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Rising interest rates and their effect on P2P lenders.

Started by Peter, December 05, 2014, 11:00:00 PM

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Fee

How would P2P lenders be affected if interest rates started rising assuming the underlying economy remained largely unchanged?

 I imagine that the value of notes held would drop, although prepayment risk would diminish. I think that new loans would generally be originated at a higher interest rate. I could see many lenders abandoning P2P lending for a safer return in savings accounts, CDs, etc. Perhaps several more discounted loans would then become available on Folio?


TravelingPennies

Thank you for the links to the informative threads. I'm still curious as to how the rate of prepayment is affected by changes in rates. Do you know if any of these platforms allow borrowers to refinance their loans? 

rawraw

Refinancing in P2P (due to the maturity) is less to due to interest rates and more to do with changing credit risk (allowing qualification for higher grades)




Fred

If we are only focusing on the single factor (rising interest rates), ceteris paribus, then

http://forum.lendacademy.com/index.php/topic,2848.msg25544.html#msg88888888Quote"> from: Fee on December 06, 2014, 03:32:45 PM

Peter

I agree with Fred.  But, I also think that we really have not seen the effect of possible higher interest rates with p2p lending.   During the life of p2p lending, interest rates have been at record lows, so, an increase in interest rates maybe little impact, initial impact and levels itself out, or it is the end of p2p.  I am thinking it would be more of an initial impact and slow leveling.   But scared investors could definitely impact this young industry.

The good news is that whatever the fed does, will be done slowly.  Rates will not go up over night and as they go up the increase I hope is managed by the platform.

The test will really be a test for the industry as a whole and a good thing if p2p lending will be here to stay.
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See my returns here: http://www.lendacademy.com/returns



mchu168

As mentioned, interest rate risk is not much of an issue, as most P2P lenders are holding to maturity and you can presumably reinvest payments into higher rate loans once the benchmark rate goes up.  Also the spread of a 18% loan vs. treasuries is so wide that even a 2% move in the fed funds rate won't matter too much to most people - you're still getting a solid return.  And duration on these loans is very short anyways, even the 5yr ones, given the high coupon rate and amortization of principal.

I'd be more concerned about defaults once the credit cycle rolls over - we're close to a peak now.  Once rates move higher, I'd probably shift my money into something safer like munis. Problem is safer stuff right now is yielding peanuts thanks to "financial repression."

macroman7799

Technically duration is the dollar weighted average maturity of a security or a portfolio. In other words, on average, how long does it take for your funds to come back to you. I believe that the estimate of a 3 yr note having an approximate duration of a year is pretty close.

A long duration portfolio will lose more value as rates rise and also as defaults rise. Duration is an important risk metric.

rj2


Rising interest rates never directly impact the returns of someone who holds a fixed income security to maturity. Where it will hurt is in the resale market where the purchase price of a loan will drop dramatically as interest rates rise. You will take a bath if you attempt to sell off your portfolio.

The other impact is lost opportunity -- as interest rates rise borrowers on the platform will start paying more. Someone who previously would have been offered a 5% loan will be offered a 7% loan, etc., and so new loans coming on the market will come in with higher rates. Money already locked up in existing loans won't be able to participate in the new higher rates, so you will miss the new higher opportunity by already being invested at the lower rate.

A third impact would be loan volumes. As rates rise you can expect fewer people to borrow and so you may see an overall decline in the number of people seeking loans. Though, that's hard to predict -- rising rates off the platform could push more people to seek debt consolidation. But in theory, overall, in the total market, there will be less borrowing.



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