Emotions are running high right now. After more bad news from Lending Club on Monday afternoon it is understandable that some investors are getting nervous. And not just the investors in Lending Club equity but also investors in Lending Club loans.
Since 2010 I have hosted over a half-dozen conferences, produced over 60 podcasts, written over 1000 articles, and had tens of thousands of conversations about one thing: the peer to peer lending industry. To boil down my collective thoughts about our current situation to a single blog post feels very difficult, but I have set out to do it nonetheless. Now, this post can only scratch the surface of the issues. It is a summary of my thoughts as of this day, which run deep and broad, and may change tomorrow as this complex situation continues to unfold. Here goes.
I have had several emails and comments in the last couple of days from investors asking me if they should take their money out of Lending Club. That is, either cease investing (and reinvesting) in Lending Club notes, or sell them outright on the secondary market via Folio. While I can’t recommend any course of action for others I am happy to tell you what I am going to do with my Lending Club investments: stay the course.
Between all the Lending Club accounts that my wife and I own, including my portion of the Lend Academy P2P Fund that has about 1/3 of its invested capital in Lending Club notes, the total is well over $250,000. That is not an insignificant percentage of our liquid assets. And I am not changing anything – I continue to reinvest my principal and interest in new loans.
Why?
I am very confident that Lending Club loans will continue to perform well despite the governance issues that cropped up and came to light over the past two weeks. Renaud Laplanche’s departure is sad and unfortunate to say the least. But the likelihood that more departures will occur, that perhaps a large reduction-in-force is in the works, that banks will cease buying Lending Club paper, that origination volumes will go down, that profitability of the company itself may plummet, that Lending Club may participate partially by investing in loans using its own balance sheet, and that “experts” and pundits like Jim Cramer will cry sell! sell! – nothing in this narrative shakes my confidence in the underlying business model of Lending Club, nor the ability and willingness of my fellow Americans to pay their debts in a responsible fashion to the best of their ability.
Lending Club’s business model is about providing a lower rate of interest to American borrowers using a more responsible structure than credit card-style revolving debt, and at the same time providing a high return by passing through 99% of the cash flows (that’s 100% minus a 1% servicing fee) to investors. Lending Club’s underwriting model – the way in which it selects loans to list on its marketplace – has absolutely nothing to do with the recent events that ended in the resignation of its CEO and founder.
Possible Outcomes for Lending Club
Many have expressed concern to me over the last couple of days that Lending Club may not make it as a company. I think that is highly unlikely. To illustrate, let’s look at a few of the possible outcomes that could occur for Lending Club over the next few months. Here they are in descending order of likelihood in my opinion:
- Originations are reduced sharply – This will in part be due to a pullback from banks, which currently comprise a material percentage of buyers on the LC platform (34% as reported in Q1). To position itself for contraction rather than growth, LC conducts a large reduction-in-force (layoffs), management changes, and raises additional cash on its corporate balance sheets to weather the storm. The company works its way through the crisis. And what becomes of my invested capital in LC notes in this scenario? It is safely generating income throughout the turmoil.
- Lending Club is taken private – This could be done by a private equity firm and the new owners may conduct many of the above changes, and weather the storm in a more private fashion. The company returns to profitability, and goes public again at some distant point – let’s say five years out from today. Under this scenario, a more comprehensive change in management is likely. What of my invested capital? Safely generating income.
- Originations are reduced but not as sharply as we anticipate – Lending Club is able to use its current stockpile of cash (in the high hundreds of millions of dollars) to push through the crisis, continue operations as normal and return more quickly to sustainable growth. Again, my capital would generate income in this scenario as well.
- Lending Club is acquired by a strategic investor – Let’s say a large bank buys Lending Club and the new owner simply uses LC’s origination engine to satisfy its own thirst for high yielding prime consumer loans, improving its profitability and shutting the market to outside participants. This, in my view, is the actual worst-case-scenario for outside investors and our industry as a whole, as it would kill one of only two marketplace lending companies that serve individual retail investors at volume. In this scenario, while I would certainly expect my current investments to be serviced by the new strategic buyer, I would have to find a new place to reinvest my principal & interest.
