This Financial Advisor is Very Bullish About P2P Lending

Brendan Ross is one of the few financial advisors who gets p2p lending. He is the principal of Ross Asset Advisors based in Los Angeles and I chatted with him recently about his practice and his p2p lending investments. An edited transcript of the interview is below.

SLN: Tell me a bit about your practice. How are you different from other financial advisors?

Brendan Ross: Five years ago I looked a lot like my peers. I used a combination of index funds and a buy and hold strategy to get the maximum return for my clients. Then came the financial crisis and that changed. Now, my clients are looking for a “Sleep Well at Night” portfolio where they don’t have to worry about their portfolio dropping 50% over the course of a year. But they still want a portfolio that grows – they certainly don’t want to have the same amount of money in 10 years time as they do today. Which is really where we have been in the stock market. The S&P 500 is not back yet to the levels that were reached in early 2000. Now, with the huge government debt that we have, it concerns me that over the next 10 years we will continue to move sideways. So the stock market isn’t attractive and the bond market is yielding just 2% to 3%. That means you are getting very little there for all the interest rate risk you are taking by buying bonds.

SLN: So where are you investing your clients money?

BR: I like municipal closed end funds – these funds are yielding 6% tax-free and I like p2p lending.

SLN: Why p2p lending?

BR: You have credit card companies charging people an average of 14% with a default rate around 4%, which gives a 10% return. Now along comes Lending Club and Prosper and they are charging investors just 1% to in effect rent their underwriting model. That is a good deal for investors. Consumer loans are a $798 billion industry and until recently there was very little opportunity for individual investors to participate in this industry.

SLN: When did you get interested in p2p lending?

BR: I have been paying attention to the space from the very beginning. Innovations in finance interest me, so I was aware of both Lending Club and Prosper from their inception. But there were some elements missing, that an institutional investor would want to see, until March of last year with the launch of LC Advisors. This new vehicle from Lending Club was the first to create bankruptcy remoteness, an important technical requirement for many institutions.

SLN: How do you invest in Lending Club and Prosper?

BR: For Lending Club I invest with both of their LC Advisors funds and at Prosper I often use a hedge fund called Colchis to invest in Prosper notes. I think of my Lending Club investment as more like an index fund and my Colchis investment as an actively managed fund.

SLN: It is clear you are bullish about p2p lending. So I am curious to know if you are still treating this as an alternative-type investment with your clients and keeping allocations small?

BR: We are doing larger and larger allocations to p2p lending for clients and less in equities and bonds.

SLN: Why has p2p lending failed to gain much traction with financial advisors so far?

BR: Financial advisors at large firms are typically not allowed to use alternative investments because the liability is too great and at smaller firms advisors find these kinds of investments a hassle to manage and stay on top of from a due diligence perspective. It is just easier to put people into traditional investments.

SLN: Do you talk with your fellow financial advisors about p2p lending?

BR: There is plenty of opportunity for financial advisors to develop expertise in this area. The general pushback from most financial advisors is that it is new and it is just not necessary. They don’t have to offer it in order to keep their clients happy. But for me, I have been investing in Lending Club and Prosper in my own portfolio and like to give my clients the best of what I own.

SLN: What do you think might happen to p2p lending returns if we have another recession?

BR: If I was to guess what would happen to returns if unemployment went from where we are now which is around 8% to say 10% or 12%, well I think returns would drop, but they would stay positive. I would think that a fund like the Broad Based Fund at LC Advisors would drop from around a 10% return today down to the 4%-6% range, still a decent return. Meanwhile the corporate bond market would be down 20% and equities would be down 30%.

SLN: As p2p lending becomes a more mainstream investment do you think returns can be maintained at their current levels or do you expect a decline in coming years?

BR: That is a good question. The only way I can see investors experiencing a sustained drop in returns would be if interest rates went down for consumers borrowing money. Now, I don’t believe that the credit card companies will lose pricing power any time soon and certainly not because of the impact of p2p lending for at least 10 years.

SLN: Anything more to add about p2p lending?

BR: People think p2p lending is new and therefore it is risky, but consumer lending is not new at all. What is new is that individual investors now have the opportunity to get returns that the credit card companies have been enjoying for decades.

