Lending Club – 3 Years of Peer-to-Peer Lending

by Mr. Cheap

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Three years ago I got into Lending Club with an American friend of mine (she could open the account, whereas I couldn’t).  This is a summary of my experiences.

Three years is a reasonable length of time to get a feel for a new investment vehicle like this, as this is the time length of loans Lending Club provides.  I’ve had people pay on time every month, pay late then get caught up, pay off their debt early and borrowers default on their debt – the full range of what can happen.  I’ve gained an understanding of why banks are as risk-adverse as they are (and am amazed that bankers don’t hate everybody – the amount of deceit in loan applications is shocking).

The concept behind peer-to-peer lending (I describe it to friends as “E*Bay for loans”) is that the company (Lending Club) acts as the middle man for lending between people.  Borrowers post a request for money, then lenders “bid” on how much they’ll loan that person, and at what interest rate.  Say I ask for a loan of $100 and Mike offers $60 at 12%, Squawkfox offers me $25 at 8% and the Canadian Capitalist offers me $75 at 10%.  The loan will be arranged at 8% 12% 10% between Squawkfox & CC (Mike will have been underbid) and myself.  Lending Club handles the loan documents, processing payments and discharging bad debts (so neither the lenders nor the borrowers need to understand the full legality of lending money – the company takes care of that).

Lending Club makes its money by taking a cut of the loan when it’s issued then taking a small portion from every payment.

Initially my friend and I put in $250 each, quickly loaned this out and were happy to see our account value growing from the high interest rate (and consistent repayments).  I congratulated my friend on how skilled we were in evaluating borrowers (since we hadn’t had a single default or late payment) and suggested we leverage her strong credit to borrow money from Lending Club to re-lend (with friends like Mr. Cheap, who needs enemies?).

Come August 2006, we borrowed  $2,500 and were quickly able to lend it out again.  We decided to pour all the repayments into early pay off of the debt (and were talking about starting lending again once the debt was repaid).  Projections looked good, and I was bragging to my friend (and other people I told about the concept / website) how we’d be making money unless there were a massive number of defaults.  On the forums, people were happily cackling about how much cash they were making and we were all patting ourselves on the back for getting in on such a good thing early.

Of course, that’s when the massive number of defaults hit.  Some lenders had talked about the insanely low rates that had been offered in the early days of Prosper (when there were far too many lenders and loans got bid down to very low rates).  Of course, we’d all done the exact same thing (and just didn’t realize it at the time).  Some new lenders were bragging in the forums about how skilful they were that they hadn’t had a single late payment or default (after two whole months!) and the old guard started to warn them to just wait, they soon would.

In April 2009 we paid off the last payment on our $2,500 loan (which had MOSTLY been covered by debt repayments, but we’d had to transfer in small amounts to cover it twice).  We put a total of about $660 into the account, and it’s currently valued at $318.62 ($234.91 in loans, some of which will probably default, and $83.71 in cash).  This is a LOSS of 48% 52% over 3 years.

Of the 50 loans we made, 12 have been paid back, 20 have been charged off (defaulted and sold for pennies on the dollar to a collection agency), 14 are current (payments up to date) and 4 are past due (and VERY likely to be charged off, two are heading to bankruptcy and I’m pretty pessimistic about the 3rd, which is 3 months late).  The one person that REALLY burned us was a fire fighter who had excellent credit, borrowed the money and never paid a single cent towards it (to me this was clearly fraud).

Some might argue that we must have been scraping the bottom of the barrel for loans, but this wasn’t the case.  Our portfolio was a mixture of A’s, B’s and C’s (we avoided people with lower credit scores).  We also ruled out people who had gone through bankruptcy or had a number of delinquencies on their credit report.  In spite of this, we had MASSIVE defaults BEFORE the financial crisis hit.

Another friend borrowed a few thousand from Prosper to start a business and got an excellent rate and got the loan more easily than getting a comparable loan from a bank (and at a very decent rate).

In summary, I would say first and foremost that investing with Mr. Cheap is almost always a bad idea (I should start a hedge fund and you can all short it!).  Peer-to-peer lending is an exciting concept, but the risk is currently being mispriced (in my opinion).  The rational response to this is to use these service as a BORROWER, not a lender.  If enough people do this, perhaps these services will get better at pricing risk and a fair reward will be offered for the risk the lenders are accepting.

