and instead own securites issued by a company like Lending Club that represent the participation in the loan.
The rate that is charged, and the return it generates for an investor, depends on the borrower. Prosper charges an annual percentage rate, like most others, which can be as low as 6 percent for top-rated borrowers and 30 percent for poorly rated ones. Lending Club does the same. Those rates end up being lower than most credit cards, which is partly how the companies attract business from traditional banks, Palmer said.
Fundbox sets up short-term loans for a single fee, based on the duration of your loan and your credit history.
The difference-maker for most of these new entrants is their ability to determine the creditworthiness of a person or business in a matter of hours. While the people employed by traditional banks typically check off a list of factors to assess a potential borrower, these new businesses let computers and proprietary algorithms do the work.
Creditworthy individuals can obtain personal loans that aren’t backed by any assets, typically ranging anywhere from $2,000 to $35,000. A person might use them to consolidate high-interest student loan and credit card debt into a single, more manageable chunk. Companies focused on personal loans include Prosper, Upstart, and Lending Club, which made its initial public offering last year.
For businesses, a loan might range from $25,000 to $250,000 or more, and might be secured by assets in the business. If the business fails on its repayment plan, for example, those assets could be claimed by the lender, like any traditional term loan. Dealstruck, Fundbox, and OnDeck, the other publicly traded peer-to-peer lender, are examples of small- to medium-sized business lenders.
Most of the companies, including Lending Club and OnDeck, make money through loan origination and other types of fees for connecting investors and borrowers, charging a percentage of the total amount of the loan, the companies say in regulatory filings. OnDeck also earns interest on some of its products, like a traditional bank, including a line of credit that borrowers can use at will. It charges interest based on the amount outstanding, as well as a monthly fee.
The type of investor can vary, including both large money-managing institutions and what are known as “retail” investors—mom and pop, who have some extra cash and are looking for an easy return. The returns of course also vary, with higher returns expected for investing in riskier companies and people who may for one reason or the other stop paying the loan back. For the lending businesses, diversifying the type of investor helps in case some investors get spooked during an economic downturn; others will still be there.
These relatively small loans add up to real money that seems to be drawing Wall Street giants into the peer-to-peer lending world. Goldman Sachs estimates that $4.6 billion of banking profits could be lost to peer-to-peer personal loans. The bank figures $1.6 billion of bank profits could be at risk from lost business loans.
But even beyond guarding their profits, big banks see opportunity in the substantial unmet demand for loans, Palmer said. An oft-cited estimate pegs unmet demand for business loans at of $80 billion to $120 billion, a statistic OnDeck says comes from consulting firm Oliver Wyman.
“If you look in aggregate at how much these firms have done in terms of loan origination to date, and look at the total addressable market, these firms in aggregate have not scratched the surface,” Palmer said.
Thanks to this rapid expansion, the industry, a decade ago dubbed “shadow banking,” has now started producing shadows of its own. A company called PeerIQ, backed by a powerhouse group of old school Wall Street CEOs, announced a $6 million seed funding round to build out its analytics and management database for peer-to-peer loans.
PeerIQ’s platform aggregates data from peer lenders, offering institutional investors credit analytics and benchmarks so they can do things like assess a loan’s performance and manage their portfolios of the pieces of debt.
“As more and more institutional investors embrace P2P lending, they are looking for advanced analytics solutions,” said John Mack, former chairman and CEO of Morgan Stanley, who led the seed round. Others who funded the round include Vikram Pandit, former Citigroup CEO, Arthur Levitt, former SEC Chairman, Eric Schwartz, former co-CEO of Goldman Sachs Asset Management, and Dan Doctoroff, former CEO of Bloomberg LP.
The company considers itself a third-party check on these new lending businesses. While OnDeck and Lending Club provide investors with numerous data points about the businesses and people they make loans to, there aren’t easy ways to independently verify the data. While ratings firms like Moody’s Investors Service, Fitch and Standard & Poor’s may provide information on default rates for large corporations, they don’t for small businesses.
Lending Club and OnDeck offer some insight, through a stat that compares the amount of loans the company thinks it won’t get repaid at a given time to the average or total amount of loans outstanding. For OnDeck, that ratio has ranged between 4 percent and 7 percent since 2009, coming in at about 6.5 percent in 2013, according to a regulatory filing. Lending Club, which may use slightly different tracking methods than OnDeck, has had between about 5 percent to 8 percent during the same time period, according to its annual report.
Given the minimal level of reporting about defaults, PeerIQ’s goal to fill information gaps may indeed spark interest from users of the lending marketplaces. More companies will inevitably follow—whether they are a response to other gaps in information or new developments to handle yet unforeseen factors, such as potential regulation—as interest in this sector compounds.
“There’s a lot of brainstorming going on right now about the opportunity to leverage technology to address many areas of finance,” said Palmer, the analyst. “There is enormous opportunity.”
