Peer-to-peer lending lures clients, investors

Scott Langmack has given more than $600,000 in unsecured loans to strangers.

"I can reliably get 12 percent, worst case 9 percent," said Langmack, 50, a former Microsoft marketing executive who began investing in so-called peer-to-peer lending last year. "I can't find anything that gives me this kind of confidence."

Investors loan money directly in peer-to-peer, or P2P lending, to borrowers through firms such as LendingClub.com, which packages the loans and sells them as notes, bypassing banks and credit-card issuers.

The industry may grow to more than $100 billion in annual loans in 2012 from about $500 million this year as borrowers seek ways to reduce their costs, said Ed Kountz, a consumer-payments analyst at market research firm Forrester Research in Cambridge, Mass.

Service to borrowers

P2P lending offers a way for borrowers to get access to money for home, auto and student bills as banks scale back lending during the deepest U.S. recession since World War II. The Federal Reserve's quarterly survey of senior loan officers released May 4 showed about 65 percent of banks lowered credit limits on new or existing credit-card customers, up from 45 percent in the January survey.

"It's a great opportunity for investors to compete with banks, which have largely been ripping off the public with their high rates," said Alan Lysaght, a Toronto-based author of financial advice books such as "The ABCs of Making Money."

Investors, discouraged by stock-market returns, are turning to P2P sites, said Renaud Laplanche, chief executive officer and founder of Sunnyvale, Calif.-based LendingClub.com, which started in 2007 and now has 17,000 lenders averaging $2,500 in loans.

LendingClub's loans more than doubled to $12.5 million in the second quarter from $5.3 million in the fourth quarter after the firm's registration last October with the U.S. Securities and Exchange Commission, Laplanche said. Peer-to-peer companies must register because the loans are considered securities, SEC spokesman John Nester said.

"What E*Trade did to the stockbrokerage industry, we're doing to the banking industry," said Laplanche, referring to how E*Trade Financial led to lower trading commissions. "A lot of good borrowers found themselves paying 24 percent interest on credit balances. They use our Web site to refinance those to 13 percent to 14 percent interest rates."

While P2P lending may grow, it isn't as regulated as banks, which provide deposit insurance, said Carol Kaplan, a spokeswoman for the American Bankers Association in Washington.

"Investors have to question whether they want to do business with a cottage industry," Kaplan said. "Banks are trying to control their risks by not granting credit to some people who may have a credit card, but are less than desirable borrowers."

Among the risks of P2P loans are insufficient information to determine whether borrowers will repay, said Ken Naehu, who manages more than $2 billion in fixed income at Bel Air Investment Advisors in Los Angeles.

"Dangerous place"

"If you use that as a barometer, you can get a very low-risk investment in comparison to these type of loans," Naehu said. "It's a dangerous place to be for the unsophisticated."

Langmack, who makes loans through LendingClub.com, said investors can lose their entire investment. He said he spreads the risk by lending money on about 1,400 loans. He estimated about 15 borrowers are delinquent, meaning more than 15 days late in payments, and two are in default.

"If you have a great credit rating and a solid job in a solid industry, then I like that person," said Langmack, who lives in Hillsborough, Calif. He said he also plans to invest in the Web site and declined to specify an amount.

Typical borrowers want to consolidate balances from credit cards with higher interest rates and seek a three-year loan from a minimum $1,000 to a maximum $25,000, Laplanche said.

LendingClub rates the loans based on an applicant's credit score with a minimum requirement of 713. Interest rates range from almost 7.4 percent to 20.1 percent depending on a borrower's credit history.

3% default rate

Jim Beach, 39, a Los Angeles-based technical writer who was paying as much as 19 percent on $2,000 in credit-card debt, sought to refinance at local banks.

"I wasn't getting responses from the banks for loans, not even at high rates," Beach said. At LendingClub, he said he pays 12.8 percent on a $2,000 loan funded by 45 people. "The way it's set up, it's more like a utility bill and less like I have to become stressed and possibly miss a payment," he said.

Investors earned an average annualized net return of 9.6 percent as of July 13, according to LendingClub's Web site. When delinquencies occur, the company tries to work out a new payment with the borrower or sends the loan to a bill collector. LendingClub's default rate is 3 percent, Laplanche said. Credit-card write-offs, or loans that aren't expected to be repaid, exceeded 10 percent last month, data compiled by New York-based Fitch Ratings show.

Growing market

Consumers may refinance as much as $159 billion by 2012 in credit-card debt with P2P, according to a January study by Pleasanton, Calif.-based Javelin Strategy & Research conducted for LendingClub.

Other companies specializing in P2P lending are IOUcentral.com, Zopa.com, and Loanio.com.

Prosper.com, a P2P lender based in San Francisco, said it originated $179 million in loans from 2006 until October 2008 when it shut down to register with the SEC.

A class-action lawsuit filed last November in San Francisco accused the company of selling unregistered securities that caused plaintiffs to suffer losses. Prosper.com, which said it obtained SEC registration and restarted lending July 14, plans to "vigorously" defend itself, spokeswoman Tiffany Fox said in an e-mail.