Jerry Nemorin, founder and CEO of Lendstreet, had a first hand look at the credit crisis while working in investment banking at Bank of America. He saw the devastation that occurred when companies and individuals get in over their head.
He also saw companies buying bad credit card debt at 10 cents on the dollar or less. When credit card defaults went north of 10% in 2009 he sensed an opportunity. One that could provide a win for the borrower, the credit card company and the investor. He had been a Prosper investor for some time and he loved the p2p lending model, so all these factors combined to form LendStreet, which Nemorin founded in June of last year.
Lendstreet combines debt restructuring, financial literacy counseling and peer to peer lending. It is targeted at those borrowers who Lending Club and Prosper reject. These are sub-prime borrowers with FICO scores under 640. To explain how it works it is best to provide an example.
Debt Restructuring With a Twist
A borrower (we’ll call him Bill) is struggling with a $15,000 credit card debt across three different credit cards, each with an interest rate over 20%. He has missed a couple of payments and is seeking debt relief, so he sends an application to Lendstreet. Lendstreet helps Bill get debt relief by restructuring his debt and setting him up in a payment plan that is within Bill’s budget. Here is what Lendstreet does to achieve this:
- They settle the $15,000 credit card debt with the three credit card companies for $8,250.
- Peer to peer investors fund this $8,250 settlement.
- Lendstreet creates a new loan for Bill at $12,000 at a more manageable 9.5% interest rate.
- Each investor receives a share of this $12,000 plus interest over the life of the loan.
The credit card companies are happy because they are getting 60 cents on the dollar for their asset that is about to go bad. Bill is happy because he has lowered his payments and has the credit card companies off his back. Peer to peer investors are happy because they have the opportunity to earn a great return that combines capitalized interest as well as cash interest.
Here is the catch for the borrower that will reduce the number of people looking to game the system. The borrower never sees the money, the payoff goes straight to the credit card companies. During the duration of the loan they are contractually obligated to not open another revolving credit line; if they do, it will be considered a default and their interest rate will go back up over 20%. The borrower can also gain credits for passing financial literacy tests and other milestones which can go towards reducing the principal balance. A studious borrower could see their $12,000 loan reduced to $11,500 with some of these initiatives.
Default Rates Expected to be Higher
Having said all that, Nemorin acknowledges that these are high risk borrowers and defaults will be significant. While it is difficult to estimate exactly what default rates will be, it will most likely be higher than current default rates at Lending Club and Prosper. But investors will be buffered from the impact of these defaults by the extra principal that is made part of their investment.
Lendstreet is expected to launch later this year. It will initially be open to accredited investors only in all 50 states. The plan is to also bring in institutional investors early, primarily those institutions accustomed to buying credit card debt on the secondary market. In 2013, once the business is well established they will seek SEC registration for their securities and start offering their investments to retail peer to peer investors.
It is difficult to say whether LendStreet’s model is going to be a successful one. It certainly is an innovative approach but the key as I see it will be risk management. If they can attract a pool of motivated borrowers with relatively low default rates then it could be a big win for all parties.
Hat tip to Matthew from P2P Lending News who covered LendStreet last week.