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Opinions and analysis of Marketplace Lending, Online Lending, and Peer to Peer Lending.

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Cognizant Report on Marketplace Lending: A Critical Review of the Study



Introduction

Recently, there has been a lot of surveys, reports and news articles published on the topic of peer to peer lending and marketplace lending. See Two Significant Reports Just Published on P2P Lending, The National Rise of Peer to Peer Lending in the Newspaper, and Why Small-Business Lending Is Not Recovering as examples. As Lending Club getting closer to filing for IPO, this heightened interest in peer to peer lending is not surprising.

One such study was recently conducted by Cognizant, an IT consulting company. The published white paper Marketplace Lending: A Maturing Market Means New Partner Models, Business Opportunities was the output of that study. We decided to look deeper into this white paper and the underlying study.

Key Study Findings

The study recommends to marketplace lending companies:

  • Focusing on vehicle and small business loans.
  • Considering both financial and social factors while categorizing loans.

The study claims that marketplace lenders:

  • Would be willing to lend more often if they were provided with options such as immediate liquidity of funded loans, securing a part of principal through insurance, updates on the borrower’s repayment track record and, importantly, if the marketplace platform was allied with traditional banks.
  • Desire provisions for bad debts and legal action against defaulters.

The study also claims that marketplace borrowers:

  • Need physical branches and opportunities for enhancing interactions with lenders through digital platforms.

Survey Participants

The company conducted online survey among sample of approximately 11,000 U.S. consumers – roughly 701 of whom are marketplace lenders or borrowers – during February and March of 2014. We suspect that the survey was done among online-savvy finance-inclined consumers and may not be representative of entire U.S. consumers.

As the study focuses on marketplace lending, the relevant survey size is only 701 participants who are either borrower or lender on marketplace lending platform. As shown in Figure 1 of study, 39% (273) of marketplace lending survey participants are borrowers, 37% (259) are lenders and 24% (168) are both borrowers and lenders on marketplace lending platforms. In essence, 38% of borrowers are also lenders.

How does this compares with Prosper platform that discloses the borrowers who are also lenders? According to PeerCube Prosper past performance pages,

Total number of loans issued to borrowers = 155,356

Total number of loans issued to borrowers who are also lenders = 13,260

% Loans issued to borrowers who are also lenders = 13,260 / 155,356 = 8.54%

Only 8.54% of the Prosper loans were issued to borrowers who are also lenders. There may be an objection that percentage of loans is not same as percentage of borrowers. Let’s identify the unique number of borrowers on Prosper platform.

Total number of loans issued to repeat borrowers = 24,028

Total number of unique borrowers = Total loans issued - Total loans issued to repeat borrowers * Number of prior loans held by such borrowers = 155,356 - 34,938 = 120,318

% of borrowers who are also lender = 13,260 / 120,318 = 11.02%

As evident from above calculations, the 38% of borrowers are also lenders in the survey participants is more than three times higher than the borrowers are also lenders on Prosper platform. This discrepancy potentially skews survey findings regarding borrower preferences toward lenders expectations. And, we consistently noticed the pattern of items showing up in borrowers preferences that are intuitively preferred by lenders rather than borrowers and may be even detrimental to borrower’s objectives. Below are a few snippets of such patterns:

  • Online tools for portfolio analysis, risk calculation, etc. and lender-borrower interactions being listed as one of the borrowers’ priorities for a marketplace platform (Figure 5 and again repeated in Figure 10). Do readers see the portfolio analysis and risk calculation being important to borrowers?
  • Virtual interview with potential lenders listed as one of the borrowers’ recommendations (Figure 11). How will virtual interview with lenders benefit borrowers? Should it be reverse? In our opinion, the lenders will benefit from virtual interviews with borrowers.
  • Do not like to work with big banks/institutions as the one reasons for choosing marketplace lending by lenders (Figure 20). Is it the borrower or lender who doesn’t like to work with banks?
  • Partnering with retail banks and branch availability of marketplace lending site as features sought by lenders (Figure 22). Will the branch availability benefit borrowers more or lenders?

Reasons for Default

It was strange that study shared lenders’ view of reasons for default and skipped over borrowers’ view. We believe a survey may be a better tool for providing borrowers’ view of reasons for default than lenders’ view. Lenders’ view can easily be gaged by reading the online forums such as Lend Academy forums where lenders hang out.

The study authors missed out on a good opportunity to share borrowers’ view that would have been more relevant to marketplace lending platforms and lenders on those platforms.

Preferred Loan Types

The Figure 23 in Cognizant white paper indicates that the top four loan types preferred by marketplace lenders are Vehicle, Education, Small Business, and Home Improvement. Debt consolidation, which is by far the most common loan type on Lending Club platform, accounting for 57% of all loans issued to date, is the sixth preferred loan type.

