Are we ready for peer-to-peer lending?
by Harry Singh
The private lending market has been around for as long as there have been unforeseeable circumstances and major life events. And, it’s natural for every borrower to expect the lowest possible rate and fees when it comes to borrowing money.
TRADITIONAL LENDING MODEL
Traditional banks generally are the cheapest sources of funds for borrowers. They can do this thanks to the rock bottom yields they provide to their investors in return in the name of security, which in Canada originates from depositor insurance provided by Canada Deposit Insurance Corporation and the Federal Deposit Insurance Corporation in the U.S. Additionally, it is easier for banks to securitize mortgages, at least in the U.S., where the capital markets are a lot more robust than in Canada.
The concept is quite simple: raise capital from depositors like you, pay minimal return on the deposits with minimal risk, lend the funds at higher rates to borrowers, pool the mortgages into portfolios and then sell them via third parties to investors to replenish the capital. Well-capitalized financial institutions with large and deep balance sheets are diversified, while institutions that are not as well capitalized run the risk of restrictions on the securitization process or viability. This may perhaps be an oversimplification of the securitization model, but it captures its essence.
A government that wants to slow down the supply of mortgage funds available to borrowers (an indirect measure to slow down the amount of borrowing) may look to restrict or limit the securitization activity by imposing additional guidelines or by imposing a maximum ceiling on what an institution can securitize. The measure would slow down the supply of credit and indeed reduce competition, which would put upward pressure on the cost of borrowing for borrowers.
The Canadian governments have, over the last nine years or so, been grappling with a unique situation where the interest rates needed to be kept low while keeping the consumer debt to income ratios and boisterous real estate markets in certain parts of the country in check. The Canadian government using its watchdog, the Office of the Superintendent of Financial Institutions (OSFI), chose to restrict the mortgage credit availability through a progressively tighter set of guidelines that have shifted a significant share of the business that previously would have been funded through banks, alternative institutions over to Mortgage Investment Corporations (MICs) and private lenders.
Private lenders and MICs have previously funded a relatively insignificant portion of the overall mortgage credit outstanding in the Canadian market, but over the last nine years, private lenders and MICs have noticed a dramatic increase in their portfolios. Coincidentally, the increase has aligned with the introduction of credit tightening regulations imposed by OSFI. Indeed, the number of private lenders and MICs has also noticeably increased in Canada. While there is plenty of business for private lenders and MICs in the market, it continues to be done rather inefficiently.
Private lenders that are focused on dealing with the ultimate borrowers find it challenging since borrowers generally do not know whether they are a fit for a given private lender, let alone the gap that needs to be filled regarding rates, fees and equity/down payment. The cost of marketing to ultimate borrowers is expensive and the resultant borrowers may not fit a private lender’s requirements. For this reason, many private lenders and MICs in Canada choose to deal with mortgage brokers.
The idea is that a mortgage broker will vet the borrowers and in turn match them with a suitable private lender. Of course, the assumption is that brokers will be knowledgeable regarding private mortgages as they tend to be not as straightforward as a cookie-cutter prime mortgage. Moreover, the number of private lenders in any marketplace is an elusive number to keep track of. Most mortgage brokers will tend to narrow the universe down to one to
three private lenders, which precludes the borrowers from truly benefiting from competition among various lenders.
TIME FOR P2P LENDING?
As we approach 2018, technology undoubtedly will shape the landscape and an age-old business like private lending will undergo tremendous change. Consumers, with the availability of information on the internet, are much better informed regarding trends and opportunities.
Peer-to-peer (P2P) lending is around the corner. Sites are starting to pop up that facilitate lending from one person to another, cutting out the middlemen and creating a process that is both cheaper for the borrower and more lucrative for the lender. The predictable and ongoing obstacle will be regulations in the name of protecting the public; however, the regulatory framework around Uber and bitcoin are classic examples of how market efficiency will prevail in the end. Predictably, it is not an accident that every major bank in North America is chasing fintech investments and acquisitions, as they too see the writing on the wall.
One of the more practical challenges of P2P lending focuses around the underwriting skills of an average person in understanding the risks versus rewards of private lending. However, with bottom of the barrel returns on savings, retirement saving funds and volatility of mutual funds, investors are hungry for stable yield. At least in Canada, and perhaps the same logic might prevail in the U.S., as more quality business shifts from traditional lenders to private lenders, investors can have higher yields while taking on risk that their banks would have gladly accepted if it were not for a regulator forcing them not to do so for reasons other than credit risk. Additional credit/lending education and perhaps use of cheaper but knowledgeable underwriting hubs could be a solution that may also solve the problem of needing a license in some jurisdictions to deal in mortgages. Effective web marketplaces that amalgamate business from across the country—so that investors/lenders can in real time peruse available,opportunities—will be highly effective and reduce costs for borrowers while enhancing the yield for investors.
From an innovation perspective, 2018 will be an exciting year, in terms of both unsecured lending and secured private mortgage lending. With record breaking bank profits and margins while investors starve for yield, the macro environment is very conducive for P2P lending models. The private lending world naturally lends itself to such a model, as does unsecured lending, which tends to be a much smaller ticket item in terms of dollar amount. Web marketplaces that facilitate P2P lending models will be sought after, particularly ones that build an element of risk mitigation through property valuations and other ancillary services that further enable an investor to lend.
About the Author: Harry Singh is the founder and editor-in-chief of Private Matters Today, the leading magazine for Canadian mortgage professionals in the private lending and investing arena. Harry is also the president and CEO of Indigoblue Mortgage Investment Corporation. For more information, contact email@example.com