Data, above all, are what marketplace lenders pride themselves on. They think data allow them to weed out the bad risks, choose the ones worth taking and monitor portfolios to boost recovery rates. They argue that the use of data gives them an advantage that banks lending to similar customers do not possess.

“The only thing we really can cherish is information,” says Mark Währisch, chief risk officer at creditshelf, a German marketplace lender that makes loans averaging about €700,000 exclusively on behalf of institutional investors.

Moreover, marketplace lenders say they are getting better at using data all the time.

However, in many cases their lending began after the depths of the credit crunch. This means marketplace lenders still have to work hard to persuade institutions that their loans will perform satisfactorily during the next downturn. Despite all their information advantages, this is one information weakness for marketplace lenders when compared with many conventional direct lenders.

Built for purpose

Marketplace lenders’ proudest boast is that they have flattened the information asymmetry that exists in traditional models, where the borrower usually knows much more than the lender about potential stresses and actual weaknesses in the borrower’s business or personal finances.

Marketplace lenders argue that their purpose-built systems are better at absorbing and then analysing data than the banks’ legacy systems, which have been patched here and upgraded there over the decades in an effort to keep up with data advances. Bank employees could in theory look at all this data manually. However, marketplace lenders argue that because the systems can absorb, sort and analyse it automatically, they can weed out the bulk of prospective borrowers far quicker than many banks. This, they argue, leaves time for human brainpower to analyse those borrowers that might make the cut.

Währisch explains: “You want a situation where the analyst can really take the time where it’s needed: asking critical questions, talking to the clients and forming an expert view. You don’t want them spending time running numbers through Excel files, sorting them and trying to make them understandable for everybody.”

Thomas de Bourayne is chief executive and founder of credit.fr, France’s largest marketplace lender for SMEs by volume – 592 companies and counting, with an average loan size of €115,000. “We receive about 17,000 application forms a year, or 70 a day, and we have a team of three analysts, so we need the tools and the onboarding process to be able to analyse these,” he says. “We really need to industrialise that.”

The firm is owned by Tikehau Capital, the French alternative asset manager whose business includes conventional direct lending.

Sachin Patel, chief capital officer for the UK at Funding Circle, Europe’s largest marketplace lender for small businesses, says the arrival of Open Banking flattened the information asymmetry yet further. Under the initiative, promoted by the UK government last year and, since September, by the EU’s Second Payment Services Directive, Funding Circle can access current accounts if given consent by the customer to do so. This allows the firm to easily see cashflow history. Because of this last step, claims Patel, “the information asymmetry has pretty much been removed”.

Marketplace lenders’ desire to flatten this information asymmetry applies just as much to managing the portfolio as to underwriting. They claim an advantage here over many banks because their systems automatically absorb any new data from the borrowers every day, thus allowing them to see immediately when the borrower defaults. Marketplace lenders argue that conventional banks assess defaults more rarely.

Lacking the human touch

Sceptics might suggest that data have been placed on too high a pedestal and that this has been at the expense of judgments based on lenders’ long experience of reading people in face-to-face meetings. Conventional banks prefer one of their employees to cast a gimlet eye over each prospective borrower and determine whether they find them trustworthy and credible. “We are really focused on all the information,” says de Bourayne. “We do not see the client, so we need to be better at that.”

However, potential investors might be reassured that, in most cases, creditshelf does actually meet people from its prospective borrowers – as might be expected for a firm that tends to make much bigger loans than the average marketplace lender. For companies in what Währisch calls “the final mile” before securing a loan – “maybe 15 or 20 out of 100”, compared with the eight to 10 that actually secure the loan – “we have a call or meeting with the company”. For loans above €250,000, which is far below creditshelf’s average, the firm undertakes a site visit.

Another potential problem for institutional investors is a lack of evidence on how marketplace lenders might perform in a downturn. Even Funding Circle, one of the older businesses, only began making loans in 2010. Credit.fr and creditshelf have both been lending since 2015.

