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Why a National Interest Rate Cap is a Bad Idea

Legislators want to introduce a national rate cap of 36% but there are better ways to solve the problem they are trying to address

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Last month five legislators introduced the Veterans and Consumers Fair Credit Act, a bipartisan piece of legislation that proposes an ill-advised solution to a difficult problem. It seeks to put an interest rate cap on all loans nationally in the name of consumer protection. Unfortunately, it will likely have the opposite impact on the consumers it seeks to protect.

No one likes predatory loans where consumers can sink into a debt spiral that often ends up in financial ruin. While this bill seeks to focus on payday and car-title loans, two loan products that are universally disliked, it will also impact many installment lenders. These are the companies who sit between the low interest marketplace lenders and the payday loan industry, offering loans with APRs of 36% to 100%, many of whom provide critical financial support for struggling consumers.

The fact is that an interest rate caps is a very blunt instrument to use on a nuanced problem. There are some who believe that any interest rate above 20% or 25% is unacceptable and certainly 36% is out of the question to many. But what is the solution for people who simply don’t qualify for a loan at a lower percentage rate? According to the legislation proposed these people would just be out of luck. This will lead to more bankruptcies and more lives disrupted.

This is not just my opinion. This recent op-ed in The Hill by Consumers’ Research cited a study conducted in 2014 on the historical evidence of the impact of rate caps at the state level and they concluded that “state interest rate ceilings restricted credit availability…for higher-risk borrowers.” So, the legislation that is supposed to help higher risk borrowers in effect will price them out of the system and leave them with no good options.

Sometimes I think critics of high interest loans suffer from a kind of magical thinking. That if we simply legislate away a product the demand will go away. Clearly that is not going to happen, in fact demand will likely increase for a product that would now be banned. [Read more…]

The Future of Idle Cash Held at Marketplace Lending Platforms

As interest rates rise marketplace lending platforms should offer a return on cash waiting to be put to work

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The marketplace lending industry has never had to deal with an environment where interest rates are increasing. We’re not talking about how loan interest rates affect returns, but instead how platforms handle idle cash. When interest rates were close to 0% it was no big deal that platforms paid nothing for the idle cash that builds up in your account. But now that many money market and savings accounts offer 2% or more there has become a real cost to keeping cash just sitting in a marketplace lending account.

For some platforms this is not much of an issue since there are plenty of loans available and the minimum investment per loan is relatively low. But for many platforms, particularly in the real estate space minimum investments are high and cash builds up, sometimes to several thousand dollars before an investment can be made. These platforms may need to consider offering an incentive to investors to keep them happy.

YieldStreet Becomes First Platform to Offer a Return on Idle Cash

YieldStreet is one such platform. The minimum investment is often $10,000 or more in new deals so cash has to build up significantly before it can be reinvested. Also, with investor demand strong it is not easy to deploy idle cash since many of the deals are fully funded within minutes and there is no auto-invest feature. So, cash tends to build up and the cash drag problem has an impact on investors overall returns.

YieldStreet’s solution to this problem is YieldStreet Wallet which is a savings account that earns 1.6%. What’s interesting is that while you must be an accredited investor to invest in investment opportunities on the YieldStreet platform, this is not a requirement to hold a YieldStreet Wallet account. Similar to other savings accounts, users are restricted from making more than six transactions per month, deposits excluded. Funds are FDIC insured since the account is held at Evolve Bank & Trust which is an FDIC insured bank. One of the major benefits to investors is that they no longer have to worry about timing ACH transfers for new investments since the account is held at YieldStreet. Distributions and payments will also be made to the YieldStreet account so you automatically earning interest as loan payments come in.

My account was automatically upgraded to the YieldStreet Wallet and I have been earning 1.6% on my idle cash for over a month now. And for new transfers cash starts to earn interest as soon as the money is received.

Will Offering a Return on Idle Cash Become Standard Soon?

