As our economy winds its way back to health, one thing is certain: recovery requires credit, and far less is available to consumers through traditional lending channels right now—at least at anything approaching reasonable rates.
So why not help to solve the problem by bringing the individual money owners and money borrowers together?
That’s the premise behind peer-to-peer lending, which is experiencing strong growth as it steps in to help fill the vacuum left by the crisis in the financial establishment and the resulting contraction in consumer credit. Spotting an opportunity in the credit conundrum, some clever entrepreneurs are leveraging digital technology to bring both sides of the money equation together.
On the one side, you have masses of consumers who want to fund everything from debt consolidation and medical expenses, to honeymoons and home remodels, and entrepreneurs who want to start or expand small businesses. For them, unsecured credit has meant credit cards with high fees and interest rates.
On the other side, you have individual investors who have been burned in the stock and real estate markets and are tired of seeing their money sit in virtually interest-free accounts.
By bringing these two very complementary groups together, P2P lending can provide a win-win situation: borrowers get the credit they need, often at more affordable rates than otherwise available to them, and lenders make a decent return on their investments.
It’s a great example of grass-roots capitalism.
How it works
Consider the case of a woman in Minnesota, who was shocked when a major retailer unexpectedly raised the interest rate on a card she’d had for years and always paid on time. Through Lending Club, she borrowed $12,000 in a three year loan with an 8.94% APR and used the money to instantly pay off the credit card.
The woman’s loan was indirectly financed by more than 100 investors via Lending Club. Investors on the Lending Club platform can diversify their investments by purchasing small pieces of many notes issued through the Lending Club platform. Investors receive the monthly payments of principal and interest (subject to a service fee), which can be withdrawn or reinvested.
P2P lending, such as through Lending Club, bases rates on risks, starting with the creditworthiness of the borrowers. But P2P rates can be lower than those offered by traditional financial institutions or credit cards because P2P lenders don’t have massive overhead costs and leverage technology to streamline the lending process. This technology was recently recognized by the World Economic Forum, which named Lending Club one of its 25 Technology Pioneers for 2012.
The P2P Opportunity
In the U.S. economy we see a giant gap between the rate at which creditworthy people can borrow, and the rate at which people with money can lend. We believe that this creates an enormous opportunity for P2P lending. Many traditional financial institutions have stopped making personal loans to consumers, thereby leaving a lot of pent-up demand for a new unsecured credit offering.
This unique offering fills a void on the investing side and it provides investors with access to a new fixed income asset class of consumer notes. This asset class is not highly correlated with traditional investments such as stocks and bonds and can enable more diversified portfolios for investors.
On the sides of both borrowers and investors, the size of the opportunity for P2P lending is huge. The Federal Reserve reports that U.S. consumers are carrying $800 billion in revolving credit card debt, while low yielding U.S. bank deposits surpassed $10 trillion for the first time ever in 2011, according to Market Rate Insights.
Of course, there is nothing new about P2P lending. It’s what people did before financial intermediaries existed, to create pools of capital for funding human endeavors and absorbing their risk. Banks eventually displaced P2P lending because they could offer greater efficiencies and economies of scale in a rockbound, non-virtual world. But now the scale and efficiencies of the Internet are returning the advantage to P2P lending.
Why Lending Club?
A new business model for consumer finance was long overdue, and that’s what we believe Lending Club has brought to the table. From my perspective as a venture capitalist, I like fresh, disruptive business models – ones that are difficult to duplicate and have a big market opportunity in front of them. Those characteristics defined Lending Club up front, and they have been manifested in the company’s subsequent performance.
Lending Club can provide borrowers with access to risk-based interest rates because its technology-enabled business model eliminates a lot of the overhead of conventional lending. In general, creditworthy borrowers get their money quickly, and often at rates that are below those charged by credit cards. Some specifics:
- More than $630 million in loans have been originated through the LendingClub platform since 2007, and Lending Club currently accounts for 75 percent of P2P lending in the United States
- Borrowers with excellent credit can get rates starting at 6.78% APR — well below the national average credit card rate of 15.00% for similar borrowers.
- Annual returns to investors average 5.8% – 13.4%, varying by the credit grade (A-G) of the borrowers, which correspond to the credit worthiness and risk of the borrowers. (Of course, returns for any individual investor may differ and past performance is no guarantee of future results; investments may lose value).
Initial Lending Club investors typically opened accounts with just $5,000 or $6,000. Now, thousands of Lending Club investors have invested in tens of thousands of loans, and more than 60 investors have invested in excess of $1 million each. Institutional investors are also starting to discover the strong returns of P2P lending, and their growing investments with Lending Club may enable even faster loan volume growth.
The Risk Factor
P2P lending may be a grassroots phenomenon, but Lending Club is registered with the SEC and subject to extensive compliance requirements. Lending Club’s notes have also been a low-volatility investment to date, as demonstrated by the platform’s 19-quarter track record of positive returns, based on platform performance through March, 2012.
To further address risk, the loans get chopped up into small pieces, so individual investors can elect to have small stakes in many loans. For example, an investment of just $20,000 can be distributed across as many as 800 loans. This helps spread the risk of defaults, which average about 3% a year for the platform. This default rate can be seen as a testament to the credit policy and underwriting process operated by Lending Club, which screens out about 90 percent of the loan applications. Only prime, creditworthy applicants qualify for loans through the Lending Club platform.
It is important to note that P2P lending isn’t an outgrowth of the current economic crisis. Rather, it is a beneficiary of the digital revolution. The environment of tight credit is just helping to accelerate its growth.
In the digital age, we think that P2P lending is the simplest, most transparent and most efficient form of lending. In a sense, it represents a return to the way lending used to be: people lending to people.
For the American economy to fully recover, consumers must be able to borrow at reasonable rates, and people with money need investment vehicles that deliver decent returns. P2P lending answers both challenges, making it a very powerful lever for the continued progress of the U.S. economy.
Mr. Crowe is a board member of LendingClub Corporation and NVP is an investor in the company. These are the views of Mr. Crowe and NVP and are not necessarily the views of LendingClub.
The above is not an offer to sell securities or the solicitation of an offer to buy securities, nor shall there be any sale of securities in any jurisdiction in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of such jurisdiction. Your actual investment or borrowing through the LendingClub platform could differ materially from that discussed above. Past performance is no guarantee of future results. Investments may lose value over time and no return is guaranteed.
All loans made by WebBank, a Utah chartered industrial bank.
Only residents of the following states may invest in Lending Club notes: CA, CO, CT, DE, FL, GA, HI, ID, IL, KY (accredited investors), LA, ME, MN, MO, MS, MT, NH, NV, NY, RI, SC, SD, UT, VA, WA, WI, WV, or WY.
Notes offered by prospectus (https://www.lendingclub.com/info/prospectus.action). Please review the risks and uncertainties prior to investing through Lending Club.