Last year was brutal for almost all assets classes across
all markets. Investors who diversified
still had sizable losses. Many investors
have pulled in their horns and moved to safe assets like cash or treasuries. Savvy investors have been trying to navigate
the myriad opportunities offered in today’s markets – ideally enhancing returns
without the risk of another 2008. I
attended the Finovate Startup 2009 conference in San Francisco last week and
was excited and impressed by some of the companies trying to create alternative
asset classes by cutting banks out of the lending loop.
Although credit markets have thawed somewhat since the
deep freeze of in the Fall of 2008, it is still difficult for many people and
institutions to get credit. This creates
a perfect opportunity for the expansion of peer to peer (P2P) lending. P2P lending effectively takes banks out of
the lending process by allowing people to borrow directly from other
individuals (or sometimes pools of borrowers from pools of lenders). There were four companies at the Finovate
Startup conference focused on this space:
Lending Club, People Capital, Pertuity Direct and Prosper. While the borrowing side of the P2P space is
fascinating, I am focusing this post on the lending side – how these services
stack up as an alternative asset class.
Prosper. Prosper
pioneered this field a few years back and ran into trouble both with the SEC as
well as allowing too many deadbeat borrowers.
They have recently relaunched and remain the largest player in this
nascent field. I find Prosper’s process
to lend money to be time consuming and clunky.
You have to handpick all the loans you want to fund plus bid on the
interest rate you are willing to accept.
That said, among the four, Prosper seems to have the most opportunity
for earning the highest yields for a motivated lender. I expect that with their relaunch, risk
management will be more of a theme since the losses on the first batches of
loans were quite high. In fact, Prosper
made the point that they have raised the minimum FICO score for a loan
application. Prosper says a secondary
market for longs that an investor would like to sell is coming soon.
Lending Club.
Lending Club was “fast follower” in this space and learned from Prosper’s
challenges. They filed with the SEC and
grew quickly. Their historical loss
rates are lower and their risk management seemed to have been more rigorous
from the get go. I also think the
process for creating a loan portfolio is a bit clunky, but easier than Prosper
since there is no interest rate bidding.
Interest rates are set by the risk bucket a borrower is placed in when
they apply. This simplifies the process
but may reduce potential yield for lenders.
Overall, I thought Lending Club had a nice balance of risk management,
ease of use and potential yield. Their
demo showed an average yield of over 9.5%.
Since launch a report on their website says that average yield earned on
the site is over 9%. Lastly, Lending
Club is the further along on the liquidity front – they have created a
secondary market for loans if you do not want to hold them to maturity. The Lending Club rep said that some loans are
sold for more than par, some less but overall it is likely slightly less than
par.
Pertuity Direct and National Retail Fund. Pertuity Direct launched in January of 2009
and is the simplest of the P2P concepts from an investing standpoint. Pertuity Direct is funded by the National
Retail Fund that pays the average yield to all investors in the fund after
fees. I like this model from a
simplicity standpoint. This would be the
service I would recommend to someone who was not a web expert or a credit
expert. It is simple, easy to setup and
easy to manage. That said, it remains to
be seen what type of yield you will get from the National Retail Fund – the
site suggests in excess of 13%! A lot
more rides on Pertuity Direct’s ability to attract, screen and retain high
quality borrowers. Liquidity in the
National Retail Fund is currently quarterly but their reps indicated that they
are working on more frequent liquidity windows.
People Capital.
People Capital will be launching later this year with a focus on educational loans. I like their focus on the educational market
since it distinguishes them from competitors and potentially attracts a more
creditworthy borrower. People Capital
expects that they will have competitive yield with the other services. However, their CEO indicated he expects some
lenders might be generous family members (e.g. Grandma), enabling a lower
blended interest rate for borrowers.
This could be a big win for borrowers and the platform by lowering the
overall interest rates that people pay for education. Lastly, their CEO informed me that student
loans are not wiped out during personal bankruptcy - effectively reducing risk
by putting lenders in a higher place in the borrower's "capital
structure." Overall, People Capital is an unknown quantity since it has
not launched, but I see a ton of potential here.
I like the peer to peer lending model. While banking has a bad reputation across the
globe right now, traditional banking (deposits and loans) is a wonderful
business. By cutting out the bank, P2P
allows borrowers and lenders to get better interest rates and yields than they
would otherwise. Success for these
services depends upon risk management – if they set the bar too low for
borrowers and defaults soar, they could kill lender demand before the platforms
have a chance to succeed. That is why
all of them have trumpeted their focus on high FICO, “super-prime”,
creditworthy, credit-savvy borrowers.
Transparency goes a long way towards ensuring good risk management. I think transparency has been a big positive
for Prosper and Lending Club. I hope the
Pertuity Direct and People Capital both emulate that element of the pioneers'
services.
Going forward, P2P services are indicating yields of 9%
or more on average (even after fees and delinquencies). Your mileage may vary on what type of yield
to expect given the deteriorating macro-economic background, but these yields
are pretty juicy, even adjusting for risk.
Over time, I expect yields will come down when credit normalizes and the
fees charged by these services rise (as I expect they will).
With the possible exception of People Capital, I don’t
expect these to appeal to institutions (bigger fish might want to check out
Second Market or The Receivables Exchange – both very promising). I would recommend each service to different
type of small lenders - people looking to lend less than $50k. For the savvy alpha-seeker, I would
recommend Prosper. For the “set it and
forget it” mainstream investor, National Retail Fund seems like the simplest
option. Personally, I liked the balance
that Lending Club has struck between yield and simplicity. If the equity markets start to get frothy
again, I would probably try Lending Club first.
