Peer to Peer Lending – Wells Fargo Forbids Its Employees From Making Personal Loans

Peer lending or P2P lending at its often call was conceived to directly connect borrowers with individual lenders, bypassing banks. But the peer lending sector has rapidly evolved as institutions such as hedge funds and other large investment companies went to great lengths to get their hands on the best loans—to the extent that now, more than 60% of the industry’s loans are purchased by institutions. Perhaps this is the reason that Wells Fargo is forbidding its employees from lending their own money on P2P websites; maybe Wells Fargo doesn’t want their employees competing with them! So much for peer lending as a cottage industry.

If you want to learn more about the P2P industry and start offering loans to other individuals and small businesses yourself, you still can. However, I would strongly suggest that you limit these loans to a small percentage of your investing portfolio. The two biggest players in this industry are Prosper and Lending Club.

There’s been considerable interest in these types of loans, here’s excerpts from a few mainstream media sources:

From the Economist:

Savers have never had a worse deal but for most borrowers, credit is scarce and costly. That seeming paradox attracts new businesses free of the bad balance sheets, high costs and dreadful reputations which burden most conventional banks.

Foremost among the newcomers are peer-to-peer (P2P) lending platforms, which match borrowers and lenders directly, usually via online auctions. The loans issued often comprise many tiny slivers from different lenders. Some P2P platforms slice, dice and package the loans; others allow lenders to pick them. Either way, the result is a strikingly better deal for both sides. Zopa, a British P2P platform, offers 4.9% to lenders (most bank accounts pay nothing) and typically charges 5.6% on a personal loan (which is competitive with the rates most banks charge).

Elsewhere, returns (and risks) are higher. IsePankur, which lends to more than 60,000 people in four euro-zone countries, pays its lenders (who include your correspondent) a stonking 21.45% average net return (after a 3% default rate). Its typical borrowers do not flinch at rates of up to 28%: they are refinancing far costlier credit-card debt and doorstep loans.

Peer-to-peer lending is growing fast in many countries. In Britain, loan volumes are doubling every six months. They have just passed the £1 billion mark ($1.7 billion), though this is tiny against the country’s £1.2 trillion in retail deposits. In America, the two largest P2P lenders, Lending Club and Prosper, have 98% of the market. They issued $2.4 billion in loans in 2013, up from $871m in 2012. The minnows are doing even better, though they are growing from a much lower base.

Neil Bindoff of PwC, a professional-services firm, speaks of a “perfect storm” supporting P2P’s growth. Interest rates are close to zero, the public is fed up with banks, costs are low (one third of a typical bank’s, according to Renaud Laplanche of Lending Club), and e-commerce is becoming part of daily life. People use the internet for peer-to-peer telephony (Skype) and shopping (eBay), so why not loans?

Awareness is still low—a survey by pwc found only 15% of Britons claimed to have heard of the big P2P firms such as Zopa, Funding Circle and RateSetter; 98% had heard of the main banks. Another hurdle in Britain is that P2P is not fully regulated; that will change on April 1st. The Financial Conduct Authority will issue the new rules imminently. In America, people saving for retirement can apply tax breaks to their loans, and offset their losses against profits. Britain’s P2P industry is awaiting a decision to extend tax-free savings schemes to its lenders.

Regulation should help forestall a big worry: that an ill-run platform might collapse, taking investors’ money with it. At a conference organised by the P2P Finance Association, a trade body, this week, executives were worried about the risks of a “Bitcoin-style bust” that could rattle confidence in the nascent industry. New rules are likely to insist that P2P businesses ringfence unlent funds gathered from savers and arrange for third parties to manage outstanding loans if they cease trading.

Other big questions abound. One is insurance. Funds placed with P2P lenders are not covered by the state-backed guarantees that protect retail deposits in banks. Some platforms offer something of a substitute. Zopa and most other British companies have started “provision funds”, which aim (but do not promise) to make good on loans that sour. These smooth the risk for lenders, but blunt the original P2P concept. So too does insurance: Ron Suber of Prosper, America’s second-biggest lender, says “deep actuarial conversations” are going on with outsiders who would like to help lenders provide for the risk that their borrower defaults, dies, or loses his job. Purists fear such arrangements could recreate the moral hazard that has plagued conventional banking.lender_336x280

The boom in cross-border P2P raises tricky legal questions. The European Commission has yet to get to grips with the industry. National rules often determine how credit is issued and debts are collected. But they offer little help when the money comes from hundreds of lenders in dozens of countries. Yield-chasing foreigners, private and institutional, are investing heavily in the American market.

Only a third of the money coming to Lending Club is now from retail investors: the rest (the fastest-growing slice) comes from rich people and institutions. Should such big investors get a better deal—such as getting their pick of the best loans on offer? In Britain, Giles Andrews of Zopa regards the idea as anathema: all savers should be treated equally. Some others think big lenders will eventually dominate P2P.

