Banks have found a better investment in peer to peer investing, should you follow their lead?
It took the stock market four years to rebound after the financial crisis. It took shoppers just two years to get consumer spending back up to its pre-recession levels. Banks are making tens of billions a year in profits so why is bank lending to small businesses still well off pre-recession highs?
Data from the Federal Financial Institutions Examination Council (FFIEC) shows that bank loans of $1 million or less was less than half the pre-recession high in 2013. The Wall Street Journal reports that small business lending was still off the 2007 peak by 16% through 2014.
Banks aren’t lending but are certainly still making money. Bank of America just reported making $2.68 billion in the first three months of 2016 while Wells Fargo made an amazing $5.46 billion over the quarter. Bank of America has cut almost 6,500 jobs and closed 150 locations over the last year.
Obviously banks are still making money even if it’s not through loans to business owners or to operate bank branches. For a clue to where the money is going, take a look at the increase in peer loans on the Lending Club website.
Now understand that Lending Club doesn’t make loans itself. For every loan made on the p2p site, there’s a peer to peer investor putting up the money.
The Financial Times reports that investment from traditional banks is up to 25% of the $4.5 billion market for peer loans in the United Kingdom. Data on peer loan investing by domestic banks isn’t available but there’s good reason to believe it’s a sizable part of the $6.6 billion U.S. market.
Some UK banks have even formed partnerships with peer lending sites. RBS and Santander have teamed up with Funding Circle to refer smaller businesses for business loans that they can’t fund.
Why Banks are all over Peer to Peer Investing
There are several reasons driving the change in bank lending and the increase in peer loan investing by banks. The increase in regulation and regulatory costs through Dodd-Frank and Basel III have made it harder to make a profit in traditional bank lending. Banks must keep more money set aside and higher regulatory costs mean it’s just as expensive to make small loans as it is to make larger $1 million-plus loans.
Beyond the increased regulation on bank lending, it’s just cheaper to make p2p loans. Physical branch locations account for about a third of a bank’s total operating costs. Not having these location costs mean peer lenders can originate a loan for up to 4% cheaper compared to traditional banks. Banks need to put their money to work, peer to peer investing has become a way to earn loan interest without taking on the origination costs themselves.
Possibly an even greater force than costs is just the general move into the digital world. People are feeling more comfortable moving their financial lives online. Online loan volume for traditional banks and peer lenders alike has jumped higher. Investing in peer to peer loans gives banks a digital income without the cost of making loans themselves or creating their own online lending platform.
Why You Should Follow Banks into Peer Loan Investing
Investing in peer loans isn’t just for banks and Wall Street money managers, the revolution in online loans has opened up a new world for investors as well. Peer to peer investing got off to a rocky start during the financial crisis as peer loans defaulted along with every other type of loan but the industry has surged higher over the last few years. The largest peer lending platform, Lending Club, has even issued shares on the stock exchanges to fund enormous growth.
I did a review of peer to peer investing on Lending Club a few months back, walking investors through the process of becoming a Fat Cat Banker. There’s no minimum to open an account on Lending Club and opening a retirement account means the interest you earn grows tax free until retirement.
Peer loan investing is taking off with individual investors but it’s still considered an ‘alternative’ investment. Like most things digital, it’s quickly becoming mainstream and it won’t be long before p2p investing is an accepted asset for everyone’s portfolio.
- Peer loans provide diversification from stocks and bonds. P2P loans have almost no correlation with either asset class, meaning they won’t tumble just because your other investments have a tough month. Adding peer lending investing to your portfolio will help smooth your returns so you don’t freak out during the next stock market crash.
- Peer loan investing is a great bridge between stocks and bonds. Loans provide the safety of fixed-income debt while still providing the upside return of stocks. I interviewed one peer to peer investor that has earned an annual return of 12% since 2009, making $10,000 in profits on p2p investing.
- While there’s the beginning of a secondary trading market in peer loans, where you can buy and sell old loans, most people aren’t trading loans like they do stocks. You’ll be locked into holding your loan investment for up to five years but it will also keep you from paying too much in trading fees and panic-selling your loans. Since loans are fixed-rate and default rates can be forecast from averages, you’ll have a pretty good idea of the return you’ll get for as long as you invest.
Fortunately for small business owners, peer lending has also become a source for funding needs though personal loans are still the majority of p2p loans originated. Peer lending is just the evolution of finance into the online social revolution and peer to peer investing should be a part of every investors portfolio. Check out our earlier post on p2p investment risks and don’t miss your chance to profit in this new investing asset.
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.