The crowdfunding “revolution” brought with it very interesting investment opportunities for asset managers. I use quotation marks because there is nothing revolutionary or technological about the business practices, and so the buzz-word “Fintech” is often a misnomer. Personal loans for example are as old as finance.
Assets which were previously available only to banks, small private lenders, and wealthy families are now available to the public. What makes it different is that assets which in the past would have been financed in whole by a lender who had almost exclusive access are now being financed online by many crowdfinanciers. Slicing up financial assets and assigning economic and/or legal ownership to different investors is nothing new in finance either.
Personal loans are the biggest asset class, with about $1bn mediated online per month by Lending Club alone, and are providing investors a steady 7% USD net returns after losses and fees. Note that Personal Unsecured doesn’t mean the borrower can simply not pay. Non-payment leads to pestering collection attempts, civil proceedings, and eventually, personal bankruptcy and liquidation.
Another major asset class is Real Estate Bridge Loans wherein a real estate entrepreneur would borrow 60% of the asset’s value for a period of 12 months at an 8-12% rate, fix it up, and flip it for a profit. In case of default, the operator of the crowdfunding platform will seize the property, sell it, and pay back the borrowers. The biggest risk is of course inflated valuations and fraud, which is countered by the platform operator’s experience and reputation.
Next after that is Invoice Financing, wherein small suppliers with no access to funding sell their “due from clients” receipts to the crowd. The credit risk is with the client, who often is a larger company. Think as a hypothetical example about a supplier to the great Apple. This supplier might sell his invoice at a discount representing a 7-10% annualized interest rate to the crowd investors. The crowd purchasers of the invoice will get a 40-day note with underlying risk on the great Apple at a 7-10% rate, which in this example is clearly risk-arbitrage.
The seemingly excessive returns on assets as old as finance are another indication of inefficiency in banking. Ask any small borrower and he will tell you that banks are simply too slow, arrogant and inflexible in how they treat small borrowers. The reason for this in my opinion is not capital or compliance requirements, even though the two are often used as excuses and as weapons of negotiation. The reason is not some macro terminology that economists use all too loosely without ever having tried to open a bank account for an offshore legal entity to realize how obtuse low ranking bank employees can be. It is good old fashioned entrenched monopoly power arising from the banks’ age-old exclusivity in deposit-taking from the public, in the facilitation of transfers, and in deposit-making with the central bank in each country. This exclusivity is one reason that led – over decades and centuries – to the massive accumulation of capital and assets with the banks.
Hopefully this is all about to change slowly in the coming years, then rapidly, with the adoption of Bitcoin to compete with the monopolized mechanism of bank-and-sight deposits, and with the rise in volumes on crowdfunding platforms taking the credit transformation function outside the banks. Indeed, too-big-to-fail may prove a non-issue in the future if one could have a deposit account from which to initiate outgoing payments and into which receive incoming payments without having to finance – at a subsidized rate – institutions with already trillions of dollars on their balance sheets, and separately from that, if one could have an expert crowdfunding platform operator manage their loan-asset portfolio as opposed to just leave the opportunity at the hands of the privileged few.