p2p lending
Invest in Marketplace Lending in 2016 (New Year’s Resolution)
January 4, 2016
The story of 2015, at least according to CNN, was that 70% of investors lost money. The big winners were apparently people that didn’t invest at all or those that took humongous risks. Millennials are notorious for being perpetually pessimistic about the stock market and headlines like these probably don’t raise their spirits. And while there’s nothing wrong with caution and skepticism, there’s really no reason that 2015 should’ve been a losing year, especially for such a large percentage of people.
Peer-to-peer lending evangelist Peter Renton is earning more than 10% a year through his Lending Club and Prosper investments. And he’s not an anomaly. The majority of Lending Club investors are earning above 5%, including myself as shown below as the dot compared to everyone else:
After splurging on very high risk notes in 2014, I’ve since settled on a strategy of only A & B-rated notes for individuals making more than $85,000 a year. Since July of 2015, my notes have been purchased automatically by LendingRobot based upon the filters I’ve programmed in. Thus, marketplace lending has become a rather passive investment for me that runs in the background and it should for you too, especially if you work in the alternative lending industry.
In May and June of last year, we told you to break out of your bubble. If you didn’t heed those words, maybe the new year will give you the excuse you need to give marketplace lending some consideration.
Over the last two years, I’ve personally invested nearly $75,000 in consumer debt through Lending Club and Prosper, entirely in $25 increments. Suffice to say, I didn’t lose money on these in 2015. The monthly principal and interest payments from them are constantly reinvested into new loans on a daily basis, compounding my earnings. It definitely beats not investing at all, which is apparently what a lot of people did last year.
Even if marketplace lending isn’t for you, you can earn a few hundred basis points less per year with an FDIC guaranty. 5-year CDs are paying up to 2.42% right now. Back in June I wondered whether or not the risk undertaken with consumer debt was worth a few extra percent a year, especially considering how these notes are taxed (you may only be able to deduct up to $3,000 in losses per year).
I guess you could say that I decided it was worth it. My new investing strategy takes the $3,000 loss cap in stride because the number of A and B-rated notes (which are all I buy now) that default are very low. In fact, I’ve never even had an A-rated note default in the two years I’ve been investing.
The one disclaimer I will add is that I did indeed invest more money in mutual funds (stocks) in 2015 than I did in marketplace lending. While I enjoy the reprieve from daily volatility that Lending Club and Prosper notes bring, it’s important to never lose sight of the fact that those investments are ultimately in Lending Club and Prosper themselves. Originally envisioned as peer-to-peer, both companies actually just issue bonds to investors that are backed by nothing other than the performance of chosen loans. So if Lending Club and Prosper blew up tomorrow (or worse), it might not matter how all those loans were performing. If the secret to investing is to diversify, then you should treat your total investment on a marketplace lending platform as if it were a single stock. That’s precisely why I won’t open an IRA with Lending Club or Prosper, even if the tax advantages would be better.
Nevertheless, as my mutual funds were flat for the year, my marketplace lending portfolio pushed me forward. At the very least I plan to reinvest all the payments from my portfolio this year into new notes on a daily basis. If you were discouraged by the headlines that 70% of investors lost money last year, you should consider complementing your stock portfolio with marketplace lending this year.
Consumer debt might seem like an odd choice for an individual to invest in, but once you get the hang of it, you’ll eventually consider it to be an integral part of diversification.
Lending Club Gets More Aggressive With Direct Pay
December 28, 2015
Lending Club’s maximum debt-to-income ratio eligibility level until now had been 30%. But under a new pilot program called Direct Pay Loans, borrowers whose DTI is as high as 50% can now get approved. But there’s a catch…
The Direct Pay Loan program “requires a borrower to use up to 80% of their loan proceeds to pay off outstanding debt,” according to a notice published by the company. They’re not trusting the borrower in these cases to do that on their own either. Lending Club will actually be the ones making the payments on the borrower’s behalf.
The move is reminiscent of a fairly common practice in the commercial financing industry where liabilities such as past due rent and tax liens are payed by the funding company directly.
It’s unclear if the ultimate goal is to be able to lend to more risky borrowers or if this is an experiment to determine if paying directly reduces the odds that a borrower will lie about how they intend to use the proceeds.
As of September 30th, 2015, Lending Club reported that 67.7% of their borrowers used their loans to refinance existing loans or pay off their credit cards. Since that’s based entirely on what box applicants select on the online application and isn’t actually verified, it’s possible that no borrowers actually refinance or pay off anything. With this being the case, Direct Pay may help Lending Club force their borrowers to hold up their end of the bargain.