Responding to this, Funding Circle’s Patel is eager to explain its competence in performing high-quality stress tests, based partly on its facility with data: “The more data you have, the better, the more sophisticated you can be.”

But how much better at making loans could marketplace lenders become as data sources expand and data techniques improve?

Patel sees strong possibilities in reducing fraudulent applications by cross-referencing the manifold sources of data that exist digitally. However, he is wary of using non-conventional data that are based not on standard credit metrics, but on metrics that might show the personality or state of mind of the prospective borrower. This, he says, is “quite a grey area” that poses ethical challenges.

De Bourayne takes a different view. Credit.fr is researching this area to see the correlations between various borrowers’ data and their creditworthiness. It already uses some non-conventional data, such as the time the application was made, and on what device. An application made at 3am earns a lower credit score, all things being equal, than one made at midnight. However, de Bourayne adds: “Let’s be clear: most of the scoring is through using traditional financial information.”

But while the marketplace lenders make a good case for themselves, some investors can identify gaps in their expertise. Francesco Battazzi, head of diversified debt at the European Investment Fund, says such lenders need to get better at explaining themselves when trying to raise funds with institutional investors. The fund, an arm of the EU’s European Investment Bank, is nevertheless increasing its exposure to the sector.

“They are typically experts in technology, and also often on the human side of credit too,” says Battazzi, speaking from the fund’s base in Luxembourg. “But they might not necessarily be expert in fundraising among institutional investors. This is typically one area where most work needs to be done.”

They need, for example, to think “how they can really be convincing in terms of the soundness of the overall credit process, including loan workouts”. He adds that targeting institutional investors also requires the ability to show a track record, good risk modelling, credible market positioning and sound governance.

Asked if they are getting better at dealing with institutions, Battazzi says: “I think it’s a little bit binary. Yes, we have supported players that have been able to do that. This is visible through the growing size of their funds.”

On the other hand, “others are much smaller, and may not provide enough comfort that they can be successful in the same way”, though if they are convincing enough, the EIF is prepared to invest in them, even if it is only a small amount. Battazzi rejects the idea that the business of investing in marketplace lenders, including monitoring the investments, is more time-consuming than for other debt funds.

The EIF’s only publicly announced investment in a marketplace lender has been in the first three funds launched by October, formerly Lendix, a firm headquartered in France and operating in five European markets.

However, the fund has agreed to investments in other marketplace lenders, which it plans to announce by the end of the year. These are part of the European Fund for Strategic Investments’ Private Credit Programme, which was designed to broaden and deepen financing options for small and medium-sized enterprises, in part by acting as a cornerstone investor in funds. The EIF began investing in Lendix loans in 2016.

Another weakness Battazzi sees with some marketplace lenders is returns, though it is not the problem one might expect. He says the EIF, which has a remit to make commercial returns, is satisfied with the actual returns achieved so far. However, he is suspicious of excessively bullish expectations.

“If we see high returns being promised by the platform, we start to challenge whether these loans are really senior loans or more like venture loans,” he says. “We are not looking for high single-digit or double-digit returns. We want to be sure that we are able to compare what they are presenting to us with risk/returns seen in more traditional bank financing.” With this in mind, “we believe that 4.5-6 percent is a sustainable price for the market”.

Marilena Ioannidou is the London-based head of fintech at British Business Investments, the UK equivalent of the EIF, which has also invested in the sector.

She thinks marketplace lenders are getting better at giving investors the information they need: “As the sector matures, people are realising that you have to be very transparent.”

Transparency in the investment process is what marketplace lenders claim to be best at. Being able to replicate this openness in their dealings with investors will be crucial to their ability to fund their loan pipelines.

