As part of their 10 year anniversary, San Francisco-based LendingClub reached out to me to sponsor an overview of their latest initiatives. It’s been over a year since I wrote about P2P lending, so this is a good time for an update. All thoughts are my own.
Before 2007, the world was quite different. There was no such thing as an iPhone, blogs weren’t very popular, and I was still in my 20s. Sigh. It was around then that I started to learn more about the peer-to-peer industry given both LendingClub and Prosper were born in San Francisco.
When the financial crisis hit a couple years later, I remember getting a rubber chicken sandwich downtown with a P2P executive who told me that based on their lending book, those who invested in 100 or more A-rated loans didn’t lose money despite the collapse in the real estate and stock market. I was intrigued since about 35% of my net worth just got crushed.
Even though the defensiveness of a well-diversified portfolio was intriguing, I never fully went all-in on P2P lending because I was too sensitive to people not paying me back. It’s one of my financial pet peeves, along with people who vote to raise taxes on other people without paying more themselves.
LendingClub has been through a lot over the past 10 years – successfully IPOing in 2014 on the NYSE to ousting its founder and CEO in 2016 due to faulty loans when they first started out, to expanding into small business lending and auto loans.
LendingClub was founded on the premise that an online marketplace powered by technology would operate at a lower cost than traditional banks, and those savings would be passed on to borrowers through better rates and investors through stronger returns. They’ve done just that.
P2P Investment Landscape
My main questions as an investor centers around credit quality (default rates) and returns in a potentially rising interest rate environment. I say “potentially” because the Fed has and will continue to raise the Fed funds rate for the foreseeable future, but lending rates haven’t necessarily moved up since the 10-year bond yield has remained suppressed.
Here’s a 2H2018 update from LendingClub’s CIO:
Economic Backdrop. The American economy remains robust but growth remains slow. Unemployment remains at historically low levels, measuring at 4.5% as of March 2018. On the other hand, GDP grew at an annual pace of 2.9% in the fourth quarter of 2017.
Borrower Performance. Recent vintage performance is coming in broadly in line with our expectations. We see delinquency rates stabilizing across most grades and terms which we attribute to changes made in 2016.
Interest Rates. The overall interest rate environment remains low, though the Federal Reserve raised its target rate multiple times in 2017 and in 2018. In total, interest rates for the platform are increasing slightly (by a weighted average of 50 basis points).
Projected investor returns (IRRs) for loans issued after today are substantially unchanged relative to last quarter. Please see the summary table below, which includes the impact of interest rates effective May 4, 2017 and the new forecast.
My Take On The Investor Update
The overall investor returns are projected to be between 4.12% – 9.62%, which is not bad based on the current risk free rate of return of 2.25%. All investors should demand a risk premium, otherwise, it wouldn’t be worth it to take any risks.
What’s interesting is that investors can take more risk going for 25% – 30% annual returns by lending to E and F/G category borrowers. However, with projected annualized net credit losses of between 17% – 18%, the projected returns are closer to 9%.
But 9% is still a fantastic return, which makes me wonder: if you’re going to build a diversified portfolio with over 100 loans, why not just build a 100+ portfolio of low rated loans to try and get 9.62%? So long as you mentally expect 17-18% of your borrowers to never pay you back, you should feel fine.
The likely answer as to why some might not do this is because we don’t know the exact rate of default increase will be if the economy turns sour. For example, the A-rated borrower averaging a 2% net credit loss might have a 2.4% (20% increase) net credit loss during a recession. But a F/G-rated borrower averaging a 17.24% net credit loss might have a 34.48% (100% increase) net credit loss during a recession, thereby wiping away all projected returns.
Hence, as a P2P investor, it’s important to take a view on where we are in the economic cycle. So far, everything looks rosy, but everything looked rosy in early 2007 as well. If you are lending to C or lower borrowers, such borrowers have a history of poor credit, delinquencies, and questionable uses for your money e.g. buying a speedboat, starting a fidget widget business, etc.
I’d rather focus on the higher end of the quality curve where borrowers are looking to consolidate their higher interest credit card debt. It feels better to help people save money and be more financially responsible with their lives.
The biggest risk to P2P lending is higher delinquency rates (net credit loss in the chart) and the lack of liquidity in a downturn. Hence, the reason for focusing on quality and having a large enough number of notes to withstand a slowdown.
What’s New With LendingClub?
