The attraction of Lending Club

By Felix Salmon
April 24, 2009

I just had a very interesting meeting with Renaud Laplanche, the CEO of Lending Club, the peer-to-peer lender, and I’ve come out very enthusiastic about what he’s doing there.

Lending Club is the most advanced of the US peer-to-peer lenders, in that it has gone through all the legal pain needed to get full SEC registration and therefore has less in the way of legal question marks hanging over it. It also seems in some way the most professional: rather than scrolling through sob stories looking for someone sympathetic to lend to, lenders never even know the identifying details of the individuals they’re lending to, and generally just invest a lump sum over a couple of hundred different people.

The returns so far have been good: according to a report from Javelin Research,

At the close of November, the overall investment return averaged 9.05%, with a median return of 10.48%, based on a Weighted Average Return on Invested Capital (WAROIC). That calculation accounts for Lending Club’s 1% service charge, as well as for loans paid off early, hobbled by late payments or defaulted.   

That’s a healthy return, for a fixed-income investment, without being usurous as far as the borrowers are concerned. Indeed, that’s one of the reasons I like this model so much: it allows people to pay off their credit-card debts, which might be well over 20% or even 30% per annum, at a much cheaper rate, over a reasonable three-year time period. You can even prepay your loan at any time without penalty.

Lending Club isn’t trying to lend to people who can’t borrow money elsewhere: indeed, it has pretty stringent underwriting standards, and turns down 90% of the would-be borrowers at its site. The ones who do qualify end up paying somewhere between 8% and 19% interest, depending on their creditworthiness; the interest rate is set by Lending Club, rather than bilaterally between borrowers and lenders.

The company’s default rate is more or less where you’d expect, in the 3% to 4% range; once a loan has defaulted, the recovery is very low. But recoveries on loans which are 60 days delinquent are actually very high, in the 75% range: borrowers really want to repay these loans, and don’t hate Lending Club in the way they hate their bank or credit-card company. What’s more, because the loans amortize over three years, a substantial chunk of the principal amount has generally already been paid back even by those borrowers who do end up going into default.

Another thing I like about Lending Club is that it isn’t only stringent about its borrowers; it’s stringent about its lenders, too, requiring an income of at least $70,000 a year and liquid assets of at least $70,000. In California, where right now most of the lenders are based, those numbers actually rise, to $100,000. For the time being, substantially all of the company’s lenders are individuals — there are a lot of angel-investor Silicon Valley types who consider this kind of investing to be extremely low-risk and a way of making the world a better place. But moving forwards, there’s no reason why Lending Club shouldn’t get substantial institutional investments as well, especially once it’s been going for three to five years.

That said, this kind of investment is particularly well suited to retail investors, because of its three-year time horizon. (It recently launched an IRA product, too, with income reinvested.) There is a secondary marketplace for loans, but it’s not a major feature of the site, and most investors are very much buy-and-hold.

Lending Club is not the best way of looking for particularly sympathetic borrowers, or for lending in an arm’s-length and legally-binding way to a friend. (Virgin Money is the place to go for that.) Instead, it’s just a way of disintermediating a banking system with which many Americans have become increasingly disgusted, with both sides happy with the deal.

How safe an investment is Lending Club? This is the bit I like the most: it’s safe, but not too safe. The desire for safety was one of the main drivers of the financial crisis, and I believe that people with thousands of dollars to invest over a three-year time horizon should be comfortable taking a certain amount of risk. Going forwards, it’s possible that Lending Club will find an insurer willing to offer a principal guarantee in return for a certain insurance premium of say 300 basis points, but in a weird way I like it more this way: it forces investors to worry just a tiny bit about the prospect of losing some of their money, and that worry is ultimately healthy.

No investment yielding 9% a year can ever be risk-free, but I don’t think the amount of risk embedded in a diversified portfolio of Lending Club loans is at all excessive, given the yield. It’s certainly much lower than the risk of investing in a diversified portfolio of stocks, which is something that hundreds of millions of Americans do as a matter of course. Plus, you get to help out people who are really grateful for your money. So if you want to diversify out of the markets and make more money than on a bank CD, it’s definitely something to consider.

Should you borrow from Lending Club? Well, you can try — but most people who do try, fail. For the time being the demand for loans greatly exceeds the amount of money available, so there’s not a great chance you’ll get what you want. But if and when Lending Club takes off, it could become a great place to borrow money easily and at much lower rates than your credit-card company is charging. Banks have been making it increasingly difficult to get a personal loan in recent years, because they make so much more money from credit cards. Lending Club is now offering a product which really the banks should have been offering all along, but weren’t. I wish it very well.

Update: Renaud, Steve Waldman, and I spent much of the weekend emailing back and forth about weaknesses in the Lending Club business model, most of which I won’t get into but which Steve might, if he’s so inclined. The upshot is that there is a weakness there: lenders get unsecured obligations of Lending Club, rather than a direct security interest in the loans themselves. Just how much of a weakness this is is open to debate: Renaud told us by email a bunch of things which are not easily findable in the prospectus, if they’re in the prospectus at all, and which are pretty reassuring. But if you’re thinking of Lending Club as a place to invest a serious amount of money, they might be worth looking into.

19 comments

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I also liked the lending club concept, but when I did an actual loan, my net return is nothing near the claimed “Weighted Average weight” of 9.63. Since I only have one loan, the weighted average weight is the claimed return for my loan.

Here are my loan details:

With the 25 dollar lending club sign-up bonus, made a 9.63 interest loan, and after three years (if the loan isn’t pre-paid), I will have 28.88 from the 36 payments. So I will have made 3.88 over three years, an Annual percentage yield of 4.93 percent on my 25 dollar investment.

