Cottage industry thrives on bypassing banks

Scott Langmack has given more than US$600,000 in unsecured loans to strangers.

"I can reliably get 12 per cent, worst case 9 per cent," said Mr Langmack, 50, a former Microsoft marketing executive who began investing in so-called peer-to-peer lending last year. "I can't find anything that gives me this kind of confidence."

Investors loan money directly in peer-to-peer (P2P) lending to borrowers through firms such as LendingClub.com, which package the loans and sell them as notes, bypassing banks and credit-card issuers. The industry may grow to more than US$100 billion in annual loans in 2012 from about US$500 million this year, as borrowers sought ways to reduce costs, said Ed Kountz, a consumer payments analyst at Forrester Research.

P2P lending offers a way for borrowers to get money for home, car and student bills as banks scale back lending. The Federal Reserve's quarterly survey of senior loan officers released on May 4 showed about 65 per cent of banks lowered credit limits on new or existing credit-card customers, up from 45 per cent in January.

"It's a great opportunity for investors to compete with banks, which have largely been ripping off the public with their high rates," said Alan Lysaght, a Toronto-based author of financial advice books.

Investors, discouraged by stock market returns, are turning to P2P sites, said Renaud Laplanche, founder of LendingClub.com, which started in 2007 and now has 17,000 lenders averaging US$2,500 in loans.

The Standard & Poor's 500 Index declined 38 per cent last year, the most since 1937. Yields on one-year certificates of deposit fell to 1.88 per cent on July 10 from a five-year high of 5.62 per cent in July 2006, data compiled by Bloomberg shows.

LendingClub's loans more than doubled to US$12.5 million in the second quarter from US$5.3 million in the fourth quarter after the firm's registration last October with the US Securities and Exchange Commission, Mr Laplanche said. Peer-to-peer firms must register because the loans were considered securities, SEC spokesman John Nester said.

"What E*Trade did to the stock brokerage industry, we're doing to the banking industry," said Mr Laplanche, referring to how E*Trade Financial led to lower trading commissions. "A lot of good borrowers found themselves paying 24 per cent interest on credit balances. They use our website to refinance those to 13 per cent to 14 per cent interest rates."

Even though P2P lending may grow, it was not as regulated as banks, which provide deposit insurance, said Carol Kaplan of the American Bankers Association.

"Investors have to question whether they want to do business with a cottage industry," Ms Kaplan said. "Banks are trying to control their risks by not granting credit to some people who may have a credit card, but are less than desirable borrowers."

Among the risks of P2P loans were insufficient information to determine whether borrowers would repay, said Ken Naehu, of Bel Air Investment Advisors LLC in Los Angeles. He said he can purchase 10-year California state tax-free bonds that yield about 5 per cent. S&P rates California the lowest US state, giving its general obligation bonds an A grade.

"If you use that as a barometer, you can get a very low risk investment in comparison to these type of loans," Mr Naehu said. "It's a dangerous place to be for the unsophisticated."

Mr Langmack, who makes loans through LendingClub.com, said investors can lose their entire investment. He said he spreads the risk by lending money on about 1,400 loans. "If you have a great credit rating and a solid job in a solid industry, then I like that person," said Mr Langmack, who also plans to invest in the website.

Typical borrowers wanted to consolidate balances from credit cards with higher interest rates and seek a three-year loan from a minimum US$1,000 to a maximum US$25,000, Mr Laplanche said. LendingClub rates the loans based on an applicant's credit score. Interest rates range from almost 7.4 per cent to 20.1 per cent.

Jim Beach, 39, a Los Angeles-based technical writer who was paying as much as 19 per cent on US$2,000 in credit-card debt, sought to refinance at local banks.

"I wasn't getting responses from the banks for loans, not even at high rates," Mr Beach said. At LendingClub, he said he paid 12.8 per cent on a US$2,000 loan funded by 45 people. "The way it's set up, it's more like a utility bill and less like I have to become stressed and possibly miss a payment," he said.

Investors earned an average annualised net return of 9.6 per cent as of July 13, LendingClub's website said. When delinquencies occur, the company tries to work out a new payment or sends the loan to a debt collector. The default rate was 3 per cent, Mr Laplanche said. Credit card write-offs, or loans that are not expected to be repaid, exceeded 10 per cent last month, data compiled by Fitch Ratings shows.

Consumers may refinance as much as US$159 billion by 2012 in credit-card debt with P2P, according to a January study by Javelin Strategy & Research conducted for LendingClub. The industry can get a large percentage of the almost US$3 trillion in US unsecured debt, said Chris Larsen, co-founder and chief executive of Prosper.com, a San Francisco-based P2P lender that restarted lending on July 14 after a nine-month suspension while it registered with the SEC. Prosper differs from LendingClub by permitting lenders to bid on the interest rates for borrowers. "This is a new asset class that is easily diversified," he said. "People are going to be able to find some great returns."

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