Peer-to-peer lending programs were once heralded as a promising way for extending credit, but the initial reports suggest that the model still has a long way to go.
Prosper and Lending Club are several of the largest peer-to-peer sites. In just the last few years, both have witnessed huge huge gains in overall volume. That should underscores their appeal, both for borrowers as well as for lenders. These sites reduce many of the transactional costs involved in lending. Most of the underwriting work is shifted to lenders. The costs of hosting and maintaining sites is not de minimis, but nonetheless, it is hardly anything when compared to costs of maintaining a branch location.
One problem is that the Prosper loans are not performing. A report in 2010 said that almost 23 percent of Prosper
loans had been charged-off. More than 35 percent of 2007-vintage loans were non-performing. Lending Club, by contrast, is working: only 2.7 percent of loans were in default in February 2010.
A Personal Experience with Prosper
I can attest to this problem. I've put in about $1,500 into Prosper, mostly in loans with loan amounts of between $50 and $125. I opted for borrowers that Prosper rated as "A" or "AA" credit, although I did sign up for one "C" borrower. Those are their highest grades. By doing that, I avoided the high interest rates that some of their loans bear. The highest rates were often yielding over 22 percent. The A and AA notes fell in a range of between 10.15 and 19.75 percent. Apparently, their standards are high. Only about 11 percent of applicants are approved for a listing.
The performance would suggest that credit scores are not good indicators of repayment. My AA credit borrowers had scores that were at least 760, yet 5 out of 10 of those borrowers failed to pay back their debts. The A borrowers did better - only 4 of 14 have defaulted. My "C" borrower never missed a payment, and was never even late.
Lending club is a bit more conservative. It will not approve a borrower with a FICO score below 640, debt-to-income above 30 percent, or an existing delinquency. Those borrowers can migrate to Prosper, where loans with FICO scores of as low as 540 are given a cahnce.
Prosper interest rates are established through an auction process. Borrowers establish a ceiling that they are willing to pay, and lenders provide a bottom point. Through bids, the rate settles at a point of equilibrium.Lending Club filters the borrowers that are ultimately presented to lenders.
Borrowers lay out their business plan for the notes. Some merely want a means to reduce their credit card debt, whereas others are opening up a business. I funded businesses of all types: wedding chair rentals, electric scooter importing ($55 at 21.75 percent), clothing for autistic children ($63.32 at 13.8 percent), a youth group home ($134 at 16 percent), a bakery ($65 at 10.5 percent), an emporium of imported beads and bracelets ($72 at 10.15 percent), another bakery ($72.35 at 10.15 percent), a medical good rental firm ($101.15 at 10.39 percent),a new office in suburban Chicago ($124 at 12 percent), rental houses ($107 at 11 percent). Those are a few. I suppose that gives enough of a picture of the variety of credit needs out there.
So, how did things turn out? At this point, only four of notes are outstanding. All of those loans are current. Eight were charged off and fourteen were paid in full. Four of those borrowers filed bankruptcy.
The scooter business failed almost immediately. The rental housing business was charged off, as was the loan for the youth home. The owner of the autistic clothing firm declared bankruptcy. "Bridge loans" didn't work out. Both of my "bridge loans," for a and carpet cleaning business and an importer of Scotch whiskey, ended in bankruptcy.
Prosper tries to use social factors to provide more information. Many borrowers participate in borrower clubs, where membership is contingent upon repayment. The idea, borrowed from the circle lending favored by Muhammad Yunus, is to leverage relationships. Borrowers can add a picture to their listing, as well as a brief description. More than a few attested to their Christian faith. Others offered pictures of their young child or their recent wedding.
Other borrowers used the money to shore up other financing. Several paid off credit cards, and another used a loan with an 11.69 percent interest rate to pay off his home equity loan.
In all, I participated in 26 notes.
Prosper may have been a poor choice. Prosper's founder made his fortune through the sub-prime lending firm E-Loan. E-Loan was a subsidiary of Popular, along with an investment from Sequoia Capital. Sequoia is the same firm that has invested in Green Dot, along with several payday firms, and PayPal. Prosper has had some legal troubles. It was hit with a cease-and-desist order from the SEC in December 2008. Prosper had to go dark for three months in 2009. Currently, only 25 states allow their citizens to make loans with Prosper. My state is not one of those, so I will not be able to replenish my dwindling portfolio.
There is also a troubling race issue. A paper written by professors at Wharton and Case Western Reserve found that listings with pictures of African-Americans were 25 to 25 percent less likely to receive funding, after controlling for variations in credit score. They paid higher interest rates, too. Race wasn't the only factor that showed loan bias. Overweight and elderly borrowers were disadvantaged, whereas women and those in military service were able to get credit more easily. It came down to a picture. This is probably not something that is the fault of Prosper. It's just one more statement about where our country comes down in terms of race, as well as against the overweight or seniors.
The performance of peer-to-peer lending is mixed. While Lending Club, with its higher credit requirements, shows afar better performance than does Prosper, credit scoring is by itself still unproven. There is clearly a need for this kind of credit, but the results suggest that plenty of people are not ready to handle it. For those borrowers, this opportunity sets them even further back for a chance to tap credit in the future.