Marketplace Lending

Marketplace Lending (also known as peer-to-peer lending or P2P lending) is a modern form of financing that uses an online platform to directly connect borrowers with investors who want to lend money. Think of it as a digital matchmaker for loans, cutting out the traditional middleman—the bank. Individuals or small businesses seeking a loan can apply through a marketplace lending website. The platform then uses technology and data analytics to assess the borrower's creditworthiness and assign a risk rating and an interest rate. On the other side, investors can browse these loan applications and choose which ones to fund. Instead of funding an entire loan, investors typically fund small fractions of many different loans, a practice that helps spread out risk. In return for lending their capital, investors receive regular payments of principal and interest from the borrowers, with the platform taking a small fee for originating and servicing the loan.

The beauty of marketplace lending lies in its streamlined, technology-driven process. While platforms vary, the core journey for borrowers and investors is generally consistent and far simpler than traditional bank lending.

• The Borrower: This can be an individual looking to consolidate debt or a small business needing capital to expand. They apply online, submitting financial information just as they would to a bank, but with a much faster turnaround time.
• The Platform: This is the technology company that runs the online marketplace. Its crucial role is to vet borrowers through a proprietary credit scoring model, assign interest rates based on perceived risk, and facilitate the flow of money. It also handles all the administrative work, such as collecting payments and chasing delinquencies.
• The Investor (The Lender): This is you! As an investor, you get to act like a mini-bank. You deposit funds into your platform account and then build a portfolio of loans. You can often set criteria for the types of loans you want to invest in automatically or manually pick and choose individual loans.

1. Application: A borrower fills out a simple online application.
2. Underwriting: The platform’s algorithms analyze the borrower's data (credit history, income, etc.) in minutes, not weeks. It then assigns a grade (e.g., A1 for low risk, E5 for high risk) and a corresponding interest rate.
3. Funding: The approved loan is listed on the marketplace. Investors can then fund small pieces of it until the full loan amount is reached. For example, you might invest €25 in a €10,000 loan, alongside 399 other investors.
4. Servicing: Once funded, the borrower receives the money. They then make monthly payments back to the platform, which distributes the principal and interest to all the fractional investors, minus a servicing fee (typically around 1%).

From a value investor's standpoint, marketplace lending presents an interesting, albeit risky, asset class. It offers the potential for attractive income but requires careful analysis of the risks involved, which are quite different from those of the stock market.

• Attractive Yields: The primary appeal is the potential for higher returns than many traditional fixed-income investments like government bonds or savings accounts. In a low-interest-rate world, earning a 5-9% yield can be very compelling.
• Diversification: An investor can easily spread a relatively small amount of capital across hundreds or even thousands of different loans. This diversification is crucial, as it smooths out the impact of any single borrower failing to pay back their loan (a default).
• Monthly Cash Flow: Unlike a stock that you hope will appreciate, marketplace loans provide a predictable stream of monthly cash flow in the form of interest and principal repayments.

• Credit Risk: This is the number one risk. The borrower might lose their job or their business might fail, causing them to default on the loan. You will lose your remaining principal. A value investor knows that a high promised interest rate is not a gift; it's compensation for taking on higher risk. The key is to assess if the compensation is adequate.
• Platform Risk: What if the platform itself goes bankrupt? While regulated platforms (e.g., by the SEC in the US) must have contingency plans, this remains a significant operational risk. Due diligence on the platform's financial health, history, and management team is non-negotiable.
• Liquidity Risk: Your investment is highly illiquid. You can't just sell your loan part in a second like a share of Apple. Some platforms have secondary markets, but you may have to sell at a steep discount, especially if the loan is showing signs of trouble. A value investor demands a higher return for tying up their money in an illiquid asset.
• Economic Cycle Risk: Marketplace lending as an industry is relatively young and has not been stress-tested by a severe, prolonged recession. In an economic downturn, defaults are almost certain to rise across the board. An investor looking for a margin of safety must be cautious and factor in a potential spike in default rates when forecasting returns.

Before you dive in, approach marketplace lending with the same disciplined mindset you would apply to buying a business.

1. Analyze the Platform, Not Just the Loans: Choose established platforms with a long, transparent track record. How have their loan portfolios performed in the past? What are their fee structures? How do they make their money? Read their annual reports as if you were analyzing a public company.
2. Understand the Underwriting: Don't just trust the platform's grade. Try to understand who they are lending to and for what purpose. Are they prime borrowers with stable jobs, or subprime borrowers with shaky credit histories? A portfolio of high-quality loans at a 6% return is often superior to a portfolio of risky loans at a 12% promised return.
3. Diversify Relentlessly: This cannot be overstated. Spread your investment over the largest possible number of loans. Investing the minimum amount (e.g., $25 or €25) in each loan is a common and effective strategy to mitigate the impact of individual defaults.
4. Calculate Your True Return: The advertised interest rate is not what you will earn. You must subtract platform fees and, most importantly, your expected losses from defaults. Your goal is to achieve a positive net yield after all costs and losses are accounted for.