Person-to-Person Lending Set to Impact Credit Market

While consumer awareness of person-to-person (P2P) lending continues to grow and established consumer credit providers awaken to the marketplace’s potential, the financial services world should keep an eye on the growth of P2P lending.

P2P lending, simply put, is a loan process where one individual lends money to another individual circumventing a bank’s traditional role in the process. The Internet has provided the perfect medium for lenders and borrowers to connect.

As a business model, P2P lending has already displayed early success with United Kingdom-based Zopa commencing operations in the U.S. and establishing a San Francisco headquarters. But in this young market, with less than three years since its inception, many see the potential for significant growth. 

Even established financial service providers are beginning to look at online P2P lending in strategic terms as evidenced by the May 2007 acquisition of Massachusetts-based CircleLending by Virgin USA, the North American investment arm of UK-based Virgin. 

Such an acquisition places a clear emphasis on creating inroads to both the young adult and higher income markets. According to a recent study by Javelin Strategy & Research, consumers aged 25-34 and consumers with incomes above $150,000 are more willing to offer or accept P2P loans than other groups.

A recent report by Celent used loan origination as its key measure to size the P2P market during 2006 at $300 million. While this is just a fraction of the $1.2 trillion consumer credit market, online P2P lending is still in its infancy, reports Celent, a consulting firm that covers information technology and the global financial services industry.

Recent reports show the P2P market growing to $5 billion by 2010, an increase of more than 1000 percent in a four year period. As impressive as these numbers are, some reports show even greater growth.

The obvious beneficiaries of such growth are the market participants themselves, most notably P2P lending network Prosper Marketplace which stands out for several reasons. 

As the largest P2P lending network – current membership is counted at about 490,000 – Prosper has the size to generate sufficient loan origination even at this early stage of the game.  Prosper has already moved forward with creating a secondary market, a system enabling lenders to resell loans originated through its network.  This will have the effect of attracting to Prosper not only lenders looking to make a connection with individual borrowers, but more sophisticated investors seeking to make trading profits.  Prosper currently stands alone in developing a secondary market, but may stand as an indicator of future market-wide initiatives.

Prosper already employs a process-driven, and very public (the process is spelled out on its web site for potential borrowers), system to handle loans that fall behind in payments. All loans are repaid by direct bank account draft. On the day payment is due Prosper attempts to withdraw payment from the debtor’s account. If unsuccessful, the collection process begins.

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In the first 30 days after a missed payment, Prosper handles the collection internally, contacting the debtor up to three times. After 30 days, a late fee is charged and the case is referred to one of its first-party collection agencies: Southampton, Pa.-based Penncro Associates or Mumbai, India-based Firstsource. After four months in collection, Prosper sells the loans to debt purchasers. In August 2007, the company sold a pool of 309 loans, the most recent sale it has made public.

Such an expedited process in the handling of delinquent accounts may signal that the P2P lending industry has yet to develop effective management of bad debt or that the receivables management is neglected as a non-priority.  In either case, ample opportunities for participation exist.

As P2P lending grows, firms like Prosper will increasingly turn to first party service providers and debt purchasers to reduce the negative impact of loan defaults felt by their community of lenders.  Such developments should be watched carefully by the ARM industry.

A further stimulus for continued growth in the online P2P lending marketplace could be found in the U.S. housing debacle currently playing out.

The aftermath of the credit crunch has forced banks to respond by raising interest rates on credit and scaling back on non-revolving consumer credit – for example auto loans – as a protective measure and to minimize exposure to the current market turmoil. While social lending marketplaces have always claimed to offer borrowers cheaper credit than they could obtain at banks, the credit crunch itself could soon stimulate a short-term increase in the growth of P2P lending.

Skeptics of the potential for P2P lending may want to look at the rapid growth and popularity of social networking sites such as MySpace and FaceBook – with 200 million and 55 million members, respectively, as of November. The acceptance of the Internet as a medium for financial transactions is inevitable as a younger generation of consumers comes of age. Additionally, online banking has already gained widespread acceptance, counting as many as 56 million users. The next major growth area appears to be loan origination, expected to reach $9 billion by 2017, according to research firm Online Banking Report.

Networks such as Prosper operate only because members are willing to lend money.  Lending inevitably comes with risk, credit risk chief amongst them – where the lender risks a borrower defaulting on borrowed funds. In this situation, the lender could potentially lose their principal, the initial investment, as well as any profit from interest payments on the loan.

The ability of online P2P lenders to maintain lender confidence will hinge on their ability to effectively manage their portfolio of bad loans much more so than with traditional banks. That presents a new opportunity for ARM firms.

Dimitri Michaud analyzes trends in strategic receivables management within the consumer finance sector, including the banking, credit card and mortgage markets.  He conducts research, writes publications and hosts a regular blog on insideARM.com for Kaulkin Media.