Last month we discussed the Lending Club debacle, and what it means for p2p investors. Thanks to all of you who read it and commented directly to me, or contributed to the Lend Academy Fourm, or added your contributions via Twitter and elsewhere in the media. We really appreciate your feedback, your support and your compliments! In case you missed it, check out May's newsletter here. For the Cliffs Notes version, the takeaway is this: none of the alleged transgressions contradict the basic tenets of the Lending Club model.
Well, with that in mind, let's get back to our regular business of educating you, our clients and friends, about peer-to-peer lending. It's our favorite subject after all! This month, we dig a little deeper and debunk Myth #1, that p2p lending only attracts low-quality borrowers. You'll love Summer's video on defaults (click above), coupled with our brief analysis below. Enjoy!
Myth 1: P2P only attracts low-quality borrowers
The history: Where does this legend come from?
It’s hard to say for sure but I assume it’s a combination of the following: First, p2p loans offer attractive fixed income yields that have historically generated 6% to 9% annual returns. With these returns, some investors deem p2p loans too good to be true. There must be hidden risks here... these borrowers must be desperate, low-quality types, right?! (Wrong!)
Second, up until 2007, if a borrower in the U.S. needed access to an unsecured personal loan, they went to a bank and took out a traditional loan. No one questioned the process and it was assumed to be the only reasonable method to obtain a loan. So why would a high quality borrower leave the comfort of a traditional funding source for p2p? (More convenient! Lower cost! Better terms!)
Third, usury limits. If a bank won't approve a borrower, why would an online lender? Doesn’t that make online lenders either usurious or too risky, or both? (Nope.)
The facts: Give it to me straight!
Historically, P2P loan originators have matched the underwriting quality of traditional banks. They use sophisticated underwriting, operating, and technological models to originate high-quality loans with acceptable risks of default. On top of this underwriting, investors may choose to use a third party fiduciary -- such as NSR Invest, perhaps? -- to provide an additional layer of scrutiny and portfolio management.
Look, it's simple. Borrowers can generally obtain lower interest rates, better terms and faster, more efficient access to capital by going online for their personal borrowing needs. For a borrower looking to consolidate debt, on average they can access credit that is 35% less expensive than traditional banks or credit cards offer, according to Lending Club statistics.
To better understand usury rates, let's look at the state of New York as an example. It is generally unlawful for a New York State-chartered bank to lend to a borrower at any rate above 16%. Maybe a borrower deserves a loan, but only at 17%. In other words, they're riskier than a 16% borrower, but just a tad. Well, if they are dealing with a New York chartered bank, they simply could not obtain a loan, because the state usury laws would prohibit the bank from proving the borrower a loan that was fairly priced above the usury limit. These borrowers are not necessarily bad borrowers, they just qualify for loans above the state's usury limit. In this example, the borrower would have zero access to capital from the NY-state chartered bank, and access to 17% cost-of-capital from an online lender. Meanwhile, their credit cards may be burning them alive at 29% APR.
The conclusion: You guessed it!
P2p is an attractive alternative for both borrowers and investors. Borrowers have access to better rates, better terms, and faster capital. Investors are offered an appealing fixed income alternative for their portfolios that has historically provided a higher yield and lower volatility than traditional fixed income investments. This is primarily due to the fact that online originators like Lending Club and Prosper operate more efficiently than banks.
Now, check out the following minimum standards outlined in financial disclosure documents for Prosper and Lending Club.
A minimum credit score range of 640 to 660
A debt-to-income ratio below 40% to 50%
Fewer than seven credit bureau inquiries within the last six months
Two current revolving accounts and at least three open trades reported on credit report
No bankruptcy filing within the last 12 months
A minimum credit history of 36 months
Given these lending criteria -- and the fact that the average investor is actually much more creditworthy than the minimum -- investors clearly have the ability to choose from a wide range of high-quality borrowers.
Conclusion: this myth has been DEBUNKED.
As always, I would be elated to hear from you personally. Call me directly at 720-259-0472 or send me an email at bo@nsrinvest.com.
Please feel free to forward this letter to your trusted friends. We are open to new investors, and welcome those conversations.