Peer-to-peer lenders include Prosper and Lending Club in the US, Community Lend here in Canada and Zopa in the UK.

 

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{ 29 comments… read them below or add one }

1 Nicolas

http://www.myc4.com is another one for those who want to deal in euros.

Based in Denmark, “MYC4 is an online marketplace that connects you directly with African entrepreneurs, who lack capital to develop their businesses. We see a huge business potential in Africa waiting to be triggered. MYC4 is the explosive. “

2 ObliviousInvestor

Wow, fascinating stuff. So far I’ve mostly only heard the stories about how well it’s going. (Probably similar in cause to why you don’t often hear stories about people’s terrible stock picks…) Thanks for sharing!

3 Blogging Banks

I agree that P2P lending is not a very good option for your cash. You are much much better off with an FDIC insured Bank CD, yielding 3% than with an AAA rates, super high credit score prosper loan yielding 8%-9%.
The biggest issue is that Prosper doesn’t seem to have a good collections system in place. I have accounts with Prosper and Lending Club. I opened them for the bonus, and have one loan in each one of them for $50/$25 each. So far both loans are current ( for over one year now). That’s to say, I won’t be adding any more money into this untested model. If I wanted to take risks, I could simply buy bank stocks.
If I wanted to play bank, I would just buy a CD ( or GIC in Canadian ;-) ) and sleep tight..

4 Four Pillars

Very interesting – You should consider becoming a financial advisor. :)

My opinion on p2p loans is that they are like tiny super-junk status bonds. Which is not to say there is anything wrong with investing with them but the risk levels are high, the returns have to be (or should be) high as well and they have to be considered as part of your asset allocation.

The other thing is that a lot of bloggers/commenters have said that they feel like they are “helping out” or “sticking it to the banks” or some such nonsense by using p2p. The reality is that the p2p company (Prosper, LendingClub etC) IS the bank in the sense that they are making very high commissions from the loans. You are not bypassing anything by using p2p.

The other big problem is that the p2p companies don’t take on the risk of the loans – only the fees and admin work but they decide the risk levels…conflict of interest? Of course they will try to make lending on their platform as positive as possible.

5 Canadian Capitalist

Very interesting post. That’s a huge loss and some bloggers were talking about P2P lending replacing fixed income in their portfolio! Confirms my suspicions that making money lending on P2P sites is very hard (but then, I’m suspicious of everything!).

6 Mr. Cheap

cc: You’re absolutely right that it’s a large loss as a percentage (and definitely casts doubt about using this as the fixed income portion of someone’s portfolio). The two considerations are that a) it’s a relatively small absolute loss (~$350) and b) it was a leveraged position (about 5:1 I guess) which increased the loses.

7 Traciatim

At least now you’ve learned why credit card interest rates are so high for people with poor credit scores.

8 Mr. Cheap

Traciatim: Absolutely. Even lending at 20-25% to the low credit borrowers at Prosper I think you’d lose lots of money.

9 Thicken My Wallet

This is a great post!

Do you think if you actually met most of the borrowers, your experience would have been different? I think there’s something to be said for looking someone in the eye before you lend money.

10 Mr. Cheap

TMW: Thanks! :-) I *don’t* think looking them in the eye would have been difference (from a choice of borrowers perspective). When I was trying to find tenants for my condo, two times I thought I’d got good people, and both times when I dug into their application and their credit history I found problems. A number of landlords I’ve talked to went by their “gut feeling” selecting tenants and ran into huge problems. Not sure what the right system is for loaning people money…

11 Blogging Banks

Well I guess if you knew where these people lived, they would eventually pay their loans off LOL.

Then again there’s always the possibility that someone could steal your identify, get two large loans and enjoy the money coming from all the “suckers”. I would say that you are definitely not well compensated for the risks you are taking on Prosper and Lending Club.

As for my loans still not being late – I think its more of a luck than skill..

