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Lots Of Loans, But No Banks


When Lyna Lam's family landed in San Jose, Calif., in 1983 after fleeing Vietnam, they soon learned what it means to rely on a community for money. Times were tough, with seven people in a studio apartment. "My parents were on welfare a long time," she says. But the Lams tapped into their local hoi, a cooperative of Vietnamese neighbors who pooled money to lend one another. Lam's father first used hoi to buy a used Oldsmobile. Then he borrowed from it to launch a landscaping business that took the family out of poverty.

Today the Net is taking the logic of Asian microlending co-ops global. One of the Web's most intriguing trends is the rise of peer-to-peer lending communities such as London-based Zopa Ltd. and San Francisco's Prosper Marketplace Inc. Fifteen-month-old Zopa (www.zopa.com) has attracted 75,000 members. But the most buzz surrounds Prosper, the four-month-old site (www.prosper.com) whose undisclosed number of members have made about 1,500 loans for over $7 million. Backed by eBay Inc. (EBAY) founder Pierre Omidyar and the venture capital firm that funded eBay, Prosper has spawned a raft of microbusinesses that recall the eBay economy. Prosper founder Chris Larsen is the former CEO of Web mortgage pioneer E-Loan Inc. His wife? Lyna Lam. "He was fascinated by how we work together and come through for each other—and that's how he started Prosper," Lam says.

"WHAT DO WE NEED A BANK FOR?"

At first blush, the idea of making loans to complete strangers seems crazy. But it turns out that online communities can do a lot of what banks and payday loan companies do—and cheaper. In Prosper's market, loan rates are set by auction. Borrowers post an application, and prospective lenders bid on the interest rate, aided by basic analysis tools provided by Prosper such as simplified credit scores. Prosper rates borrowers from AA (top credit) to HR (high risk). Many lenders do extra research; some contact prospects by phone.

Analysts say peer-to-peer lending could become a big deal. Americans make 6.1 million friends-and-family loans, for more than $89 billion each year, says Asheesh Advani, CEO of CircleLending, a Waltham (Mass.) startup that provides billing services for friends-and-family loans. Forrester Research Inc. (FORR) lumps peer-to-peer lending with "social computing" phenomena such as blogging, podcasting, and wikis that are shaking up industries. The opportunity lies in consumers' mistrust of financial institutions: In Forrester studies, most people believe their banks put their own interests ahead of consumers', and a majority don't think their financial institutions have strong ethics. Their attitude, says Forrester analyst Catherine Graeber: "If we can get this done cheaper between ourselves, what do we need a bank for?"

That said, Prosper and Zopa probably won't have an eBay-like upside. EBay created the first national market for stuff people used to move at garage sales and craft fairs. But capital markets are dominated by big companies that sell a smorgasbord of credit cards, mortgages, and other products to people with virtually any credit profile—and rates finely calibrated to borrowers' credit scores and other data. Fact is, no one knows if borrowers will reliably repay loans from relative strangers. CircleLending says 14% of person-to-person loans go unpaid in the non-Internet world. Zopa says its default rates are a tiny 0.05%; Prosper hasn't broken out default rates.

Then again, peer-to-peer lending isn't a risk that can't be managed. The key is diversification. Loans are typically divided among lenders; a $5,000 loan might be funded by 100 people. Payments are sent directly to Prosper or Zopa, which distribute the money to lenders and report deadbeats to credit agencies or collection firms. Lenders can simply ignore high-risk borrowers; only 2% of Prosper applications from poor-credit customers have been funded, according to SavageNumber.com, an Atlanta Web site that tracks Prosper data. Formal arrangements seem to make people responsible about repayment even without a bank involved. Advani says delinquencies fall to 5% when friends-and-family loans use his firm's billing service.

The result: Loans are cheaper, while lenders can earn more than from other investments. Last month Doug Sophia borrowed $12,500 on Prosper to buy equipment for his new pizzeria in North Myrtle Beach, S.C., at 11.75%; his local finance company wanted 26%. Meanwhile, Frisco (Tex.) lender Dave Elliott, CEO of a small software company by day, says he expects a 13% return on 97 loans. "There aren't many investments that will get you more than 12% without much management," he says. Zopa CEO Richard Duvall says the average Zopa lender makes 7% to 10% after bad debt is written off, twice what top British savings accounts pay.

THE SHAME FACTOR

One draw is the sense of community that online peer-to-peer lending shares with Asian co-ops, though there are some differences. At a May dinner for Prosper lenders in New York, a half-dozen agreed on a favorite example of their quirky clique: A mother of five who wanted breast implants to undo the effects of nursing. Members were impressed enough with her—and her AA credit—to bid the interest on her loan down to 7% from 14%.

Mostly, though, borrowers and lenders are drawn by better prices. Take Sophia, who plans to open Acme Pizza in late June. When a partner backed out in May, he needed money fast. Prosper rated his credit AA, its lowest-risk category. His three-year loan, at $413 a month, was not only cheaper than finance companies offered but also felt far safer to him than starting a business with revolving credit cards. "Once that teaser rate goes away, you're looking at the same rate as the finance company," he says.

For lenders, the trick is charging enough to cover defaults and still profit. If online communities are paid as reliably as others, says Prosper, lenders must add 2% or so to rates for defaults. Small fry are springing up to help: Part-timers from Germany to Atlanta have set up sites to crunch data about Prosper market conditions.

Most of all, Larsen relies on a strategy borrowed from hoi: shame. He says people repay real-world co-ops because they fear losing face among peers. So Prosper has 1,000 organized groups set up to let members lend to one another. "If you acquire customers through a Jimmy Stewart sense of community, you'll have a better business," he insists. And if his virtual savings and loan takes off, it will be a wonderful life indeed.

By Timothy J. Mullaney


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