New Businessweek Article on Prosper (and other P2P Lending Sites)

I was reading the latest edition of BusinessWeek online and came accross the article below, which discusses the P2P Lending environment and provides some very useful information on the pros and cons of each different service. This should give Prosper (and others) some additional traffic over the coming week or two. For BusinessWeek has done a very nice job (probably among the best) at covering the emergence of the P2P Lending marketplace, so check out their site (and the embedded links below) for some of their work in this area. Enjoy!

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Will a Stranger Lend You $25,000?

How for-profit social lending marketplaces work, and why they might be worth considering to land a business loan

by John Tozzi

Chris Lindgren needed money. His textbook price comparison site, Direct Textbook, depends mainly on the referral fees it gets when college kids buy books through it. But this past August, the four-year-old business had already used up most of its cash on online advertising, with weeks of the back-to-school rush season still ahead. Lindgren wanted to buy more ads, but revenue from previous sales wouldn't come in for months. His profitable three-employee company had tapped out two lines of credit worth $60,000 from banks in Salem, Ore., where the business is based, and had been turned down by two more.

The day the last loan officer rejected his application, Lindgren heard about Prosper. The auction-style site connects borrowers with lenders and promises both sides more favorable interest rates than banks by cutting overhead costs. Lindgren applied for the maximum $25,000 loan the next day, offering to pay 17.5% interest. Lenders found the offer so attractive that they bid the rate down to 10.2%, and Direct Textbook had the cash in its account within two weeks. The rate is comparable to what Lindgren pays on his bank credit lines.

"Considering our credit situation, I might have ended up paying more,"; he says.

An Alternative to Banks

Prosper, based in San Francisco, is one of a tiny but growing number of for-profit online social lending marketplaces in the U.S., which some entrepreneurs are looking to as alternatives to bank loans. (The original concept of making small loans available to people with no collateral in the developing world started in the 1970s and has been growing steadily more popular, sparking praise (BusinessWeek.com, 10/13/06), controversy (BusinessWeek.com, 12/13/07), and nonprofit successes like Kiva (BusinessWeek Small Biz, 7/31/06).) As the credit crunch (BusinessWeek Small Biz, October/November, 2007) makes getting a loan even harder for small business owners, for-profit social lending could play a bigger role in financing small enterprises in the U.S. Most sites reported that between 20% to 30% of loans are for businesses; it is the second most common reason borrowers listed, after refinancing debt.

Three companies besides Prosper offer similar services in the U.S: Zopa, Lending Club, and Virgin Money. Zopa just began lending in the U.S. on Dec. 4; the site operated in Britain for about two years before that. Lending Club, which started as a Facebook application in May, became available in all 50 states on Dec. 13. Virgin Money, originally CircleLending, doesn't connect lenders and borrowers, but it formalizes loans between family and friends. British mogul Richard Branson bought CircleLending this year and relaunched the site in October. Two new sites, Loanio and GlobeFunder, have announced plans to launch in 2008.

"These peer-to-peer lending sites are ideal for people who are not quite in the normal, plain-vanilla credit model that everybody has," says Jim Bruene, publisher of the Online Banking Report, a trade publication, and the author of a recent report on social lending. "Certainly business startups or business people who are self-employed fall through the cracks."

No one is counting on social lending to replace banks. Virgin Money has documented $250 million in loans since it was launched as CircleLending in 2001. Prosper users borrowed a total of $103 million through the end of November. The volume is miniscule compared to the total amount loaned: "That's Bank of America (BAC) for a couple hours,"; Bruene says.

More Flexible Standards

But these sites offer a quick turnaround that appeals to entrepreneurs, especially in a difficult credit market. Nearly one-tenth of responding banks tightened credit standards for small business loans in the third quarter, while none said they had loosened standards, according to the Federal Reserve's October survey of senior loan officers. Social lending sites still evaluate borrowers' credit ratings, but they add another factor as well: the power of the pitch.

Zopa Chief Executive Officer Doug Dolton points to a borrower on his site who got a $10,000 loan at 16.99% to start a Christian comedy club in San Jose. "I think it would have been challenging for him to find that financing from a normal bank," Dolton says. In Zopa's model, the loans are funded by partner credit unions. Then investors on the site can buy certificates of deposit from the credit unions, insured investments that reduce the borrower's payments. "They look at the story and they find the story compelling, and then they click on the borrower," says Dolton. "What we found is that people enjoy reading these stories."