YieldStreet’s offering could be the start of a new trend. They are the first to address the problem of idle cash but they most certainly won’t be the last. The Federal Reserve is expected to increase interest rates three times in 2019 which will put the federal funds rate near 3%. As interest rates continue increase there will be more pressure on platforms to provide investors with a yield on their cash. Seems like a no-brainer to me to keep investors happy.

Savings and Deposit Rates in a Rising Rate Environment

As rates rise fixed income investors are looking for places to put cash.

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For many years there have been few opportunities for yield which is one of the reasons some investors turned to marketplace lending or real estate. For those looking into safe investments there weren’t any appealing options as savings deposit rates and CD rates at banks haven’t been attractive for years. Since Lend Academy attracts fixed income investors it’s no surprise that they have been watching rates closely.

This thread called Cash Parking on the Lend Academy Forum was created back in December 2016 and since then, forum members have discussed opportunities at banks and credit unions. Forum members have discussed where it makes most sense to have their money and how other investment opportunities like marketplace lending compare.

The discussion caught my eye when one user posted a 3% 5 year CD which happened to be offered by my local credit union. Since these accounts offer FDIC insurance earning 3% guaranteed by the government is a good deal some investor’s eyes. In fact this is the best deal in almost 10 years. I have since been following CD rates and savings deposit rates at various banks over at Bankrate.com which I find is a simple site to use. Another website mentioned on the forum thread is DepositAccounts.com by LendingTree.

Signing Up for a Savings Account at Marcus

Although rates vary from day to day by any given bank, Marcus by Goldman Sachs has been near the top of the list since I began checking. We last did a piece on savings account rates back in June 2017 when Goldman Sachs’ deposit accounts were still branded under GS Bank. Rates are now 30 basis points higher at 1.5% on Marcus accounts. I already hold one savings account at Ally which tends to be competitive with other banks and as I was looking to open up another savings account I decided to test out the newly branded Marcus by Goldman Sachs.

The user experience was about what I expected as the branding around Marcus has always been simple and modern. The signup process was straight forward as they took a minimalistic approach to signup as well as the account homepage. A few screenshots from the process are included below.

Marcus has invested heavily into consumer finance and the newly branded Marcus savings accounts are just one example. Their investment has paid off and it was recently reported that they had $17 billion of deposits. These deposits can be drawn on to fund the personal loans branded under the same name. Since Goldman Sachs acquired GE Capital’s retail deposits, deposits have grown a whopping 90%.

Conclusion

With rates where they currently are it is probably a bit too early to get excited with more rate hikes expected this year. However, a strong case can be made for holding your savings account at one of the banks with current rates in the 1.5% range if your bank’s rates are significantly lower. Current CD rates for 1 year are hovering around 2% while 5 year CD rates at the large institutions are around 2.60%. It’s important to be aware of these options and weigh the risk and rewards of each. For me, I am keeping an eye on CD rates as they approach the mortgage rates on my home and investment properties. If I can earn what I am paying in interest on a mortgage I have the additional benefit of the cash cushion for emergencies.

Have you made any changes as rates have increased? Where are you parking cash? Let us know in the comments section below.

Lending Club Announces Launch of Next Generation Credit Model

Lending Club outlines what's new in their fifth generation credit model in an email to investors.

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Today, Lending Club announced a new credit model in an email to investors. According to the email, this is the most advanced and predictive credit model ever used on the Lending Club platform. This is Lending Club’s fifth generation model that began to go in effect on September 8, 2017 and will roll out to all borrowers in the coming days. While Lending Club historically has made improvements to their credit models, the new model caught our eye for a few reasons.

