Banking in the Age of Facebook

"Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry..."

IF YOU BUY AGED POLONIUS’ ADVICE to his hotheaded son Laertes, turn the page. This column isn’t for you.

But if you’re either a borrower or a lender, read on. We’re going to check out a new phenomenon known as peer-to-peer lending and look at the effects of some new rules for portfolio margining.

Combining elements of online affinity groups and investing sites, the Lending Club ( recently progressed beyond its initial test phase. The venture-capital-backed startup is an online community that connects lenders and borrowers based on shared interests that can include geographic location, workplace or university. The idea is that this community allows borrowers to get better rates on loans than they’d receive from a traditional bank while giving lenders better returns than CDs or money-market funds offer.

Lending Club was launched privately as a Facebook application in May, signing up 15,000 members. About 1,000 loans were financed from a pool generated by 700 individual lenders during the test. CEO and founder Renaud Laplanche says, “It’s an investment class that has very interesting characteristics in terms of both risk and return, plus it gives lenders the feeling of doing something useful.”

Becoming a lending or borrowing member of the club requires filling out an online form that verifies your identity. As a lender you must link your Lending Club account to a bank account so you can transfer funds online. After your bank account is verified, which takes a day or two, and you’ve transferred money in, which takes up to four business days, you can lend.

Lending Club identifies its members only by a screen name. It runs a credit report on borrowers, checking income when necessary, and will approve only those with credit scores over 640.

An algorithm called Lending Match, which lets lenders come into the site and set their risk, geography and connectivity preferences helps structure the loan. Based on the algorithm, a list of 20 recommended borrowers—with loan limits running from $500 to $25,000, is generated. If you have, say, $10,000 to invest, you can spread it over 20 different borrowers in $500 parcels, creating a diversified portfolio that lowers your overall default risk.

Lending Club’s portfolio recommendations are based on credit score and certain category memberships (e.g., military personnel, MIT alumni, Florida residents). You can take the recommendation as is, or remove some borrowers, allocate amounts differently, or add other borrowers.

If borrowers miss a payment, Lending Club will contact them and assess a late fee payable to the lender. Those going into arrears are put into collection and barred from the site. There is no Federal Deposit Insurance Corp. backing for funds that have been lent out.

How much can you make as a lender? Laplanche says that the average annualized portfolio return would be about 11.5%—much better than most CDs or bonds offer. And having some funds allocated to consumer lending is a good way to diversify your portfolio beyond stocks and bonds, he says.

Lenders pay a 1% service fee, based on their monthly take, while borrowers pay a 0.75%-2% loan-origination fee plus the rate Lending Club calculates; it currently ranges from 7.12% (grade A1 creditworthiness) to 17.86% (grade G5).

The one limitation at present: You can’t be both a lender and a borrower simultaneously. But they’re working on it.

PROFESSIONAL TRADERS HAVE been taking advantage of updated margin requirements that went into effect in April, allowing more portfolio leverage. The new margins account for the effects of options in hedging a stock holding, which the old rules didn’t. As a result, the new rules permit brokers to be more generous in extending credit to traders in many cases.

Think of this as portfolio margining—reflecting all of a trader’s positions including options that offset the risk in a particular stock—rather than margining for individual trades. ("New Options for Traders,” Barron’s, Oct. 30, 2006). A less risky portfolio can be leveraged further.

So far, professionals, who have bigger portfolios and more expertise, are being extended most of the credit from brokers. “While I do have selected retail clients taking advantage of additional leverage, our standards are aiming more for the institutional clients” like hedge funds, says Douglas Engman, managing director for equities at Fimat Preferred, who’s pleased with the initial results.

Posted by on 10/01 at 12:46 PM






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