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State Securities Regulators are Clueless About P2P Lending

by Peter Renton on December 22, 2010

It seems that regulators in Pennsylvania have had some misgivings about p2p lending. So, the PA Securities Commission issued this “warning” last week. A couple of other states followed up with similar warnings and the National American Securities Adminmistartors Association (NASAA) issued a warning as well that was picked up by Investment News yesterday.

Why? Because they want investors and borrowers to be “mindful of the risks of peer to peer lending.” Let’s thank the state regulators for stating the obvious. Investing money is inherently risky, and new investment vehicles such as p2p lending should be thoroughly researched before investing. Of course, p2p lending has risk, just like investing in anything other than US treasuries or FDIC insured deposits has risk. In fact, there is even risk with those investments because inflation may eat into your returns – but presumably you will never have any principal loss.

My question is this. Where were these state regulators in 2008 when the stock market was tanking? Did they issue a warning that stock market investing contains a high level of risk. How about during the housing bubble, did they warn real estate investors that investing in real estate contains risks? Let’s not even mention Bernie Madoff, Allen Stanford or Sean Mueller. Investing involves risk. And I concede that it is important for regulators to protect consumers from companies making misleading claims that can’t be substantiated. But P2P lending has always been transparent. All the information about the loan history of these two companies is available with third party tools and on their respective websites.

Investing is Not Just About Risk

When investing money, it is important to understand the risks involved. Every investor should do their homework and understand the potential downside for any investment. But more importantly they should understand the potential rewards. Then ascertain whether this risk/reward equation is worthwhile. Sure, you can put your entire nest egg into Apple stock (and pray that Steve Jobs stays healthy), but you will be exposing yourself to a great deal of risk and a potential large loss of capital.

Why  I Love Peer to Peer Lending

With peer to peer lending you can realistically get returns of 8-10% on your money. I even know of an investor getting north of 15% returns – he shares his story here. Now, the biggest risk with p2p lending is borrower defaults which is why I recommend investors diversify into as many different loans as possible. You can do this in one of two ways. Manually comb through all the loans on offer and make your own decisions about whom to invest in, or you can use one of the automated tools provided by both Lending Club and Prosper. These tools will automatically diversify your investment into as many loans as possible.

I continue to believe that peer to peer lending is the best risk/reward investment available today which is why I am an investor with both Lending Club and Prosper. I have done my due diligence and I am aware of the risks involved and I believe that I am being well compensated for taking these risks.

I think it is irresponsible of these securities regulators to just come out with a vague 500-word warning and offer p2p investors no real guidance other than “investors should proceed with caution.” P2P lending is a new industry and as such challenges the status quo. While it is always important to invest with caution I believe investors can take these vague warnings with a grain of salt.

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Lewis Zwick December 23, 2010 at 10:07 am

Within the P2P program who does the due diligence, underwriting and servicing for these loans? Does the investor provide the loan money directly to the borrower or is buying a security based on the note?

peter December 23, 2010 at 12:17 pm

Good questions Lewis. My understanding is the due diligence, underwriting and servicing of these loans are done by Lending Club and Prosper. Because these institutions are not banks, the origination is done by WebBank, a Utah industrial loan company. WebBank immediately assigns the loans to Lending Club and Prosper.

The investor does not provide money directly to the borrower, the money must be sent to Lending Club or Prosper. Then investor is then buying portions of these unsecured notes and then receive their pro-rated portions of principal and interest from these notes.

If you want to get all the technical details you can read the Lending Club Form S-1 filed with the SEC here and Prosper’s form S-1 here.

Dan B December 25, 2010 at 11:44 pm

Did you guys read the Inv. News report?? I found this part very interesting & I quote ” Lending Club claims that its investment notes have thrown off a 6.9% net annualized return as of Dec. 15″.

6.9%?? Is this a typo, or is LC finally providing numbers that have some resemblance to reality?

peter December 27, 2010 at 10:31 am

Dan, My guess is that the 6.9% is a typo – I have never seen a number like that claimed by Lending Club. My guess is that it should have been 9.6%.
FYI, I am going to be doing a post next week about claimed versus actual returns, because as you have pointed out before there is a definite difference.

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