I Warned You About “P2P Lending”… and I Was Right

I’m following “Disruptors” because I think they’re going to be a huge nexus of wealth creation (and destruction) in the coming years.

They’re causing monumental shifts in everything and changing our lives. In the markets, these Disruptors send huge capital caves into new paradigm businesses… and push big capital waves out of adversely disrupted businesses.

Marketplace lending, or P2P lending, is a perfect example of a Disruptor business.

I’ve written before about the issues marketplace lenders were going to have and how you’d be better off borrowing from a marketplace lending site than investing in any of them.

[ad#Google Adsense 336×280-IA]I don’t want to say “I told you so,” but I’m being proved right yet again.

Things aren’t getting better for investors in what used to be called “peer-to-peer” lending.

So, if you want to get an online loan, go for it – but don’t waste your money betting on any of the sites being a home-run investment.

For now, you should keep your capital away from marketplace lenders.

Here’s why…

P2P Lenders Aren’t Actually Independent

p2pFirst of all, peer-to-peer lenders aren’t banks.

They’re Disruptors precisely because they aren’t banks, but act like banks.

But just because marketplace lenders aren’t banks doesn’t mean they’re immune from banking regulations. That’s because marketplace lenders have bank “partners.”

The disruptive side of P2P lenders is upfront. It’s in where borrowers go, which is online. It’s in how borrower’s creditworthiness is profiled, which is largely based on online access to things like payment histories and social media profiles. And upfront it looks like a borrower is borrowing from an online “peer.”

That’s upfront stuff. The back end of P2P lending is still about banks.

Disruptive P2P lenders need a bank to operate. And that’s becoming a problem.

The Dark Side of “Conduit Banks”

You see, P2P lending sites don’t make loans. They are simply an online introduction conduit. They’re matching rooms where borrowers and lenders “speed date.”

When a lender agrees to fund a borrower’s loan request online, the actual loan runs through a bank, usually a very small bank, more often than not located in Utah.

Why Utah? Because Utah doesn’t have state usury limits or rate caps like other state-chartered banks have.

Tiny Utah-chartered WebBank is the back-end bank of several marketplace lenders, including LendingClub Corp. (NYSE: LC) and Prosper Funding LLC, two of the largest and best-known P2P lending sites.

WebBank acts as the lending bank to the borrower, where WebBank uses the lending “peer’s” capital as collateral. If the borrower doesn’t pay, WebBank has the peer’s capital and isn’t at risk.

But conduit banks are coming under increasing scrutiny – as are lending sites themselves – with regard to cutting regulatory corners on customer information, antiterrorism, and anti-money-laundering regulations.

American-born terrorist Syed Rizwen Farook – just weeks before he and his wife, Pakistani-native Tashfeen Malik, murdered 14 people in San Bernardino, Calif. – got a $28,500 loan through Prosper.

That loan was subsequently sold to Citigroup Inc. (NYSE: C), which intended to package it into an asset-backed security to be sold to investors.

The California Department of Business Oversight is now looking into Prosper, LendingClub, and 12 other marketplace lenders doing business in California.

The U.S. Justice Department is also looking into marketplace lenders, as are state and federal bank regulators.

On top of those inquiries, the U.S. Treasury is looking into conduit banks to see if they are being used to facilitate terrorist financing or money laundering.

Regulatory pressures are taking an increasing toll on lending sites. Publicly traded LendingClub’s stock is trading near 52-week lows and will likely remain under pressure as lending businesses face more scrutiny.

Investors Who Lend Through P2P Sites Are at Risk, Too

Besides not wanting to be an investor right now in these P2P lending businesses, it’s not a good time to be a lender on the sites.

Citigroup will no doubt be scrutinized for buying the Rizwan Farook loan from Prosper, as will other big bank “lenders” who have essentially replaced what used to be “peer” lenders on most of the big marketplace sites.

And small investors who manage to lend to high-interest-paying borrowers through marketplace sites might want to take another look at how at-risk they are.

After all, they’re lending to borrowers who are mostly consolidating high-interest loans, which are likely to go higher if the U.S. Federal Reserve raises rates and as the economy muddles along amidst increasing global strains, geopolitical, and domestic uncertainties.

All in all, it’s not a good picture.

That’s why I say you’re better off taking advantage of these marketplace Disruptors by borrowing from them rather investing in them.

And you can say I told you so.

— Shah Gilani


Source: Money Morning