Lending Club, and the P2P lending movement more broadly, reached a major milestone this past week as the company attained its 25,000th investor. In addition, they also issued more than $5mm in loans in September, presumably becoming the largest P2P Lending operation (based on monthly volume) worldwide. After being the first peer lending facilitator to pursue and complete the path of SEC registration, thus insulating its investors and borrowers from regulatory upheaval, Lending Club is now boasting average return rates of 9.65%, after fees and defaults are taken into account, and an annualized default rate of only 3%. I had the pleasure of chatting recently with Rob Garcia, Senior Director of Product Strategy (on Twitter @RobGarciaSJ) about how Lending Club is doing and how they plan to take the concept mainstream as they approach their third year– including what they can learn from other P2P platforms like microfinance.
The connection between microfinance and P2P lending
With the obvious similarities in their core practices – P2P connection, community emphasis, cutting out traditional middlemen, simple and sound investments – I questioned what Lending Club felt that it had in common with microfinance platforms like Kiva. At Transcapitalist, we have been criticized for drawing too close a connection between these sites, but Rob agrees that their essence is the same, “people lending to each other practically and directly to accomplish something that they wouldn’t otherwise be able to accomplish.” He notes, however, the major difference in their reach and application.
Unlike Kiva and other microfinance platforms, participating in Lending Club is only marginally driven by a sense of social good. P2P lending in the United States is measured like most financial investments: by rate of return. The fabulous success and reach of Kiva, however, still offers some major lessons to the domestic P2P lending industry about how to make an innovative financial product appeal to a mainstream audience.
Rob also mentioned the differences between borrowers. At Kiva, loan recipients are typically unbanked or underserved entrepreneurs around the world, whereas Lending Club’s borrowers are those with excellent credit in the US looking for a better rate, and an easy yet confidential loan process.
Is P2P lending right for small business?
In contrast to the microfinance focus on entrepreneurs, most of Lending Club’s loans deal with current debt obligations, like paying off a credit card. Some experts think that P2P lending will never take off for American small business owners since the barrier to entry is so high that most aspiring entrepreneurs who can pass through all of the other hurdles can also qualify for a bank loan. Small business loans are actually declining as a portion of total loans made through the site, from 20-25% at Lending Club’s launch 2.5 years ago, to 15-20% today. Rob said this is most likely due to the current economic environment that makes entrepreneurship more difficult in general, but also to Lending Club’s adjustments to their credit policy since they opened.
Lending Club, however, believes that there is a strong place for small business loans in the P2P lending framework and Rob suggests that the movement towards loans for credit card consolidation is largely a product of the current credit crunch. He offers two types of businessmen who could benefit from a small, relatively short-term loan: small business owners experiencing an upward cyclical phase and entrepreneurs with a new and innovative idea.
The former can probably get a loan from the bank, but with business lines of credit so expensive, a P2P loan may be a more cost-effective solution. The latter, Rob believes would probably actually struggle to get a traditional bank loan. The benefit for this type of borrower is that credit risk is evaluated according to personal ability to repay rather than more stringent small business loan requirements, meaning that borrower should be able to repay the loan regardless of the success of his product. For high credit individuals, it is thus easier to attain an unsecured, personal loan of up to $25,000 – the Lending Club product – than a bank business loan. Rob offers Lending Club as an easier, cheaper and crowd sourced way to get an innovative idea off the ground, helping entrepreneurs avoid the typical trap of putting start-up costs on their personal credit cards.
Taking P2P lending mainstream
Given Lending Club’s success and growth, I inquired whether the company was considering applying the P2P lending concept to other products like micro-investing or crowdfunding, but Lending Club seems to first be committed to the success of their current product first, saving product expansion plans for when the right time comes. As P2P lending shows signs of going mainstream, Rob fears that adding any new product will just make it more confusing and is instead looking to first build a track record. The 9.65% return rate is helping to convince skeptics that the power of the platform is real and here to stay.
Lending Club is expecting the tipping point to be at their three year point, only a few months from now. They are already seeing a rapid increase in deposits in the platform with average initial deposits growing from $100- $500 at launch to over $1,000 this past year, which Rob sees as evidence that “there has been a clear shift in trust.” Now that the story is sinking in on the investment side, the company is focusing on finding good borrowers, as they accept only a small fraction of those seeking loans. This commitment to quality has shown clear results: Lending Club’s initial screening plus the lending community’s judgment of the credit risk of individuals has so effectively evaluated risk that the site has only a 3% annualized default rate.
Rob identified Lending Club’s three current areas of focus that would help them increase P2P lending mainstream reach: keeping their operations efficient, evolving the product to address people’s initial concerns to adopt a new product, and making profile browsing and investing more efficient to allow the concept to better scale.
One limitation of a 25 person company with low operational expenses is that there is a very small marketing budget that simply can’t compare to traditional banking advertising. Lending Club has strong social media presence, which can only go so far.
The second hurdle is one of adoption. The normal cycle of any new product is to go through a phase of skepticism and Lending Club has seen this doubt manifest itself with accusations of being like a Madoff Ponzi scheme. Rob believes that phase is dying down now that the initial community that has tried it and succeeded. I would counter that the big test remains the three year point, when the initial cadre of loans come full term. With that said, many Lending Club investors are pleased with their loans’ performance thus far.
Finally, single profile browsing can be a laborious process. The only responsible way to lend on Lending Club is to diversify your investments, but with larger amounts of money, browsing and evaluating a sufficient number of investment options is no small task. Pertuity Direct attempted to confront this problem by eliminating profiles entirely, but this was probably a step too far at the time and created confusion about what exactly the term “social lending” meant. Lending Club is pursuing a less severe course. Rob disclosed that Lending Club is preparing to release a new investment UI to make it easier to invest large sums of money without needing to browse profiles individually, instead letting investors choose advanced credit and social filtering criteria to help assemble a diversified portfolio. Rob recognizes that people are used to going to the bank and opening a CD without needing to look at it for 6 months, so while browsing is part of the core P2P lending concept, they need to find new ways to make it easier and give investors just enough control.
Moving forward, Lending Club is clearly betting on a growing place for P2P lending. Even as the credit crunch subsides, it is still unclear whether/when credit card rates will fall. Traditional banks will probably have a hard time cutting into their spread to offer rates closer to the ones offered by Lending Club (as low as 7.89% APR) because in the end, credit cards are still an intermediary that needs a spread to account for a 10% default rate. By nearly eliminating that spread and operating leanly, P2P lending will continue to be a competitive product for both borrowers and investors.