The Current Crisis in Peer to Peer Lending isn’t the Biggest Issue Facing the Industry
The peer to peer lending naysayers are having their moment and a brief ‘I told you so’ after half a decade of huge p2p growth. Media outlets have used the recent debacle at Lending Club to fill their news scroll and investors are questioning the future of peer lending.
But behind the sound bites, speculation and questions is a bigger issue holding back peer to peer lenders. Despite loan originations that have surged 247% in two years, the issue has plagued p2p growth for years and may have only one solution.
It just happens that solution may be the worst thing for investors in peer loans.
Lending Club Sets Off a Peer to Peer Lending Crisis
P2P leader Lending Club has been getting a lot of attention lately and its led to a crisis of confidence in the future of peer to peer lending.
Investment Banker Jeffries Group had agreed to buy Lending Club loans, bundle them in a process common across all debt called securitization and then sell pieces off to investors and money managers. The market had been on edge whether peer lenders could keep up their torrid pace of loan growth and attract more big money buyers so the Jeffries deal was pretty huge for the company.
It all hit the fan on May 6th when it was reported that dates had been changed on $22 million of loans to meet Jeffries’ criteria for bundling. It’s a big deal if you are Jeffries trying to resell the securitized portfolio and does nothing to help the credibility of the nascent Fintech peer lending industry.
But let’s go beyond what’s been reported in sound bites. The deal with Jeffries was for $150 million in loans. It’s conjecture but I’d put odds on what happened behind closed doors. The specialist assigning the loans came up short of the $150 million order. Since it was such a huge deal, not just for the size but to show other banks that securitization would work, they weren’t about to go back to Jeffries and say they couldn’t fill the order.
The specialist escalated the matter until it reached a Senior VP who made the (horribly stupid) decision to change dates on the remaining $22 million in loans to meet criteria. The thinking was probably that it in no way affected the loans’ values or projected returns so it really didn’t matter and would probably never be discovered.
Another issue that’s come up is that then-CEO Laplanche had invested in Cirrix Capital, a fund which was in-turn investing in Lending Club loans. This was only a problem when Laplanche asked the board of directors to approve Lending Club to invest in the fund as well without disclosing that he had already invested. Investors have called up questions of conflict of interest to legitimacy of loan funding from the news.
Memories of the subprime disaster are still fresh enough around Wall Street that even the slightest hit to the firm’s credibility and lending standards has taken shares of Lending Club down 44% since the news broke. The shockwave is booming through the entire industry with large investment firms pausing their loan purchases. Online lender Avant has announced worker layoffs and Prosper recently cut its affiliate program citing, “aggressive growth.” Prosper President Ron Suber declined to comment in an email for this article though he offered some interesting ideas on the Future of Peer Lending in our 2014 interview.
CEO and Founder of Lending Club, Renaud Laplanche, was immediately asked by the board of directors to resign and was replaced with acting-CEO Scott Sanborn. Sanborn sent out an email on the 18th to assure investors of the company’s financial stability, noting more than $868 million in cash and securities on the balance sheet.
It’s telling that the same banker, Jeffries Group, that was directly wronged in the loan-changing debacle is still working with Lending Club to get the company back in Wall Street’s graces. Bloomberg reported May 20th that the peer to peer lender was working with Jeffries to approach other large investors for loan purchases.
What’s Good for Peer Lending May Not Be Good for Investors
There is a hurdle holding back growth in peer to peer lending but it has nothing to do with recent news. Changing the dates on the Jeffries loans was a stupid call but not endemic of Lending Club or other peer lenders. Lending Club hired one of the Big Four accounting firms to conduct a ‘forensic data change analysis’ on more than 670,000 loans sold over the last two years and found that 99.99% had no changes. Even the proposal by Laplanche to invest in Cirrix would not have been so questionable had he disclosed his prior investment.
The biggest challenge for peer to peer lending is the problem of liquidity, which is just jargon for how quickly and cheaply an investor can get in or out of an investment. Investors in Lending Club loans are able to sell their loans on Foliofn but it requires another brokerage account and the platform isn’t as user-friendly as it could be. Institutional investors, the asset managers and banks buying billions in loans and really the main growth for the industry, aren’t really able to use the Folio platform so have even fewer options.
This lack of a secondary market, like the New York Stock Exchange where investors can buy or sell stocks after they’ve been issued by a company, is what’s really keeping peer lending from all it could be.
It’s a perceived disadvantage for regular investors. Loans pay off over three or five years but I hear constantly from investors that they don’t want their money ‘tied up’ for that long. Really? Three years is too long to hold an investment? It’s a bigger issue for institutional investors which need to be able to model risk with liquidity and be able to free up cash for redemptions.
The solution would be a legitimate secondary market for peer loans, one that trades peer loans across all platforms or trading within the platforms themselves. This would allow investors to sell their loans quickly and easily and would increase the amount of loans available for purchase.
It would be a huge step forward for the P2P industry…but possibly the worst thing for investors.
The average investor saw returns of just 2.6% annually over the ten years through 2013, despite the fact that the stock market grew at an annualized 7.4% and even bonds returned 4.6% over the period.
The problem isn’t with the concept of a secondary market but with how investors use it. Investors get caught up in market booms only to freak out and panic-sell their stocks at the first sign of falling prices. Investors on Lending Club have enjoyed a 7.9% annualized return on all loans issued since 2010 and 99.96% of investors with more than 100 loans in their portfolio have had positive returns.
Create a secondary market where investors can sell their loans at a whim and the return on peer loans starts to look more like the average investor returns on stocks.
Learn how to avoid the biggest risks in peer loan investing.
See how one P2P investor has made $10,000 and returns of 12% since 2010
None of this has changed the future of peer lending as the evolution of finance and a secondary market will eventually be created. As the online social revolution creeps into every other aspect of our lives, it’s natural that people would find a financial solution as well and online lenders benefit from significantly lower costs to originate loans. While the credibility of one company has been called into question and investors are taking a step back from loan growth that has nearly doubled every year, Fintech and online lending is only going to become a bigger part of our daily lives…just make sure you use it wisely.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.