Lending Club – Pioneering P2P Lending

Lending Club is the world’s largest online marketplace for connecting borrowers and investors. Through its innovative online platform, the company is able to pass on a portion of its savings to investors and borrowers because of its substantially reduced need for physical infrastructure, which is typical to most financial institutions. The company has issued $11bn in loans since inception.

As the first company in the peer-to-peer lending industry to go public, Lending Club has the inherent advantage of being the most capitalized by far, having raised over $1bn in its public offering in 2014. This enables the company to further execute its strategic growth initiatives and pursue acquisition opportunities as they arise through its first-to-market advantage.

Borrowers benefit from the reduced cost and complexity of seeking a traditional bank loan. Investors benefit by gaining transparent access to a diversified range of lending opportunities offered at above-average rates of return. Lending Club benefits as a middle man earning fees on successful loan originations.

Value creation

  • Greater financing access to SMEs
  • Lower borrowing costs for consumers
  • Better returns for investors
  • Gives investors access to a new asset class (consumer credit and small business credit)

Benefits to borrowers: easy online application, low fixed rates, flexible terms, no hidden fees

Benefits to investors: better returns compared to traditional deposits, easy to diversify across many loans, simple and straightforward

Value capture: Contribution margin from loans originated

Network effects

1. Data, track record and trust

  • Lowers risk premium
  • Expand investor base
  • Lower interest rates

2. Benefits of lower interest rates

  • Expand borrower base
  • Lower acquisition cost
  • Positive selection
  • Reinforce track record

“A key driver of our network effect comes from the amount of data we have been collecting over the last 8 years and our track record of delivering consistent returns, which we believe increases investor confidence and lowers the risk premiums required by investors. This enables our platform to deliver lower interest rates to borrowers, which drives positive selection, increases loan performance and further reinforces our track record.As a result, the risk premium on the Lending Club platform, as measured by the spread over 3-year treasuries, came down by 270 bps over the last 3 years. ” – Q2 2015 Earnings Conference Call

The disruption of an online marketplace for lending is giving rise to tensions between large banks and peer-to-peer platforms, because the P2P model cuts traditional lenders out by matching capital directly with borrowers.

Given that it doesn’t need to comply with reserve requirements, branch infrastructure of traditional lenders, the operating expense of Lending Club is ~2%, compared to traditional lenders’ operating expense of 5-7%.

Traditional banks excel at originating loans and underwriting credit, but are slowed by the batch process and portfolio approach to their deposit and loan legacy systems. By far the biggest advantage for marketplace lenders has been the lack of capital and liquidity requirements relative to the incumbents.

For marketplace lenders, the regulatory environment remains a questions mark, as financial rule-makers play catch-up with the latest technology. Another wildcard is how this model would fare in an economic downturn.

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Student comments on Lending Club – Pioneering P2P Lending

  1. Hey Christine – great post. I’m curious the extent to which network effects are actually at play with Lending Club. Is there data that more users help others make better investing decisions? Do more users make costs lower and therefore everyone benefits?

    1. Agreed with Jon. It is clear that network effects are in play in the relationship between borrowers and lenders – i.e. borrows are better off as new lenders are added to the platform – but less clear between the addition of borrowers with new borrowers. In fact, I could see diminishing value in adding additional borrowers for a few reasons: 1) I, as a borrower, need to compete for the attention and funding of limited lenders; 2) the proliferation of too many users (potentially SMEs turned away from other traditional financing) could undermine the lending quality that exists on the platform, in turn dissuading lenders from coming to P2P lending platforms.

  2. Interesting post, Christine. It’s interesting to see how they leveraged the data to better understand and to diversify risk (bringing down the risk premium significantly). I imagine that there are diminishing returns on the amount of data and there’s probably a limit to how low they can drive the risk premium. The question is how quickly does the return on data diminishes as this will determine the barriers to entry. In other words, if only a limited amount of data is required to diversify most of the risk, then other players can enter and compete with them, but, if the marginal data are still relatively important even when a lot of data have already been gathered then Lending Club’s first mover advantage is significant and the network effects are strong.

  3. You should read my take on the Lending Club as well!

    I think the peer-to-peer lending platforms could be a potential way of the future for banking, where people no longer need large infrastructure to access capital, and other collaborators, such as financial advisers, could come into the platform and add more value to the job.

    I wonder if the traditional banks see the threat of a peer-to-peer lending platform as substantial, and how would they respond to it.

    1. Agree that banks will have a difficult time competing against these modern lending institutions.. Nonetheless, I think the peer to peer lending model could be improved with new models such as the one used by Vouch

  4. I think fintech and other ways to connect SMBs with lenders will be a huge way of the future as it serves to fix the unmet need between microfinance and business loans. As a former banker, I can attest that the processing and strict requirements of adherence (both by the government and for internal purposes) lead to heavy overhead costs. Additionally, in order to make money back off of a bad loan, you need lots of scale. Therefore, it is important to be “right” ~97% of the time when making a loan. In the SMB market, you typically have SBA loans, personal credit cards, small term loans tied to fixed assets or perhaps a very small revolver BUT you must be willing to sign personal guarantees and follow strict covenants. Firms like Lending Club, Upstart and Nerd Wallet are the intermediary to allow everyday citizens and investors an alternative investment vehicle while helping regular SMBs. Banks are not likely competition as it is economically unprofitable to do so when they can make much more off of mortgages, large corporate loans, real estate loans, investment offerings as well as large scale retail banking.

    The item that will differentiate the winners from the losers in this space, and particularly for Lending Club, is how they utilize the data to attract even more users and offer the right products to the right people. While there are inherent indirect network effects, the tipping point of the market is likely a far ways off (if it occurs at all). The repeat use of borrowed funds and refinancing does not occur as often as one takes an uber or perhaps an AirBnb. Rather it occurs every 2-3 years at best. Can’t wait to see how all of these companies shake out, but I hope they continue to do well as the market desperately needs them.

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