A big change at Lending Club

By Felix Salmon
January 22, 2010
post on peer-to-peer lending. "Currently, the platform is 'demand constrainedā€¯, meaning that we have more investors willing to invest in these loans than loans available,' he wrote.

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Lending Club CEO Renaud Laplanche said something very interesting in his response to my most recent post on peer-to-peer lending. “Currently, the platform is ‘demand constrainedā€¯, meaning that we have more investors willing to invest in these loans than loans available,’ he wrote.

That’s a big change from when I met Laplanche in April, so I asked him what has happened since then. He replied:

It is a big change indeed. The platform went from being supply-constrained most of last year to now being demand-constrained. I believe 3 factors contributed to the shift:

1. Our track record continues to get longer, inspiring more confidence to investors, who now invest larger amounts. The average net return after defaults and fees remains over 9%.

2. The dynamics on both sides of the platform are different: investors are repeat customers and the entire base contributes each month, with more than 10,000 investors contributing each an additional $500 to their account each month on average. On the other side, each borrower takes one loan and that’s pretty much it for the next 3 years. We do very little upsell to borrowers, for risk management reasons. So the base getting bigger is not helpful on the borrower side, for now.

3. There are certainly macro-economic factors, with investors’ sentiment evolving. Investors are a lot less risk-averse now than they were a year ago, and those who were only taking FDIC-insured products are looking for yield again.

There’s good news and bad news here. The good news is that the investors keep on coming back with new money: they’re happy with the returns they’re getting and the default rates they’re seeing. But the bad news is that it’s becoming harder to find sufficient borrowers to meet investor demand — and no investor wants to put thousands of dollars into Lending Club, only to see it kept in cash, earning no interest.

The pressure on Lending Club to weaken its underwriting standards, then, is going to be intense — but it’s precisely those underwriting standards which investors are relying on and which set Lending Club apart from the likes of Prosper.

The best-case scenario here, of course, is that Lending Club will become better known among individuals and small businesses wanting to borrow money, and will be able to do much more matching of investors with borrowers. But I also have a concern that Lending Club, and other peer-to-peer lenders, risk becoming the Heloc of the new decade.

Back during the housing boom, people who found themselves over their heads with credit cards could wipe the slate clean(ish) by paying them all off with a home equity line of credit. The problem was that if you’ve gotten yourself over your head with credit cards in the past, you’re likely to do so again in the future — only with that big Heloc to add to the total debt load.

By far the most popular category of loans on Lending Club is debt consolidation. And indeed it makes perfect financial sense for people paying enormous interest rates on their credit cards to refinance it all at Lending Club, tear up their cards, and embark upon a life of newly-discovered frugality. On the other hand, it makes very little sense for those people to refinance everything at Lending Club if the main effect of doing so is simply to reopen those old credit card lines, and find themselves in a situation down the road where they’re paying not only the Lending Club obligations but also a whole pile of new credit-card obligations on top.

For a while there, at the beginning of 2009, I believed that Americans really were rediscovering the wonders of living within their means. But in hindsight they simply didn’t have any money or credit. If the Lending Club spigots continue to open up, we might just be creating a whole new asset class of loans which are weighing down Americans who should never have spent so much in the first place. Personal expenditure, it seems, will always expand to fill the amount of credit available. And that might not bode well for Lending Club investors down the road. Can the company’s underwriting standards stop that from happening? Right now, it’s impossible to tell for sure.

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