Subscribe
Notify of
24 Comments
Oldest
Newest Most Voted
Inline Feedbacks
View all comments
Dan B
Dan B
May. 3, 2012 8:34 am

So who is going to explain the “bankruptcy remoteness” comment & why it may or may not provide us any comfort?

RJL
RJL
May. 3, 2012 9:44 am

Dan — good point. Do they have protections that average investors do not? I’m a huge fan of P2P lending but in both companies I sense — as with most investments, regrettably — that the game is quietly tilted toward financial institutions / big money. For example, residents of certain states are ineligible to invest … unless you are a hedge fund or accredited investor! It’s a tough balance for Prosper and LC, because they pride themselves on being platforms for average folks but they realistically need the big money to grow their businesses. In the end, I guess if big money adds credibility and stability to the platforms, it’s good for everyone … as long as individual investors continue to have equal access to quality loans.

Dan B
Dan B
May. 3, 2012 7:19 pm

One would hope expect & assume that IF there is a way to clarify & solidify the rights of lenders, that it should be something that is made available to all lenders, not just the well heeled or the institutional.

While it certainly is true that larger lenders & institutional lenders routinely get perks everywhere,……………it is also true that without the many small individual investors that have supported Lending Club since their Facebook origins 5 years ago, LC would likely be nowhere. These same smaller individual investors have in fact “made” Lending Club viable & put them in a position to recently attract the interest of larger institutional investors………………..instead of just being laughed at & shown the door. Some well deserved consideration to the smaller investors would therefore be entirely appropriate.

Brady
Brady
May. 3, 2012 11:29 pm

Here is how I believe all of this works. (**I’m no expert in what I’m about to talk about and some of this is speculative due to lack of information on how LC has set this up.**)

From Lending Club’s prospectus: “The Notes are unsecured and holders of the Notes do not have a security interest in the corresponding member loans or the proceeds of those corresponding member loans.” That’s us. We are investing in unsecured, subordinated, uninsured debt. If LC became bankrupt, we’d be pretty low priority.

Now, watch this video on collateralized loan obligations:
https://vimeo.com/10220256

“John” in the video is LC Advisors, which is a special purpose entity created and owned by Lending Club, legally structured as a bankruptcy remote entity. That means if Lending Club becomes bankrupt, fewer hands can go after the debt obligations owned by LC Advisors. According to Lending Club’s prospectus, at times LendingClub may fund member loans directly on the platform and they do so without purchasing notes. That’s probably LC Advisors chunk of the pie, which is also probably secured / insured. Our friend Brendan is one of the investors in LC Advisors securitized debt vehicle.

Lending Club is very happy to sell their debt us and LC Advisors for a pretty balance sheet and they can remain focused on their primary objective – making money from service fees based on transactions that occur on its marketplace.

Louis Lamoureux
Louis Lamoureux
May. 4, 2012 8:57 am

We used to have a senior claim to the notes in the case of an LC bankruptcy, but then LC made a change to their prospectus that gave their debt holders senior status in the case of a bankruptcy. Meaning those institutions that held LC debt when LC went bankrupt could grab the notes you and I hold. “Bankruptcy remoteness” sounds like LC Advisors has the senior claim that we used to enjoy.

Lou

Dan B
Dan B
May. 4, 2012 3:26 pm

Let me be clear………….The problem I have with this isn’t that there’s always been this un-clarified, un-chartered situation that could occur with these notes in the very very unlikely scenario where Lending Club goes under. This is something that I’ve known from day one as a LC investor & it’s a risk that I’ve accounted for. My problem is that after the rules have been laid out & understood Lending Club has apparently rewritten this one rule in order to make it beneficial to a particular segment of their lenders. And who is in this particular segment? Were these Lending Club’s founding members who have been with them from the start? No, in fact these were people & institutions who just joined. What kind of crap is that?