12 Cam Birch

What are the typical loan sizes? If the typical loan is small as in your example I am surprised at the low rates being offered. People don’t usually borrow a few hundred or thousand dollars because they are doing well.
Starting up small or home based companies could be possible on a few hundred or thousand dollars but then venture capital is even riskier than standard lending. Venture capitalists usually look at returns in the multiples of lending like 5x or 10x return. Maybe this type of system could work acceptably for small venture capital type loans.

I think for true success it would be better if they had a managed option, were your money is pooled and a sizable group takes a combined risk and averages the returns. Would certainly help reduce the risk for default. Maybe a business opportunity there somewhere…

13 Mike

Cam, the loan size is a good point. I’ve never used p2p so I don’t know what the typical amounts are.

Lending Club has a portfolio option where you can buy into a group of loans rather than do individual ones – kind of like a bond mutual fund I suppose.

Mr. Cheap – I agree that borrowers are better off using p2p rather than lenders but I’m thinking that borrowers with bad (or not great) credit would be the biggest beneficiaries.

14 Lems

Too bad you bought into the Prosper craze. Unfortunately, they did a horrific thing by putting low credit borrowers in front of regular joe’s like you and me. I never felt comfortable “bidding” to give my money to some credit-score and financially challenged loser out there in exchange for the hope of a 30% return. I only invested $500 and I’m happy to say I’m actually breaking even.
I’m now a fervent believer in the concept through Lending Club. I’ve invested close to $5K and making a solid 8.67% returns after losses. This is due to the fact that Lending Club is “screening” the borrowers looking for good credit people only. The other feature I like is that Lending Club assigns a credit grade and rate based on some ingenious credit review process… I don’t have to bid because I know exactly what interest I’ll get. Also, collections are very good here.

15 Mr. Cheap

Cam: I think the minimum loan with Prosper was $2500 before they entered their quiet period. Sorry if my example made it seem like they were arranging payday loans (they aren’t). The maximum is $25K (and loans run the full range between these). You’re absolutely right that lending small amount attracts a different (worse) type of borrower

Zopa apparently offers only pooled loans, as you suggest.

Mike: Absolutely! My friend had good credit, so it wasn’t THAT great of a deal, but people with D credit ratings who couldn’t get a loan elsewhere are the big winners. I agree with you 100%.

16 Mr. Cheap

Lems: Good to hear you’ve had a better experience with Lending Club. How long have you been invested there?

17 X

Hey Mr Cheap,
I’m not sure I understand.

So you are saying, that you invested $660, borrowed $2500, lent the $3160. And got some money back every month from your loans but had to pay your $2500 back with interests. So the profit made by the difference of interest was pretty low. At the end of the day, you lost $341.38 – thus 51% as of today.

What you may not realize is that you got leveraged like a bank. You simply got greedy – hoping for a return of 30% or more per year with your leverage – and you got burned like the banks when the number of defaults increased.

There is nothing wrong with peer lending here, and everything wrong with your thinking. Please don’t be a financial advisor, you are going to ruin your clients.

If you did invest your money normally (just $660) with NO leverage, your losses would have probably be more in the range of $36 to $72. Thus losing around 11% over 3 years. And in the worst period for several decades. Once the situation improves, the default will stabilize and this should return to a positive strategy. Don’t accuse the model, if you use one of the worst period for the economy, people abusing of Prosper, and especially you taking reskless risks.

Now about Propser, yeah their rate model is completely broken, their bidding favorized the borrowers not the lenders. (Lenders did not realize that – “Yeah, I won the bid! – I lent to this schmock at a 6% rate – What a loser!”). Prosper actually changed that and pretty much stopped everything anyway. They have a 20% default rate! Compared to 5% for LendingClub, go figure. When you are leveraged, that makes the whole difference between gain and big losses.

Finally LendingClub rates are indexed on twice the current default rate, thus the rate adapts over time (you are out of luck on the previously originated loans though if situation changes a lot). But it is still much better than the scam that Prosper was proposing. And something as simple as reducing the entry cost ($25 to start lending on a loan) allows you to spread your risk between much borrowers than Prosper.

P2P lending is not a perfect, but is a good complement of stocks (want to compare return there? :) ).

