Specialty Finance Provides Lucrative Investment Opportunities

by Next Edge Capital

Specialty finance, alternative lending, shadow banking, and internet enabled lending are a few of many titles used to broadly define lending activities, primarily technology based, conducted outside the typical banking system.

Digital enabled lending offers individuals an autonomized, technology driven approach to borrowing and lending money. It’s through this marketplace that borrowers and lenders are digitally paired. The borrower being an individual or small to medium sized business (SME), and the lender, a wide array of capital providers.

Although various forms of alternative finance have long existed, they have become much more popular through the wake of the 2008 financial crisis. Reconfigured regulation, repurposing technological capabilities and a shift in consumer perception towards certain banking activities have been the driving force behind this change.

Relative to the size of the overall unsecured lending marketplace, these digital alternative lenders have captured only a small percentage of market share to date, leaving considerable room for growth. In this paper we will explore the enabling factors that have led to a rise in decentralized industry players and the opportunity that has uncovered itself as a result.

New regulations are playing an integral role in developing the digital lending marketplace and have paved the way for new entrants and competition. A combination of factors including, but not limited to the Dodd Frank Wall Street Reform (U.S.) and Basel III, have forced banks into tightening their product offerings to consumers and small to medium sized businesses (SMEs). Thus driving clients into the arms of these new platforms.

This has led to reduced credit availability in some lending areas as it has made the cost of doing business more expensive for regulated banks. 1


This has led banks to pull back from dealing in some areas such as loans to non-investment grade companies. 1

Technology overall is best known for disrupting industries by taking a business model and redefining it with efficiencies in cost and time. This could not be truer for the evolution of the specialty finance industry.

Over the past decade, the general population of the western world has welcomed a digital lifestyle with both arms open. Increased online security standards and a cultural shift towards living professional and personal lives online has created a need to seek the most convenient, technological way in which to live our lives.

Specialty finance lending offers simplicity and convenience to the application process and provides a safe, familiar space for this activity.

There is an estimated $3.2 trillion of consumer debt in the U.S. 2 (Chart 1). To date, only 1%2 has been captured by the digital lending market, yet these companies are growing at an accelerated pace as both borrowers and investors recognize the advantages relative to the traditional bank lending model3 (Chart 2).



The European alternative finance market has seen significant growth in the past three years, from €487m in 2012 to €2,957m in 2014, with an impressive average growth rate of 146%4. (Chart 3)


Recent figures show that the US, UK and China, represent the vast market share of the online lending market totaling 96%7, however these businesses are taking a foothold globally. 2 Due to the traditional lenders vacating this sector (Chart 4), talent and proven management teams are available and have formed alternative finance businesses with significant backing. Very attractive to this talent and investors to the space are that, unlike traditional brink-and-mortar lenders, online specialty finance companies have low overhead, attractive margins and scalability. Goldman Sachs estimates that just between consumer loans and SME lending outstanding, there is $387 billion ‘at risk’ of leaving the banking system over the next 10 years. 1


In both Europe and the U.K., SMEs find it increasingly challenging to find available financing through the typical banking system (Chart 5 & 6). Studies show that most managers of European SMEs feel that the availability of bank loans have not improved since the financial crisis, and may have even deteriorated or worsened. 4 Governments are aware of the funding gap and in many instances are embracing these new lenders.



In conclusion, the digital enabled lending space is providing to be lucrative to sophisticated investors, which is helping to fuel the growth in the sector. Funds are flowing from institutional investors into peer to peer consumer loans, for example, leading to the creation of investment-grade asset classes being packaged and financed in the traditional capital markets. 4

Providers of capital to these non-bank lenders have an opportunity to capture attractive yields traditionally made by the banking sector. Various forms of participation in this growth are occurring from private equity providers used to finance working capital, to enablers of capital utilized for lending activity. The latter being done via the purchase of these loans from the platform (packaged), or by structuring a debt facility with prescribed terms and security.

Change is happening, the future looks bright and along with that comes opportunities for investment in this emerging industry.

  1. The Future of Finance, The Rise of the new Shadow Bank, Part 1” Goldman Sachs, March 3rd, 2015
  2. “Peer-to-Peer Lending: Prospects and Pitfalls” Moody’s Investor Service, January 29th, 2015
  3. Victory Park Capital, September 2014
  4. “Moving Mainstream, The European Alternative Finance Benchmarking Report”, Ernst & Young, February 2015
  5. “Introduction to Alternative Lending”, Fundnation, March 19th, 2015
  6. “Understanding Alternative Finance, The UK Alternative Finance Industry Report 2014”, Nesta, November 2014
  7. “Alternative Lending: A Regulatory approach to Peer-toPeer Lending”, Grant Thornton, 2014

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