One other thing……….this is not strictly a big money gets special perks situation as Peter suggested earlier. Lending Club has a number of big money individual investors who do not invest through LC Advisors. It is my understanding that some of these long term individual investors have account balances of over $1 million, a few of them even more. These investors are mostly in Prime & invest through the platform just like the rest of us. So do these guys get the added protection that apparently is available to LC Advisor clients? Why or why not?

Chris
Chris
May. 4, 2012 7:56 pm

This ongoing confusion of “what EXACTLY happens to our investment (both cash and notes held) if LC/Prosper goes under” is the NUMBER ONE reason I cannot in good conscience shift more of our company’s assets into P2P lending notes. Prosper maintains a similar level of low transparency on this topic and it is really frustrating for individual investors and institutions alike.

I have high hopes for the P2P industry but there is a lot of money sitting on the sidelines and will remain there until investors know with complete confidence what happens to monthly note payments if the either platform were to go under. After all, LC/Prosper are babies in comparison to the size of established Fortune 1000 companies that have crash and burned in recent years.

Lou lamoureux
Lou lamoureux
May. 4, 2012 8:40 pm

Chris, there is no confusion. If LC goes bankrupt then note holders are subordinate to LC debt holders. it’s in the prospectus. The debt holders pick the company clean and then take over the payments we are supposed to get. You get to keep any cash in your account though.
Lou

Dan B
Dan B
May. 4, 2012 9:45 pm

Lou………….Although what you say is technically correct the reality in that eventuality is that it’ll end up in court. There is a complete lack of precedence here & I guarantee you that there will be some very strenuous challenges, both legally & politically. Doesn’t Lending Club alone have over 60,000 individual investors already? By this time next year it’ll almost definitely be over 100,000 in total. How about In 2 or 3 years time? Those are not numbers to be sneezed at………..especially when they all have skin in the game.

Unconvinced? When you’re bored read up on how just 30,000 angry British savers in 2008 rewrote the laws & had their accounts 100% reimbursed when the non-insured high interest Landsbanki Icesave accounts went under.

But again, I feel compelled to emphasize that in my opinion the chances of anything like this coming to pass is very highly unlikely.

RJL
RJL
May. 5, 2012 6:06 pm

Peter, do you have the same confidence in Prosper? I for one prefer their platform to LC for various reasons …

Chris S
May. 5, 2012 6:36 pm

@RJL, good question.

, above you state:
“How it all plays out in the end would be anyone’s guess but some kind of bailout would be possible,”

A bailout from whom? The US Government? How or why do you feel that way?

@Everybody, despite how well both platforms have grown, we still have to appreciate the gravity of the fact Lending Club (and I also believe Prosper) are still not actually making a profit. By that measure, we should take no complete confidence everything will be just fine for them now or especially years from now. Promising business models aside, I would like to bring the topic of future unforeseen disasters into consideration such as accounting fraud or management scandals. Everything I have read about both companies and their members of management seem to be very dependable – but how could we say that about future employees of either company? Just two problems such as accounting fraud and management scandals destroyed legendary (and once profitable) firms such as Enron and Worldcom. We have to remain mindful that it can happen to any company and right now we are told from the two main p2p platforms (of which most of us are investing more and more money in) that if they run into any issue causing them to become insolvent – we (not their VC backers or corporate debt holders) may loose everything. That’s like saying I bought a car with my own money from GM and because GM goes bankrupt, GM’s corporate debt holders or investors can come take my car because it has value to help them recover their costs. To that point, I agree with Peter and Dan that there would be broad outrage if such an event transpired – but that doesn’t mean we get to keep our notes, or anything for matter.

I imagine a healthy dose of caution would continue to serve us all very well; at least until the industry fully matures and we know exactly what will happen to our notes held and their corresponding monthly payments if Prosper/LC makes a bad move that could hurt us all.

