Direct Lending: Finding Value/Avoiding Risk

Cormac was on stage with a highly information-rich presentation about the direct lending industry. The presentation was structured around the four main focal points: big picture trends, assessing interest income, equity investment perspective as well as sector issues and opportunities.

He highlighted the remarkable growth of the industry of 150% per year, saying that online lending has become a global phenomenon that is here to stay. Geographically, China is a region that stands out for the sheer size of the market. Lack of investment opportunities for retail investors led them to online marketplace lending platforms.

Europe, on the other hand, presents a tremendous growth opportunity as only 1% of the addressable market is currently serviced. In the UK, the top 6 platforms account for the about 90% of all loans and, similar to Europe, only 2% of the addressable market is currently serviced. A recent survey showed that awareness of online marketplace lending among consumers did not grow in recent years; hence, growth is coming from deeper penetration in the existing investor segment.

Deals come from a variety of sources, including traditional banks. There is a gap in terms of yields available to investors, ranging from 2% to 16%. The average yield is 8% in the US and 6% in the UK. Cormac highlighted that the sector is quite resilient, for investors have consistently achieved positive returns.

Nevertheless, we are in a remarkably benign credit environment. Real yields are expected to be negative in the UK, but some high yield bond traders are concerned about the quality of loans that are generated in such an environment. Looking into the future, what kind of returns can online marketplace lending platform investors expect? Cormac thinks returns will be in the 1% region throughout the business cycle, falling down to 0 and -0.5% at the trough. He notes that during the same trough returns of equity and real estate investors will be significantly more negative. In order to maximise returns, investors should look at niche lending markets.

In summary, Cormac expects continental Europe to overtake US during the next five years. He emphasises fantastic Sharpe ratios available to online marketplace lending platform investors, compared to those in equity markets. In Cormac’s opinion, what is needed to further increase consumer awareness of the segment is a one-stop shop p2p lending platform for retail investors. Over the long term. Comrac expects marketplace lending loans to partially disintermediate cash as a source of payment and store of value.