Began as Facebook app
Year-to-date loans: More than $1 billion
Lesson: Radical business model or not, trust in the credit rating.
When Wall Street isn’t lending, it creates an opportunity for others to step in—and five years after the financial crisis, with banks still chastened and technology start-ups more flush with cash than ever, sleek new online shops are predictably filling the consumer-lending gap where the banks used to be.
The most successful companies in this space are the ones known as peer-to-peer lenders, which match small-scale borrowers with like-size lenders, and the most successful peer-to-peer lender is Lending Club. Which makes it, actually, not very small-scale at all. Founded in 2006, Lending Club lent its billionth dollar in November 2012, and its second billionth dollar less than nine months later, in July 2013. And that was with just two products: three-year and five-year unsecured amortizing personal loans. (You borrow a certain amount and slowly pay it down over 36 or 60 months, remitting the same amount every month.) Lending Club makes its money by charging you an upfront fee for the loan and also by skimming a small amount off your repayments before they reach the lenders.
Lending Club wasn’t the first peer-to-peer lender—that honor goes to its main competitor, Prosper, which was launched by entrepreneur Chris Larsen in 2005. Larsen’s dream was a utopian one: He wanted to effectively disintermediate the banking system and its fat cats. “Disintermediate”: Prosper hoped to do for lending what other sites are doing for … everything else: Airbnb, for instance, which puts travelers in empty rooms; Etsy, which matches artisans with people who want to buy their work; Lyft, which allows car owners to make money giving rides to their peers. All of them are disintermediation plays: They cut out hotels, or craft shops, or fleets of taxis.
Banks, too, are intermediaries. They make their profits by borrowing at extremely low rates (a deposit, to a bank, is essentially a very low-interest loan from the depositor to the bank), lending at extremely high rates (especially on credit cards), and pocketing the difference. Prosper was designed to effectively cut out the banks and split the difference: Individuals with money would lend directly to people who needed to pay off their high-interest credit-card debt or who needed cash for any of a million other reasons. On the other side of the transaction, borrowers would see their interest rate drop, saving them hundreds or even thousands of dollars a year. Both would benefit, since the lenders would see a healthy return on their investment even after accounting for a statistically inevitable number of defaults. Where banks, running on pure profit motive, would push interest rates up whenever possible, Prosper was built on a more optimistic model: that a community of lenders and borrowers would be able to meet each other halfway, and that borrowers dealing directly with real people would be much more likely to repay their loans than those dealing with faceless banks.
It didn’t work out that way. Crowds might be wise, but it turns out they’re not very good at loan underwriting, and Prosper was soon overrun by people who would take out loans and never pay them back. It also had to close down for six months after it ran into trouble with the SEC. Into the breach stepped its biggest competitor.
Lending Club, founded by a French lawyer named Renaud Laplanche, was, from the beginning, always more elitist than Prosper—and, given the problems of its predecessor, its pickiness helped enormously. Under the Lending Club model, individuals can still choose which people they want to lend to—but only one in ten borrowers is ever accepted into the program. Lending Club’s most valuable innovation, it turns out, wasn’t its mechanism for matching borrowers with lenders; instead, it was its uncanny ability to use proprietary algorithms to identify which prospective borrowers were most likely to repay their loans. And which were least likely—the 90 percent of applicants, often the people most in need of cash, who would end up turned away.
This innovation has been great for lenders—but it doesn’t quite count as progress if you believe in the philosophy behind peer-to-peer lending.
Once upon a time, humans really did roam the Lending Club website. Lenders would browse various potential borrowers’ requests for money and would usually ask detailed questions of those borrowers; if the answers were sketchy, often the loans didn’t get funded. But Lending Club has increasingly become an investment vehicle for Wall Street and little more than an automated loan service for the web’s most creditworthy borrowers. Go to the Lending Club site today, spend a bit of time browsing the list of people asking to borrow money, and you’ll find that a few very short stories are still there in the “Loan Description” section. (“I would like to pay off a credit-card bill, $7,000, and do some small home repairs.”) But most of the notes are now completely generic debt-consolidation requests, with no loan description or narrative at all. It doesn’t matter: Once they’re accepted, they all get funded anyway, since today’s lenders trust the Lending Club algorithm so much that they’ll happily fund any borrower it approves.
Indeed, whole new layers of facelessness are being added. For while Lending Club is based in San Francisco, Wall Street didn’t take long to notice that the company had found a pool of creditworthy borrowers willing to pay double-digit interest rates—even as the Fed was willing to provide those banks money at close to zero interest.
As a result, Lending Club’s investors are increasingly hedge funds, or high-net-worth brokerage clients, or other pools of money highly redolent of the Wall Street of old. Some of them are even levered: Silicon Valley Bank has a whole business lending money to people who just turn around and reinvest those funds in Lending Club. The borrowers are still individuals. But they’re being lent money by the very Wall Street institutions that the peer-to-peer system was designed to circumvent.
And just look at the investors in Lending Club—not the people making the loans but the owners of Lending Club itself. The board features such crisis-era grandees as John Mack (the bailed-out former CEO of Morgan Stanley) and Larry Summers (who needs no introduction). A rival company, CommonBond, of Brooklyn, just raised $100 million in new capital—including a substantial check from Vikram Pandit, the bailed-out former CEO of Citigroup. And Prosper’s latest $25 million round included money from BlackRock, the world’s biggest money manager.
The good news is that individual investors can still get in on the Lending Club game—and even get slightly better returns to boot. If you’re a brokerage client or a hedge fund investing in Lending Club loans, you have to pay a few extra layers of fees. (Wall Street will always take its cut.) Individuals, on the other hand, can still pick their own loans (or just press a button and have the Lending Club robot to pick the loans for them) and get the highest possible returns.
But there’s work involved in going down that route: When you make lots of little loans in the $25 to $100 range, you get lots of little interest payments as well. And although the interest rates are still impressively high, the loans are extremely illiquid. They’re at least three years long, with some now stretching out to five years—which means that it’s going to take a very long time to unwind your investment.
As Lending Club grows, both organically and via acquisition, its product line is certain to get longer: It will move into auto loans and maybe small business loans too. But if you’re hoping that the company will get less picky about whom it lends to, don’t hold your breath. If you can’t get a loan from a bank, you’re certainly not going to be able to get one from your peers.