EIS Mini-Project: P2P Lending

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1 Lending Club Lending Club is a US-based peer-to-peer lending company, which was founded in 2006 in San Francisco, California. Lending Club uses an online marketplace to connect borrowers and investors by providing transactional services, including screening borrowers for borrowing eligibility and facilitating payments. The peer-to-peer lending industry was originally started by Prosper, also in 2006, followed by Lending Club and other lending platforms. Lending Club was the first peer-to-peer lender to register its securities with the Securities and Exchange Commission, and to offer loan trading on a secondary market. The key characteristics of peer-to-peer lending are: Transactions take place online Prior relationship between lenders and borrowers is not necessary Lenders may choose where to invest Loans are unsecured Loans can be sold to other lenders Lending Club s customer acquisition process, registration, underwriting, processing, and payment systems are automated and electronic. It encourages the use of electronic payments as the preferred means to disburse member loan proceeds, receive payments on outstanding member loans, receive funds from investor members, and to disburse payments to applicable investors. The self-directed investors have the opportunity to purchase, directly on the company s Website, member payment dependent notes issued by the company, with each series of notes corresponding to an individual member loan facilitated through its platform. The notes are unsecured, are dependent for payment on the related member loan and offer interest rates and credit characteristics that the investors find attractive. The company attracts members to its Website, through various sources. It drives traffic through referrals from customers and other parties, search engine results, and online and offline advertising.

2 As of December 31, 2012, the platform facilitated 95,902 member loans. As of June 2013, the company has originated over 2 billion USD in loans, and averages $2.7 million in daily loan originations. Added Value to Borrowers Lending club enables borrowers to create loan requests on its website by supplying details about themselves. All loans are unsecured personal loans between $1,000 and $35,000. Lending Club determines whether the borrower is credit worthy and if so, the company assigns a credit grade for approved loans that determines payable interest rate and fees. The evaluation is based on the borrower s credit score, credit history, desired loan amount and the borrower s debt-to-income ratio. Loans are only available to U.S. residents and can be repaid any time without penalty. The standard loans period is three years; five-year period is available at a higher interest rate and additional fees. Added Value to Investors Investors can consider and select loan listings on Lending Club website and decide where to invest based on the information supplied about the borrower, amount, grade, and loan purpose. The loans can only be chosen at the interest rates assigned by Lending Club but investors can decide how much to fund each borrower, with the minimum investment of $25 per note. Investors make money from interest paid by the borrowers, with rates varying from 6% to 25%, depending on the credit grade assigned to the loan. Average return is between 6% and 9% since company founding. Lending Club makes money by charging borrowers an origination fee (depends on the credit grade and ranges from 1.1-5% of the loan amount) and investors a service fee (the size of the fee is 1% on all amounts the borrower pays). The company facilitates interest rates that are better for lenders and borrowers than they would receive from most banks. However, lenders are making personal loans to individuals on the site, investor returns are taxable as personal income instead of investment income; as a result, investors are subjected to a higher tax rate on their returns than they are with alternative investments.

3 Ecosystem Map Technology platform Lending Club Banks Regulators Investors Borrowers Execution Risk In this new ecosystem, Lending Club aims to eliminate banks from the equation or at least send them to the periphery and cement itself as an online service in their stead. As the company endeavored to create such an ecosystem, the company faced some execution risks: the online service it was aiming to provide required significant upfront capital investment, proof that its transaction model would be effective, development of a technology platform, and regulatory approval. Backed by a relatively-large $10M Series A investment from VCs (Norwest Venture Partners and Canaan Partners), worked hard to simultaneously build out its technology platform and gain regulatory approval from the SEC. By 2009, less than three years after its inception, Lending Club had largely overcome most of its initial execution risks and grown into a legitimate lending service. Adoption Risk The larger obstacle in this ecosystem was (and continues to be) adoption risk by consumers, who comprise both the investor and borrower groups. Their level of adoption will ultimately determine how expansively Lending Club can scale. Although Lending Club offers borrowers better rates than traditional banks, many consumers may be wary of deviating from a known model (banks) to an unfamiliar one (online) when it comes to large decisions such as borrowing