Lending money is still a business, however, and lenders want to see returns regardless of how good a story the borrower has. Lenders are advised to spread their investments across many loans to reduce the risk. "I think that human-interest part of it is definitely a factor in how people decide," Bruene says. "Whether it helps this thing go from being a very small niche to being mainstream activity, it's going to depend on whether it works for the lender."

Because peer-to-peer finance sites expose borrowers to thousands of potential lenders rather than just one loan officer, the hope is that some of those lenders will be willing to take on risk that a bank won't.

"Sometimes banks have an inflexible way of operating their credit policy, as they probably should," says Lending Club founder Renaud Laplanche. "Lenders make their own decisions to fund businesses based on different factors: how they relate to that person and how much they want to help that person in addition to getting a good return for themselves.

Lindgren says his creditors on Prosper understood his online business better than bank officers did. "When we went to the banks, they're not used to lending to Internet companies," he says. Loan officers balked at the debt Direct Textbook already had on its books. But the Web-savvy lenders on Prosper understood why the company needed to borrow to buy ads at the back-to-school rush, and they deemed Lindgren a good credit risk because he demonstrated how the ads had led to traffic and sales in the past.

For Lindgren, the loan paid off. Direct Textbook, which expects profits of $120,000 on $500,000 in revenue this year, poured the money into Google (GOOG) ads to boost his site's traffic and the money it makes on sales referrals. "We could pay the full amount back now," Lindgren says. "We keep it open because then that keeps $25,000 in our lines open."

Flip through this slide show to learn about the advantages and disadvantages of the four for-profit social lenders: Lending Club, Prosper, Virgin Money, and Zopa; that are trying to appeal to entrepreneurs in the U.S.

John Tozzi is a freelance writer for BusinessWeek.com.

President Bush Reveals Sub-prime Relief Plan: What do you think?

The Bush Administration today released the much-anticipated sub-prime loan plan that provides for lenders, investors and loan servicers alike to voluntarily freeze “teaser” interest rates on a select number of sub-prime loans made from January 1, 2005 to July 31, 2007 for up to five years. This agreement does not include any funding or bailout from the government (e.g. tax payers), but some fear that this may be the first step toward deeper government involvement in the credit meltdown. While the agreement will provide relief to some borrowers, the qualifications for relief are somewhat unclear (I'll keep this post updated as more details emerge). For example, to qualify, a borrower must have a loan that was originated during the above timeframe, must still live in the home, must be able to afford the current payments (while proving they won't be able to afford the payments once their rate adjusts upward), and must have less than 3% equity in their home.

P2P-Loans.com View
As a general rule, P2P-Loans.com has mixed feelings about the government getting involved via increased regulation in just about anything that the free market can sort out due to the laws of unintended consequences (for example, the Alternative Minimum Tax). P2P-Loans.com does believe there were some unscrupulous mortgage brokers that gave bad advice to borrowers, but P2P-Loans.com strongly believes that individuals need to take responsibility for their own actions. If you signed the mortgage documentation, you should have read it to be sure it said what your broker told you it said! If you didn’t, shame on you and we hope you learned a valuable lesson for the next time.

This deal, however, is not a bailout as it is being willingly agreed to amongst private parties (lenders, loan servicers and others) at the “urging” of the US treasury department and the White House, and not as a result of new legislation, regulation or subsidy. Additionally, the net result of this agreement is simply to accelerate what the banks were likely going to have to do for many borrowers anyway (cut them a break and offer a new deal). As the number of foreclosures continues to climb, lenders/servicers were going to have to eventually face the music and begin to cut borrowers a break through adjustments to their loans. After all, it is a far superior outcome for the lenders to keep a loan performing (even if it is at a lower rate) versus foreclosing on a property.

So Why Are the Banks Willing to Agree to This?
As stated above, P2P-Loans.com thinks they were going to have to end up doing something like this at some point anyway (and, by many accounts, they are already renegotiating a number of loans with late payers). But, the real reason, we think, lies in the fact that the financial services companies are being increasingly attacked by Congress (principally Democrats) as the banks/mortgage companies and Wall Street make the most convenient scapegoat for this whole mess (the story goes something like this, “greedy, self-serving, wealthy financial types lied to millions of innocent borrowers, stole their money and now want to take their house and kick them out on the street,” etc.). By agreeing to this type of deal, the lenders buy themselves some political cover (and time) to stall or eternally defer some nasty legislation working its way through the Democrat-controlled Congress. In addition, the banks do get to slow the pace of foreclosures and, hopefully, the rapidly declining value of their collateral. This is just one idea, keep in mind, but it makes some sense.

So, what do you think? Please submit your comments on this difficult issue.

P2P-Loans.com