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No Mr. Lieber, P2P Lending is Not Gambling

by Peter Renton on February 9, 2011

In Saturday’s New York Times, columnist Ron Lieber penned an article in his regular Your Money column titled, The Gamble of Peer-to-Peer Lending. While in some ways it wasn’t a bad article, it did make assertions that peer to peer lending was akin to “a new type of casino game in Vegas.” But within two days of writing the article Lieber’s chief concerns have been proven to be unfounded.

The Unverified Income Question

One of the key questions that concerned Lieber had already been answered by the end of day Monday by Felix Salmon, the finance blogger for Reuters. Lieber was concerned that Lending Club verifies income on only 60% of the loans on their platform. He wondered about the other 40% and thought the whole thing “doesn’t smell quite right.” But rather than do some digging to find out why he just left the question hanging. Felix Salmon did some digging for him in a follow-up post on Sunday. He pointed out that the underwriting system likely only raised a flag 60% of the time and so those loans were the ones that were investigated. But the big question was this: how do the performance of the 60% income verified loans compare with the 40% unverified loans. He reported his findings in a second blog post on Monday night.

To be fair, it is completely valid for Lieber to question the performance of these unverified loans. I, as well as some of my readers, have wondered that very same thing. Now, it appears we have an unequivocal answer from Lending Club. Loans with unverified income are actually performing slightly better than loans with verified income, according to CEO Renaud Laplanche. Salmon confirms a loss rate of 2.8% versus 2.7% on loans that are at least one year old. How can this be? Laplanche explains that it is only the very best borrowers whose loans are not verified for income; the reason being that you want to make the borrowing process as easy as possible for these people because they can easily obtain funding elsewhere.

Why Peer to Peer Lending Isn’t Gambling

The biggest error in judgment that Lieber had in the article, in my opinion, is equating peer to peer lending with gambling. This was only a small part of the article and it was a shame (and even somewhat misleading) that it made it into the article title. But newspapers like to stir controversy I guess, which was probably the reason for the choice of title.

I think in the early days of peer to peer lending it was a little more like gambling in that more investors lost money than made money. But since both companies reopened after their quiet periods returns have been much better and defaults have gone down dramatically. But don’t take my word for it. Use a third party statistics site like Lendstats.com to investigate. If you compare loans made before 2009 to loans made in 2009 and later you will see a dramatic improvement in loan performance for both Lending Club and Prosper. Lieber is still stuck in in his pre-2009 view of Lending Club and Prosper.

My own experience backs up this data. I have four different accounts total at Lending Club and Prosper. I have one Lending Club account that is now 19 months old and despite several defaults my total investment has increased every month since I started (except for one month that I explained in my Biggest Mistake in Peer to Peer Lending post). Two of my accounts use the automated plans offered by Lending Club, so I am not doing anything special to generate above average returns with these accounts and still they go up in total value every month. I certainly wish I could say the same for my portfolio of stocks and bonds.

The Article Was a Net Positive I Believe

The biggest challenge that p2p lending has is one of overcoming ignorance. If every investor and borrower in America was even partially informed about the concept of p2p lending it would become a multi-billion industry overnight. What this article does is reduce that ignorance (in an imperfect way), and for those people who are inclined to explore alternative investments it provides some interesting tidbits.

Sure Chris Larsen, CEO at Prosper, and Laplanche of Lending Club probably hated the gambling references in the article, but the Lieber article wasn’t all negative. Far from it. He explained the rationale for borrowers paying high interest rates on their credit card seeking out p2p lending. From the investor side he noted the large number of million dollar accounts at Lending Club and he stated that p2p lending now “is precisely the sort of uncertain situation that experienced investors with a high risk tolerance can capitalize on.”

It would have been nice if Lieber had done a little more homework in this article but regardless of that I am happy he published it. It gave the millions of people who read the NY Times, either in print or online, a little taste of p2p lending. With both Lending Club and Prosper looking to grow rapidly this year, an introduction to p2p lending in a widely read publication can only increase awareness for both companies which is certainly needed to help drive that growth.

{ 12 comments… read them below or add one }

Dan B February 9, 2011 at 9:27 pm

I’m not sure if it’s you Peter or Felix Salmon or someone else that is being a little too fast & loose with their “facts”.
One of two things is in fact factual………………….Either LC does not verify 60% of the loans for income, as is stated in the above article, or it does not make it public via the listings that it has done so. Because I have never ever in the 15 months I’ve been lending seen 60% of listings contain verified income.
As I write this there are 310 loans listed, with 50 having verified income. That’s not 60%. That’s not even 20%! Let’s get our facts straight, please!

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Peter Renton February 9, 2011 at 9:59 pm

Dan, That’s one for Lending Club management, only they could say the answer to that. I have an old listing of current loans downloaded a month ago and the percentages are similar to what you state. I will follow up on that one and see if I can get a definitive answer.

I think it is a shame that a lot of the information in the current notes spreadsheet doesn’t make it into the main file.

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Lewis Zwick February 10, 2011 at 10:28 am

And investing in the stock market is not gambling? Actually P2P lending seems like a better bet.