- Lending Club is unable to right-size its operations, unable to attract a buyer – There is no going-private transaction, no strategic purchase and it is unable to raise new equity investment at any valuation, and eventually runs out of cash and goes bankrupt. This, in my view, is a very distant possibility. But I know this is a concern for many people so more on this below.
In the first four scenarios, which I consider to be the most likely possibilities for Lending Club’s future, my family’s money is taken care of and my capital is unaffected. The likely “worst case” scenario as I see it is that Lending Club is forced to wind down their marketplace by a new owner, in which case we may be prevented from investing in new loans. While our currently invested capital would continue to be serviced, as I mentioned above, the detriment to retail investors seeking high, uncorrelated yields would be severe.
The Worst of Worst Case Scenarios
But let’s consider the case of a Lending Club bankruptcy even though I believe it is unlikely. One reason I believe it is unlikely is taking a look at Lending Club’s balance sheet. They have plenty of cash and very little debt outside the loans themselves so it is difficult to surmise what could trigger a bankruptcy.
If you are concerned about a bankruptcy I suggest you read the Lending Club prospectus closely. There are 25 pages of Risk Factors that include discussion of bankruptcy. If Lending Club was to cease operations a backup servicer is in place and they would take over the servicing of the loans – this would happen in a quick and efficient way and borrower payments would continue as before. Now, I should point out that even with a backup servicer in place, there is no guarantee that payments will flow to investors in a bankruptcy. Attorneys I have spoken with have said while borrower money will likely still flow in there is no guarantee that this money will continue to flow to investors. It says as much in the prospectus.
As I said I think that a bankruptcy is an unlikely scenario although certainly not impossible. In the end, everyone must weigh the risks, and measure the estimated consequences, for themselves.
Lending Club Has a Powerful Franchise
Here is why I think Lending Club will continue to be a going concern for a long time to come. First, I am assuming that the problems discussed ad nauseam in the press over the last nine days are isolated incidents and not a systemic problem. There is nothing I have read that indicates these problems are systemic at Lending Club.
Lending Club has a powerful franchise even after all these problems. They have well over one million borrowers, most of whom have high opinions of the company. They have an efficient system in place to obtain these borrowers and now they are not focused on growth I think we will see customer acquisition costs come way down as they cut the least profitable marketing programs.
They have a large number of diverse investors, many of whom still believe in the company, like I do, and will continue to invest. Many of these investors have automated reinvesting, which will provide a consistent source of fresh capital to fund loans as previous loans are repaid.
I am under no illusions that this will be easy. Lending Club did $2.75 billion in new loans the first quarter. I expect that number is going to drop significantly in Q2 and drop again in Q3. They may not get back to that $2.75 billion number for quite some time. But that is ok with me as long as they keep to their strong underwriting standards and continue to make the marketplace available to regular investors like me.
As long time readers know, I have always been a glass half full kind of person. But I do believe that Lending Club will get through these problems and emerge a better company and one that will have the best compliance and internal controls in the industry. I am very comfortable with my decision to stick with them.
I know others may have differing opinions – feel free to share them in the comments below.
Disclosures: Peter Renton, the founder and CEO of Lend Academy, and Ryan Lichtenwald, Senior Writer at Lend Academy own LC stock. The information in this article should not be considered investment advice.
What do you think about the chances that the shareholder class action lawsuits against LC potentially totaling hundreds of millions of dollars or more will be successful? Why should I invest in more loans of LC with no protection in bankruptcy when Prosper protects my interests with a BRV?
Hi Alan,
I thought about class action lawsuits but that will take many years to sort through and will no material impact on Lending Club in the near term, say the next 12-24 months. Whether or not they will be successful is hard to say but I expect by the time Lending Club has to pay anything they will be in a much stronger financial position than they are today.
But you make a valid point about the bankruptcy remote vehicle. Prosper has had one in place for several years now and Lending Club does not.
what is a BRV?
i would be surprised if LC does not have shareholder liability insurance
BRV = Bankruptcy Remote Vehicle. It is a legal structure that protects investors in the event of a bankruptcy.
It could be that it all works out for the better too.
