Forbes by Nick Clements (April 13, 2016)

Over the years, marketplace lenders have become increasingly reliant upon institutional investors to fund their growing loan portfolios. Hedge funds in general and the securitization market in particular became hungry for student loans, personal loans and small business loans being originated by the proliferation of lending platforms.

But in 2016, marketplace lenders were reminded that institutional capital can be fickle.

According to PeerIQ, the weighted average spread of marketplace securitizations has increased from 200 basis points in 2015 to over 500 basis points in March. Hedge fund investors have become less willing to write big checks. And all of this is coming at a time when marketplace lenders thirst for capital is growing rapidly. SoFi CEO Mike Cagney noted that the industry is reaching an inflection point because of its success. According to Cagney, “when you originate $1 billion a month, you need to have a take-out.”

The common narrative at Lendit is that this will be the year when the strong platforms will start to emerge as champions, and many of the weaker platforms will go out of business. The best platforms are demonstrating that they can originate at scale. But, more importantly, the winning platforms are demonstrating a diversity of funding sources. Small platforms overly reliant on hedge funds buying loans will be particularly exposed in 2016.

A Diversity of Funding Sources 

Lending Club and Prosper have both invested heavily in a retail investor platform. At Lending Club, more than 50% of its funding continues to come from retail investors. Creating this platform required significant investment and regulatory approval. But it is paying off today by providing a more stable source of funds. In addition to retail investors, Lending Club has also formed partnerships with banks, which are buying approximately 25% of their loan portfolio.

Many banks are rich in deposits, but do not have the capabilities or expertise for consumer lending. Platform lenders are increasingly reaching out to these community banks to secure stable funding sources. Mike Cagney of SoFi noted that “there are lots of balance sheet partners and balance sheets out there. Banks have an enormous amount of balance sheet capacity and they understand credit.” As marketplace lenders demonstrate that they can originate, underwrite and service consumers and small businesses in a more cost-effective manner than many traditional banks, this unlikely partnership model is becoming more mainstream.

CommonBond CEO David Klein has built partnerships with community banks, and continues to invest in that funding channel. He believes that the “opportunity is massive, but it takes longer.” Those platforms that invested time in building relationships with banks when hedge fund capital was ample will enjoy the rewards of that investment today.