Why These Two Big Banks Are Stiff-Arming P-to-P

Peer-to-peer lending platforms should strike two banks — Capital One and Regions  — off their list of potential new bank partners.

Leaders of both banks were quizzed this week about their interest in buying peer-to-peer loans or partnering with peer lenders to attract new customers, and both distanced themselves from such suggestions.

"The peer-to-peer lending opportunity is not one that is at the top of our list," Richard Fairbank, the chief executive of Capital One, told analysts in a conference call this month. "There are a number of other really clever things that are happening with startups that we're a lot more interested in."

Fairbank's comments were a surprise to those who have seen Capital One engage the peer lending industry closely. Fairbank described Capital One as a "very eager observer" but said it will not pursue peer lending partnerships outright because of regulatory risks.

The McLean, Va., bank seems to have found others ways to profit from the peer-to-peer mania that has swept yield-starved investors into a race to snatch up riskier credits. It is quietly offering investors leverage financing to build their books of peer loans, market observers claim.

"Bank loans to small businesses are declining, yet they are playing behind closed doors, and they are still active, only, now in a second-risk position, by levering [firms like] me," said Brendan Ross, president of Direct Lending Investments, which has invested $120 million in peer-originated small business loans.

Ross would like to add leverage to his fund in January, he said. Direct Lending may also deploy as much as $200 million more into purchases over the next two years, some of which may go into peer-originated real estate loans.

Banks are beginning to openly communicate once-closely held thoughts on potential peer-lending partnerships. Smaller banks, like BMC Bancshares in Dallas and Congressional Bank in Bethesda, Md., already have agreements to refer customers or purchase outright whole loans made by online-marketplace operators.

The latest bank to add its voice to the debate was Regions Financial in Birmingham, Ala. It is uncomfortable with the idea of partnering with peer lenders, Chief Executive Grayson Hall said this week, responding to analysts' queries about peer-lending possibilities.

"Quite frankly, we have got a number of competitors, [whose] rules of engagement are different than ours," Hall said on the company's third-quarter conference call this week. "And so you know today in our environment some of that type of lending, I just think we have to stay away from."

The fast-growing trend in consumer credit offered by alternative, nonbank lenders funded by individual investors, or increasingly, institutional ones, is eating into bank business at a rate that may grow as large as $70 billion in originations annually in just five years.

Obtaining cheaper access to funding is a top priority among so-called marketplace lenders, and their existence may very much depend on how broadly they can access other and cheaper forms of capital.

Yet, for banks, the decision to partner with what is essentially a competitor is a prisoner's dilemma, according to Richard Bove, head equity analyst at Rafferty Capital. The peer lenders' "costs of funding are much higher, so they have to seek business in lower credits. That ultimately means that when the next downturn comes, these companies will be hurt very badly. However, between now and then these firms are going to make a fortune."

Regions in January announced it would discontinue its Ready Advance program after facing broad regulatory scrutiny into high-interest loans resembling payday products. It expects to take a $5 million hit in revenue on the year as it winds down that product.

Like other banks also contemplating referral programs and loan purchase agreements with Lending Club and Prosper, Regions seems more focused on long-term strategies to bring in new customers.

"That really seems to be the better alternative versus being a funding agent, if you will, for somebody else's customers," Regions' Chief Financial Officer David Turner said on the call. "But as Grayson [Regions' CEO] mentioned, things are changing pretty rapidly and we have to be able to adapt and deal with this on a prudent basis and obviously within the confines of our regulatory regime that we have."