The company outlines that the model further leverages machine learning along with the 10 years of data on 1.5 million borrowers they have accumulated. The new model is 24% better at differentiating the likelihood of a borrower charging off compared to the fourth generation model. It also includes more data points, and uses new custom attributes that Lending Club states are predictive in assessing risk. Lending Club provided the two below examples for these custom attributes:

  • Instead of using aggregates, the new model uses very granular views of credit data which discern individual borrower actions vs. a simple aggregate (e.g. a borrower’s credit card balance per credit card vs. his total credit card balance).
  • The model makes more extensive use of trended data, which provides insight into a borrower’s credit behavior over time rather than a snapshot into a borrower’s credit behavior at a point in time. Dozens of new custom variables like these improve the model’s predictive power and are proprietary to Lending Club.

It also appears that Lending Club is continuing to tighten their credit criteria for higher risk borrowers with a shift to higher quality loans:

We expect loan volume to shift toward higher quality grades (grades A and B) because some borrowers will qualify for lower interest rates under the new model, and other higher-risk borrowers, who may have received an offer previously, will be screened out.

Lending Club has made a lot of changes to both credit criteria and interest rates over the last couple of years. We shared the trend of increasing interest rates in a blog post earlier this year. Following poor loan performance that started late 2015, the company began increasing interest rates. They also publicly announced that they identified pockets of loans that were underperforming last year. Lending Club is now tightening credit even more with the reduction of higher-risk borrowers.

LendingClub also noted that they are seeing lower delinquency rates across grades and terms in the existing loan portfolio than in the second and third quarters of 2016. This is good news for investors.

In a blog post, Lending Club provided updated projected returns based on the changes. Returns range from 4-9% and expected charge-offs platform wide have decreased from 6.2% to 6.0%.

Conclusion

One of the main advantages that Lending Club has over their competitors is the amount of data that their 10 year history provides. It appears they have taken a closer look at their underwriting models which now is leveraging machine learning even more. We’ll have to wait and see whether these recent changes provide a meaningful increase in returns for investors. It will also be interesting to see how the platform mix changes and how originations are affected in the coming quarters.

Lending Club and Prosper Interest Rates, Loss Curves and Loan Performance

With recent interest rate changes and economic uncertainty, we look at the latest Lending Club and Prosper loss curves.

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LendingClub_Prosper_Loan_Performance

There has been a lot of news recently with regards to interest rates and loan performance on the Lending Club and Prosper platforms. While some may argue that these concerns are unfounded, investors are clearly taking an increased interest with the changes going on and the recent market volatility. In this post, I’ll address interest rate increases and then delve into vintage performance at both Prosper and Lending Club, which is the best gauge of performance.

Below are stories that received a lot of press, leading to additional speculation of poor loan performance:

[Read more…]

Lending Club Raises Interest Rates for New Borrowers

Reacting to the Fed's 0.25% interest rate increase last week Lending Club raises their rates by an average of 0.25%.

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Lending Club Raises Interest Rates

How rising interest rates would affect marketplace lenders has been a question that many people have been asking for a long time. Demand for loans, credit performance and supply of capital to the platforms are all things that may be affected as interest rates increase. Today, we found out how the leader in marketplace lending is going to react. Lending Club announced in this press release today an average interest rate increase of 0.25% for all new loans going forward.

Last week, the Fed raised rates 0.25% for the first time in nearly a decade. Now this was a very minor move, but it is important symbolically as it gives us a window into how marketplace lenders will respond to interest rate increases. Renaud Laplanche, CEO of Lending Club, has regularly gone on the record to state that Lending Club is not interest rate sensitive at all.

This suggested that Lending Club’s marketplace continues to operate in an equilibrium. As short term credit interest rates increase, Lending Club will charge their borrowers more, thus passing on higher yields to the investor. And that is precisely what they are showing by this move today. [Read more…]

Harmoney Celebrates One Year in Business and NZ$100 Million in Loan Volume

New Zealand's first P2P lending platform has a great first year in business achieving their goal of deploying their $100 million of committed lending capital.

