Consumers Find Investors Eager to Make 'Peer-to-Peer' Loans

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Wall Street Journal
By: Ianthe Jeanne Dugan
August 6, 2013

At the new headquarters of Prosper Loans Marketplace Inc., the mission was spelled out on a whiteboard: "NEED $28,676,530.13."

That is how much more Prosper wanted to lend to consumers by the end of June to hit a $30 million target. The twist: The money would come mainly from individual investors who trawl the company's website looking for borrowers willing to pay them attractive returns.

Prosper and a bigger competitor based a few blocks away, Lending Club Corp., dominate an obscure corner of the financial-services sector called "peer-to-peer" lending, in which consumers bypass banks altogether to borrow money from other individuals. It is part of a shadow-lending system that has thrived since the 2008 financial crisis caused many banks to tighten their credit standards.

There are, of course, plenty of would-be borrowers. Lately, however, there has been even greater interest from lenders--mostly individual investors so starved for high yields that they are jumping to fund unsecured, high-interest-rate loans. Even some investment funds are getting into the game, snapping up entire loans before individual investors act.
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With more money chasing the loans, lenders such as Prosper are working hard to come up with enough borrowers to meet the demand. Each month, Prosper mails more than a million preapproved loan applications. In June, the company arranged $27.5 million in loans, a bit short of its goal. In July, it originated $30.3 million.

Prosper and Lending Club together originated about $871 million in loans last year, more than double the prior year's total and up tenfold since 2008. Lending Club says it is on track to lend $2 billion this year.

Both have turned to outside investors to fund growth. This year, Prosper raised $20 million, including $10 million from Sequoia Capital, a venture-capital firm. In May, Google Inc. led a group that invested $125 million in Lending Club. Previous backers include John J. Mack, Morgan Stanley's former chief executive, who serves on Lending Club's board, and venture-capital firm Kleiner Perkins Caufield & Byers, whose partner Mary Meeker also is a director. Lending Club plans to branch into small-business loans and to take itself public.

Peer-to-peer lenders are subject to consumer-protection, securities and banking rules, and usury laws. Nevertheless, some state regulators have grown worried about whether investors understand the risks, whether borrowers are ripe for exploitation, and whether the push to originate new loans will lead to an erosion of credit quality.

"I understand there is a credit crunch and these platforms are providing an alternative," says Chris Naylor, securities commissioner in Indiana, one of the 26 states that don't allow investors to lend through such online platforms. "But there are limitations on the financial data that is available, and a chance of default, so we need to protect investors."

Prosper and Lending Club say they thoroughly vet borrowers, provide ample data on credit quality and have kept defaults to a minimum.

Prosper Chief Executive Officer Stephan Vermut says it is in the company's interest to have borrowers and lenders thrive. "If we have a lot of defaults, we'll go out of business," he says.

Lending Club Chief Operating Officer Scott Sanborn agrees. "We have not only a reputational risk but a financial risk," he says. "Our interests are aligned with investors." The company's revenues, he says, hinge on making good loans.

Prosper and Lending Club act as middlemen between borrowers and lenders.

Would-be borrowers can apply online for unsecured loans of up to $35,000. Employees swiftly vet potential customers by checking on their credit history, outstanding debt, employment and bank accounts.

Many applicants wash out in the vetting process. Those who are approved are quoted an interest rate based on the credit risk. Lending Club says annual interest rates range from 6% to 26%, with the average rate for a 36-month loan around 13%. Prosper says rates range from about 6% to 35%.

The process is then thrown open to individual investors, who can scroll through the companies' websites reviewing the vitals on each potential borrower, whose identifies aren't disclosed: income, credit history, size of desired loan, and a personal statement about why they want it. Investors can grab pieces of loans online, generally in increments of $25.

The loans are issued by Web Bank in Salt Lake City, in an arrangement with Prosper and Lending Club, and the slices sold to investors are technically securities issued by the lending platforms.

The platforms make money by charging each borrower an origination fee, again calibrated according to credit risk. At Prosper, the fee is between about 1% and 5%. The platform also collects from lenders a servicing fee of 1% for handling tasks such as pursuing borrowers who stop paying.

Both companies tout the ease of getting a loan.

"Individuals with good credit records can be preapproved for a loan via Lending Club instantly, with no impact to their credit score by applying quickly and easily online," said a recent online advertisement. And both platforms are trying to entice consumers to borrow money for everything from home improvements to adoption to retiring credit-card debt.

When Janie White, a consultant for the city of San Francisco, was turned down by her bank last year for a personal loan to consolidate debt, she found Lending Club online. Five minutes after she filed an application, she says, she was approved for a $25,000 36-month loan at 7.62%. "It was kind of like borrowing money from a friend or parent," she says.

Prosper, which began making loans in 2006, says its annual default rate is 5.8%. Lending Club, which opened in 2007, says its annual default rate is currently 4%.

Late last year, Justin Burge, a 34-year-old chef from Overland Park, Kan., applied for a personal loan to start a restaurant in Lone Jack, Mo.

His application reflected a stellar credit history and included a personal statement about his lifelong dream of opening his own restaurant.

Lending Club checked his credit history and bank account and called his employer. Investors signed up to fund an 11.9% loan. In five days, he says, a check was deposited in his bank account for $32,000.

"My heart was racing," he says. "I didn't actually believe I was going to start the restaurant until I got the money."

He used much of the money to lease space, fix it up and open his restaurant, J&K's Roadside Grill. But financial problems developed after he had equipment problems and his wife had a baby. His loan payments totaled $889 a month, nearly rivaling his home mortgage. This year, he says, he stopped making payments. In March, he filed for bankruptcy protection. His restaurant closed. He said he continues to pay his home mortgage and taxes, because he doesn't want to lose his home.

Many peer lenders say they aren't deterred by the default risk. Peter Statia, a computer-security engineer from Snellville, Ga., says he was a borrower before he became a lender. After filing for personal bankruptcy, he borrowed three separate times from Prosper, at interest rates ranging from 8% to 17%. He repaid all the loans.

Mr. Statia, 46 years old, says he has since invested a total of $2,000 in 10 separate loans. The borrowers, he says, had even riskier profiles than he did, so the interest rates have been more than 20%.

"Nobody would touch them with a 10-foot pole," he says.

Two of the borrowers defaulted, he says. One of the two described himself in his online listing as a 21-year-old who had recently bought a house and was seeking $23,000--$10,000 for to pay down credit cards, another $8,000 for home improvements and $5,000 for marketing a business venture. "I would rather give up my assets before I miss payments!" he wrote in his online profile. He made six payments over nine months, and then defaulted. Mr. Statia says he incurred losses on those two loans, but made enough on the other eight that hisName

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This page contains a single entry by CFED published on August 7, 2013 4:49 PM.

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