Sorry to be a “Negative Nancy” everybody… =)

RJL
RJL
May. 5, 2012 7:25 pm

Good points Chris. Despite being uncomfortable with the bankruptcy issue, I can’t say it’s holding me back much from investing. As with any investment there is risk, and I am just as skeptical of stocks and bonds and real estate (and of the various companies selling those investments) as I am of P2P. At some point one needs to trust that the system will not fail completely, while at the same time not putting all one’s eggs in a single basket. People who invested with Bernie Madoff or Enron can’t really be blamed for doing so (they had solid reputations for a time), but those who invested more than they could afford to lose were unwise.

storm
storm
May. 6, 2012 11:41 pm

This is a great discussion. It has been a while since I’ve read LC’s prospectus, and it seems the language is a bit more dire than I remember. I don’t know much about bankruptcy laws, but I’m wondering if a bankruptcy judge would be required to put secured creditors first, or there is some legal leeway.

This discussion has certainly made me reconsider my investment choices the last few days, but I’m not sure I would feel any safer with bonds or stocks. Even with a couple of college accounting classes under my belt, corporate accounting still makes very little sense to me. I recollect how Enron and Worldcom were able to hide their losses from auditors and investors until it was too late. Employees at Lehman Brothers were cleaning out their desks while the company still had an excellent credit rating. In the few years I’ve dabbled in the stock market, I never enjoyed any lofty gains that all those free financial advice websites say I should expect…at least not in the last decade or so. Is it a conspiracy against the middle class investor? That is hard to say, but I certainly feel that it is not for me.

What I do know is I understand the consumer loan process. I’ve taken out loans and loaned money out to my family. I understand how my credit history is rated, and how I can improve it or ruin it. It is some comfort that other individuals are rated the same way and have to play by the same rules. For once my money is making money, and it feels really good to help others out of the credit card trap.

I guess I always knew that my P2P lending investment may go up in flames. If it happened, it wouldn’t send me to the poorhouse, but I certainly wouldn’t let it go without a fight. P2P lending still seems like the best investment for me, but I feel a greater need to ensure I’m diversified outside of P2P lending as well.

Dan B
Dan B
May. 7, 2012 1:16 am

Apart from the whole LC Advisors situation, it is important to note that there isn’t a single item that has been brought up here that hasn’t been brought up here previously, & discussed/debated at great length on several occasions, a year, a year & a half ago.

I know this for a fact because I have been one of the loudest voices who has hammered away, perhaps too diligently at times, at the potential risks of p2p investing during these past few years. Believe me when I say that I’m no p2p cheerleader. Some here even questioned why I was here in the first place. Back then I was urging a good deal of caution not because of any imminent danger but rather because I felt that there wasn’t enough discussion of the dangers. Coupled with that seeming “innocence” was a certain euphoria of expectations for unrealistic returns that seemed to permeate the small number of blogs that were covering these new investments.

As expected much of that euphoria has dissipated over time or been brought back down to earth by the realization that return percentages after 6-7 months investing are almost always rosier than after say 2 years, or more. This sobering up is a healthy thing. Unfortunately one of the side effects of this sobering up is that it has made some investors revisit the old fears of possible insolvency, possible frauds & what have you…………….without perhaps understanding that the possibility for these scenarios have actually decreased substantially! Furthermore, all signs suggest that these dangers will continue to recede as p2p investing continues to gain credibility, respectability & like I mentioned before, the large increase of individual investors that I see coming in the next few years.

The reason I’ve engaged in this trip down memory lane is that if I was a potential investor reading this topic I probably be scared away or it would at least give me serious pause. So for what it’s worth let me be clear about where I stand. Even with the risks brought up & discussed a couple of years ago, I thought that this was a good investment. Today, as I see it, the risks are substantially less, making this overall an even better investment.

Disclosure………..I’ve been an investor since October 2009 & currently manage 5 accounts totaling $180k, all of which are returning 12.5% or higher.

scott
May. 9, 2012 7:46 am

There was a new p2p player out of NY I think you mentioned in the winter . WHo are they an are there any other national players besides LC and Prosper

Financial Advice for Young Professionals

I think what’s holding me back the most from investing more money is the infancy of peer to peer lending. As others have stated, not much has gone wrong since this type of investment came out.

A lot of people seem to be expecting these investments to have the same security as a CD or savings account?? I’m getting a return 10 x higher than my best CD at Ally! Any time you can achieve this, there will be some major inherent risk. That being said, I’m young, willing to take risk, so I’ll probably be putting 5k into a Roth IRA this year and seeing how that goes.