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Harmoney New Zealand

You could fit the entire population of New Zealand (4.5 million people) in the New York City boroughs of Queens and Brooklyn. It is not a big country and certainly not where you would expect to find one of the emerging world leaders in marketplace lending. But Harmoney, celebrating their first year in business, is quickly becoming a force to be reckoned with.

I caught up with the Harmoney team this week to discuss their one-year anniversary and get an update on how they are doing. When I covered their launch 12 months ago I said they were the first platform I had ever seen launch with $100 million in lending capital before making a loan.

At that time they said they would deploy that entire $100 million in their first year. True, to their word, CEO Neil Roberts shared that they crossed that milestone two weeks ago. Here are some of the highlights from Harmoney’s first year in business:

  • $1 billion in loan inquiries
  • $100 million in approved loans
  • 7,200 loans issued ($14K average size)
  • 10,000 retail investors, 3,000 logging in several times a day
  • 100,000 accounts created on their website

Harmoney was the first platform to be granted a P2P lending license by the New Zealand regulator, the Financial Markets Authority (FMA). The FMA has since granted two more licenses but Harmoney is the only company operating today. They have also recently been granted an Australian Credit License and will be launching operations there shortly.

Strong Interest from Retail Investors

[Read more…]

An Updated Look at the Risks of Marketplace Lending

This financial advisor thinks the risks of marketplace lending have changed over the years in part due to lower interest rates offered by the platforms.

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[Editor’s note: This is a guest post from Matt Shibata, a Portfolio Manager at Morling Financial Advisors, where he provides investment advice and allocates to variety of asset classes, including marketplace lending. He also writes on investment topics at his blog ThoughtfulFinance.com.]

Several years ago, I wrote a two-part guest post about marketplace lending as an investment asset class. It has been truly amazing to watch the industry’s growth and see how widely marketplace lending is now accepted as a bona fide asset class. The industry’s maturation has mitigated many risks, but I also believe that the rapid growth and increasing competition has increased other risks.

The primary risks today, in my opinion, stem from the decline in lending rates. Although rates were declining in 2013 (when I first invested in and wrote about marketplace loans), rates were much higher then. Today, rates have already come down significantly and continue to decline. Lower projected returns translate to a narrower margin of safety. Many, if not all, of the below risks have existed for quite some time and have been widely expected at some point, but they warrant more caution now due to today’s lower and still-declining rates.

Loan Refinancing

One factor that has been driving down returns has been loan refinancings, which represent a conflict of interest between investors and the platforms. Investors would generally prefer to hold performing loans to maturity in order to maximize returns, whereas the platforms are incentivized to originate as many loans as possible in order to maximize revenue. These are not mutually exclusive interests, but the platforms have been actively soliciting existing borrowers to refinance their loans at lower rates for the past several years. This is not inherently wrong (it’s great for borrowers), but investors should realize that a conflict of interest exists and that their loans are callable at any time (which is detrimental during a period of declining rates, since reinvestment returns will be lower). Orchard Platform recently posted a good summary of this issue here.

Loan Quality Questions

As more platforms go public, the pressure to grow continues to increase. Growing loan volume needs to be carefully weighed against maintaining loan quality. My observation is that both the pressure to grow and the huge demand for loans has led to a loosening of underwriting standards. We are seeing explicit examples, such as “high yield” offerings and euphemistically named “near prime” loans. But several sources have also confirmed that at least some platforms are now accepting less borrower documentation than they have in the past. My hope is that the technology used in place of traditional underwriting methods is robust enough to make up for the weaker verification processes. Only time will tell.

Questionable Practices in the Corners of Business Lending

The 2015 LendIt conference in New York (highly recommended!) was a great showcase of the industry and I met a ton of interesting people and learned about many marketplace lending platforms that focus on business lending. However, a few of the business lending platforms and funds were extremely aggressive. I am not trying to be moralistic, but it was honesty difficult to tell whether some of the platforms were helping or exploiting borrowers. A more economic concern is that several claimed that their high-degree of collateralization mitigated a lot of risk, but further questioning about recovery rates called many of these claims into question. This certainly does not apply to the entire business lending segment, but I would encourage investors to research any platform and/or manager that they are considering.

