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Direct Lending in Europe – Progress & Opportunity

Those who closely follow the astounding progress of Direct Lending in the United States sometimes forget that Zopa launched in the U.K. in 2005, 1 year before Prosper and 2 years prior to LendingClub.  Indeed, the alternative lending business is thriving on the other side of the Atlantic, with strong growth, innovative product offerings, rapidly-developing regulation, and some uniquely European traits.

Market Size

U.K. P2P lender Zopa recently announced that it had lent over 500 million GBP since its inception.  Exact numbers for most originators in the European market are hard to track down, as most do not publicly report statistics.  However, there are some commendable exceptions, including isePankur (now renamed as Bondora), whose data we analyzed here a couple weeks back.  In addition, Claus from p2p-banking.com performs a great service to the industry by tracking and reporting loan volumes each month for those originators who will share their data.  In March 2014, the loan volume of  European originators on that list totaled 104 million Euros, which equates to approximately $144 million USD.  The true total is likely substantially higher, given the several notable omissions, including Lendico, Prestiamoci, Wonga, TrustBuddy, and Funding Empire.

Consumer and Business Loans

In Europe, the P2P business model has not solely been applied to consumer lending.  In fact, some of the largest European P2P lenders focus on small businesses, most notably Funding Circle, with many upstarts looking to expand the market, including Funding Empire and Zencap.

Investor Protection & Brand Proposition

Looking to Europe, we can identify certain business models and brand propositions that we haven’t seen in the U.S.  For instance, LendingClub and Prosper both refer to the act of investing money in a loan on their platform as “investing”.  This makes complete sense, as the investor is putting up capital to fund a loan that has a potential for profit, but also a risk of loss.  In contrast, certain European originators brand this act as “saving”, rather than “investing”, and some actually go so far as to guarantee the investment.  See the screenshots below for an illustration of the contrast.

Direct Lending in Europe – Progress & Opportunity_01

As we can see in the imagery above, originators in the U.K. emphasize saving and safety in their investor branding.  The concept, however, is much more than simply advertising.  Zopa and Ratesetter have actually set up funds, the Safeguard and Provision funds, respectively, that provide a buffer against the risk of credit loss on the underlying assets.  While interest yields are lower than many U.S. P2P investments, this concept is likely quite attractive to retail investors, who are now offered a place to put their money that offers higher interest than a traditional bank savings account but is theoretically just as safe.

Lending Across the Continent

Some European originators have chosen to pursue a multi-country strategy, offering their services to borrowers and investors in a variety of jurisdictions across the continent.  Generally, these companies build a core competency in their native market and then tackle the challenge of expanding to each new one.  Bondora (formerly isePankur) began in Estonia, which remains its largest market, and has since expanded to Finland, Spain, and Slovakia.  Lendico is based in Germany and now offers its services in multiple countries across the E.U., with new ones being added seemingly every few weeks.  While there is significant opportunity in cross-border lending, the task of operating in multiple countries presents many challenges, including country-specific legal considerations, the differing capabilities of credit bureaus in each country, and the need to support multiple languages.  Originators who have been able to overcome these hurdles have now begun to expand their operations even outside of Europe.  Examples include Lendico’s recent launch in South Africa and FundingCircle’s acquisition of U.S. business lender Endurance Lending, now rebranded as FundingCircle USA.

Regulation

The popularity of P2P lending in Europe as well as a clear public desire for innovation beyond traditional banking has led regulators to move quickly in adopting rules aimed at protecting borrowers and investors, while ideally providing space for the industry to grow.  In Britain, the Financial Conduct Authority (FCA), recently released a set of rules for P2P lending and crowdfunding.  As with any government action, the rules have received a mixed response, and only time will tell if the regulation will help online lending become mainstream or if they may introduce unintended barriers to growth and innovation.

Considerations for Institutional Investors

The rise in institutional participation in direct lending in the United States is, by now, quite well known.  While slightly controversial among the mass-retail investor base that gave the industry its start, the influx of institutional capital has helped borrowers to get funded more quickly, brought capital stability to the originators, and ultimately fueled significant growth.  While European direct lending is still heavily-weighted towards retail investors, there is strong reason to believe that institutions will take a larger role in the market.  In making this shift, there are some interesting issues for investors to consider.

First, while investor-protection funds may be useful in managing downside risk for retail investors, larger institutions would likely opt for higher interest yields while managing their own risk and liquidity.  This trade-off would likely be attractive to larger funds that could hedge their own bets and mitigate risk through diversification, as we’ve seen among some U.S. investors who have opted for the higher-yielding, albeit higher-risk loans on LendingClub and Prosper.  In addition, each investor will need to decide whether to pursue an active or passive investment strategy.  While some funds will opt to invest in a broad index of loans offered by an originator, those who have the analytical and technological ability to do so may earn higher returns by actively choosing which loans to fund.  Finally, European institutional investors will undoubtedly want to set up many of the good compliance and due diligence practices that we have seen employed elsewhere, such as the appointment of an independent custodian, use of a fund administrator that is familiar with this new asset class, and the activation of detailed portfolio reporting to monitor performance.