Securitized Peer-To-Peer Loans: A New Growth Area

by: John M. Mason

Picture this…securitized peer-to-peer loans with a secondary market with credit ratings and a Bloomberg-like terminal.

Well, the first step of this progression has been achieved. Tracy Alloway, in the Financial Times, tells us "Earlier this month, Eaglewood Capital, a New York-based investment firm, bundled together $53 million worth of P2P loans into the kind of sliced-and-diced bonds that gained notoriety during the subprime crisis. There is talk of more securitizations to come, as well as exchange traded funds and secondary markets where large investors can trade the peer-to-peer loans they have already bought."

The yields on the loans themselves? According to Lending Club, one of the more prominent peer-to-peer lenders, a investor can earn returns of 5.57 to 9.16 percent on the safest loans available to purchase.

The peer-to-peer lending market developed around the concept that individual investors could be put directly into contact with potential borrowers and avoid entirely the "middle man," an intermediating bank.

The idea caught on.

It caught on to the extent that even such high profile players as John Mack, the former chief executive of Morgan Stanley… among others… serves on the board of Lending Club. Furthermore, Morgan Stanley's wealth management division has already invested $100 million in peer-to-peer lending.

So, like other startup sectors, once the possibilities of the sector are displayed, scale starts to intrude upon the role of the individual investors that formed the initial foundation of the business.

And, scale is one thing that the Internet seems to be able to handle quite easily. Remember, also, that finance is just "information" and information can be transformed (sliced and diced) and transmitted in about any form that is needed or wanted… and can be done almost instantaneously.

Now, Ms. Alloway writes, for Lending Club and Prosper, another major P2P lender, "more than half of their loans are now bought by big institutional investors such as hedge funds and pension companies, or funds investing on behalf of individuals."

She goes on to add that "Much of the interest has been buoyed by the creation of 'whole loan programs' which allow large investors to take down entire loans, instead of pieces of loans that appeal to individual investors with more limited budgets."

This is pivotal because it is a needed development for securitization to take place. In order to securitize you need scale and leverage from banks. And, for banks to be players you need the 'whole loan programs.'

For example, the Eaglewood Capital deal, mentioned above, came about because an "unnamed insurance company" took the senior tranche of the securitization, an amount equal to $40 million, and Eaglewood assumed the remainder of the offering.

These expansions seem to be just the start of even more lending types and lending vehicles that can come about… more opportunities to create other vehicles with which to invest in an asset class.

Commercial banks have now started to partner with peer-to-peer lenders, buying loans from their internet platform. Some of these banks have also used peer-to-peer websites to originate some loans that would not be done if the bank had to work directly with the borrower.

This, of course, opens up other possibilities for commercial banks to work "on line."

One of the big questions facing these peer-to-peer organizations is how the sector will evolve given the fact that bigger lenders are entering into the area and are becoming competitors to the individual investors that helped to originate the process.

But, this is a part of how markets work. Where there are incentives for players to enter… they will enter.

So, we have good news and bad news for the industry and the individual investors. Bigger players are entering the industry. That is the good news.

The bad news is that bigger players are entering the industry.

Here we are seeing how the Internet is playing a role in the evolution of the financial system. Obviously, it will not end here and will, eventually help to define what the financial system is going to look like in the future.

As I have stated many times before… it is in areas like this that an investor in companies might want to look… not only to lend to… but also to invest in.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.