National Security Could Prove to be Alternative Lending’s Achilles Heel
December 11, 2015
While alternative lenders debate disclosure policies, stacking, and the cost of bad merchants, there’s a new regulatory threat taking root that no one seems to be able to slow down, national security. Ever since it was revealed that one of the two terrorists in the San Bernardino attack received a $28,500 loan from the Prosper Marketplace, government officials and the public at large are pointing fingers at online lenders.
House Financial Services Chair Jeb Hensarling said on Thursday that, “clearly the financing link to terrorism is a critical one.” As quoted by Politico, “everything’s on the table,” he said when asked about further scrutiny of online lenders.
His sentiment echoes other responses, some of which are clearly emotionally charged and accusatory. LendAcademy’s Peter Renton for example wrote, “I have had to answer such ridiculous questions as, is P2P lending going to become the new way for terrorists to get funding?”
With so much misinformation now floating around out there about online lenders, conspiracy theorists are even claiming that it would be impossible for someone earning $53,000 a year (As Syed Farook did) to get an unsecured loan for $28,000, the implication being that there is something more sinister going on. Of course those that work in the alternative lending industry, including myself personally as someone who invests on the Prosper Marketplace, know that’s not true.
But before the experts can be called on to answer the questions, those motivated to protect this country at all costs (with noble intentions) are rallying around swift and immediate consequences for online lenders such as Prosper.
“The issue may end up being whether marketplace lenders are too easy of a source of cash to finance terrorist attacks,” said Guggenheim Partners analyst Jaret Seiberg in a research letter.
In an article published by The Street, writer Ross Kenneth Urken basically likened Prosper Marketplace to Silk Road where bitcoins were used to buy drugs, weapons, and killers for hire.
Breitbart News, a right-wing news website, led in with an even bigger headline, San Bernardino: Has Islamic State Hijacked Consumer Loans?. It quickly sums up the story by insinuating that online lenders will become the funding tool of choice for ISIS. “The San Bernardino terrorists, Syed Rizwan Farook and his wife Tashfeen Malik, funded their killing spree with a debt consolidation loan, raising questions about whether terrorists might use popular consumer loans to fund their activities,” Breitbart wrote.
And the International Business Times argued that Utah industrial banks are aiding terrorism. “Meanwhile, industrial banks in Utah are taking full advantage of the lack of regulation in the peer-to-peer lending market while they still can, aiding potential terrorists along the way,” author Erin Banco concluded.
According to the WSJ, the House Financial Services Committee will examine whether new legislation is needed in online lending. They’ve also made inquiries to the Treasury Department about existing online lending regulations. Treasury Counselor Antonio Weiss’s previous remarks hinted that the Treasury up until recently was concerned about discriminatory lending practices more than anything else, but stressed that they were not a regulator in this area. Terror financing was not something they even addressed.
According to many sources, lawmakers are drafting up legislation on terrorism financing and expect to have something ready early next year. As for how that will impact online lenders is unknown. Right now, everyone’s still trying to figure out what just happened. Hopefully whatever is ultimately done is done intelligently.
Prosper Loan Linked to Terror – A Preliminary Assessment
December 9, 2015By now you have probably heard that one of the San Bernardino terrorists received a $28,500 deposit from WebBank.com two weeks prior to committing the attack. After Fox News broke that story, I may have been the first to publicly connect it to an alternative lender which was later revealed to be marketplace lender Prosper about 12 hours later.
As a Prosper investor myself, here are some things you should know:
The $28,500 deposit (if that was the exact true amount) would have been net of the origination fees. In all likelihood this was a loan for around $30,000 and the borrower only netted $28,500.
Those that have speculated that it would be impossible for someone making $53,000 a year (as Syed Farook did) to qualify for an unsecured loan of this amount are wrong. There are loans on the platform right now that fit these parameters. Online Lenders like Prosper and Lending Club are pretty aggressive with their lending.
The notion that Prosper somehow could’ve detected what the borrower planned to do two weeks later just isn’t possible. In lending, this is known as the asshole factor, meaning that even if the applicant meets all the criteria, they could just decide to be an asshole, and there’s no way to predict that.
