There was a time, not that long ago, when the only individuals you could make business loans to were friends, family members and smooth-talking strangers you met on the street. The circles were small, the qualifications smaller and the returns uneven.

Enter peer-to-peer lending, which opened up a market of millions of borrowers to an army of lenders with too much cash on hand and too few avenues for placing it. A few years in, LendingClub Corp. (LC), LendingTree Inc. (TREE), parent of Lending Tree, and privately held Prosper have now emerged as the largest and best recognized players in an industry predicated on determining which borrowers offer the best possibility of return, without going to the trouble of securing the loans. (For more, see: Can't Get a Bank Loan? Turn to Your Neighbor).

Lending Tree

Lending Tree, which was bought by IAC/InterActiveCorp (IACI) — the parent company of Investopedia — in 2003 and spun off five years later, is more of a streamlined marketplace than a pure peer-to-peer lending service. In the late 1990s the company began taking the tedious procedure of applying for financing — mortgages, car loans, what have you — and inverting it. It’s inefficient for a potential borrower to go to US Bancorp (USB), Wells Fargo & Co. (WFC) and multiple neighborhood community banks, filling out application after application. Instead, why not apply once and have the lenders come to the borrower? The result is that borrowers enjoyed monopsony — power they’d never had the capacity to flex before. Sure, a single borrower who wants $80,000 for a modest townhome loan isn’t going to set the industry on its head. But having an organized market of borrowers forced lenders to compete and as a result did at least as much to lower interest rates as any dictum from the Federal Reserve. (For more, see: IAC/InterActive Spinoff's One-Year Review).

Despite being around for more than seven years, Lending Tree still has the financial data of a startup. The parent company made $4 million on sales of $139 million in the last fiscal year and even that comes with an asterisk. Most of the profits over the last biennium have come from the sale of the company’s loans business and are filed under discontinued operations.

Lending Club

The similarly named Lending Club invites ordinary people on board as lenders as well as borrowers. Founded in 2007, Lending Club maintains it “offers credit worthy borrowers lower interest rates and investors better returns,” styling itself as an “alternative to the traditional banking system.” (For more, see: Lending Clubs: Better than Banks?).

The company’s board of directors includes the former CEO of Morgan Stanley (MS), the former president of Visa Inc. (V) and a former U.S. Secretary of the Treasury, among other alumni from said traditional banking system. Lending Club went public in December of 2014. To date the company has funded over $6.2 billion in loans and has paid out $600 million in interest. That may appear to be a 9.7% rate of return on the surface, but keep in mind that it’s calculated by totaling loans of various terms over the company’s entire existence. The vast majority of Lending Club’s borrowing clientele use the funds to refinance loans and pay off credit cards, thus in large measure representing the perpetually insolvent populace who make lenders rich. (For more, see: Investing in (and With) Lending Club).

On the other end, Lending Club takes 1% of what borrowers earn and charges investors a percentage of each dollar recovered from delinquent loans successfully taken to collection. Lending Club charges borrowers anywhere from 6.03% to 26.06%, depending on credit worthiness. As a result the company attempts to eliminate all sorts of middlemen, from commercial banks to storefront payday loan places.

Prosper

As for Prosper, which boasts $2 billion in loans delivered to a quarter-million borrowers, its rates are higher than Lending Tree’s across the board, ranging from 6.73% to 35.36%. Prosper also advertises a qualified 8.89% rate of return for lenders, creating a spread that’s theoretically enough to turn a comfortable profit on its personal loans of up to $35,000. However, Prosper charges a 1% servicing fee to lenders, calculated annually. The company originally handed out money to anyone with a heartbeat, resulting in a 22% default rate. In 2008 Prosper started being more stringent with its borrowers and defaults predictably dropped.

Disrupting the Industry?

Do you need further convincing that tiny peer-to-peer lending players are disrupting a financial industry that, paradoxically, seems to be consolidating into ever fewer hands? How about this: in January 2014, America’s largest bank by market capitalization forbade its employees from lending their own money via peer-to-peer services. (For more, see: Peer-to-Peer Lending Breaks Down Financial Borders).

The official word from corporate was that “for-profit peer-to-peer lending is a competitive activity that poses a conflict of interest.” This came from Wells Fargo, a bank worth $289 billion, or about 190 times what the market values Lending Club. At the very least, no one can accuse the legacy banks of taking this upstart form of competition lightly.

The Bottom Line

Peer-to-peer lending platforms, such as Lending Tree, Lending Club and Prosper, have gained steam by offering borrowers options beyond the traditional banking system, more leverage and, often, better rates. (For more, see: Peer-to-Peer Lending: Determining the Future of Banking Around the World).

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