On Lending Club platform, loans for vehicle, education, small business, and home improvement accounted for 1.3% (7th), 0.1% (13th), 1.7% (6th), and 5.8% (3rd) of total volume respectively. The rankings by volume are listed in parenthesis, when loan volume is sorted from high to low. Among the 14 loan purposes used by Lending Club, vehicle (car by proxy), education, small business and home improvement loans were ranked at 3rd, 12th, 14th, and 2nd when sorted on the basis of Loss Rate, from low to high, according to PeerCube Lending Club Past Performance.

It is hard for us to believe that the study found top three loan types preferred by lenders to be of either with low volume or of high loss rate on Lending Club platform. Cognizant must have found the ‘needle in the haystack’ marketplace lenders in their survey who preferred loans that not many do and should do. In addition, Figure 25 that shows the purpose of Marketplace borrowing itself does not match with the lenders’ preferences.

As the guest in our previous blog post mentioned Do not make any loans to be used for Business, we don’t see many marketplace lenders could build a decent size loan portfolio and of acceptable quality with the preferred loan types found in Cognizant study.

Orphaned Claims

We found several claims in the study where no data, reasons or explanation supporting the claims was provided:

  • “Lenders still trust the banks - an incentive for banks to enter the marketplace lending arena.”
  • “Institutional investors are finding other ways to gain an advantage in this space. In some cases they have set up servers near the marketplace lender’s premises to get a head start and provide funding quickly, before other lenders.”
  • “The importance of data privacy and security features can be gauged by the fact that almost 77% of borrowers and lenders are willing to pay a nominal fee for biometric security features.” The study failed to elaborate and we failed to see the applicability of biometric security feature in the context of marketplace lending.
  • “Lenders prefer to lend to those rated highly by the platforms because the risk of default is less.”
  • “The preponderance of loan default is an open question since most loans issued on marketplace lending platforms have yet to run their full course.”

Interesting Tidbits

Below are a few nuggets we found during our review of the study that our readers may find valuable and to keep in mind while being participants on marketplace lending platforms:

  • Marketplace Shutdown: 35 marketplace lending companies have launched in UK since 2005. Of these 10 have shutdown due to high default rates. This fact shows the importance of managing defaults by marketplace lending platforms as well as by lenders. In addition, it should also keep lenders at guard about new platforms that may be started by the same operators as the default picture can take 3 –5 years to clear.
  • Longer Term Collateralized Loans:Borrowers have shown an inclination to borrow for the long term, beyond 5 years, to buy a vehicle or a house against collateral. Potentially, a few startups like Realty Mogul, RealtyShares, Red Rock Assets, Patch of Land, LendingHome are already addressing such domains and worth checking out if readers are interested in longer term collateralized loans.
  • Social Media in Ratings: Borrowers are amenable to subjecting their social media profiles to scrutiny; 82% have shown a willingness to share their social media profiles. Though there hasn’t been any research on effectiveness of combining social media with credit information to better gage credit risk of borrowers, it is not stopping startups like Upstart from pursuing such angles.
  • Education Loans: As for the second preferred loan type found in Cognizant study, lenders may believe that education loan hopefully may lead to the stable and better-than-average earnings for borrowers, a potentially positive influence on return of money back to lenders. According to the Labor Statistics of 2013, person with collage degree earns 1.7 times more and experiences almost half of unemployment rate when compared with one who only earned high school diploma. Also, in this society, there is a sense of virtue of supporting people to get education and funding education loan may give lenders a sense of philanthropy. These may be the reasons education loan are popular among lenders surveyed in this study. If you are a supported of education loans, Sofi and CommonBond are the places to go in order to invest in peer-to-peer student loan. Interestingly, on Lending Club platform, no educational loan has been issued since 2011. It may just be a coincidence that Sofi and CommonBond were founded in 2011.

Key Takeaways

Though Cognizant study provides some interesting tidbits, some of the findings may seem counter-intuitive to our blog readers and those who have been around the p2p lending industry for a while. Overall, in our opinion, this study didn’t meet our expectations of rigor of a solid research and lacks basic understanding of peer to peer lending industry.

Comments: (2)

Carl Saperstein | Sunday August 31, 2014, 2:30 pm
Thank you Anil: Your Key takeaways are an excellent synopsis. Loose research" is not only questionable but also potentially dangerous. Note this quote from the study: " • Marketplace lenders: » Believe that lending through marketplace platforms is risky, but are attracted by the solid rate of returns, which range from 7% to 24% per annum" As an active investor I don't know of anyone who earns 24% per annum.
Anil Gupta | Thursday September 11, 2014, 11:07 pm

Carl,

Thanks for your comment. I agree it is a reach to claim that marketplace lenders are achieving 24%.

Thanks.

Anil

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