There are strict laws in place to prevent all kinds of discrimination, meaning that even if Prosper had formed some kind of suspicion about the borrower, it may have been illegal to act on that suspicion. Such is the hypocritical paradigm of fair lending where factors that are measurable predictors of negative performance (or worse) cannot be legally used. Federal laws have purposely tried to create an environment where lenders make decisions on an objective basis they consider to be fair. In business lending for example, there is a law within Dodd-Frank that has not been implemented yet, but seeks to prevent loan officers from knowing the gender or even the name of the prospective borrower to protect them from subconscious discrimination.
Investigators have publicly announced that the terrorists were not on any watch lists and therefore there are no systems or checks that Prosper could’ve plugged into to have gotten the information.
Prosper and other alternative lenders already have Anti-Money Laundering Policies. I know this because I complained about Lending Club’s over a year ago.
The Wall Street Journal stated, “Only some nonbank financial institutions, such as mortgage lenders, are subject to Treasury rules requiring lenders to report suspicious activity to the government under the Financial Crimes Enforcement Network.” Maybe that’s true, but there is nothing suspicious about someone applying for a loan online who is not on any watch lists. I can’t think of anything that could’ve been suspicious unless they submitted fake pay stubs or forged documents.
“There’s no due diligence that’s done into how these loans are actually going to be used,” said Brian Korn, a partner at the law firm Manatt, Phelps & Phillips, LLP in the WSJ. This is true and at the same time related to anti-discrimination laws. Judging a loan applicant by their detailed monetary plans could potentially induce gender or ethnicity bias, even if subconscious.
There will be plenty of questions in the coming days from Americans, the media, and government officials about what alternative lenders are doing to make sure they’re not funding terrorists. Part of what they may learn is that for all the data that alternative lenders have at their disposal to make intelligent decisions on an automated basis, some of them cannot be legally used. They’ll also find out that there’s only so much that predictive analytics can actually predict.
It’s very unlikely that Prosper could’ve handled anything differently…
Alternative Lender Likely to Be Questioned in San Bernardino Terror Tragedy
December 7, 2015Fox News has reported that terrorist Syed Farook received a $28,500 deposit two weeks before committing the terrorist act with his wife. The source of the money? WebBank.com, an FDIC-insured, state-chartered industrial bank based in Salt Lake City, Utah. Perhaps more notably, it’s the bank that originates loans for dozens of alternative lenders including Lending Club, Prosper, and Avant.
WebBank.com is reportedly refusing to comment but in all likelihood we are probably going to learn that the loan was made by an alternative lender.
As written on Fox News:
The loan and large cash withdrawal were described to Fox News by the source as “significant evidence of pre-meditation,” and further undercut the premise that an argument at the Christmas party on Dec. 2 led to the shooting.
If the loan was indeed originated on a marketplace lending platform like Lending Club or Prosper, hundreds of Americans could potentially face the horror of having bought shares in the loan and made it possible.
For now, all we know is that Farook got $28,500 through a WebBank.com deposit. I’ll post more as the story develops.
Lending Club Borrower Exceeded 5 Credit Inquiries | Investors Raise Eyebrows
December 5, 2015
Unblinking investors on the Lending Club marketplace called attention to an anomaly through the LendAcademy forum two weeks ago. At issue was a borrower whose profile reportedly had 9 recent credit inquiries, which exceeded Lending Club’s maximum eligibility to even be listed. As the prospectus of each loan stipulates “5 or fewer inquiries (or recently opened accounts) in the last 6 months,” investors wondered how somebody with 9 had slipped through the cracks.
But it wasn’t just one, user Fred revealed that this was a very common occurrence. “In my database of LC loans collected so far, I saw 1000+ loans with 6+ inquiries in the last 6 months,” he wrote.
Concerned, somebody reached out to Lending Club to find out what the deal was.
The response they got back was that auto or mortgage inquiries do not count as inquiries in their underwriting. However, their system had glitched and was inadvertently including them. That meant the borrower showing 9 inquiries did indeed have 9 but 4 of them were auto and mortgage related and therefore weren’t subject to the cap of 5.
While car loans and mortgages might not be as relevant to unsecured consumer debt activities, it is interesting that these inquiries are supposed to be glossed over in the total inquiries revealed to potential investors.
For instance, in this case, a borrower with approximately 720 credit earning $73,000 a year has 11 inquiries but for all points and purposes, Lending Club is only counting up to 5 of them. They were seeking a $29,175 personal loan for “business purposes.” The loan was eventually removed for reasons unknown.
For those buying these notes, as always, buyer beware.
