what kind of returns [inclusive of defaults], less fees are you guys getting?
I was always under the impression that P2P/microlending was a collection of unsecured loans that the banks wont touch so the default rates can be 5% + [credit cards have a historic 3% or so avg, I presume these are as bad or worse]
like say LC/prosper takes a 1% fee, you get a 6% note or something, and have a 5% default, leaving you about even, with a pretty substantial risk profile. Perhaps you string together a couple lucky-years in a recovering economy and it looks good, then when the economy turns a bit you get stuck with a stash of bad loans and you've got nobody to insure your losses [unlike the banks].
Am I wrong about this? Sounds like un-compensated risk to me. Junk Bonds in an index look safer.
Here's the Cliff Notes version of the deal:
- Unsecured consumer loans for terms of three years (although in some cases it could be five years).
- Default rates ranging from 2% to about 4%, but that depends on the quality of the borrower. Defaults rise pretty closely with interest rates.
- Defaulted borrowers get hammered on their credit reports, just like walking away from a credit card or a mortgage. Rather than default, it's in their best interest to file for bankruptcy (because they're unsecured loans).
- ~10% of borrower's applications are approved.
- ID theft on applications is so low as to be insignificant (35 cases for LC out of thousands of borrowers).
- LC pulls a credit report and a FICO score. Everything else is taken at the borrower's word (including stated income). In situations where LC has asked borrowers for additional verification, 40% of those borrowers have declined to provide it. I see this as the majority of borrowers being honest.
- LC takes 1% of the payments. They also take a fee from the borrower, and they take a fee from collections of late payments. (LC is just the servicer.) the yields that are reported from their website are assuming that the loan is paid back on time (no late fees) and those numbers are reported after LC's fees have been deducted.
- LC and Prosper have been through the 2008-09 recession. Their theory is that defaults won't be any worse than those from that era. If defaults are rising then their interest rate committee will raise rates to compensate.
Before you respond "Yeah, but..." to any of the foregoing, I recommend that you read the prospectus below.
Both major companies have sucked down millions of venture capital and are not profitable. (Although LC had positive cash flow last quarter.) When Prosper closed their latest round, the VCs cleaned house on the board and in the exec suite. Maybe the company will get back on the fast-growth track, or maybe they'll need another 6-12 months to recover. Both have backup entities that would continue to service the loans if LC or Prosper went bankrupt. If a BK were to occur it is unclear whether borrowers would continue to pay, and whether the entities could pick up servicing without an "interruption", and what the bankruptcy lawyers would try to do with the setup. I'd bet that accounts would be frozen for several months, and there would be unsettling "processing delays". But that's just my opinion.
Loan funding is rising at a monthly increase in double digits. The "problem" is that LC is understaffed and can't process the applications quickly enough. Right now, too many lenders are chasing too few loans. This is going to lead to quality-control problems with borrower applications.
I think the primary attraction of P2P lending is the tremendous amount of data and analysis tools available to the retail investor. Lenders get a really cool website with plenty of power tools and lots of ways to slice the data. We hands-on control freaks can even read the personal
pleas statements of the borrowers and make moral judgments on their financial lifestyle choices. The illusion of control is very powerful, and it reminds me a lot of the early days of online brokerages or The Motley Fool.
I'll let Brewer analyze the relative benefits of junk bonds vs LC. They're two completely different assets and I don't think you're going to get an answer that'll make you happy. The only realistic answer is to diversify-- if you think one is better than the other then buy more of it.
For those who like to read 100-page prospectuses, here's one:
https://www.lendingclub.com/fileDownload.action?file=Clean_As_Filed_20121128.pdf&type=docs