X

18 Mr. Cheap

X: Great to hear from a Lending Club booster. Good for you that you can stay so enthusiastic in the current environment (and are willing to go right out there accuse Prosper of being a scam – a lesser man would explain his accusation, but no need for you!). Clearly there’s no hidden agenda to your comment. Do you work for Lending Club or are you just heavily invested there?

Thanks for the career advice too!

19 Mike

X, I do agree with your point about the leverage. It should be removed from the equation when analyzing investments. Losing 11% in 3 years isn’t exactly a ringing endorsement though.

However, why did you say that this period was “the worst period for several decades”? – I didn’t realize that p2p lending was that old.

20 Mike

I got burnt on AA, A, and B borrowers too. The problem with higher credit borrowers is threefold:
1. Why are they even trying to borrow on Prosper to begin with? The interest rates from traditional lenders consistently beat Prosper’s rates; their lending on Prosper is not a sound financial decision.
2. The credit and expected default rates were calculated based on traditional lending models, not P2P borrowers. Getting a loan through a bank is a fairly daunting task; getting one through Prosper takes 20 minutes of work. These borrowers are quite different.
3. Enough lenders were swayed by the fallaciously calculated rates that high-grade borrowers were allowed to dictate interest rates. Too many were trying to lend to too few.

Contrast this with C, D, and even E and HR borrowers:
1. They can’t get traditional loans; If they have to borrow money, it’s from family or a payday lender with usurious interest rates. Given these choices, Prosper is a fantastic financial move that can mean the end of living paycheck-to-paycheck.
2. There were a TON of borrowers available, but few lenders. Lenders were able to demand maximum rates.
3. While investing in the average bad-credit borrower was still a losing proposition, weeding out poor candidates was fairly straightforward. Furthermore, because these loans were relatively small, there was a large pool of multiple-time borrowers with bad credit but good payment history. (All you people who lost money on bad first-time borrowers: thank you for weeding out the deadbeats and slackers, and pointing me to good borrowers!)

If I had to point at one thing that killed prosper lenders above all others, it would be portfolio plans. To a computer looking at credit scores, all borrowers fit into neat categories based on nothing but how well they paid in the past. To any human with a lick of common sense, though, the D borrower presenting a meticulous budget and offering 35% is a far better investment than the AA-borrower whose listing is titled “A wanna buys a car!!!11!”

If you’re going to give up information that can help protect you, and trust a computer to make decisions based on just a fraction of the data available, you are not going to do as well as someone who prudently hand-picks his investments. It means more work, of course, but as experience demonstrates, doing that work means the difference between losing a little and gaining a lot.

21 Mr. Cheap

4P Mike: I agree as well that leverage affected my returns, but I didn’t mean the post as an absolute statement on p2p lending, just *my* results (which included leverage). Sorry if something I wrote was misleading on this point.

Looking at the number again, I should have wrote that the *value* of my account was down *to* (not by) 48% (which would mean a lose of 52%).

non-4P Mike: Your views make a lot of sense to me. I’m not particularly eager to put more money into p2p, but perhaps targeting the lower credit scores is the way to do go. How long have you been investing and what does you loan portfolio currently look like (if you’re willing to share)?

22 X

>>Good for you that you can stay so enthusiastic in the current environment

Are you kidding? I have my shotguns ready in case somebody walks onto my lawn to steal my gold under my mattress.

>>(and are willing to go right out there accuse Prosper of being a scam – a lesser man would explain his accusation, but no need for you!)

I did not want to create a too long post, but hey, I’m a lesser man, so I’ll explain what I meant. There is an interest for Prosper and LendingClub to handle as much volume as possible to pocket more profit. Thus there is a conflict of interest right there. But for me the scam is the broken business model that Prosper employed. I don’t think that Prosper wanted to scam people, they just didn’t think about the unintended consequences of their business model, that was a stupid choice.
As you say Prosper model favorized borrowers instead of lenders, and everybody felt they were going to have easy money (except only the borrowers – especially one fire fighter had easy money).
The rate has to be indexed with the default rate to integrate the risk (twice for Lending Club). And I believe LendingClub realized that and fixed that once they saw that Prosper was going into a wall.
Also Prosper stopped pretty much everything for the past 6 months now (due to the SEC approval I guess). This with the 20% default rate doesn’t feel very healthy for the company.