Imagine if LC hires a CEO who’s even better and takes the company to new heights. It wouldn’t be the first time that a company lost a CEO, it looked like all was lost, and a better CEO came in to save the day.
That said, I have stopped my auto investing at LC and will be taking some money off the table in the short term. I have about half of what you do invested and it’s a small part of my net worth, but still not an amount I’d like to lose.
ESI,
From conversations I have had around the industry the past few days many people think this whole episode will be a good thing for the industry. There has been more emphasis on growth than governance and that has clearly changed. Growth will come again but only after governance is rock solid.
They have about 600 million in cash. Even with a burn rate of 100 million a year which has never happend they will still be around for 6 years so they are in a very strong financial position. That is all true unless they decide to invest in the loans themselves which if they do it recklessly they can burn through much faster but I don’t seem them doing that.
That cash is so critical to them. It can help them weather a long and sustained dry spell.
I think #4 is unlikely. LC loans likely are not favorable in a CCAR stress test and their growth is significantly limited if all loans are portfolioed. At worst, I could see a hybrid model where the market place continues but the balance sheet is used to fill gaps in demand.
I am sure you are right Rawraw. I think a hybrid model is actually more likely anyway. Most other lending platforms are using that model today.
I think we are ignoring one scenario which I view as a worst case.
This attracts attention of regulators (already did) and regulators (and media) come down hard on peer-to-peer industry.
Additionally some court somewhere, declares some loans as usury or something silly like that and whole model is threatened. With breached trust, regulators jump on this and things spiral down.
I don’t think this is likely, I am actually buying a lot of discounted notes on FolioFN but I would not put above as out of the realm of possiblity
Yes, it is likely that regulators will come down harder on the industry now. But I don’t think it is likely that LC or the industry is legislated out of existence.
@BP
Lending Club can’t be sued for usury under Marquette (1978) because they originate the loans via Utah. Subpoenas are irrelevant.
Any idea if Lending Club continues forward with the new consumer product they were planning to announce on June 10th?
Chris, I think that is very, very unlikely at this point.
THIS may be a blessing in disguise if LC focuses on peer lenders again and deemphasizes institutional money
regulation will help LC – regulation increases barrier to entry and stifles competition
Michael, I think we will find a renewed enthusiasm for retail investors again at Lending Club but they will also need institutional investor support if they to get back to where they were in Q1.
larry summers is on the board
he has a lot of connections in DC and NY
Peter, I think you are underestimating risk here, especially political risk. Bad outcomes that have non-negligible probabilities:
– Government shuts down LC a la Arthur Andersen.
– Government assesses fines so large LC becomes not viable. Just look at all of the arbitrary multi-billion dollar fines assessed to banks.
– LC plaintiffs (of which there are legion) win massive payouts.
– LC becomes unstable due to borrowers thinking they can get away with not paying on their loans and lack of lenders. And/or LC starts burning quickly through its cash in an attempt to get the business growing again (instead of being conservative like we wish they would be).
The problem for us fractional loan holders is that we are subordinated to government fines and pari passu (I think) with other LC creditors like successful plaintiffs. In the events that LC fails, we can expect recovery of perhaps dimes on the dollar ($0.20?).
As things stand, no sane investor should have > 5% of their net worth in fractional loans that are basically senior unsecured debt of LC.
The good news is that nobody seems to be panicking so far on Folio. Fractional loans are selling at just a 2-3% discount to how much they were selling for pre-crisis. In a true rush-to-the-exits scenario the discount would be at least 10%.
On another note, LC has heavyweight board members like Larry Summers and John Mack. Why aren’t they trying to calm the flames by being visibly supportive in the press? That’s what Warren Buffet did to save Salomon Brothers. Their silence so far is very troubling.
Hi Harlan,
Good to hear from you and thanks for the thoughtful response. Given what we know today I think your scenarios 1, 2 and 4 are highly unlikely. While the misdeeds are serious at LC if nothing else is found it would be a gross overreaction from the government to come down so hard on a company that until this month was well liked and respected in Washington.
Most borrowers are paying by automated ACH payment and most would be unaware of this news I expect. I would be shocked if more than a tiny percentage took action and stopped paying regardless of what happens at Lending Club.
