One of the main things readers should know about Directmoney Ltd (ASX: DM1) is that it’s not quite a conventional ‘Peer-to-Peer’ (or “P2P”) lender. I’ll get to that in a moment, but first a quick brief on:

What is P2P?

P2P lending has been seen as something of a Holy Grail in the finance sector in recent years. It’s thought that streamlining the link between lenders and customers (reducing bank overheads) will simplify the process of lending and deliver greater results for both parties.

Generally speaking P2P lenders can offer more than double the return of an equivalent savings account, and a discount of a few percentage points on a standard personal loan.

A number of peer-to-peer lenders have been growing in popularity recently, including New Zealand-based Harmoney, which is part-owned by Trade Me Group Ltd (ASX: TME). However, none has made it to the ASX until Directmoney appeared this week.

Not technically a P2P lender

Directmoney maintains some distance between its lenders and borrowers, with the company acting as a money ‘warehouse’ and intermediary. Directmoney sells pools of loans to investors and uses that money and its credit rating process to loan money to borrowers.

However, this procedure also means that losses and defaults will be worn by shareholders in the company, rather than the actual lenders.

According to Chairman Stephen Porges, the target yield on an investment (for a lender) is around 7-8%, while interest rates to borrowers range from 8-18% on loans between $5,000 and $35,000. The difference between lending and selling rates is around 4% thanks to management fees of 1.5% and a bad debt buffer. Loans attract a $575 establishment fee.

Why I’m sceptical

I’m glad to see a ‘marketplace’ lender finally make its way to the ASX as I believe P2P lending is a logical next step in the evolution of banking services. However, I have several caveats to my positive outlook.

First, the sector is going to be heavily fragmented as a number of other competitors enter this kind of market. Just off the top of my head, ThinCats Australia and RateSetter are two conventional P2P lenders while a third, SocietyOne, counts News Corp (ASX: NWS), and Westpac Banking Corp (ASX: WBC) as significant shareholders. Unless many main-stream banking customers can be lured away, these companies will be fighting for a shallow pool of borrowers and lenders.

Second, competition is growing and will be intense. While Directmoney appears to have a first-mover advantage (on the ASX, anyway), can investors count on it being able to establish a clear market-leading presence? I don’t think so. There’s no guarantee that another player –on the ASX or off – won’t have a more successful model and gobble up the market.

Third, I’m not sure Directmoney borrowers are getting a much better deal than they would at the bank. With a $575 establishment fee, smaller loans become seemingly unviable ($575 adds an extra 5.75% to the size of a $10,000 loan). With that said a number of smaller lenders like Money3 Corporation Limited (ASX: MNY) and Cash Converters International Ltd (ASX: CCV) do quite well out of niche financing roles and Directmoney is certainly worth a closer look.

As with any new launch, there are risks that the company will not hit its forecasts and, taking all of the above factors into account, I would recommend readers pass over Directmoney until they get more of a sense of how the business performs in the future.

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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.