P2P also ends the dangerous mismatch between short-term deposits and long-term loans inherent in conventional banking—but generally by locking lenders in for the loan’s duration. A secondary market in P2P loans is developing fast. This allows investors to get their money back if they need it, usually by selling the loans at a discount. But rules vary: some platforms will buy back the loans; others just hold an auction.

P2P is not complicated: success largely depends on marketing oomph, the quality of the algorithms used to screen borrowers and ease of use (P2P platforms are scrambling to develop apps for smartphones and tablets). P2P may attract big outsiders, such as banks, or internet companies which already have lots of data about their customers and (like Facebook) are good at connecting them. Google last year led a $125m investment in Lending Club, valuing it at $1.55 billion. It might well want more.

From CNBC:

Wells Fargo Bank is prohibiting its employees from using their own money to offer peer to peer loans:

From the Wall St Journal:

Instead of taking more-traditional paths—such as borrowing money from a bank or other financial-services company—an increasing number of consumers are looking to their fellow consumers for loans via peer-to-peer websites.

The two biggest U.S. peer-to-peer lending sites say they originated $2.4 billion in new loans last year, up from $870 million in 2012.

“The peer-to-peer model offers some great new options for consumers,” says Linda Sherry, director of national priorities for Consumer Action, a consumer education and advocacy nonprofit in San Francisco.

Indeed, by cutting out the middleman, consumers can save money and secure better rates.

But dealing directly with strangers also carries its own risks. Here’s a look at how some peer-to-peer models work, what the potential advantages are, and what borrowers and lenders need to be aware of.

The two main peer-to-peer lending sites are LendingClub.com and Prosper.com. These sites are the two biggest in terms of loan volumes. There are other online lending options, such as SoFi.com, for example, which specializes in student loans from alumni, and LoanBack.com, which lets users create legally binding loan agreements to lend to friends or family. At Kiva.org, you can lend money to needy entrepreneurs in developing countries. Lending Club and Prosper.com, however, basically bring together people with money and people who need it.

Both sites look at potential borrowers’ credit histories and other factors and assign them risk scores, which are then used to decide the interest rate of the loan. On Prosper.com, someone with the best rating, AA, recently could get a three-year unsecured loan with an annual percentage rate as low as 6.73%. A lower-rated borrower could pay more than 20%.

After borrowers get a rating, they create a listing on the site explaining why they need the loan and detailing their financial situation. Potential investors browse and choose which loans to invest in. When a loan is completely funded, the funds are transferred to the borrower’s bank account within a few days.

“Lower rates are the big draw for these loans,” says Curtis Arnold, founder of credit-card comparison site CardRatings.com and author of a book on peer-to-peer lending. “A lot of banks have really gotten away from making unsecured loans. Peer lending is a good alternative to credit-card debt.”

Indeed, Lending Club says that 83% of borrowers report using their loans to consolidate debt or pay off their credit cards. Other reasons include home improvement, car financing and medical expenses.

Returns for lenders can be impressive. Both sites say that historic annual returns range from around 5% for the safest loans to more than 10% for riskier loans.

A few caveats for lenders, though: The loans on both Prosper and Lending Club are at fixed rates. While this will be advantageous for borrowers if interest rates start to rise over the next few years, it poses a potential risk for investors. Right now, a 5% return looks healthy compared to the much lower rates available on safer investments like certificates of deposit and money-market funds. But five years from now, that may no longer be the case.

Check for any restrictions on peer-to-peer lending in your state of residence. Both Prosper.com and Lending Club post states’ rules on their websites. While most states allow borrowers to participate in peer-to-peer lending, the rules for investors vary. Residents of some states are not allowed to participate, while other states have minimum-income or net-worth requirements.

It’s also important to remember that the loans are unsecured and that lenders can lose money if the borrowers default. Prosper says its default rates range from 1.55% for the highest-rated borrowers to 16.7% for the lowest.

A default affects the peer-to-peer borrower’s credit score just as it would with any other loan, so borrowers have plenty of incentive to repay their debts. Loans in default are passed to an external collection agency.

Both sites, however, advise investors to diversify, investing only small amounts in each loan to minimize risk. Prosper President Aaron Vermut recommends lending small amounts to many borrowers, “100 or more,” he says. Any less, he says, and “you really could have unpredictable returns.”

CardRatings’ Mr. Arnold recommends that people invest only a small proportion of their savings in peer-to-peer lending, and that they choose the loans carefully.

There is quite a “learning curve” with these sites, Mr. Arnold says. “Basically you’re becoming a loan officer. That’s an exciting thing, but it can be a little scary, too.”

From The Motley Fool

Peer-to-peer lenders, Prosper and Lending Club, are building a new marketplace for borrowers and investors. In this segment of The Motley Fool’s financials-focused show, Where the Money Is, banking analysts Matt Koppenheffer and David Hanson discuss the pros and cons of investing in peer-to-peer loans, the costs associated with it, and what it would take for them to put their money behind the concept.

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