There are two main features that may be of interest:
1) LendingClub Invest for iOS. They’re working on an Android version. With the mobile app, you can:
- Check their account value, returns, and their portfolio of notes
- Manage their Automated Investing strategy or manually invest in Notes
- Add additional funds to their account
LendingClub for iOS mobile ap. Click to download
LendingClub Mobile app for iOS
2) $1,000 New Account Minimum. Starting May 18, LendingClub implemented an account minimum of $1,000 from $1 for all new investor accounts opened. The investment per LendingClub Note is unchanged and still sits at $25 per Note. This move by LendingClub is an act to motivate potential investors to start with a more diversified portfolio to minimize the effect from any singular loan defaults on potential returns. Whereas $2,500, or 100 Notes, is the optimally suggested amount by LendingClub based on their data, $1,000 is still a move in the right direction to hinder any folks who are looking to try the platform with anything lower that pushes their likelihood of a subpar experience.
This first chart shows that 16% of investors with less than 100 notes saw a negative adjusted net annualized return. Meanwhile, only 2% of investors with more than 100 notes had a negative adjusted net annualized return.
The next chart shows the long tail returns of investors with up to 1,000 notes broken up by the top 10%, the median, and the bottom 10% investor. Given the investment minimum per note is still $25, it’s recommended to invest at least $2,500.
P2P Lending To Continue
It’s hard to believe that LendingClub has been around for 10 years. Over $24 billion has been invested through its platform during this time period. Banks are still quite inefficient when it comes to lending money, which is why the fintech lending space has exploded to arbitrage out such inefficiencies to the benefit of the consumer.
But unlike most fintech lenders, LendingClub is listed on the NYSE. They’ve made it, whereas most private fintech lenders have not or will not. Being a public company means that they must follow NYSE and SEC reporting guidelines. With each quarterly result, they are scrutinized by thousands of investors. They’ve been through bumpy times in the past, but I believe that each setback is an opportunity to learn and grow stronger.
My hope is that if interest rates rise, investors will be able to partake in higher returns. The key is for the projected annualized net credit loss figure (defaults + prepayments) not to rise faster than the pace at which returns rise. This is exactly the struggle the Fed faces as it raises interest rates. How fast should they raise interest rates to step rising inflation without choking off employment. I’m looking forward to improved transparency and more sophisticated underwriting standards for improved returns.
Here’s a great comment from reader Brian who has been investing in P2P since 2014 and has over $400,000 invested:
* Make sure you have the discretionary cash to invest in the first place. You must appreciate that for any investment return that you have to take on risk. What’s your level and will you be fine if you lost all that you put into P2P lending. If not, you best stay out.
* Also, think about liquidity. Do you have a separate emergency fund? Are you saving $ in case other investments become more attractive? From my experience, LC is not very liquid. My LC cash flow makes about 5% of my total investment available for income or other investments on a monthly basis. In other words, it would take 20 months for me to pull out all my money. I haven’t seen anyone publish good results with the secondary market folio option available separately for LC users. That’s an emergency exit with a cents on the dollar kind of outcome.
* As with any investment, you need to understand how it works, risks, returns, etc and *before* you put substantial sums of money in. I have spent 5 years learning about P2P and performed some small $ experiments before I invested substantially. There’s no magical investments with big returns and low risk!
* Be very aware that your P2P results will most definitely downtrend over the course of about 18 months and based on solid stats, stabilize in a 5-8% range IF you have a sufficiently diversified portfolio
* If you invest larger amounts, you will need an automation strategy or this vehicle will be very time consuming and likely won’t achieve the best returns.
* There are hundreds of P2P investing platforms but LendingClub is arguably the most solid. It has a 10 year published track record including during periods of economic downtown and rising interest rates.
Readers, anybody a P2P investor like me? Any existing LendingClub investors? How have your returns been, and where do you see the P2P lending industry going in the future? Will banks ever become more efficient in lending to beyond just the highest quality borrowers? Please note that P2P ranks LAST in my passive income rankings. I’d much rather invest in real estate crowdfunding where you have a tangible asset that rises with inflation.
Lending Club is another form of diversification of your overall portfolio. After 7 years with them, our mature ANAR is ~ 5.5%. $150k invested, with a blend between $25-$50/note. Auto-investing since we passed $50k invested as it was taking way too much time.
The winning key, imo, with this investment is in the #’s. Have lots and lots of notes. Over time, our portfolio is around 10,000 notes. You have to expect non-payers. They typically kill off about 2-3% of the profit margin, and LC costs another 1% in management fees. 5-7% on widely diversified portfolio is highly acceptable in my opinion.
