PEER TO PEER LENDING
An Innovation in Financing
The hassle of dealing with banks, their twitchy nature, their reluctance to lend
and payment of extremely low interest rates has given rise to a new innovation
in lending. That innovation is Peer to Peer lending.
In peer to peer lending, investors, those with money to invest provide capital to
those wanting to borrow.
When one deposits money in a bank and the bank lends it, if the loan goes bad,
the depositor is protected by the bank’s capital first, and ultimately by the
Federal Deposit Insurance Company (FDIC).
Peer to peer lending involves substantially more risk to the individual lending
funds than depositing funds in a bank. So how does peer to peer work?
Nothing in this lecture is a recommendation to invest in Peer to Peer lending.
Peer to peer lending operates through a management company that collects loan
applications, underwrites (evaluates) the risk, makes shares of loans available to
investors, collects payments from borrowers and pays loan payments to
investors. Peer to peer management companies charge a fee of 1% to 2% of the
Peer to Peer Managers
Peer to peer management
Investors companies collect loan Borrowers
Investors look at a Businesses and
applications; underwrite loans,
portfolio of loan individuals complete
reject applications that don’t
applications and loan applications;
meet certain criteria. Facilitate
purchase slices of and if they receive
purchase of loan shares by
loans offered for loans make monthly
investors; and remit payments
sale. to investors. payments.
Investors spread risk by purchasing a small slice of several loans. Investors also
have the ability of sell their slice of a loan through the Peer to Peer manager if
they need cash or believe the loan has become more risky than it first appeared.
There are at least a half a dozen Peer to Peer Management Companies. They
have a mixed track record.
Lending Club self-reported the following statistics as of December 14, 2011:
Approve fewer than 10% of the loan applications, based on stringent credit
criteria designed to focus on the most creditworthy borrowers. The majority of
our members use the loans to pay off high interest rate loans, most often credit
Average Lending Club borrower shows the following characteristics:
▪ 715 FICO score
▪ 13.2% debt-to-income ratio (excluding mortgage)
▪ 14.9 years of credit history
▪ $69,870 personal income (top 10% of US population)2
▪ Average Loan Size: $10,743 (Small Business Loans up to $35,000 for now.)
▪ Over $390 million of loans issued
Notes have provided a Net Annualized Return by grade between 5.82% for A
grade Notes and 12.15% for G grade notes.
Dunn & Bradstreet Credibility Corporation
Downloaded January 3, 2012
Business Financing through Peer to Peer Lending Sites
By Charles Peterson
The current business environment is characterized by a tight credit market,
more stringent underwriting standards, and a reduction in available debt capital,
which is making it very difficult for small businesses to get business loans. In
order to finance ongoing operations and business expansion, business owners
have to find new innovative ways to raise capital. One of these new creative
financing methods is supplied by peer to peer lending web sites. Peer to peer
(P2P) lending gives investors a way to pool their money to make business
loans, while providing business owners with an alternative to traditional
Of these peer to peer lending sites, the major players include Zopa,
LendingClub, Prosper.com, and Loanio. The deals that these sites have made
can be substantial in a number of loans and the amounts borrowed. One of the
largest of these sites, Prosper.com, has made over $185 million of fixed rate
individual and business loans of up to a maximum of $25,000, since it launched
back in 2006. Other than the source of the capital, the process in which loans
are approved is similar to any other traditional lending institution. A borrower
registers at one of the lending sites who then underwrites the borrower’s ability
to repay by traditional methods including running the borrower’s business
credit report. Once the analysis is complete, the borrower is assigned a credit
rating, which gives an indication of how likely it is that the borrower will
service the loan.
As part of the approval process, the borrower completes a loan listing
indicating the amount requested, (and if a business loan, the details of the
business) an explanation of the financing needs, and the borrower’s ability
to repay the loan. In order to underwrite the business, the borrowers must
provide financial statements detailing income and expenses as well as a
forecast of future cash flows including principal and interest costs.
Borrowers must indicate the highest interest rate that they are willing and
able to pay, and any applicable loan costs that have been agreed to. Peer to
peer lending rates are set at the discretion of the lender although they must
abide by usury and any other state lending regulations.
Businesses that have previously established a business credit profile usually
have a better chance of approval than those without one. A business credit file
not only provides the lender with the payment histories between the borrower
and other creditors and vendors but also provides explanations about how and
why the borrower may be a better credit risk than their credit rating might
Business with relatively low credit ratings can still be approved for a peer to
peer loan, although they will probably have to pay a higher interest rate than
those with better business credit. Since the loans are not securitized and are
held by the investing pool, peer to peer lending sites can provide both
conventional and higher risk loans.
Once your loan profile is posted, investors will bid on the loan until it is
eventually funded. Since investors in a pool can contribute as little as $100,
many individuals must decide to participate before the loan can be made.
As part of the approval process, investors may ask specific questions about
you and your business that need to be addressed directly and immediately.
As they bid, lenders note the lowest rate that they will accept for
participating in the loan. At the end of the bidding period, the peer to peer
lending site company evaluates the investor proposals and then determines
the interest rate you will have to pay. If time runs out before the requisite
number of investors decide to participate in the loan, then the loan request
is cancelled and must be reposted again if the borrower wants to attempt
getting approval for a second time.
If the loan is eventually approved, then the peer to peer lending site will
administer the loan and collect the loan payments. Like traditional loans,
making prompt debt service payments will strengthen your business credit and
make it easier for you to receive funding in the future. On the flip side, if you
fail to make scheduled payments or make payments late, your business credit
will be negatively affected and will make it harder for you to get financing and
decent trade terms from vendors. If things get really bad, your account will
be passed to a collections agency, the collections effort will be posted to your
business credit file, and your credit rating will be reduced accordingly.
Although peer to peer lending sites are providing business owners with an
innovative way to borrow and an alternative to bank financing, many of the
same rules apply. Companies will still need to establish and maintain good
business credit well in advance of the need for funds. Since it is getting more
difficult to obtain external financing, the value of good business credit is also
increasing. Regardless of the source of capital, whether it is a traditional bank
loan or line of credit or a new variation such as the peer to peer lending site,
companies will still need to manage their business credit if they expect to be
financed. Although the funds are coming from different places and are funded
by a different type of investor, lenders still need to be assured of a borrower’s
credit quality before they will part with their capital.
End of Article