Lawsuits are an issue as I have said above. The only good news is that they will take years to work their way through the courts. But they could be big. The only consolation here is that by the time they come due I expect LC to be in a far better financial position than they are today.
LC appears to be doing the same mischief that was reported as leading to the turmoil, i.e. back dating loans. When a group of loans gets down to Day1 or Day 2 it seems to magically become Day 6 or 7.I called them on this weeks ago and provided copies of past screens to prove it and the answer was ‘oh, yes. we’ll get the engineer to look at it’ Caveat!.
You are spot on. I am a relatively new LC investor and noticed the same back dating issue couple of weeks ago. I called them to explain what is going on and provided them with details. I was told that they will forward the issue to their back office to investigate and call me back with an update. Three days and counting…no update yet! This does not help with restoring any confidence.
Thanks for bringing this to our attention. This is clearly a situation that needs to change.
Big question is what these events do to current levels of business. We’ll know soon, because if volumes are way down due to lack of funding, layoffs will occur quickly.
Loan volume at Lending Club is going down and probably down significantly. I expect a sizable round of layoffs from Lending Club in the near future.
Size of the layoffs will tell us something about the current state of things.
Personally I think the idea that this is the end of Lending Club and marketplace lending in general is very premature. Investors still want yield, and borrowers still want better rates. Lending Club will have an opportunity to make that case in the coming months, especially when a new CEO is hired. Certainly name recognition has gone up, which may have a positive effect in the long run; see https://www.gsb.stanford.edu/insights/when-bad-publicity-good.
Also, since expectations for performance are currently nil, the company will have an opportunity to address profitability concerns. With respect to the single largest cost–marketing–there may be some relief owing to the drying up of VC money chasing market share.
Hi Peter. Your post is all about what you would do as far as your investments in the Lending Club platform. However, I am curious about your thoughts and what your actions are in regards to Lending Club stock.
Well that is a completely different question. But giving advice on what to do with any one particular stock is not something I care to comment on. I can tell you that I have sold no Lending Club stock and have no plans to do so.
Thanks for your reply. That is all I wanted to know 🙂
Here’s my take. I’m a little guy and when I first heard about this industry in 2008 it didn’t make sense to me becuase I didn’t understand how it worked. It seemed silly to me. Why would I lend to someone based on a photo and a story? So I stayed away. I came back in 2010 and it seemed to be maturing but I couldn’t find enough materials to support the investment. Fast forward 3 years later with more information available I came to understand the model better. In my estimation it’s sound. I’ve decided to stay with it. In essence I’m going to ride this ship to the bottom of the ocean if that’s where it goes. Only time will tell if it’s a good or bad decision. I also realize if I and other small guys stop investing the ship would seem to take on more water faster. Good luck to all! Thanks to the passion of Peter and Ryan we can stay informed.
B Smith, You are welcome. I don’t think Lending Club is going to the bottom of the ocean any time soon.
The fundamental problem at LC is that the underwriting process is deficient, resulting in too many shaky loans being issued and default rates too high and rising. Advanced analytics and analysis of historical defaults should have allowed for a narrowing over time of the spread between nominal and actual rates of return. In addition. recently it has become increasingly apparent that some parties are getting preferential access to loans. Also recently, the projected expected loan return is less than the historical range. What is going on here?
If the current problems cause LC to address its weaknesses, they can emerge stronger and growth can resume in due course. No one wants a repeat of the mortgage fiasco, and if further safeguards are put in place before securitization resumes, so much the better.
If LC were required to retain a portion of each loan on its books, this would also help correct any perverse incentives to issue deficient loans.
My understanding is that the loans are segregated. I would be very concerned if lenders are no more than unsecured creditors in a bankruptcy. This issue should be clarified
Regardless, no one should have more than 10% of their portfolio in lending club.
I hit my target for LC loans last year, and now reinvest and take a monthly stipend. Defaults have been rising recently. If returns do not stabilize and defaults continue to rise, I will discontinue investing in LC loans.
Just as LC succeeded the problems in Prosper, someone else will come out with a better model. Peer to peer lending is here to stay, whether or not LC is at the forefront.
LC is at a crossroads. I hope they adapt and succeed.
