Peer to Peer Lending: The Lending Club

Prepared by Stephanie Kimani

(A review of The Lending Club)

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Brief Summary:

The Lending Club was started in the year 2007 as the second peer to peer (P2P) online lending platform in the US. It is currently the world’s largest lending market place that connects borrowers and investors. Through innovation and technology, the Lending Club has achieved great success in lowering its costs compared to traditional bank loans thus being able to provide the borrower with lower rates and the investor with solid returns.

Highlights:

  • Borrower credit score determines lending rate.
  • Origination fee of 5% charged to the borrower for servicing the loan.
  • Service charge of 4% – 5% charged to the investor for servicing their account.
  • Investor can earn a return of 5% – 10% per year on their investment.

How it works:

The system is fairly simple:

  • Borrower – Applies for a loan by filling out an online application form. (Loan amount of up to $35,000)
  • The Lending Club technology – Using online data, the borrower’s risk is assessed, their credit rating determined and they are assigned an appropriate interest rate.
  • Borrower – Receives timely information and can evaluate different loan options without impacting their credit rating score.
  • Investors – Selects loans in which to invest in and earns a monthly return.

Information for the Borrower:

When the borrower takes a loan with the Lending Club, they will be charged an origination fee[1]. The fee is deducted from the total loan amount and thus the borrower receives their requested loan amount less the origination fee.

Normally the origination fee stands at 5%:

Once the borrower is cleared for the loan, the Lending Club wires the loan amount to the borrowers account (provided for in the application process).

Loan portfolio:

Since its start in the year 2007, the Lending Club has a total loan issuance of $7,620,367,965[2]

The Lending Club does not discriminate on the types of loans that borrowers want. Currently the loan portfolio stands as follows:

“Other” constitutes:

Medical Expenses 1.01%
Home Improvement 5.51%
Business 1.57%
Major Purchase 2.02%
Car Financing 1.09%
Other 9.54%
Home Purchase 0.47%
Moving and Relocation 0.67%
Vacation 0.54%
Learning and Training 0.08%
Green Loan 0.08%
TOTAL 22.58%
(Source: The Lending Club

Debt refinancing constitutes the largest portion of loans provided for by the Lending Club. This is because at the lower interest rates, borrowers are able to service existing debt with cheaper debt.

  1. Interest Rates:

Based on the borrower’s loan application and their credit score, the Lending Club technology assigns a grade and a corresponding interest rate as follows:

  1. Investor Fees:

The Lending Club collects fees from investors when they receive loan payment proceeds. This means that their revenue is directly tied to the investor’s cash flows.

  1. Service Charge:

This is a charge for servicing the loans. The service fee is 1% of payments received within 15 days from when they are due and 0% service charge if a borrower misses payment.

  1. Collection Fee:

This is the fee deducted from the recovered amount when a borrower misses a payment. It currently stands at 18% of the amount recovered, if the loan payment is 16 days or more late, without litigation fees and 30% of hourly litigation fees plus costs.

How do investors benefit?

From the perspective of the investor, they invest in notes or a minimum of $25 of each loan. Eligibility to invest is based on the ‘state’ that the investor is in. this is because Lending Club investments are legally classified as securities in the US.

The investment return of up to 5%-10% per year is of great value to the investor. To understand this, let’s say a loan has a 15% interest rate, a default rate[3] and service charge[4] are deducted from the loan interest rate to provide the investor with a return by the end of the investment period.

Even with a downturn in the economy, the Lending Club still manages to provide investors with a higher return than the economy. In the case of the stock market crash, peer to peer loans are less tied into the stock market than most investments.

There are also much lower default rates associated with the Lending Club as the good credit worthy borrowers are generally consistent with their repayments thus making it a good and consistent investment.

Risks involved for investors:

So far, default risk has been the biggest risk from peer to peer lending. It is also of value to note that the loans provided are unsecured and thus the investor can lose everything in the event of default.

  • Diversifying investments is crucial in minimizing the above mentioned risk. This can be done from the notes that the investor invests in. The more notes the better.

The whole point of peer to peer lending is that it offers borrowers lower interest rates than traditional banks and offers investors higher interest rates than the conventional savings account or bond. However if market interest rates were on the rise, this could mean that investing with these peer to peer lending platforms is not a worthy investment.

  • Like any other financial ‘lending’ institution, the peer to peer lending platforms like the Lending Club would have to adjust their lending rates upwards so as meet investor expectations through better returns.

The importance of a borrower’s credit score cannot be disputed as this establishes their lending rate. As shown in the interest rate table with corresponding loan grades (determined from the credit score), if the borrower’s credit score were to be lowered, this means that there will be a higher number of borrowers accepted for a loan, probable increase in the default rate and thus lower returns for the investor.

The importance of a borrower’s credit score cannot be disputed as this establishes their lending rate. As shown in the interest rate table with corresponding loan grades (determined from the credit score), if the borrower’s credit score were to be lowered, this means that there will be a higher number of borrowers accepted for a loan, probable increase in the default rate and thus lower returns for the investor.

  • The standards of underwriting are key in determining the overall default rate in any financial institution. This is more of an internal matter and thus with increased prudence and better underwriting this is an unlikely event.

The Kenyan Market:

Case: Zidisha[5]

Zidisha was launched in Kenya in late 2009 and is an online based lending platform that links web users to entrepreneurs by providing them with microloans.

Zidisha’s unique characteristics are as follows:

  • No intermediaries during the lending process.
  • Through a ‘profile page’, borrowers are able to post loan applications themselves and communicate directly to the potential lenders.
  • Zidisha only accepts perfect credit histories[6].
  • Zidisha interest rate is on average between 7% – 8%.
  • Borrowers can send and receive repayments and loaned funds, respectively, through mobile banking (MPESA).

Conclusion:

Based on the stated pros and cons of peer to peer lending, there is a notable need for this platform in the country as the Kenyan economy grows into the internet age. Currently the internet penetration in Kenya is 57% and is set to increase to about 68% by the end of 2015. This creates an ease of access for the borrowers.

The average lending rates in Kenya are between 18% – 24% per annum, while the highest government and corporate bonds rates have been around12% per annum. An investor could easily earn a return between the lending rate and bond rate for a shorter term duration (which is typical for peer to peer lending).

Investing in commercial paper can also be profitable for the investor as returns are typically much higher than bond rates for a short duration, but they require a significant minimum investment that most investors may not have readily available.

In conclusion, the online peer to peer lending platform may be viable in Kenya.

Notes

[1] An origination fee is a fee charged for servicing the loan to the borrower.

[2] As at 31st December 2014

[3] Default rate of about 4% – 5%

[4] Service charge of 1%

[5] http://www.zidisha.org

[6] Credit histories are provided and verified by a local microfinance institution at a small fee.

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