Beat The $3,000 Capital Loss Cap in Marketplace Lending
November 24, 2015
Because interest on platforms like Lending Club is counted as normal income and the losses as capital losses, you can only deduct a maximum loss amount of $3,000 if you don’t have capital gains from other investments. That can be an expensive mistake for an investor with a large portfolio who isn’t paying attention. For instance, if you earned $20,000 in income through Lending Club but had $10,000 in losses from defaults, you’d actually be taxed on $17,000, not on the difference between the two. In, Is the Premium Gone in Peer-to-Peer Lending?, I wrote that there’s a whole lot of risk in marketplace lending and not a whole lot of yield to compensate for it, especially when considering the poor tax treatment.
It’s surprisingly easy to rack up thousands of dollars in defaults in a single year even if you spread the risk around through small $25 increments. I know this because I’m teetering on the fence of it just on Lending Club alone. I had approximately $2,600 in charge-offs so far for 2015 at the end of October. Anything beyond $3,000 I can’t offset against my gains so there’s little sense in investing any more money.
Unless…
There is one way to build a significant portfolio without breaking the threshold, invest in the low risk loans. Of the 246 A-grade loans I’ve invested in, so far none of them have ever defaulted. Of the 675 B-grade loans, only 9 of them have already defaulted. Compare that to the 52 G-grade loans I’ve participated in where 11 have defaulted. It might interest you to know that the average time remaining to maturity on those G-grade loans is about 3 years. That means 21% of them have already gone bad and there’s still another 3 years left to go. While these stunningly high risk loans might return in yield for what they lack in performance, they’re a great way to build a capital loss mountain, something that could cause significant damage once you exceed $3,000.
By investing in low risk loans and staying below the capital loss cap, you can invest substantially more. Illogical as it may seem, a big lower yielding portfolio can earn more than a higher yielding one because of the tax treatment if you do not have outside investments with capital gains.
If you are a small investor looking to play with $5,000, none of this will likely be relevant to you, but if you were looking to place $100,000 or more, you might want to remember this phrase in marketplace lending, lower yield is more.
Read more about the capital loss rules and Lending Club on the LendAcademy blog.
FDIC Issues Guidance that May Curtail Bank Purchases of Marketplace Loans
November 20, 2015
On November 6, the Federal Deposit Insurance Corporation (FDIC) issued Financial Institution Letter FIL-49-2015, titled “Advisory on Effective Risk Management Practices for Purchased Loans and Purchased Loan Participations.” Though billed as an update to an advisory letter issued in 2012, the new guidance requires all FDIC-supervised banks and savings associations to implement a number of new procedures before purchasing loans or loan participations that are originated by third-party nonbank entities. These restrictions would include the purchase of or participation in small business loans originated by marketplace lenders. In fact, the letter cautions supervised entities from relying on marketplace platforms that the FDIC believes do not provide sufficient information to potential investors:
[A]n increasing number of financial institutions are purchasing loans from nonbank third parties and are relying on third-party arrangements to facilitate the purchase of loans, including unsecured loans or loans underwritten using proprietary models that limit the purchasing institution’s ability to assess underwriting quality, credit quality, and adequacy of loan pricing. In some situations, it is evident that financial institutions have not thoroughly analyzed the potential risks arising from third-party arrangements.
The three pages of new guidance require a variety of procedures be implemented, including:
1. The new guidance significantly expands the policies a bank must establish before purchasing, such as:
- Establishing detailed procedures for purchased loans and participations
- Defining loan types that are acceptable for purchase
- Requiring board of directors approval of arrangements with third-parties to purchase loans and participations
Additionally, financial institutions are required to establish ongoing risk management processes for purchases made through third-party relationships.
2. The new guidance requires enhanced independent analysis of purchased loans and participations. A purchasing institution must ensure that it has “the requisite knowledge and expertise specific to the type of loans or participations purchased and that it obtains all appropriate information from the seller to make an independent determination.” The loans and participations must also be determined to be consistent with the bank’s appetite for risk. The letter states that this analysis must be done in-house and may not be contracted out to a third-party.
3. A supervised bank must also perform due diligence on the validity of a third party’s credit models if the bank relies on the model for credit decisions. A bank is permitted to subcontract this due diligence to third-parties but is still required to review the model validation to ensure it is sufficient.
The new guidance will undoubtedly increase the costs FDIC insured banks incur to purchase loans and loan participations originated by small business marketplace lenders. What effect these costs will have on current and future bank involvement in marketplace lending remains to be seen.