It’s disappointing that they don’t return interest on your cash in your account as that would increase your yield (as you wait to reinvest).

I’d love to see a real world account return on Lending Club, or maybe the math behind a complete set of assumptions behind the process of lending, to see an estimate of real lender returns.

Posted by Jon | Report as abusive

I borrowed through lending club, and I’ll tell you one thing: I will never borrow from a bank again if I could avoid it. These guys are nice. But the fact that I was able to get a better rate than at the bank, while knowing my interest was going to a bunch of others like me?!?! I’m not making some bankers rich anymore, I’m helping those who helped me with my loan. That’s what community is all about.

Posted by Kieran | Report as abusive

I’ve invested a good amount in Lending Club since they launched and I’m not sure where Jon is getting his math skills from, but I’m earning around 10% so far with no defaults yet. Even with defaults I should end up in the high single digits in terms of return.

You need to diversify when it comes to this type of investment. Invest in 50 loans in smaller amounts vs. 1 or 2 loans.

Posted by Sam | Report as abusive

Lending Club is a great alternative investment. I’ve been a lender on Lending Club, kiva, and even Prosper. Feliz is right. Lending Club offers the best product in peer to peer lending out there. After a year and some on the platform, I have about 11 loans defaulted (out of 250+), and a few others are late, while the others have paid average of 12-13% average interest rate. Overall, I think I’ve made a healthy 8-9% (try getting that in the stock market).

My Prosper account is smaller, only 40 loans, but I stopped because the default rates there are higher. Kiva is awesome! Love it! but it’s not an investment per se.

If you’re thinking of lending (and you should), it makes sense to diversify (start with 20-30 loans). Don’t do what Jon did. If you only have $25 to invest in one loan, put that in the bank, not in p2p lending.

Posted by Caroline | Report as abusive

No mention of the pioneer and leader in the space, Prosper?

Posted by pwb | Report as abusive

Felix, the secondary market is fundamentally important to this business model (IMHO). I considered lending some money through http://www.zopa.com (a very similar business) but it was the lack of a secondary market that put me off. Put simply, I wanted to know that I had a chance of getting my money out if I needed it. If Lending Club need more liquidity then this is a feature they should make more of.

Of course if you need money and it’s all lent out then you can try borrowing from the same market, but it’s hardly an efficient way to achieve what you want. Selling your loans has got to be better.

@Felix,

informative article

@Jon,

I think you come to misleading numbers, because you neglect, that each month part of the principal is paid back to you. The 3.88 interest is not earned on 25 invested over the full term but on a descreasing portion of that.

@All
P2P-Lending results (and risks, defaults) vary very much depending on platform. This should be taken in consideration when considering to invest and choosing a service.

I found this surprising:

“It’s stringent about its lenders, too, requiring an income of at least $70,000 a year and liquid assets of at least $70,000.”

If this is true, why would one create such entry barriers to your lenders and limit the number of people who could invest in the site? Zopa in the UK, for instance, has no such barriers.

This is oddly similar to certain rules in the States for ‘qualified investors’ in hedge funds requiring over $100k in annual revenues or over $1M in assets. As we saw in the case of Madoff, such rules by themselves do little or nothing prevent fraud and people losing their money

Posted by Julian Kaljuvee | Report as abusive

I find the concept of P2P lending very interesting, and after reading this posting and a similar one in the wall street journal(http://online.wsj.com/article/SB 124088142201761953.html#articleTabs%3Dar ticle), I am considering investing money through the Lending Club. Before doing so though, I’d like to resolve the following question in my mind: If a large part of current financial crisis stems from the degradation of underwriting standards due to rise of originate-to-distribute lending, how is Lending Club going to avoid a similar pitfall? Doesn’t Lending Club’s commission structure seem to incent almost the exact same behavior that we all see deplored in the news every day?

Posted by tom | Report as abusive

I am surprised p2p isn’t a mainstream concept yet. It basically functions as a bank but cuts out the middle man.

I have been with LC for a while now and have had no complaints. Traditional banking should watch their back too!

BankVibe.com calls it an alternative to bank CD’s

http://bankvibe.com/an-alternative-to-ba nk-cds-certificates-of-deposit/

Posted by Dan | Report as abusive

Jon – As others have stated. If you can not properly diversify in 50+ loans (min 1,250 investment) you should keep your money in your piggy bank. If you reinvest your returns monthly your return over time is 9+%. To answer another question posted – Lending Club and other P2P lenders like prosper and soon launching IOU Central, unlike the banks there is total transparency in the loan data. Banks would continually open credit windows (and offer credit cards to household pets) to push loans into the market. P2P lenders will always have to balance deliq loan %’s and a big attraction to a P2P lender is who can maintain lower defaults. Also – as P2P loenders serivcing portfolio’s grow – if theborrower doesn’t pay, the P2P lender doesn’t make any serviing spread – so the P2P lender firm and the Lender really do BOTH have skin n the game. This is a small yet important factor that will keep P2P lenders in check. As we saw with Prospers 30% defaults, when that happens you upset MANY lenders. They have since tightened substaintially. It is a wonderful new asset class that will gain traction and will be mainsteam. Regulation is expensive and difficult to navigate but the few who do it and do it right will be pioneers in this new emerging industry.

Posted by Robert | Report as abusive

Why is everyone ragging on Jon and avoiding his point? Nowhere in his post did he say his $25 loan defaulted, so why the immaterial advice for him to diversify? It seems their might be a discrepancy with the rates being published on a per annum basis.

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