4 money. However, consumers are growing increasingly comfortable with online transactions and still face reduced availability of credit in the aftermath of the Great Recession. Attracting borrowers is not enough, though; Lending Club s service only works if there is a commensurate supply of investors willing to match the demand for borrowing. Its selling points to investors are lucrative interest rates and low risk (Lending Club sets a high bar for qualifying borrowers and additional assumes the loan obligations), but investors may yet be scared away by the unsecured nature of the loans (so if Lending Club goes bankrupt, investors could lose their money) and, again, their level of comfort with an online lending service. Ecosystem Relationships Strategy The rise of peer-to-peer lending platforms like Lending Club and Prosper came in the wake of the 2008 financial crisis. With banks in the brink of bankruptcy and credit availability becoming increasingly scarce, P2P platforms saw an opportunity to provide consumers with an additional option for short-term borrowing. The main innovation relied on a medium to connect these borrowers with potential investors looking for more attractive deals than what the current market had to offer. In this regard, Lending Club successfully executed a plan to develop a web platform that could bridge the gap between both parties. Particularly, Lending Club developed a platform that could communicate in a clear and simple way the most relevant data for its customers. For example, borrowers need to fill out a simple form describing their borrowing needs and their credit credentials. After a quick credit check the platform calculates the appropriate interest rate. This rate is usually below what borrowers would get if they attempted to get unsecured financing. The platform is particularly beneficial for borrowers seeking relatively small loans with short horizons. In general, all loans have a maximum balance of $35,000 over 3 to 5 years. However, investors are the party that benefits the most from this platform. Lending Club only accepts 10% of its loan applications aiming to get the most reliable borrowing members. Borrowers are required to have high credit ratings and a debt-to-income ratio of 35% or less. Under these circumstances, investors have access to relatively safe short-term loan opportunities. Additionally, investors have access to financial and historical data on the borrowers, on which they are investing, helping them make better informed decisions. Lending

5 Club creates securities from its pool of loans and rates them in an A to G grade scale. Each type of security is associated with a certain level of default risk and interest rate. When investors access the web platform they have the choice of assessing the distinct securities. They then decide if their investment should be directed to one type of borrower or diversified among a group of loans with different levels of risk. Finally, investors also have access to a portfolio tool that allows them to manage their account. The proprietary technology allows investors to list all available loans by their investment criteria facilitating their decisions. Certainly, the Lending Club has created an ecosystem of investors, borrowers and services that generates a new loan market and that prevents market entry from competing firms. However, this industry is still in its early stages and dominance by the Lending Club might be challenged by changes in the environment. In particular, maintaining competitive interest rates for borrowers and fending off commercial banks attempts to participate in this space will be among the most important issues the Lending Club will face. With interest rates still low in the US, P2P platforms like the Lending Club will remain attractive for most investors. However, other financial institutions like hedge funds have started to notice an opportunity in commercial lending as banks continue to struggle. If hedge funds participation continues to increase, a potential saturation of the market might ensue diluting the returns for investments. Commercial banks have also recognized P2P platforms as a threat and have started to address this gap in its services. Recently, banks like Wells Fargo, Bank of America and JPMorgan Chase have partnered up to launch clearxchange, a P2P platform that pools some of their borrowers and matches them with investors. Competition from banks might be hard to counter as these institutions intrinsically offer services that would be impossible for platforms like Lending Club to replicate. Specifically, banks can supplement their P2P platform with longer term loans. Current platforms are unable to do this because their investors have short-term investment horizons and wouldn t be interested in locking up capital for such a period of time. In conclusion, P2P platforms have succeeded in deploying an innovation strategy that created an ecosystem and addressed a particular need in the market. As of 2013, Lending Club has generated $2 billion dollars in loans and $28.6 million in revenue. However, the sustainability of its business model will be put to the test as external pressures start curbing its success. As

6 competition increases and revenues decline Lending Club might see itself retreating to a niche market of borrowers and lenders that do not benefit from comparable platforms offered by traditional banks.

7 Sources 1. Lending Club s website, 2. S&P Capital IQ 3. TechCrunch