in Loans and Borrowings

Peer To Peer Lending: Does It Give High Yields With Little Risk?

The concept of Peer to Peer Lending (P2P) is still in its infancy, having appeared on the scene barely six years ago, but is fast becoming a place for institutional investors to park some of their money. The lure? Higher yields. At a time when 5 year U.S. Treasurys are paying a tiny 0.90% and even 4 year corporate junk bonds are yielding a mere 7.3%, the prospect of realizing a potential 10% or better is tantalizing indeed.

Techcrunch.com recently reported that the industry, if it can even be called that right now, has topped $1 Billion in loans. Until the JOBS Act was passed, P2P operated under a cloud of legal uncertainty, and to this day the U.

S. government still has not quite rendered a decision as how to classify this form of lending. Whether the industry will fall under the regulatory jurisdiction of the SEC or the Consumer Financial Protection Bureau (CFPB) remains a debate at this point.

There are only two main U.S. Players in the Peer to Peer lending arena, and they are Prosper Marketplace and LendingClub Corp., both of which now file quarterly reports with the SEC.

Within the past 18 months, Lending Club has managed to lure 30 institutional investors, such as wealth management firms and hedge funds, possibly due to its relationship with former Morgan Stanley CEO John Mack who joined its board in early April and is most likely acting as a rainmaker.

Institutional assets presently stand at $170 Million, constituting 40% of loans, whereas Prosper reports $40 Million, comprising half of its outstanding loans.

Tiny in comparison to major lending institutions, both companies nevertheless have an enviable growth rate, with Lending Club doubling its 2011 loan volume from 2010, and Prosper purportedly having a 178% growth rate year over year.

Institutional interest seems to point to recognition that this lending platform is viable, and individual investors are still more than welcome. However, P2P needs to be considered a long term investment for investors in general, individuals in particular, as liquidity is limited, and should only be complimentary to a well balanced portfolio, with possibly no more than 4% to 8% of assets recommended.

Lending Club has a limit of $35,000 for as long as five years, and Prosper places a cap of $25,000 for the same duration, although commitments as low as $25 are permitted to participate in any loan. Of course, with high yields come higher risks; however, Prosper contends that investors spreading their funds in at least 100 loans have not lost money.

Borrowers are vetted as to credit worthiness, and borrowers who are rated A or B by Lending Club or AA and A by Prosper will generally have FICO scores of 720 or better.

Although some borrowers use their funds to repay high interest loans, such as credit cards, P2P has become a boon to startup businesses looking for seed funding, which may be another angle that institutional investors are looking for besides the attendant higher yields.

For small individual investors with some spare funds, this type of lending can offer a truly well diversified loan portfolio with little risk, as long as they remain on the conservative side and only invest in the highest rated loans.

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