There are two financial issues in America that have been developing simultaneously: many borrowers have been locked out from the ability to access capital, and investors can no longer rely on bonds and CDs for their investment income. Rates are at record lows and many would-be borrowers have said over and over how they are effectively unable to borrow from the banks at all any longer. The world of peer-to-peer lending may at least partially change that, and this may also be a huge opportunity for traditional fixed income investors to capture higher yields.
24/7 Wall St. was recently given a chance to interview Joe Toms, the new Chief Investment Officer of Prosper.com to hear about this growing sector. If you do not understand the peer-to-peer lending model, think about crowdsourcing loans for what would have traditionally been a personal bank loan. There is even a degree of microfinance involved, although in a larger and peer-based manner. Prosper is effectively the go-to name in peer-to-peer (P2P) lending, and the service eliminates the middleman to connect people who need money with those who have money to invest. In short, this allows Joe Public to be the banker to individuals. The aim is a win-win for investors and borrowers, hence “Prosper.”
There are many questions that borrowers and investors will want to know before they go in and participate in the peer-to-peer (P2P) lending market. Investors have started looking at peer-to-peer lending for its high yield and current income appeal, and P2P lending has grown more than 100% in the past year alone.
Prosper.com focuses on individual loans in the $2,000 to $25,000 range. Borrowers choose a loan amount, and they list what the purpose of the loan is. Investors then review loan listings and invest in listings that meet their criteria. The borrower then makes fixed monthly payments (collected by Prosper for the lenders) and investors receive a portion of those payments directly into their Prosper account. Individual lenders are able to invest as little as $25 in each loan listing they select and they get to consider credit scores, ratings and histories, as well as borrowers’ personal loan descriptions, endorsements (and participation) from friends and family, and community affiliations. Debt consolidation, home improvement and small business-related loans remain the leading loan categories on Prosper.com.
CIO Joe Toms noted that the consumer lending market is about $2.4 trillion in America per Federal Reserve data, but the average loan size is about $7,300 and about 90% of the market is controlled by six of the largest banks. Mr. Toms noted, “P2P can attack a market that is grossly inefficient. The Federal Reserve data shows that the average credit rate on the outstanding consumer credit has been more than 15.5% from 1985 to 2010 and the historic default rate has been closer to 4.7%.” Effectively, this has left a net interest spread of well over 10% and the market is now available for investors to participate in.