$150k out of nearly $3M in our portfolio represents an acceptable (and minor) risk. Each of the other investments possesses their own risk footprint.
Recommend don’t take it personal when someone defaults… its a natural consequence of investing. A bond portfolio is NO DIFFERENT. There are defaults within there, too.. you just don’t normally see them, unless you really really research the fund or bond itself.
Other alternatives to LC are PeerStreet of RealtyShares where your note obligation is secured by first-lien (aka Senior Debt). We are currently rapidly expanding our footprint in these two markets (thanks to Fin Sam)
If you don’t want to have defaults, then keep your money under a mattress, or in a savings account.
R
Fred
~~First time commentator~~
My experience with LC has been mostly good and I plan to continue on the platform.
I heard about p2p lending from a nerdy CISCO employee in 2013. He was on a platform that issued loans to residents of the state of Virginia. In late 2014 I had some freed up capital and was becoming involved in the lending space to a business I was employed. Long story short I found LC right when they went public and invested with an amount of about 70 squared @ $25 each note. I started with the intention of doing this for 10 years.
Year 1 performance: 7.98% 2015
Year 2 performance: 3.75% 2016
Year 3 performance: 4.39% 2017
2016 was disastrous. This was partially related to my error in loan grade allocation due to general inexperience and poor judgement. The first year produces the best returns and I did not reinvest interest well enough. I ceased purchase of all D and E grade notes in 2016
I like to thank the CEO scandal for saving my 2016 returns because I made an immediate contribution and subsequent bulk buy of notes as a show of my personal support to the company… a 2nd 2016 contribution was made to push up interest/earnings from Huge charge offs.
2017: Returns stabilized (interest increased and charge offs dropped). I like to think because of my due diligence. Two withdrawals were made. I’m only in the A,B,C grades *buying only C notes for the short term.* I will probably go to buying/reinvesting only “A” when the market crashes/recession comes. If the platform doesn’t collapse :) I will make a contribution and load up/reinvest proceeds on “A” notes thru whatever bear/contraction is coming.
I’ve been involved with LC for five years.
My observations so far is that LC doesn’t curate any loans; LC’s underwriting is junx and is just an academic quant model that ignores qualitative real-world factors; collection efforts have been really subpar until the CEO got kicked out (and there is no magic to that, this is unsecured loans and all there is to rely on is a borrower’s honor, implied threats and/or coercion); the borrowers are overwhelmingly “dumb money” that are scheming to acquire more time before (or to avoid) the SHTF as an amortized loan rarely lowers their actual monthly payments in any significant and life-changing way; it is mandatory to use some kind of loan selection optimization to avoid the feeble net returns that many have reported as of late and to be able so snap up the best loans as fast as institutions do; you must absolutely plan for the long-term to smooth out the economic volatility, do not lump sum invest, e.g. invest equally and continuously over the weighted period of the maximum loan terms that you’re willing to tolerate.
For round two, I hit the three year mark a few months ago and with oh-yet-another acknowledgement that LC screwed up again with their junx underwriting model, I have decided to not to commit any more new cash and will let the current balance compound forever. My returns have steadily decreased from 11% to 10% and now 9% for a balanced risk approach. I expect to stay above a net 0% during the next recession, so that is a better outcome than the eventual 50%+ losses in stocks.
So be careful and manage your expectations. 9%/0% is still better than 17%/-50% in stocks.
Hi Sam,
You’ll recall that you and I have discussed P2P lending and LC 1:1 in the past. It remains about 40% of my 7-digit investment portfolio. I’ll share some insight into my experience and also some thoughts and other things that I’ve seen/learned. I started investing with both LC and Prosper about 10 years ago. So I’ve been familiar with the platforms and investment vehicle for years. Given low interest rates and my preference for lower risk investments, I committed $150K for a LC portfolio that I launched in Aug 2014.
First, some stats on the portfolio. By grade: B-14%, C:51%, D:22% and E:13%. I consider this to be a moderate risk portfolio in terms of potential default during an economic downtown. One thing I especially like about P2P lending, is that we have good statistics on how consumer credit performs (see interesting article below) during downturns including specifics for how LC performed during 2007-2009. My given portfolio would have had about a 2% return during that period according to published data on the platform performance during that period. Given current interest rates, I wouldn’t cry if I got 2% out of P2P during a downturn. Also consider that you would have likely been down ~40% if you were invested in the stock market during that period.