How Europe and the US have diverged

Compliance, regulation and the influence of banks have produced differences in marketplace lending on both sides of the Atlantic

Like its larger corporate direct lending cousin, there are fundamental similarities between marketplace lending in Europe and the US. Yet there are also some key differences. Funding Circle’s chief capital officer for the UK, Sachin Patel, says that in both regions consumer loans make up the largest portion of the market, and that corporate lending to small and medium-sized enterprises requires a lot more effort.

“[SME loans] are much harder to originate than consumer loans,” he says. A “sophisticated model” is needed to underwrite the debt facilities of SMEs, which he defines as companies with up to $2 million in revenue. There are many existing credit score metrics and other data that can be used to determine what loans, if any, a consumer borrower would qualify for.

Rodrigo Trelles and Baxter Wasson, co-heads of UBS Asset Management’s O’Connor Capital Solutions business, say marketplace lending can tap asset managers for capital in three ways.

First, marketplace lenders can line up financing for specific products, such as auto or home loans, which enables the lenders to originate and fund those loans. Second, those firms can fund their operating business with loans from alternative lenders. Finally, it can also be a combination of the two. Some of the biggest differences between the US and Europe in terms of marketplace lending are just like those in other areas of capital markets: the make-up of the two regions’ financial systems and the existence in Europe of multiple sovereign jurisdictions.

“In the US, you have to make sure you’re in compliance with state and federal governments,” Trelles says, pointing specifically to the country’s Consumer Financial Protection Bureau. “Europe presents a different story because firms must adhere to EU regulations in addition to those required by the countries and the provinces and regional governments in which the assets are originated.”

The supranational European Investment Fund and European Investment Bank add another layer, says Patel. The two institutions have a mandate that includes ensuring EU economies continue extending capital to their best SMEs. One way they can do this is by participating in marketplace lending securitisations, which means they can have a significant economic impact.

Before the global financial crisis, Patel says, the US had a “fairly sophisticated ecosystem” in which banks, securitisation markets and private placements all played a vital role in the flow of capital.

However, banks dominated the landscape in Europe, and those private placement and securitisation markets that existed were less developed in alternative assets such as private credit than those in the US.

All debt market participants know what happened in the wake of the crisis: regulatory changes, among other factors, pushed banks out of the mid-market and enabled the rise of alternative lenders. Banks still make up a much larger part of the Europe-wide financial ecosystem, however, which, along with the individual nation states’ legal and regulatory frameworks, make marketplace lending much different than in the US.

One of the biggest innovations in the past five years has come in the way marketplace lenders carry out their securitisations, which have been a key avenue to liquidity for them. “In their earlier forms, the platforms were primarily using a ‘balance sheet-lite’ model,” says Wasson. “The company was originating those loans and selling them to investors. There were certain firms that took a different view. They held a substantial amount of the loans that they originated. That was meaningful, and the market has shifted. Investors now feel better about alignment.”

The tech firm going large

ThinCats has gone big on both data and loan size – blurring the gap between traditional and new-generation approaches

The official title is PRISM (Propensity and Risk Model), which ThinCats describes on its website as a “suite of predictive data models that are used to enhance our understanding of a potential borrower”. Alex Schmid, founding partner of ESO Capital, which was the original institutional funder of ThinCats and retains a minority stake in the business, describes it simply as a “cool algorithm”.

UK-based ThinCats is part of the new generation of technology-enabled lenders and is happy to emphasise its use of big data. However, it is also an example of where private debt 1.0 and 2.0 meet. It is, after all, an SME rather than a consumer lender. Moreover, although it operates at the smaller end of the market, it can still make loans of up to £15 million.

It is also one of the fastest growing businesses of its type. Launched only around three-and-a-half years ago, it now has more than £800 million of lending capital available and it has lent in excess of £500 million to more than 1,000 businesses.

Schmid says he would not be surprised to see more 2.0 lending businesses pop up with their roots in the traditional fund world: “There are few private debt firms that spotted the opportunity to build up financial services companies. You have to watch out for conflicts, but people like to see these kinds of firms emerging from an existing base of experience. We’re by no means the only one and I could see more cropping up.”