Investor Risk Analysis

The platforms’ risk models appear much more robust, but my guess is that many individual investors rely on some of the public commentary that compares the credit risks of marketplace lending with the credit risks of credit cards. This is an imperfect analog, at best, since revolving consumer credit (like credit cards) is fundamentally different from non-revolving personal loans (like marketplace lending) on many levels. For instance, a troubled credit card customer has an incentive to continue paying their monthly bill so that they can continue to use the card. A marketplace lending borrower does not have that incentive. This is not a prediction that marketplace loan loss rates will exceed credit card loss rates in the next economic downturn (although they may), but I would encourage investors to consider possible losses carefully.

Conclusion

As “peer-to-peer lending” matures towards “marketplace lending,” the high returns of early-adopters are now trending down towards market-driven ones. I believe marketplace lending will provide positive returns for quite some time, but the margin of safety is narrowing and its relative value to other investable markets has diminished as well. My hope is that all parties protect the integrity of the asset class, to ensure its long-term viability. Of course, hope is not a prudent investment strategy, which is why I am writing this and encourage all marketplace lending investors to recognize and weigh the risks along with the opportunity.

Full Disclosure: I advise clients on private investment vehicles dedicated to the marketplace lending asset class, as well as personally own loans on both the Lending Club and Prosper platform. I am also a client of NSR Invest.

A Visit With Prosper

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Prosper New Officce Reception

This week saw my first face-to-face meeting with Prosper management in several months and there was a lot to talk about. So, on Tuesday morning I sat down with several of their senior managers for an in depth conversation.

This meeting was my first in their shiny new offices (pictured above); Prosper has moved across town to the SoMa (south of Market St) district of San Francisco. While their previous offices were in a beautiful historic building I like the new space better. It has a more modern feel that is more fitting to a cutting edge company like Prosper.

When I last met with the Prosper executive team they were 20 days into their new jobs and president, Aaron Vermut, was yet to come on board. They talked about hitting the ground running with their 100-day plan and righting the Prosper ship that had been struggling for several months. Now, we are more than 200 days into their tenure and they reported everything on their 100-day plan has been accomplished and they are ahead of schedule on many items.

They provided a list of some of their recent accomplishments:

  1. Switch to FICO from Scorex (more on that later)
  2. New borrower funnel to increase conversions
  3. Sustained growth in new loan volume
  4. New API for investors
  5. Simplified data download for investors
  6. New internal accounting system
  7. New and less expensive office space
  8. Settlement of the class action lawsuit

Prosper now has 77 full time employees in their San Francisco office. They also have retained an outsourcing firm that provides them with 24 independent contractors (full and part time) in a Texas call center dedicated to supporting the borrower funnel in the gathering of documentation, a very time consuming and labor intensive process. This call center provides a similar service for companies like American Express and Sallie Mae.

[Read more…]

New Fund Invests in Small Business Loans

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[Update: Brendan Ross was arrested in August 2020 and Direct Lending Investments was placed into receivership. Court cases are ongoing but needless to say his company is no longer a going concern. More here.]

Those of us that have been following the p2p lending industry for a while will recognize the name IOU Central. Back in February 2008 they became the first p2p lending company to launch in Canada. In late 2008 they opened an office in Atlanta to service the US market.

But their foray into p2p lending didn’t last very long. After dealing with similar regulatory issues that plagued the start of Lending Club and Prosper, founder Phil Marleau decided to pivot into an opportunity that he thought would be more lucrative: small business loans.

Not only did IOU Central switch from consumer to business loans they also decided not to pursue the p2p lending model, preferring instead to pursue a direct lending model. In December 2009 they had issued their first business loan. To give you an idea of their growth and volume, in 2012 they issued $11.5 million in new loans and in just the first quarter of 2013 that number was $8.7 million.

