At the height of the recent financial crisis, consumers
discovered that banks were in no mood to make any sort of loans.
In response, they sought out a new kind of bank, known as a
Banks now likely rue the day they turned those consumers away.
Peer-to-peer lending represented just $26 million worth of loans
in 2009. Today, it's a $1.7 billion business and could be a $10
billion business within five years.
Peer-to-peer lending is just one of the radical changes taking
place in the banking landscape. For example, banks issued 90% of
all mortgages in 2009. Today, that figure has dropped to 58%. And
small businesses, which are at the backbone of the U.S. economy,
are now going out of their way to get loan quotes from
alternative finance providers.
Gone are the days when local banks cultivated deep
relationships with local businesses and citizens. Many of those
banks have been gobbled up in an industrywide consolidation, and
borrowers are quickly discovering new alternatives.
Frankly, it's easy to see why both consumers and businesses
are flocking toward the upstarts. Not only do the "non-banks"
offer slightly better loan rates, but they are also much more
likely to approve a loan. According to Goldman Sachs, alternative
lenders approved 62% of small business loan requests last year.
The traditional big banks approved just 21%.
The big banks are being buffeted by a pair of factors that are
leading them to reduce their exposure to lending.
First, they've been working hard to shore up their capital
bases to meet new mandates. That means they've had little
interest in making new loans that weigh down a balance sheet.
is boosting expenses for the major banks, as they comply with a
slew of new regulations. Alternative lenders -- also known as
"shadow bankers" -- aren't burdened by the regulations and costs
and as a result, can offer better loan rates and still generate
similar net interest margins.
To be sure, the big banks may soon conclude that their capital
bases are sufficiently strong and they may start to boost their
lending activity. And regulators may eventually force the
alternative lenders to adhere to stricter regulation. But the
longer it takes for such changes to take place, the deeper
inroads the alternative lenders will have made.
The other major factor in this industry disruption is the
traditional bank branch business model. The big banks still
maintain thousands of local branches across the country. And
every branch consumes hundreds of thousands of dollars in annual
salary and general overhead. The alternative lenders simply use
the internet to conduct most of their business.
The Peer-To-Peer Revolution
The peer-to-peer lending industry is growing very rapidly, and
investors can invest in this niche in several ways. My colleague
Jimmy Butts provided
an in-depth pre-IPO profile
LendingClub Corp. (NYSE:
. And roughly a month ago, I noted that George Soros' investment
firm now owns
more than four million shares
LendingClub, along with privately-held Prosper.com, are
currently the leading providers of loans to and from consumers.
How big might the consumer end of peer-to-peer lending grow?
"Of the $843 billion of consumer loans outstanding, we see
$209 billion 'at risk' to move to new players over the
longer-term," predict analysts at Goldman Sachs.
To be sure, such a large total market opportunity will attract
new entrants, making it crucial that LendingClub and Prosper grow
as fast as they can in the near-term. (Prosper's venture capital
backers may look to bring the company public later this
In terms of small business lending,
On Deck Capital, Inc. (Nasdaq:
and privately-held Kabbage have the early lead. Notably, shares
of both LendingClub and On Deck have traded off of their highs,
following concerns that growth expectations may have been too
aggressive. Still, each of these firms appear on pace to boost
revenue at least 50% in 2015 and 2016. Investors interested in
this niche should also research Steel Partners Holdings LP (NYSE:
), which owns WebBank, a provider of administrative and
compliance services to a broad range of peer-to-peer lenders.
Business development companies
(BDCs) have been making loans to mid-sized businesses for many
years. They are more heavily regulated, though not to the extent
that the major banks are. My colleagues Andy Obermueller and
Nathan Slaughter have been writing about BDCs for a number of
years, and I encourage you to read their newsletters (
, respectively) to see why they hold BDCs in such high
Perhaps one of the largest niches of "shadow banking" will be
in the area of student loans. There is now $1.2 trillion worth of
student loan debt outstanding, up from $700 billion in 2008 and
range of upstarts are angling to get a slice of that pie.
Privately-held companies such as SoFi, CommonBond and Earnest are
working to connect students with alumni and other potential
These firms also work with students that are well-suited to
consolidate multiple student loans into one loan. A backdoor way
to invest in this niche is through
Nelnet, Inc. (Nasdaq:
, a traditional student loan issuer that has been making a series
of investments in CommonBond.
Risks To Consider:
Now that the big banks have strengthened their capital
bases, they may start to re-take lost market share in various
lending niches. So even as you track the peer-to-peer firms,
it's wise to track the competitive response of the big bank as
Action To Take -->
The traditional world of finance is being upended and billions in
profits are at stake. This is a good time to start researching
all of the leading industry upstarts, whether they are public or
private. A few have already come public and trade nicely below
their all-time highs. That doesn't make them bargains per se, but
the early froth seems to be gone from these stocks.
Oftentimes the little ideas are the big game changers --
something like peer-to-peer lending.
My colleague Andy Obermueller devotes his time to identifying
game-changing trends and the companies that should benefit from
this. This has led readers to investments that went on to gain
triple-digits. More recently, Andy has been talking about the
profit potential for Apple's newest technology Apple Pay -- and
the company's key suppliers
. If you haven't heard about this opportunity yet, then I urge
you to check out his comprehensive report on how to profit from
this technology, by