Peer-To-Peer Lending Sites Weather Credit Market Storms
from the distributed-credit dept
Will all of the turmoil in conventional credit markets spur greater interest upstart peer-to-peer lending exchanges? It seems possible, since, in a way, sites like Prosper and Zopa are the antithesis of the highly impersonal, securitized industry that’s facing so many problems right now. From the outset, these P2P lending sites have emphasized diversification, manageable risks and direct relationships between lenders and and borrowers. Whereas traditional loan brokers are closing their doors left and right, these sites continue to do brisk business. Lenders aren’t seeing mass defaults, because the standards have been high since the beginning. Of course, the scale is different. You still can’t finance a house through one of these sites, but for other needs, they may work just fine. Between the lack of available credit to consumers and a desire to diversify investments on the part of individuals, this moment in the business cycle offers these sites an excellent chance to really prove their worth. Update: A number of commenters make some interesting points about default rates, suggesting that they may be higher than these sites would have you believe. Also, it’s pointed out that there are a number of users playing both sides of the game — borrowing at one rate only to lend out at a higher rate, which is not so different than traditional financial institutions.
Comments on “Peer-To-Peer Lending Sites Weather Credit Market Storms”
Prosper
Gotta say, I was stunned at how well Prosper worked out for us. And it allowed us to take better advantage of the back-to-school season, creating business we otherwise couldn’t have done this year.
I’m just shocked a) that it works, and b) since it works, that I haven’t heard more about it. It seems like a huge deal to me.
I haven’t checked out Zopa but I will now.
Not really the Antithesis
I don’t see how Prosper and Zopa are all that different from the credit crisis that we find ourselves in today. Essentially, what the hedge funds were doing was lending money at a higher risk level and then using their good credit to borrow at lower rates. Everything was fine until high risk money stopped paying, then everyone had to look more critically at the safety of the underlying loans. What made things so bad was how much leverage they used.
With propser, essentially what someone does is lend out money at a higher amount then what they can borrow at. I’ve already seen several loans on the service for people who are raising money on the site, just to buy more speculative debt on the site. To me, this isn’t really the antithesis of the hedge funds, it’s some of the same tactics only on a smaller scale.
If sub-prime borrowers are walking away from their homes, there is no reason why they wouldn’t also default on other unsecured loans. Just like we don’t know how much leverage the hedge funds have used, I’d also argue that no one knows how much of propser’s business is coming from credit arbitrage. It’s an innovative concept, but if you are going to take on that type of risk, you should be asking for equity instead of debt.
Re: Not really the Antithesis
Davis – you’re right, many people are borrowing money on Prosper to lend it out at a higher rate. This is a very, very bad plan as Matt wrote about in this article:
Borrowing money to lend on Prosper: Wise or Foolish.
It has caused quite an uproar because many of these borrower/lenders are now late or defaulting on their loans.
RE: Davis
It’s comparative advantage. Here’s a hypothetical example:
Joe can borrow money at 6% from a bank, or “lend” to the bank at 5%. Say Joe has a ‘A’ credit rating.
Tom can borrow money at 8% from a bank, or “lend” to the bank at 5%. Say Tom has a ‘B’ credit rating.
Now, Joe could lend money to Tom at 6.5%. Joe is now getting 1.5% higher return and Tom is paying 1.5% less. Both are happy with this.
Joe is taking on extra credit risk by lending to Tom, but he’s receiving a better return. It’s classic risk vs reward.
I think this is a great idea for financially savvy people to increase investment options. Granted, I over simplified but the same principles apply.
Prosper experiencing high defaults?
Anecdotally, Prosper.com seems to be suffering from high default rates. I have made a relatively small number of loans but have seen a number of them default – including loans with “A” and “B” credit grades (though moderate to high debt-to-income ratios). Part of this might be my inexperience, but I have spoken with a Prosper.com “power lender” ($200k+ outstanding loans and for awhile in the top 10 by loan amounts) who has also experienced high default rates despite due diligence.
Prosper.com has, so far, seemingly failed to integrate the community component that has made microlending in developing nations successful. There is little to no peer pressure, if you will, that enforces repayment of loan obligations. It’s one thing to have a collection agency come for you, and have a bad credit report, it’s another thing entirely to have your family, friends, and entire village know that you’re a delinquent.
Perhaps the social-network-lending model will work better – lending to people you know or people who know people you know – but that surely goes against grandma’s wisdom of not lending money to friends or family.
RE: High Defaults
The issue isn’t that are people defaulting. The issue is are they defaulting at a rate greater than their credit score would lead you to expect? Also, are you receiving a high enough interest rate to justify the additional risk?
P2P Lending Sites Weather Credit Market Storms?
Joe, thanks for writing this post. I blog about the P2P loan market and it is very interesting to me. I agree that P2P lending sites will get more attention as the credit market dries up. I disagree, however, with many of your points. I wrote a lengthy response here.
Wrong conclusions
Joe,
I think you are wrong in your conclusions – at least if you want to take Prosper at an example.
Have a look at how prosper defaults develop over time. If you take loans that originated well over a year ago, the default rates are already 5-10% (and thats not counting the loans that are 1-4 month late).
Your conclusion might be right for Zopa which has much lower defaults
Wiseclerk
Prosper default and late rates are very high. The company doesn’t admit this – they wait until a loan is bought or the borrower declares a(nother) BK before labeling it as defaulted. A loan can go 6-12 months without payment and still count as “not defaulted”, ergo inflated stats. Skews the results. Collection attempts are weak. But Hey – go for it.
Prosper Type Defaults Not Likely on SeedBucks.com
Let us not forget that Prosper.com lenders lend to individuals with mostly sob stories.
By Contrast, SeedBucks.com, which goes live in December 2007, allows only business borrowers. People starting a business are much more likely to pay back the loan than a person whos just got evicted.
But in all cases, it falls upon the lenders to exercise good judgment. If you loan money to 100 people and 10 default, you lost all your profit or more.
Marketplace data is transparent.
The initial default rates were… not fantastic. Something on the order of 18% or so, aggregate. Prosper has since tightened up the minimum credit requirements, and is now offering lenders much more realistic guidance based on past performance of actual loans in the marketplace. Growing pains or something else – remains to be seen. More here:
Peer-to-Peer Lending & P2P Loans Info