James Cox, March 15th
Shadow banking in general has come back to life after getting hammered during the financial crisis, but one segment has been especially rampant.
Peer-to-peer (P2P) lending, in which loans are made privately through individuals who most often connect through a network of relatively new websites, has exploded over the past five years. It is now the fastest-growing sector of non-bank lending, according to an exhaustive Goldman Sachs report on the shadow banking industry.
The P2P industry had just $26 million in loan issuance back in 2009, as the worst of the banking crisis passed; but that figure now stands at a robust $1.7 billion. While that's still a fraction of the total $12 trillion in loans across the U.S., and even pales in comparison to the $4 trillion in total shadow bank loans, it represents a growth of 65 times during the period.
"Personal lending (installment and card) is likely to continue to see disruption as the benefits of a lesser regulatory burden, lower capital requirements and a slimmer cost structure [over time] drive pricing advantages for new players...leading to share moving away from traditional players," Goldman said in its report.
Broadly speaking, shadow banking refers to nonbank lending, with total liabilities in the industry put at $15 trillion. That's a decline from the 2007 peak of $22 trillion.
The name originated from former Pimco executive Paul McCulley, who used it to describe the myriad institutions that helped provide the easy-money financing that led to the subprime mortgage market crash, which in turn triggered the financial crisis.
While the term became a pejorative closely tied to the crisis, the industry has evolved.
As banks find themselves under tighter regulatory scrutiny, customers are turning back to nonbank lenders for financing. The shadow firms don't face the same regulatory burdens as banks, because they don't take deposits and are thus less constrained when making loans.
No 'shadow', but sunlight
In fact, one of the leaders in the space, not surprisingly, bristles at the "shadow" moniker.
"We don't consider ourselves to be quote, unquote, 'shadow' anything," Prosper Marketplace CEO Aaron Vermut told CNBC.com in an interview. "One of the things that's unique about what we're doing is we're very, very transparent about what we're doing, which is unusual in banking and lending."
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Indeed, Prosper and other P2P lenders actually shun borrowers with poor credit histories, and instead focus on those with slightly blemished records who still have access to credit but are looking for better rates. Those trying to consolidate high-rate credit cards and personal loans, for instance, are part of the industry's sweet spot.
One of the other leading firms in the P2P space, Lending Club, requires a FICO credit scores of 660, which is around the prime credit realm. The firm also requires "satisfactory debt-to-income ratios, 36 months of credit history and a limited number of credit inquiries in the last six months," according to Goldman.
For peer-to-peer lenders, the business model is even simpler than some other shadow bankers: The firms don't take deposits, and they don't even provide the actual loans. Rather, the site merely serves as a conduit between investors and borrowers, taking a fee usually in the 5 percent range.
Prosper requires a 640 score, which also is in the prime range.
"Over the last two years we've grown loan originations by about 20 times," Vermut said. "The quality of underwriting and the profile of the performance on those loans has actually gotten better. We've proven we have growth without sacrificing quality."
Banking analyst Dick Bove, vice president of equity research at Rafferty Capital Markets, recently issued two research notes practically gushing over Prosper. Bove is more accustomed to writing about Wall Street's bigger names, but has repeatedly said shadow lending is a major wave in banking's future, as institutions facing regulatory pressure shed non-core and costly businesses.
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"It becomes a breath of fresh air to actually speak to a company that has a business plan and is successfully executing it," Bove said in the latter of his notes. "Prosper Marketplace is a P2P company which is a delight to speak with."
He listed some bullet points in favor of Prosper, one of which is "multiple investors knocking on the door starving for yield," who are looking to pony up to $500 million to lend. Prosper needed eight years to issue its first $1 billion in loans and only six months to hit the next billion, which happened in October.
While touting the company, Bove did say there will be challenges ahead.
"This is a real company doing real business not a government construct run by a series of invisible bureaucrats," he said. "The interest rates being charged on loans are relatively high.
Some borrowers "may not be able to make the required payments," Bove added. "At the moment, this is not a factor because the business is growing so fast. It may become one a few years from now."