Investing Intelligently recently posted [Update: Investoid broke the news a while back] that Canadians could soon be getting our own social lending service, which would allow you to lend money to (or borrow money from) other people eliminating the middleman (read bank) from either side of the transaction. The lending service called CommunityLend will be modelled on already successful websites such as Prosper in the US and Zopa in the UK. While I understand the advantages such services provide to borrowers who are unable to get an unsecured loan for a reasonable interest rate elsewhere, I do not see the attraction of lending money to total strangers:

  1. You need to lend a lot of money to make a significant difference to your bottom line. If the interest rate spread between a savings account and a P2P loan is 3%, lending $10,000 will net you $300 per year. The extra spread you earn may not be worth the time spent in managing your loan portfolio.
  2. A P2P loan is not a savings account. By making a loan, you are agreeing to lend your money for a period of three years. Unlike a savings account, a P2P loan is not liquid and does not offer 100% principal protection.
  3. The biggest risk you face with P2P loans (which are unsecured) is default: the possibility that your loan will not be paid back either in full or in part.
  4. A P2P loan is similar to investing in mortgages because every loan payment is a mixture of principal and interest. Unlike Government of Canada bonds, you face the risk that your loans will be repaid early, either due to decreasing interest rates or improving credit history of the borrower.
  5. Since bonds are best held in a tax-deferred account such as RRSP, the location of a P2P loan in a taxable account is not ideal. You have to pay tax at your marginal rate on your interest earnings.

Prosper has been online for a while and US bloggers have been posting their experiences with the service. You might be interested in My Money Blog’s review (Part 1, Part 2, follow-up) and Tired but happy’s experience as a lender.

This article has 22 comments

  1. I always thought that a community lending business would be a neat idea. I’ve read around the blogosphere, that it’s common to get 8% returns from the borrowers with the highest credit ratings.

    I’m looking forward to Community Lend opening it’s doors so that I can test the waters. But you are right, the risk of default and high taxation doesn’t make it attractive as a serious source of cash flow.

    FT

  2. Yes, that’s what I am most afraid of – a default. I do agree that the whole process is easier without a middleman but higher is the risk. So, maybe I’ll try lending, but the borrower will be the one I know.

  3. I think it could be a great idea. There is obviously a huge risk of default. But when you think about it, you have no guarantee whatsoever that you money on the stock market will flourish either.

    CC, I was just to post a similar article about the possibility to have a “prosper.ca”. You beat me on this one ! lol.

    FB.

  4. Canadian Capitalist

    FB: You shouldn’t compare P2P loans to equities. Since they are essentially loans, they are more like bonds. I am not enthusiastic about lending money to companies (corporate bonds), so why would I be enthusiastic about lending to individuals.

  5. Actually, Carevest (and a few others) already offers that right here in Canada. You have two choices, either a syndicated mortgage where you are investing directly in some individual’s mortgage as proposed… Or the other choice is to put your money into a mortgage pool which would spread your risk. Of course, Carevest takes a cut from administering the pool, so your yield is slightly diminshed, but still generally pretty good (8% historcially).

  6. I’ve know about CommunityLend for awhile (http://investoid.com/2007/02/23/prosper-zopa-like-service-coming-to-canada/), and think it will be interesting to see how much traction they get.

    I think you may be underestimating the pre-default spreads by a fair bit. I see even AA credit people getting their loans filled at 8-10%, with B-D creditors between 13-20%. If the spreads are that high in Canada, I think there will be a real opportunity for good after-default risk-adjusted returns.

    The key will be to manage risk and come up with good risk management tools. If CommunityLend doesn’t provide them, then it will be up to the borrower or some third party to create this service. One can only hope that they will provide an API like Prosper has to look into the loan data.

    I personally look forward to working on some analytics to identify risky borrowers above and beyond their credit scores.

  7. Canadian Capitalist

    Investoid: The average interest rate for a AA loan in Prosper is 8.45%. After deducting Prosper’s fee (0.5%), you’ll be left with a pre-default spread of 8%.

    The big question is what the default rate will be. If it is close to zero, the spread over the best savings account is 8% – 5.25% = 2.75%.

  8. Default rates are available here:

    http://www.prosper.com/lend/performance.aspx

    AA has a net default of 0.02%

    I wouldn’t bother loaning to AA – there’s no risk-adjusted return available. There is when you go lower down the credit scale, but you have to put more work into your selection process.

  9. Canadian Capitalist

    Investoid: I don’t deny that you may be able to make money when the lending market is very inefficient. When it becomes mostly efficient like other capital markets, my guess is that the risk-adjusted return for all credit scales will be the same (which doesn’t preclude the possibility that there will be opportunities for skilled participants to exploit).

  10. Canadian Capitalist

    Phil: CareVest is interesting enough to merit a future post. Thanks for the tip.

  11. CC – Exactly – while the market is immature you can probably do quite well, and over time it will become more efficient.

    I could see later on third party applications with which you deposit $X, your desired rate of return (and answer some behavioural questions about your risk tolerance), and click ‘lend’, which will then automatically deploy your capital efficiently, for a certain fixed or percentage fee. It’s relatively easy math.

  12. As P2P lending gains publicity it will be interesting to see how many bad apples come out of the woodwork to take advantage of community lenders.

    It will be even more interesting to see if growing competition among lenders can offset the increase in interest rates caused by the additional defaults.

    The whole concept seems vastly scalable. Maybe in 10-years they’ll even have enough critical mass and institutional sponsorship to offer sub-prime mortgage lending. 🙂 I know—that’s a stretch—but crazier things have happened.

    One thing they definitely need is a secondary market (i.e. someplace to sell your loans before 3-years is up). I hear one may be in the works at Prosper. Having that would get more heavy hitters involved and reduce the liquidity premiums caused by the 3-year waiting period.

    CC makes a compelling point about market efficiency. It makes you wonder if, over time, default-adjusted rates of return will approach risk-free savings returns, plus a small premium.

    Lastly, Investoid, have you seen Prosper’s standing orders feature? http://www.prosper.com/help/topics/lender-standing_orders.aspx

    It’s like an automated bidding mechanism–similar to what you discussed (I think).

    Have a wonderful evening!

    Melanie

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  14. I have been trying to get a house for my family for years but due to my past mistake that is not possible through the banks. I have check out Proper and that is not availible in canada. Will this new lending idea be availible here or is it jsut talk. If anyone can help all the help will be appriciated..

  15. People who are concerned about the security of the lending thorugh p2p are requested to have a look at http://www.my-lending.com. Site provides p2p where the borrower is requested to pledge the collalteral in favour of the site account lender. Mark to market of the collateral is done by the site. Site liquidated the assets as per the business rule when the collateral value falls and the borrower fails to top up the margin.

  16. Canadian Capitalist

    Craig: CommunityLend is supposed to launch later in the year. Their website is currently down, but you can check the details on their site:

    Link

  17. You might want to check http://www.p2p-banking.com which has more news on the development of p2p lending

    Wiseclerk

  18. Pingback: The Financial Blogger » More on Social Lending

  19. Pingback: Information and Sign Up For Prosper Here | Quest For Four Pillars

  20. Looks like IOUCentral.ca has launched their Canadian P2P lending site, beating Communitylend to the punch. Yes, they’re actually accepting loans and bidders.

    Take a look at my site as well for my Canadian perspective on P2P lending.

  21. Pingback: CommunityLend launches (quietly) in Ontario and Quebec | Canadian Capitalist

  22. Pingback: CommunityLend launches (quietly) in Ontario and Quebec | MoneySense