Growth in the peer lending space is likely to resemble the pattern set by online retailing. Even after more than a decade of development, growth in online retailing still far exceeds traditional retailing but only accounts for just over 8% of the total retail market. Even at just 5% of the total lending market, peer lending could reach more than $800 billion or more than 80 times its current size.