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Peter Renton February 10, 2011 at 11:15 am

Lewis, I think all of us who have been investing in the stock market the last few years will agree that it is a risky investment. Although I think it is good to diversify so I recommend all investors have money in different asset classes including p2p lending.

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Dan B February 10, 2011 at 3:39 pm

Well Peter, these are not secrets to which only “upper management” have the answers to. Clearly, the answer is that that they don’t do “income verification” on 60% of borrowers. Furthermore, I’d say that they were likely misquoted by that NY Times journalist ( and I use the term “journalist” loosely) who understands nothing about p2p (or gambling for that matter) & yet somehow feels qualified to write about it. I could crap a better article on p2p (or on gambling) than that one.

LC will probably state that they go through a verification process that includes one or more of the following categories ………….income, employment etc etc. on 60% of borrowers. That’s not the same as income verification on 60% of borrowers…………..which I doubt they said in the first place.

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Mike February 11, 2011 at 1:44 pm

There is a lot of confusion on the LC site with respect to income verification. Many investors clamor for the borrower to verify income, only to have them answer that LC hasn’t requested they do that. If they try, often LC says it’s not necessary that they do it. It seems to me that having a secure, dedicated fax line to accept W-2’s and tax returns would be relatively straightforward. As it stands now, investors have no guarantee that stated income is anywhere close to being actual income in the majority of listed loans. The percentage of listed loans with verified income has never even approached 60% since I’ve been involved with LC, which is over two years at this point.

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Peter Renton February 11, 2011 at 2:48 pm

@Dan/@Mike, I have a call into Lending Club about this. Here is the info from page 15 of their prospectus: “From April 1 through November 30, 2010,
approximately 60% of listed loan applications were selected for income or employment verification.”

I am attempting to find out how many loans are actually income verified, versus just a verification of employment. Will report back when I know more.

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KenL February 11, 2011 at 7:37 pm

There are a couple of reasons why 60% of listings do not have verified income. One is because they do some of the verifications after the listing is funded. If a listing raises red flags and it is still funded then LC will make sure to verify the income. Also many listings when they have verified income fund really fast and are not visible on the platform for very long, but the listings that aren’t verified stay up longer because they fund slower. So it always seems like they don’t verify many listings, but I think they do.

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Dan B February 12, 2011 at 1:44 am

KenL…………Those are not the reasons why LC doesn’t verify everyones information, whether it be income or employment or whatever. The reason is very simple & it is the BOTTOM LINE. The more loans, the more origination fees. And origination fees are based on loans that are issued. These fees range from 1-5% of funded amount & average 3-3.5% of funded amount & they are deducted BEFORE the borrower even gets their money. Apply for a 25k loan, have a C grade & you’re going to get a check for $25k minus $750-$925 in the above example. These origination fees account for 85%+/- of LC’s income. Here’s another way of looking at it…………..

There’s something like $200+ million out on loans that are current right now. That means that LC is getting roughly 7-8 million a month in loan payments+interest. They get to collect 1% of that amount or around $70-80k monthly in service fees from all the loans that they’ve been issuing in these past 3+ years. While this is happening, LC also issued $15 million in loans in just this past month………….which means they deducted $425-500k in origination fees last month.

Now, if you’re running a business with this model would you make it easier or harder for borrowers to get their money?………………..As long as you can keep defaults under control & therefore by extension, keep lenders satisfied, the answer is obvious. That’s it, end of story. It’s not a right or wrong thing, it just is.

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KenL February 14, 2011 at 1:03 pm

Dan, I agree with all your points. It is about the bottom line. But the primary point that I tried to make (and probably didn’t explain very well) was that when looking at active listings it only appears that LC is not verifying income on very many loans because verified listings get funded quickly. Also, I believe many flagged (by LC) listings get verified after funding therefore they never appear as verified while funding.

I should be more careful about confusing ‘listings’ with ‘loans’. LC states that 60% of LOANS had incomes verified. When considering on average 60% of listings become loans then it is possible that only 36% of listings ever get their income verified. When considering all these factors, one can expect to see only a small percentage of active listings with verified income at any one time.

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Dan B February 15, 2011 at 2:02 am

I’ll try one more time…………LC does NOT state that they do income verification on 60% of loans. The ARTICLE stated that LC stated that they do income verification on 60% of loans. These are 2 very different things.

Just read through LCs prospectus page 15,…………. it’s pretty much all spelled out there. LC verifies either income OR employment status on 65% of loans, but there’s no breakdown of the two.

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Peter Renton February 17, 2011 at 12:58 pm

@Dan/@Ken,

I just heard back from Lending Club. They do income and/or employment verification on 60% of their loans. He couldn’t share the exact breakdown with me publicly because if he did they would have to file a new prospectus with the SEC. He did say that a good portion of the loans are verified for both income and employment and a smaller portion are done for either one of the other. That is all he would say on the topic.

He did say they are working on improving their statistics page at Lending Club. Changes are not going to happen overnight but there will be a vastly improved performance analysis coming “within the year” with smaller incremental changes happening before then.

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