These are not loans made to high-risk startups – these are all established businesses looking for credit. The most common type of business is a doctor or dentist office. The average age of the businesses obtaining a loan is around 12 years and the owners all have good personal credit. The average loan size is $39,000 and most borrowers choose a 12-month loan duration (there is also a 6-month option).

The Direct Lending Income Fund Launched in October 2012

Now, to the investing side of the equation. Brendan Ross of Ross Asset Advisors launched the Direct Lending Income Fund in October 2012. This fund purchases small business loans issued by IOU Central.

Many of you may remember Brendan Ross from my interview with him last year. He was the first registered investment advisor to invest in LC Advisors and he has also invested his clients’ money in funds that invest in Prosper. He has been very bullish on p2p lending from the beginning. So why has he started a fund dedicated to small business loans? When I asked him that very question he sent me a detailed reply.

I’ve been an investor in P2P since Lending Club first created institutional vehicles in March of 2011. I’ve since put personal and client money into almost every fund that has grown up in this space. I reached the point where I couldn’t responsibly own more P2P consumer loans, but I wanted more private debt.

I knew that web-based underwriters could succeed wherever banks were failing to meet demand, and I knew in my gut that loans to local, established businesses were what was next. Starting in March 2012, almost exactly a year after I put money into consumer loans, I began doing serious research into the existing web-based underwriters whose focus was local, established businesses.

Although the Fund has a mandate to be multi-platform, I chose to start with IOU Central because they are a public company, their management team is strong and supportive of what I am doing, and they have been loaning money since Q4 2009 with excellent results.

I started the Direct Lending Income Fund because I wanted to put personal and family money to work in the business loans asset class. I lined up friends to join me during the first six months, when the Fund would be less proven. Now the results speak for themselves, and I’m typically running a 30-60 day waiting list for new investors.

The results that Brendan is talking about here are annual returns in the low to mid teens. This is what caught my attention when I first started looking at his fund.

IOU Central is not a P2P Lender

There has to be a catch, right? Unfortunately, IOU Central is not available as an investment for the general public. At this time it is only available through Brendan’s Direct Lending Income Fund and the minimum investment is $100,000.

So why am I writing about this if it is not about p2p lending? Because I believe it is a great investment that offers a predictable, high yield. This year I am expanding my focus beyond true p2p lending to other areas of direct investment. Most of the readers here are investors looking for opportunities for yield in this prolonged low yield environment.

What are the Risks?

Like any investment there are risks. In fact there are 18 pages in the fund’s Private Placement Memorandum going into great detail about all the risks involved. For example, we could have another financial crisis that could send default rates up dramatically or IOU Central could go bankrupt which could cause loss of principal, just to name a couple of the risks.

IOU Central has gone to great lengths to ensure investor’s money is as safe as possible. They file a UCC against the assets of the business for every single loan they make. Also, they obtain personal guarantees from the owners of the business. So, in effect these are secured business loans.

I Have Invested $100,000 in This Fund

This fund is not for everyone. For starters, it is only open to accredited investors. And if you are not a qualified client (see definition here) then you pay slightly higher fees.

I researched the Direct Lending Income Fund extensively including a long sit down with Brendan Ross going through the IOU Central platform and looking at the loan history. I decided to make a $100,000 investment in this fund.

To Find Out More

If you are an accredited investor and want to find out more you can fill out the contact page on the Direct Lending Income Fund site and Brendan will get back with you.

I only share investment ideas with you that I believe in and that I have invested in myself. This post is not a paid endorsement; I am sharing it with you because I have made this investment and believe it is a good opportunity. But please read my disclosure below.

Disclosure: I am by no means suggesting that you should make an investment in this fund. I want to make it very clear that this article is not investment advice. You should always check with a financial professional before making any investment decisions.

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