What’s the Risk? P2B Peer to Business Lending: The Quest for Returns

by Nik Milanovic, VP of Business Development, Endurance Lending Network

Endurance is now known as Funding Circle US.

[As with all other expert posts here, you will find my comments in parentheses. Our field of experts continues to grow.....]

Peer-to-peer lenders are finally starting to pass the “grandma test,” the tipping point for any hot new product where even your grandparents know what you’re talking about when you mention it. As growing companies like Lending Club draw more and more attention, investors are flocking to these lenders to beef up their portfolios and fintech junkies are hailing peer-to-peer lending as the next finance revolution.

Still, even though some of the more established lenders are now oversubscribed for capital [meaning more capital than there are loans], investors continue to approach peer-to-business loans with trepidation. A broad consensus seems to exist among investors that business loans can’t net the same types of returns as consumer loans.

What accounts for this perceived risk? You need only look at peer-to-peer lenders focused on consumer loans to see why investors are wary. Nickel Steamroller, which provides analytics on lenders Lending Club and Prosper, highlights this issue. Lending Club’s “Small Business” loan category has realized a lifetime ROI of only 2.21%, the second-lowest of all loan groups, with a default rate of 10.48%, the highest of any group.

This focus is too narrow. Peer-to-peer lenders are built to evaluate the risk of consumers applying for loans, but do a poor job cross-applying that risk model to businesses. To successfully deliver returns from lending to small businesses, a company has to build a very different underwriting model.

[In my years doing equipment finance and credit analysis within the field, I know this to be true as well. The underwriting is different.]

That’s why you see peer-to-business lenders doing so well in the business loan market. Take Funding Circle, a UK-based peer-to-peer commercial lender, as an example. Their business loans yield a net average of 5.8% to investors, with a median return of 6.6% (meaning 50% of investors make over 6.6%.) As a rebuttal to the high-risk naysayers, Funding Circle also boasts a bad debt rate of only 1.6%. Rebirth Financial, an American peer-to-peer business lender, has provided consistent returns to investors of 8% – 10%.

That is why at Endurance Lending Network, we feel confident in our target of delivering double-digit returns by focusing exclusively on small business loans. If you look at the below graph of charge-off rates of similar products, you can see that target charge-off range of Endurance is a low-risk proposition.

Chargeoffs for Various Forms of Lending
Chargeoffs for Various Forms of Lending
Sources for this chart: Equipment Leasing and Finance Association (ELFA), Federal Reserve and SBA.
Funding Circle loans are unsecured. Source: Company website
Data is confirmed by ELN for comparable specialty finance and bank companies, names withheld due to confidentiality

In addition to low loss risk, Endurance and other peer-to-business lenders target a much wider spread than consumer peer-to-peer companies. As shown in the chart below, the difference between rates that consumers are used to paying on credit cards and the rates of peer-to-peer lenders is much smaller than the difference between peer-to-business lenders and comparable creditors. By working within this spread, Endurance can easily offset losses to investors.

Rate Spread Hi Res
1. Interest Rates for CC plans assessed interest. CC charegeoff rates for all banks and are seasonally adjusted Source: Federal Reserve
2.Endurance Lending Network estimate
3. Average losses as a % of net receivables for ELFA Monthly Leasing and Finance Index

[I am a big fan of small business lending, not just because the need is so clearly there but established businesses can often easily afford to pay back over time and it's only the lumpsum they cannot access in order to expand.]

As with any asset class, there are no guarantees. The next couple years promise to reveal some interesting trends in peer investing. But we at Endurance are all-in on the peer-to-business model. That’s why we make it our mission to provide not one, but two great products: access to capital for main street businesses and access to a high-yield asset class for accredited investors.

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The information in this post is the author's opinion alone and does not reflect those of the Endurance Lending Network. Neither Endurance nor any individual acting on its behalf may be held responsible for the use of any information contained herein.  There are risks involved with investing including possible loss of principal and no guarantee that investment objectives of a fund or strategy will be attained. Endurance provides no promise of level of performance or guarantee against loss of principal.

About the author

Stu Stu Lustman, the author of this post, is a Credit Analyst by trade trying to bring Commercial Credit Analysis techniques to the world of Peer to Peer Lending. Check me out on Twitter, LinkedIn and Google+

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