Photograph
by Arthur Rothstein/Library Of Congress
Peer-to-peer lending most
immediately brings to mind the largely feel-good act of extending small-time
money to small businesses and individuals with quirky projects—a curiosity at
best and no threat to the lending hegemony of big banks. What’s less appreciated
is how successful peer-to-peer lending platforms such as Prosper and
Lending
Club have been in connecting wholesale numbers of individual lenders and
borrowers. Yes, they still allow you to go out there and pick a proposition to
invest in. But these successful, venture capital-backed startups also offer
portfolios of loans that have quietly registered four to six years of solid
returns with low defaults.
The more that record holds, the more these diversified offerings represent
an asset class of sorts within fixed income.
The upshot: Those earning little-to-nothing on their cash can more easily be
connected to people who are willing to give them an above-market rate of return
for capital, with no
intermediary bank needed. “It’s absolutely the perfect arbitrage
between countless frustrated low-yield investors and countless desperate small
business owners hungry for financial survival and growth,” says Robert
Lamb, a professor of finance at New York University.
Renaud Laplanche is the founder
and chief executive officer of Lending Club, which has been at least doubling
its loan originations every year since it started in June 2007 at the onset of
the financial crisis. He says he came up with the idea when he realized he was
paying 18 percent on his credit-card debt while the issuing bank was paying out
2 percent to depositors. The upstart venture, which just added former Treasury
Secretary Lawrence Summers to its highly
name-dropable board, made $718 million in loans last year and is expecting
to do $1.5 billion this year. That’s not JPMorgan Chase
(JPM) or Bank of America (BAC) money, to be sure, but consider the Internet’s
accelerant nature and you realize how disruptive the concept could be to the big
banks’ lending monopoly (which they flex through credit cards and branch-made
loans).
“We’re benefiting from the current environment as a better alternative,” says
Laplanche. “We have a pretty strong cost advantage. Plus, the banks have been
under a lot of pressure to improve their reserves, much of which were depleted
during the crisis.” Even if the banks feel their oats and begin lending again,
he says, Lending Club benefits from its operating and marketing costs, which on
average represent 2 percent of the dollar figure of its total loans outstanding,
compared with three times as much for the big banks.
Lending Club mitigates risk—its default rate has remained in the low single
digits throughout the financial crisis—by serving prime and superprime borrowers
and turning down 90 percent of loan applications. A key value proposition to
investor-lenders: Not only does the peer-to-peer service’s platform crunch and
grade individual creditworthiness, it lets those with cash to lend diversify
their investment across hundreds of notes. They receive monthly payments, which
can either be banked or reinvested. Amazingly, since Lending Club opened in
2007, no investor with 800 notes or more has lost any principal. Depending on
the loan grade picked by investors, Lending Club has delivered average annual
returns ranging from 5.8 percent to 12.4 percent.
Prosper, perhaps Lending Club’s main rival, has similarly posted nice
risk-adjusted returns across its loan portfolio. Its management and board
are studded with venture capitalists and Wall Street names.
The value proposition to borrowers, obviously, is access not just to capital
that the banks aren’t willing to lend them, but capital at a lower cost should
they make the grade.
The concept of online peer-to-peer lending is more old hat abroad. It got its
start about a decade ago in the U.K. before spreading to much of western
Europe. In more rigid debt markets, such as that of China, where the government
keeps a fat finger on banks’ scales, peer-to-peer banking has outright
exploded.
Last spring, China National Radio reported that more than 2,000 such websites
had been set up nationwide since 2007, with the value of their loans increasing
300-fold, to 6 billion yuan, by mid-2011. The field there is rife
with abuse, opacity, and lack of oversight. In September 2011, the China
Banking Regulatory Commission warned that the peer-to-peer sector’s bad-loan
ratio was “significantly higher” than that of banks and these startups are a
breeding ground for fraud and money laundering. Still, the need is there:
According to Citic Securities, only 3 percent of China’s 42 million small and
midsize businesses can get bank loans, while 36.7 trillion yuan of household
savings sits in bank deposits.
Farzad is a Bloomberg Businessweek contributor.