I am not at all tolerant of the stock market’s volatility and only invest my 401K in it because of the longer horizon. I like that P2P lending has historically had a very low correlation to stock market results. My net return from 2014 until now has dropped from 12.78% and seems to have leveled at about 7.43% according to LC account view. My personal IRR calculation shows closer to 6.86%. I expect this number to improve slightly as money is reinvested and based on LC calibration of loans last year.
I’m just fine with the return if it remains there because it’s about 3X what best CD rates are right now. Regarding the portfolio mix, I pay a small fee to use the NSR Invest platform to automate investment and have selected their balanced growth strategy (a mix of about 45% B and 45% C grade notes). This takes all the hassle out of loan selection and that’s critical given my level of investment and substantial cashflow. Negative cashflow drag is often a key impairment in investment results. And is critical given at I have about a $30K cashflow to reinvest monthly just from my P2P investments.
I also love that the notes they have selected have performed almost 2X the ones that I selected manually and using the LC auto-investing feature (which I think is insufficient). Over time, the platform will adjust my overall portfolio note distribution which I anticipate will boost my performance by possibly as much as 3-4% based on current trends. BTW, my losses to date are just about to hit $10K. I know that many are turned off by people not paying loans back. Personally, my integrity would never allow for that. However, the risk/reward is not unlike banks and credit card companies take on. And quite frankly, I’d rather take a share of that return from institutions that I often consider to be greedy and take advantage of customers.
I like that my investment can help others–especially solid borrowers (the A-C grade notes). I also invest moderately in several other platforms: Peer Street (Real Estate), Yield Street (Litigation), Funding Circle (Small Business) and Fundrise HeartLand (per Sam’s advice). This helps diversify my portfolio and boosts the blended return to ~8%. I realize that I take on a little more risk in the other platforms given their longevity. I’m still deciding on my longer term mix. Another option with this is that you can find several funds that will take your money and invest for you. They are mostly invested in LC, Prosper, and Funding Circle given their longevity and relative stability. I choose not to do this because of the fee to manage my money which I can achieve more cost effectively with NSR.
So my key observations to share:
* Make sure you have the discretionary cash to invest in the first place. You must appreciate that for any investment return that you have to take on risk. What’s your level and will you be fine if you lost all that you put into P2P lending. If not, you best stay out.
* Also, think about liquidity. Do you have a separate emergency fund? Are you saving $ in case other investments become more attractive? From my experience, LC is not very liquid. My LC cash flow makes about 5% of my total investment available for income or other investments on a monthly basis. In other words, it would take 20 months for me to pull out all my money. I haven’t seen anyone publish good results with the secondary market folio option available separately for LC users. That’s an emergency exit with a cents on the dollar kind of outcome.
* As with any investment, you need to understand how it works, risks, returns, etc and *before* you put substantial sums of money in. I have spent 5 years learning about P2P and performed some small $ experiments before I invested substantially. There’s no magical investments with big returns and low risk!
* Be very aware that your P2P results will most definitely downtrend over the course of about 18 months and based on solid stats, stabilize in a 5-8% range IF you have a sufficiently diversified portfolio
* If you invest larger amounts, you will need an automation strategy or this vehicle will be very time consuming and likely won’t achieve the best returns.
* There are hundreds of P2P investing platforms but LC is arguably the most solid. It has a 10 year published track record including during periods of economic downtown and rising interest rates.
I’m not sure what my long term commitment will be with P2P. For the next couple of years, I’m pretty committed to it given 1) I’m comfortable because of my knowledge, 2) my results to date, 3) interest rates for safe investments aren’t likely to go up much for a while and 4) I have very little confidence in the stock market which is overdue for another significant correction in the 1-2 year period. P2P Lending remains an emerging financial tool and while many will fail over time, I don’t think P2P will go away long term. Lessons will be learned and the market will consolidate. Of course returns might also go down as the market becomes “more efficient”. Those that do their homework and manage wisely can use P2P as one reasonable investment vehicle amidst a market today with few similarly “safe” options.
Consumer Credit Return History as a basis for P2P
https://www.lendingmemo.com/p2p-lending-as-consumer-credit/
How Will P2P Lending Perform During a National Recession?
https://www.lendingmemo.com/p2p-lending-recession-performance/
Fantastic feedback Brian. I’m going to incorporate your feedback in the post so that readers have the most about of information possible before making an investment decision. Thanks!