This post is the first of a three part series where I will be providing an analysis of the peer to peer lending (also known as p2p lending or social lending) industry in this country. This first post will be focusing on the industry as a whole and the two major players right now: Lending Club and Prosper.
The peer to peer lending industry is still very much a new and dynamic industry. Some players such as Pertuity Direct and Loanio have come and gone, and both Lending Club and Prosper have had to pause operations while they got all their ducks in a row with the SEC. Government regulation appears to be stifling the industry somewhat in this country as we look to the UK where four new companies launched this year, Funding Circle, RateSetter, Yes-Secure and Quakle to compete with industry leader Zopa. Not one new company in this country has launched a mainstream p2p lending service this year.
So in late 2010 we are left with two alternatives in the USA: Lending Club and Prosper. Let’s take a look inside the loan volume and finances of these two companies to get some idea of their economic state. All this information is publicly available either via their prospectus, web site or from various third party services that analyze their loan portfolios.
One of the beautiful things about this industry is that in many ways it is completely transparent. You can download the entire loan portfolio of Lending Club, or you can get a quick snapshot of the company from their statistics page. While I do some of my own analysis, I also use third party services such as lendstats.com or lendingclubstats.com that take the massive spreadsheet with the entire loan portfolio and massage it into useful information.
This chart (reproduced with permission from LendingClubStats.com) shows monthly new loan volume and demonstrates why Lending Club is now the clear industry leader. Monthly new loan volume has been marching steadily upwards from around $6 million in October 2009 to over $12 million just a year later. Based on these monthly loan numbers Lending Club is now the largest peer to peer lender in the world. Prosper still claims the title but that is based on total loan volume, and it is likely that Lending Club will overtake Prosper on this count some time early in 2011. More on that later.
When Lending Club came out of their quiet period they claim they tightened their credit standards at the same time. This tends to be reflected in the data. My own analysis indicates that for loans made in 2008 the default rate on those loans has been around 16%. But in 2009 the default rate has dropped to less than 5%. This is higher than Lending Club’s publicized default rate of below 3%, because they take into account all loans including those that have been recently issued. Newly issued loans are far less likely to default than those that have been in existence for a year or more. Still, if the default rate comes in between 3% – 5% of all loans that is quite reasonable.
If you read through the most recent quarterly SEC filing for Lending Club it becomes clear why we are still in the very early days of p2p lending. Basically no one is making any money yet. While Lending Club had a strong cash position at September 30, 2010 of $21 million in cash it is still incurring losses every quarter – in the 3rd quarter this loss was just under $3 million. We don’t know at what loan volume Lending Club would start making money, all we can say is it is likely a far larger volume than they have now.
Investing with Lending Club is not available to everyone. Currently, there are 28 states where investing is allowed but investors must also meet certain criteria such as not investing more than 10% of their net worth with Lending Club. A complete list of available states and eligibility rules can be found here.
With growing loan volumes and a large nest egg of cash Lending Club is certainly well positioned to become the dominant player in p2p lending. The key will be increasing loan volume substantially so they begin to make a profit.
While Prosper does not provide their entire loan portfolio in a spreadsheet format, they do provide a free API for third parties to create web sites that can use the data. One of the most popular of these web sites is Eric’s Credit Community where you can slice and dice the Prosper statistics in many ways.
This chart above (reproduced with permission from Eric’s Credit Community) shows the total of monthly new loans originated by Prosper in the last 18 months or so. Prosper exited their SEC imposed quiet period in July 2009 but new loans have been hovering between $2 million and $2.5 million for most of the past year. Even though Prosper still touts itself as the world’s largest peer to peer lending marketplace, it is clearly well behind Lending Club these days in new monthly loan volume. If nothing dramatic changes, based on current trends Prosper will lose this “largest” title probably in February or March 2011.
The default rate on Prosper has long been a sore point with investors. Many early investors ended up losing money on their investments with Prosper because of the high default rates (in excess of 35% of loans originated in 2006 and 2007 based on analysis from Lendstats.com). By their own admission credit standards were a lot looser when they opened in 2006. In an interview with American Consumer News back in June, Prosper CEO Chris Larsen acknowledged that the average return for early investors in Prosper was negative (-3.2% to be precise). But since the relaunch in July last year investors have been averaging returns of around 10%. Default rates have also clearly improved and are running just under 5% for loans originated in 2009 (about the same as Lending Club).
Prosper’s most recent filing with the SEC reveals a similar financial situation to Lending Club. In the last quarter Prosper lost around $2.2 million, slightly less than Lending Club. Their cash on hand is only $6.6 million so it is likely they will need another round of investment next year.
According to their latest prospectus, Prosper is available to investors in 28 states (and Washington DC) and like Lending Club their goal is to be available for investors and borrowers in all 50 states. There is also investor eligibility requirements similar to Lending Club that vary by state. For a complete listing of available states and eligibility criteria go to Prosper’s legal compliance page.
The Wild West
In doing this research it became clear to me that peer to peer lending has a long way to go before it can establish itself as an obvious fixed income alternative. When there is more competition, a long track record of successful investors making good returns, and multiple companies making profits then it will become a mainstream alternative. That might take several years. Right now, it is a bit like the wild west – only for the more adventurous investors. But those who are willing to put up with some risk and uncertainty can reap great investment returns.
While I remain convinced that this industry will eventually become a significant part of financial services, we are a long way from that happening yet. The next 12 months will likely see significant change. I expect loan volume to continue its upward trend and it is highly likely that 2011 will see the emergence of one or two new competitors.
If you are interested in who these emerging companies might be then stay tuned for the second part in my series on the state of p2p lending in the USA. Tomorrow, I will be looking at the emerging companies that could well shape the future of this industry.