>>Clearly theres no hidden agenda to your comment.
>>Do you work for Lending Club or are you just heavily invested there?

No I’m not working there, and my investment at LendingClub represents only 1% of what I lost on the stock market, so I would not call that heavily invested. :)

I just want to avoid the confusion for some. I.e. by missing the leverage issue, the conclusion of your original post can be interpreted as “I lost a s**t load of money using P2P.” where it should actually be “I lost a s**t load of money using leverage.”

Now yeah, 11% loss over 3 years is not pretty. But most asset classes lost more than that.
Everything is about risk versus benefit, but on the long term. Losing 40% on the stock market in 2008 does not mean that we should never invest in the stock market. Especially when we know that the last time a similar crash of 2008 occured was in the 30′, and that the return in average was 9% per year.

But I do realize that it takes 3 years to repay a loan, so a lot of things can happen in between (yeah when you start in 2007, you cannot know ahead of time the rise in defaults in 2008). Bad apples exist but by spreading your risk with a lot of little loans you reduce their impact. (Go go firefighters! :) )

That being said, I feel that they are some strategies that can handle better the risk of P2P. And once the job losses are going to stabilize and reduce, there is going to be a ton of value there, mostly because the default rate will be at its highest so the return will be the highest as well with lesser and lesser risk. (those who kept their job until that time should still have it once the economy get better).

To finish on this topic (and I guess that would be my real agenda here):
Comparing CDs with P2P lending is meaningless. It’s like comparing CDs and owning stocks in 2008. A real comparison has to be done over 10-20 years or more. It still seems to be an interesting asset class not completely correlated with the others.

But the thing is that I know that I can’t put all my money on CDs for retirement as inflation makes it almost a flat return. I can invest in stock but that’s not a fair field with Wall Street. At least with P2P lending, over time the risk is going to be priced in correctly with the return and there nobody has particular advantage to each others (unlike for the stock market). As such, it should still be considered as an interesting diversification tool. Whether some P2P companies have the correct formula now or they will have it in 5-10 years, I don’t know.

X

23 Mike

Mr. Cheap:
Check out ericscc.com, if you haven’t already. I wouldn’t trust his analysis, but that site is a pretty good source for raw data. You would probably want to look for lenders with default rates under 10% – they are doing better than average – and figure out how to replicate their results. It’s your money, you figure out how to make it work for you. :-)

X:
“There is an interest for Prosper and LendingClub to handle as much volume as possible to pocket more profit. Thus there is a conflict of interest right there.”
Prosper takes a commission on every payment; it’s in their interest to have a high volume of current loans. The closest they come to a conflict of interest is in that they originate the loan but have negative incentive to make any collection efforts. However, collections are assigned to third-party agencies that do have a vested interest.

24 Mike

Mr. Cheap:
“Say I ask for a loan of $100 and Mike offers $60 at 12%, Squawkfox offers me $25 at 8% and the Canadian Capitalist offers me $75 at 10%. The loan will be arranged at 8% between Squawkfox & CC (Mike will have been underbid) and myself.”

It would actually be at 10%; you only had $25 bid at an 8% return.

25 Mr. Cheap

It would actually be at 10%; you only had $25 bid at an 8% return.

Mike: Yes, you’re right.

26 ExProsperLender

Check out Fred93′s blog. He’s been charting prosper’s late loans since inception.
http://fred93blog.blogspot.com/

27 NewHorizon

@Thicken My Wallet: Meeting the borrower face-to-face has been tried – and it failed. Once they go late, they stop answering Emails, telephones, the front door … :(

Prosper has proven that the rapport ends when the money does. Kinda kills the heart of this “people-to-people” thing, doesn’t it?

28 stock market

In my opinion, it is not a good idea to invest on P2P. As you have said the risk is to high. I would rather have my money placed on a high yield savings bank account or invested in mutual or index funds than see it all swirling down the drain.
However, I have to say that you did a really good job. Yes 52% loss is not pretty but other asset classes loss even more.
This is a great post by the way and I have fun reading it.

29 Xin He

Liked the post, the discussion was even better. Clearly Lendingclub is superior to Prosper in many ways. Sorry for your loss, Cheap. So I guess the tradeoff for the firefighter is that his credit is ruined?

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