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Peer Lending Lures Yield-Hungry Investors

NEW YORK (TheStreet) -- The appeal of yield investments that claim higher returns than traditional fixed income has been heightened by a long horizon of low interest rates and an aging equity bull market.

Peer-to-peer lending -- or lending between individuals -- has seen solid growth since the credit crisis, as tighter regulation of credit causes banks to shun clients who do not fit stricter criteria.

The higher returns on offer have attracted institutions such as BlackRock, while former Treasury Secretary Larry Summers and ex-Morgan Stanley CEO John Mack sit on the board of P2P business Lending Club -- in which Google (GOOG) holds a 7% share. Ex-Citigroup (C) boss Vikram Pandit also invests in Orchard, a vehicle that offers institutional investors access to online direct lending.

Also known as person-to-person lending, the practice cuts out banks by connecting borrowers with lenders through online platforms for small loans, such as debt consolidation. Providers such as Lending Club and Prosper use technology to assess what to charge clients to reflect their credit risk -- Lending Club projects returns of 5.4% to 9.4% while Prosper lists loans on its website for investors to back. Both show information on the performance of different loan pools, with loss rates against credit worthiness and yields.

A loan funder can invest as little as $25 with some P2P lenders and may choose to fund part or all of a loan, or a portfolio of loans, in exchange for yield and repayment of capital. The greater risk of a client defaulting vs. defaults on U.S. Treasuries means higher yields against traditional fixed income.

"Our competition is not the banks, but educating the borrower that these choices are available," Prosper president Ron Suber said in a phone interview. He recommends investing no more than 10% of a person's net worth in the asset class and diversifying across loan portfolios.

Niche players are already appearing: SoFi specializes in P2P student loans while OnDeck targets the business loan market. Daric and Peerform are challengers to Lending Club (which has around 70% of the market) and Prosper, which holds most of the remaining share.

Peerform chairman Gregg Schoenberg describes the asset class as a toddler and says a secondary market will mark the next stage in its development. "Baby boomers are looking for cash flow streams that offer a measure of diversity -- it's not a good retirement plan to put all your money into utility stocks," he said in a phone interview.

Peerform targets only institutional investors, claiming this enables it to use more sophisticated risk assessment systems than can be explained to a retail audience. Schoenberg agrees with the recommendation to invest no more than 10% of assets in P2P lending, noting there is little data on how the asset class preforms in a down-cycle. Some suggest P2P lending defaults track the jobless rate, though Schoenberg says this is far from definitive.

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