INSTITUTIONAL WHOLE LOANS ARE UNDER BANKRUPTCY REMOTE VEHICLE AND SEGREGATED
RETAIL NOTES ARE NOT UNDER BANKRUPTCY REMOTE VEHICLE
IF LC GO UNDER, RETAIL GUYS WILL HOLD UNSECURED CLAIM AGAINST LC.
PERIOD!
Dave,
There have clearly been problems at Lending Club but I think the underwriting is solid. Defaults have been rising slightly but interest rates have also been rising to help maintain or increase investor returns.
P2PFACT is correct though. While institutional investors invest through bankruptcy remote vehicles, no such protection is in place for retail investors.
Is it possible that the peer to peer lending industry is under attack of the ” banking establishment ” ? Check out this quote from the New York times:
” Marketplace lending — which is fast and efficient — had been considered a potential disruptive force to the banking establishment, but now some analysts question whether it can bounce back from the recent turmoil. ”
Also checkout some of the members of Lending Club’s board, these are all snakes from the Banking industry. Is it far fetched to believe that they are there to destroy the banking industrie’s biggest threat ?
Hans Morris (former President of Visa and now our Executive Chairman), Larry Summers (former US Treasury Secretary), John Mack (former CEO of Morgan Stanley), Mary Meeker (a Partner at Kleiner Perkins Caufield & Byers) and other experienced executives.
http://www.nytimes.com/2016/05/17/business/dealbook/lending-club-already-troubled-receives-justice-dept-subpoena.html?_r=0
Syd,
While it is clear that many in the banking industry are very happy about the problems at Lending Club it is far fetched to believe that anyone from traditional banking orchestrated these problems.
Why is it far fetched ? Please explain.
“Lending Club’s business model is about providing a lower rate of interest to American borrowers using a more responsible structure than credit card-style revolving debt, and at the same time providing a high return by passing through 99% of the cash flows (that’s 100% minus a 1% servicing fee) to investors.”
LendingClub takes 5% off the top of most loans. I didn’t realize this until I had been investing for a while. This is a huge load.
Andrew,
That is true, there is an average of nearly 5% for every loan that Lending Club originates paid for by the borrowers. This represents the bulk of their revenue. But even given that load the average consumer will pay a lower interest rate than on the typical credit card.
One thing I would like to see Lending Club do is make their 5% origination fee conditional upon non-default of the loan. For example, I think that LC’s 5% origination take should be retroactively clawed back and paid to the LC investors of the note in the event of a default by the borrower. That would accomplish two things: first, LC as a platform would have more skin in the game with regards to the the credit quality of the loans originated on their platform. This aligning of incentives between LC as a business and the LC investors would undoubtedly prompt LC do more sophisticated vetting of borrowers, weed out any fraud and improve collection processes. Second, such a move would greatly increase the trust of the investors on the platform, both retail and institutional, because it would send a clear signal that LC does not stand to gain from originating dud loans that default early on.
I second that as a good idea – a good way for LC to have more skin in the game. May be some issues with revenue recognition but worth the trade off.
After many years of being out of P2P I got back in recently, intending to commit initially 50 thousand dollars to Lending Club, and to go as high as 500 thousand if results warranted. Now, 15 thousand into that commitment, I have decided against making new investments in Lending Club.
For Lending Club to make sense to me it has to pass 2 tests: 1) it has to be competitive on a risk adjusted basis with other available investments, and 2) I need to be convinced that the people running the LC platform were “honest brokers”. In my judgment, based on recent events, LC fails on both accounts.
Looking first at returns, the “indicative” returns posted by LC are currently 5.25%, 7.30% and 8.57% for their low, medium and high risk portfolios. By comparison, I have investment grade and near investment grade baby bonds of similar terms yielding 6-7-8%. I can also get a diversified portfolio of investment grade and near investment grade bonds via VWEAX at a yield of 5.65% or a slightly lower quality portfolio via HYG at 7.08% yield, both after fund fees of 0.15% and 0.5%, respectively.
Comparing returns I think it also relevant to consider that LC returns are inherently overstated inasmuch as they do not reflect the effect of cash drag on the LC portfolio. My personal experience has been that at any one time about 10% of my LC account has been earning zero while notes were waiting to issue.
