THINK!: Problems for new digital businesses.

Friday, 17 October 2008

Problems for new digital businesses.

If someone came to you with a business plan based on the idea of complete strangers lending and borrowing money from one another over the Internet, how would you respond?

Renaud Laplanche, the founder of Lending Club, a start-up that facilitates borrowing between members of social networks.

Internet lending sites come under stress
By Brad Stone
Thursday, October 16, 2008
SAN FRANCISCO: It was one of the most audacious ideas of the Web 2.0 boom - that people could lend money to other people over the Internet and cut out the middlemen - also known as traditional banks.
Over the past three years, Internet start-ups with names like Prosper, Lending Club, Zopa and Loanio have all pursued that goal.
Together, these companies were on pace to broker about $150 million in loans this year, a 50 percent increase from 2007, according to the Online Banking Report, a financial industry newsletter.
But this so-called peer-to-peer lending, which until recently seemed as if it might offer a reliable source of money in this calamitous economic environment, is now experiencing a squeeze of its own.
On Wednesday, the largest U.S. peer-to-peer lending site, Prosper, based in San Francisco, stopped allowing lenders to make new loans. It said it needed to wait while the Securities and Exchange Commission evaluated its regulatory filings. Monthly loan volumes at the company have been declining since the credit crisis worsened several months ago.
Prosper, which is unprofitable after raising $40 million in venture capital, now faces the damaging possibility that lenders might pull their money from the site instead of waiting for the SEC to allow lending to resume. That could take several months.
"Regulatory agencies seem to want to make sure they have all this understood before it gets too big," said Jim Bruene, editor of the Online Banking Report. "This is definitely going to slow peer-to-peer lending down."
There are other signs of trouble as well. Last week, Zopa, based in London, closed its Web site for the United States, citing "extremely difficult consumer credit circumstances." Zopa continues to maintain lending sites in Britain, Italy and Japan.
The problems in this fledgling corner of the finance world come at a particularly bad time. As traditional lenders hoard cash and shun even dependable borrowers, peer-to-peer lending sites could have offered an alternate source of credit and, in some cases, lower interest rates.
On Prosper, for example, interest rates on three-year fixed loans are set in a format resembling an auction. Borrowers publicly disclose the amount they want to borrow, their credit histories and some personal details (stories of hardship and photographs of cute pets sometimes help).
Lenders compete to offer these people cash, and Prosper collects a fee on each loan.
Prosper's founder and chief executive, Chris Larsen, speaking Monday just before the company unexpectedly entered the quiet period mandated by the SEC, said peer-to-peer lending recalls an age when borrowers and lenders knew each other personally.
"This is the big trend right now; Wall Street firms are becoming banks again and getting back to their roots," he said. "Peer-to-peer lending is the simplest form of pure banking there is."
But Prosper and its cohorts are encountering some very modern hurdles. Last April, Lending Club, a start-up based in Sunnyvale, California, that facilitates borrowing between members of social networks like Facebook, asked the SEC for permission to create a secondary marketplace - a place on its site where lenders could resell their loans and cash out before the end of a loan's three-year life cycle.
According to Renaud Laplanche, the founder and chief executive of Lending Club, the SEC surprised the company by asking whether it should have registered as a seller of securities before it started to broker loans. In response to those discussions, Lending Club stopped all new lending on its site for six months, frustrating its lenders, many of whom withdrew their cash.
"If we had a clean situation to start with, we probably could have registered the new offering while our current marketplace continued on," Laplanche said. On Tuesday, the SEC accredited Lending Club, and the site reopened.
On Monday, Larsen said he did not believe Prosper would need to follow the same arduous route, pointing out that Lending Club set the interest rates on its loans and was itself financing about half the overall loan volume on the site.
But on Tuesday, Prosper changed its mind and also filed to create a secondary marketplace, halting activity on Prosper.com. The company would not comment, citing the quiet period, but the painful step suggests that it, too, decided it needed to obtain proper registration from the SEC and avoid any legal ambiguity that could get it into regulatory trouble.
Even before lending on Prosper was halted, the much-hyped start-up appeared to be encountering some problems. Though the company says 7.9 percent more money has been lent on the site this year than last year by this time, the monthly total actually peaked in May and has been steadily declining ever since. The average loan amount on Prosper has also fallen 13 percent from last year, as lenders have become nervous about whether borrowers will repay loans.
Francis Vasquez, a 44-year-old lawyer in Vienna, Virginia, who has lent more than $186,000 on the site since January 2007, says one reason for those jitters is the high default rates on the site.
In his first four months on the site last year, for example, Vasquez said nearly 30 percent of his loans were in default or were four months late, costing him a 1.2 percent loss on his investment.
"I don't think there is a whole lot of trust on the site," he said, citing borrowers who never had any intention of paying back loans in the first place.
Many lenders, including Vasquez, have responded by seeking out more reliable kinds of borrowers in the top credit-score categories.
Indeed, prime borrowers accounted for 45 percent of the activity on the site in September, up from 30 percent a year earlier. But those borrowers, at least in normal economic times, have plenty of other places to raise cash.