A borrower or a lender be

Borrowers are about to get an alternative to the cap-in-hand visit to the bank manager. Rob Stock reports on the arrival of social lending.

Kiwi investors will soon be invited to follow in the footsteps of Britons and Americans lending money to perfect strangers over the internet.

Although that may sound like taking a risk with your hard-earned savings, young entrepreneurs Ben Milsom and Glenn Riddell are determined to convince investors here otherwise.

Early next year, the pair, both students at Auckland University, will launch Nexx, an online peer-to-peer social lending service which aims to bring lenders and borrowers together a sort of TradeMe for debt finance.

Social lending is all about breaking the stranglehold big organisations have on lending, and Milsom and Riddell say the track records of similar operations overseas, such as Prosper in the US and Zopa in Britain, give them heart that New Zealanders will embrace it.

Currently, investors wanting to lend their money out have little choice but to use a middleman such as a bank or finance company. But while banks and finance companies might be making loans at rates of 20% or more, they will be paying investors in their term investments and on-call accounts only 6-12%.

If those middlemen can be cut out, both investors and borrowers can get a fairer deal, Milsom and Riddell say.

Milsom says: "Personal finance is really, really expensive. Typical interest rates are between 17 and 25%, and that's before you add on top the finance company fees about 2-3% extra.

"That might not sound a lot, but for someone borrowing $5000 for 12 months at a typical rate of 22%, that's $117.31 per week, or 15% of the weekly income for someone on the average wage of $40,000.

"Things aren't much better for investors. They face a term deposit and debenture market full of fat, misrepresenting middlemen in the guise of finance companies. These companies issue debentures at rates averaging only 9.5%, barely above the risk-free bank term deposit rate of 8.6%. The return being paid to debenture holders in no way reflects the risk they are assuming.

"Our value proposition comes from removing the middle people and offering a better deal to both investors and borrowers."

By contrast to those fat lending fees and lender margins, Nexx plans to charge 0.5% of the loan amount from both borrower and lender.

Services such as Prosper and Zopa, and soon Nexx, work by allowing borrowers to post requests for funding and the reasons why they want it (along with photos). But before any request hits the screen, borrowers are screened, and those with criminal convictions, bankruptcies and the most awful credit records are blackballed.

Personal data such as borrowers' names and addresses are collected and checked, and a credit check is carried out, after which each borrower is assigned a credit grade of A, B, C, D, E or HR (higher risk).

These grades provide a guide to lenders as to what interest they should demand.

Lenders then make offers, but are encouraged to spread their money around. Someone with $5000 to lend might split it into $200 chunks and lend it to 25 borrowers. Loans can consist of dozens of small loans.

Some social lenders team up to spread their risk even further, giving their clubs names, and adopting social agendas. Clubs on Prosper include Pay Day Loan Terminators (enemies of pay day lenders), Rich Uncle (for loans to change your life) and For a Nurse (all nurses), and Nexx expects to see the same trend emerge here.

Investors' returns are taxed as income.

The track records of Prosper and Zopa show defaults on social lending are remarkably low, say the Nexx team, who have just completed a $100,000 first round of angel funding, and are about to embark on a second.

Milsom says the likes of Prosper and Zopa have very good payment histories, with losses of around 0.2% a year.

Social lending is no soft touch, though. Milsom says Nexx will look to periodically package up defaulted debt and sell it to collection companies.

There's no scope for lenders to take debt collecting into their own hands. Nexx will not share borrowers' details with them.

The pair are coy about how big their service can become, but with a personal finance market of $13.4 billion, there's scope for social lending to thrive. There are signs some lenders are already taking them seriously. One of the high street banks had been sniffing around, the pair say, though they won't name it.

Nexx is based in the Icehouse business incubator, having won $20,000 of seed funding and a nine-month residency after being named winner of the Spark $40K Challenge at the University of Auckland Business School.

HOW IT COULD WORK

A-grade credit rating: Applicant is an engineer with an MBA and excellent credit record looking to start a "Tropical Smoothie Franchise". He has raised $50,000 himself by extending his mortgage, but needs another $20,000. His monthly income is $4350. Monthly expenditure: $3740. He wants to borrow more cheaply than the 15% banks and finance companies might charge him. The likely bid range from Nexx lenders would be 10-13%. Lenders would get a rate around 0.5 to 3.5 percentage points higher than they'd get from a finance company debenture, or the 8% from a bank term deposit. B-grade rating: Applicants recently had their first child, and mother suffered unexpected medical problems which insurance did not cover. Father was laid-off from work (has since found another job). That led to them building up $12,000 of debt, which they now want to consolidate. Their monthly income is $2100. Monthly expenses are $1710. The likely bid range from Nexx lenders would be 13%-15%, but the couple would pay up to 20% to banks or finance companies. Source: Nexx

 

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