I also consider the risk, however remote one thinks it, that repayment of LC notes is dependent on LC’s survival. You can diversify away the default risk of individual notes quite easily but you have no means of diversifying away the risk of a LC failure. Quite apart from LC’s current troubles, the company has indicated it is considering putting notes on to its own balance sheet, which increases materially the risk of a future LC default. Also, LC has, in at least one case, provided credit guarantees to an institutional investor, which certainly puts LC’s balance sheet on the line.
How much more does an investment in LC notes have to pay to make it attractive vis-a-vis the alternatives? In my judgment, the additional LC yield, if any, is insufficient to compensate for the risk of LC notes.
If this were a exercise in legal reasoning, I would stop my analysis there. This not being such an exercise I will go on to consider the honest broker issue. My concerns include:
How good is the information that LC provides to investors? LC doesn’t apparently verify much of the information and there is no means of independent verification.
Does LC really provide both whole loan purchasers and fractional note purchasers the same quality of the loan offerings?
Does LC provide institutions with more information regarding borrowers than it provides individuals, thus allowing institutions to make better investment decisions (leaving unpurchased whole notes to fractional buyers in the process)?
Why is LC granting at least one institutional buyer credit guarantees against defaults when they offer no such protection to individuals?
Given the importance of institutions to the LC business model I can see enormous temptations to favor their best customers. Individual investors may have launched P2P lending, but they are fast becoming irrelevant and, in time, I suspect P2P will get away from individual investors entirely.
All-in-all, I just think that the temptation for LC to cheat is considerable and will always be so. If they will backdate a few loans what else will they do? Plus, just too many conflicts of interest.
Bottom line for me: at the outset I felt I needed 10% yields from LC to justify the additional risk (and time) that P2P lending involves. I thought that was a stretch before the recent revelations about LC but was willing to commit some capital and time to find out. In light of developments this week, not a chance.
Bob,
You raise some valid points here. These are many of the same questions that investors of all sizes are asking. One thing I would point out is a couple of years ago I saw an analysis of the whole loan pool and the fractional pool and they were statistically very similar so I don’t think we have seen any investor get preferential treatment when it comes to quality of loans. But given the recent infractions LC has to convince all investors that it has its house in order. That is going to take time. But when it is all said and done I think LC will be the leaders in data validation, consistency and compliance.
Good points by Bob and by Peter.
I’d point out that a portfolio of LC notes vs. VWEAX is not an apples-to-apples comparison. 36 month LC notes have a duration of about 2 years vs. for 4.25 years for VWEAX, and so have considerably less interest rate risk.
With LC notes you get your money back with interest, less defaults. With VWEAX you have market risk: if junk bonds are perceived as riskier or less desirable in future you would have to sell it a loss to exit the position. There would also be a loss if/when interest rates go up.
Given the current state of the economy, and given the same interest rate and default risk profile, I’d much rather hold a shorter duration, no market risk security. The problem with fractional LC notes is concentration risk. With VWEAX risk is spread among dozens of junk bond issuing companies. With fractional LC notes we are entirely dependent on LC as the ultimate backing entity.
class action lawsuits rarely go to trial
they are usually settled out of court with the lawyers getting most of the money
This is what happened to the Prosper class action lawsuit from 2008. It was eventually settled (in 2013) and the lawyers did quite well out of the deal.
You wrote: “providing a high return by passing through 99% of the cash flows (that’s 100% minus a 1% servicing fee) to investors.”
Isn’t the service fee 1% of the interest charged, or 5% to 15% of the actual investment return cash flow? Return of principal should not be counted in your investment results
Hi Tim,
Yes, you are technically correct. If you look at the service fee as a percentage of your return it is more than 1% but it is standard practice to talk in fees as a percentage of a total investment. I am always open with my own returns that you can read about here:
https://www.lendacademy.com/my-returns-at-lending-club-and-prosper/
This is the thing that worries me. The top guy and several of his subordinates saw fit to engage in extremely risky activities which could at minimum destroy their professional reputations and at worst expose them to civil and perhaps even criminal litigation. Would they put themselves at such risk simply to patch up minor glitches in the way their company was performing or to give themselves some short term financial advantage?
Or alternatively, as ultimate insiders, were they aware of more fundamental problems that made them more inclined to engage in the risky behavior?
As an individual (and therefore ‘unsecured’) investor this is what is worrying me. I know that you will say that you don’t think the latter scenario is likely. But I’d really like to know what Laplanche & co. were thinking when they pulled the pin on the hand grenade. I really hope that the motivation was something simple such as impatient greed and not something more fundamental.
My take is that there was a major focus on growth inside Lending Club. I wouldn’t say growth at all costs but it seems to me it was that focus that probably led to these problems. Now, that focus has completely gone and as I said above I think they will have a major culture of compliance and disclosures when this is all said and done.
Peter,
Most resources claim that peer-to-peer lending’s market share will shrink once interest rates normalize. Why is that the common thinking? Won’t there always be a segment of the population which banks are not comfortable lending to and/or won’t LC still be able to undercut banks via lower overhead?
I can’t follow the “higher interest rates will lead to the end of the industry” doomsday prediction. I understand that it may affect investors, but I imagine borrowers will still be there.
Any clarification you can offer would be appreicated. Thanks!!
Normalization of interest rates in a gradual manner would NOT be particularly adverse. Peer to peer lending is an asset class separate from bonds, stocks or cash. (Unlike bonds) loan asset values do NOT decline due to increases in interest rates since most loans are held to maturity. An economic decline would increase defaults.
Note that Prosper has put itself on the market. Consolidation is coming to the industry.
Note also that recently on new loans LC has reduced the expected return below the historical return. They probably did this on the advice of counsel, but it says to me that they have problems with the underwriting model.
Peter disagrees, but i believe the problem with the business model is that there is too great an incentive to push through loans that should not be issued in order to build loan transaction volume. A higher rate does not protect against default – its the old multiply by “0” issue. Above a fairly low rate of expected default, loans should not be issued – or guarantors, additional verification etc. should be obtained to reduce the expected default rate.
If LC gave preference to a subset of investors, there may be a large legal liability down the road.
I have always maintained that increasing interest rates will not have a dramatic impact in the industry. The online platforms have a infrastructure cost advantage and with rising rates the cost of capital at banks increases.
But I want to address a couple of comments from Willy05. First, Prosper has not put themselves up for sale – this has been widely misreported. They have hired a bank to help them find new investors. Here is the official quote from Prosper: “Prosper is talking to banks solely for the purpose of helping us coordinate and work with investors who are interested in buying loans on our platform,” said Aaron Vermut, CEO, Prosper Marketplace.
And I don’t think legal counsel has anything to do with the expected returns – these have gone up and down many times over the almost 7 years I have been investing. And I still have faith in the Lending Club underwriting.
Also, as I said in a previous column – the focus on growth has gone out the window at Lending Club. They will definitely have a done quarter in Q2 and possibly even in Q3. And I think when they are back on track rapid growth will no longer be the priority.
I want to clarify that despite our differences, both Peter and i believe in the concept of LC and peer to peer investing. While I believe there is much to be done to improve the business model, I continue to reinvest in loans and maintain a significant allocation.
In the event of bankruptcy, what happens to investor cash that has been transferred from Lending Club to the custodian bank for self-directed IRAs (but not yet withdrawn from the custodian bank)? Is that transferred cash protected?
For Tax Year 2016, Lending Club has changed how they report Loan Defaults.
We now receive a Form 1099-B, with Defaults reported as a Long Term Capital Loss.
Cutting to the chase, If you receive $45,000 Interest and have $30,000 on Defaults,
you pay taxes on the $45,000 but can only use $3000 of the Defaults to offset income.
What on Earth are they thinking?
Stu,
While Lending Club tweak their tax reporting every year the situation you describe above has always been the case. You pay taxes on the full amount of interest every year and you can only deduct $3,000 in losses each year (you can defer other losses to future years).
We will have an updated tax guide out shortly but in the meantime you can read last year’s:
https://www.lendacademy.com/lending-club-and-prosper-tax-information-for-2016/
SMA Accounts may differ? Had I received a Form 1099-B before, I would have been out of there.