Lending Club’s data about their borrowers could help them more efficiently price risk in future P2P lending markets
An interview with Lending Club CEO Renaud Leplanche by Zack Miller at Tradestreaming brought up an interesting point about the data that Lending Club has about each of its borrowers. Over time Lending Club will collect large amounts of data about each of their borrowers, and they could incorporate this data to more efficiently price the risk of each borrower when they apply for future loans. It will be interesting to see if the use of this data about their borrowers could be applied to more efficiently price risk in other consumer credit markets that Lending Club says they will eventually expand into, such as mortgages and auto loans.
Below are some highlights from the interview by Zack Miller at Tradestreaming.com with Lending Club CEO Renaud Leplanche.
- Future markets include car loans and mortgages: Lending Club intends to tackle the car loan, mortgage, and small business financing markets when the time is right
- What could be really interesting is the data around each borrower’s profile: Over time Lending Club will collect large amounts of data about their borrowers, and could possibly use this data to make loans that more efficiently prices risk for that borrower over their lifetime, including their mortgage and car loans.
- Incorporating social information into the risk pricing metrics is more important for sub-prime borrowers, where the borrowers have a less robust credit file, less transactional data and a shorter work history. For prime borrowers with robust credit profiles, traditional metrics have been working well.
- “Banks were invented as a really useful way to aggregate capital and redistribute it. Now, technology and the internet make banks unnecessary. We can make capital flow more efficiently and directly from the sources of capital to the users of capital.” – Lending Club CEO, Renaud Leplanche
- Two reasons why Lending Club is more efficient than the traditional banking model:
- Banks have large overhead costs as a result of using physical branches and thousands of employees to collect capital, which is much more expensive to run than a website like Lending Club
- Most credit card issuers don’t apply risk based pricing: Most credit card issuers charge an average interest rate of 18% across the board to all borrowers, and don’t assign a lower interest rate to less risky borrowers and a higher interest rate to riskier borrowers. Lending Club realized that the best borrowers didn’t default at a rate that warranted such a high 18% interest rate, and that they could offer a lower interest rate to those higher credit profile borrowers by only offering loans to the top 10% of borrowers and offering them a lower rate through a tiered interest rate system (7% to +20%), rather than a flat 18% for all borrowers.
- Growth: Lending Club will continue to grow at 8-10% m/m and will likely break $1B in loan originations this year, and do another $1B next year. Given that the consumer credit market is $2.5T they do not see downward pressure on the rates that they offer investors anytime soon and believe they can continue to grow at very high rates for the next 5-10 years.
Link to the full interview on Tradestreaming: http://www.tradestreaming.com/2012/07/02/investing-in-people-with-peer-to-peer-loans-with-lending-clubs-renaud-laplanche/
Seasoned Returns were 25% y/y in May for my peer to peer lending portfolio on Prosper, an interesting new asset class I’ve been experimenting with since late 2010. As a fixed income investment with a short duration (1.5-2.0 years) the margin of safety offered by consumer loans yielding 15-30% y/y make P2P lending a great new area to find yield, and returns have been consistent over the past 1.5 years.
Including “expected defaults” as well as existing defaults for P2P lending on Prosper the portfolio is yielding around 14% y/y, still the best yield I can find in the market at a duration of 1.5 years.
- Seasoned returns: 25.29% y/y
- Notes: ~300 – hand picked
- Late notes: 5 notes past 30 days late
- Charge-offs: 7 (included in returns above)
- Average age of all notes in portfolio: 268 days
*Seasoned returns only include notes that are over 10 months old, which seems to offer a more stable look at returns because the 10 month window gives bad notes a chance to default and also gives good notes time to start paying interest
Indexing P2P loans is different than indexing stocks, because with stocks, everyone gets a chance to own a piece of the good stocks. In P2P loans, not everyone can own the same loans, and the highest yielding loans often get funded first by active investors.
If you “index” with a P2P index fund that invests in all loans on the platform, active managers will quickly fund the higher yielding loans you will be left with lower yielding loans (AA and A grade loans) which only yield 5.18% and 6.45%, thus slightly under-performing the asset class. This problem will grow as more active managers invest on P2P platforms.
A large part of the 10% average return on Prosper is driven by the high yielding loans, and many of those are getting snapped up through the API and AQI by actively managed lenders the minute they appear on the platform (large investors sometime fund over 90% of the loan when they appear on the platform).
A better strategy is to wait for higher yield loans, pick the best loans, and diversify slowly but in higher yielding loans rather than investing in all loan grade as a tool for getting better returns.
P2P lending is a great example of a disruptive business model where websites like Prosper and Lending Club cut out the middle man (banks) and pass that savings on to investors.
- Seasoned returns: 24% y/y (will likely drop to 15% y/y)
- Notes: 186 – equal weighted, hand picked
- Late notes: 5 notes past 30 days late
- Charge-offs: 6 (included in returns above)
- Average age of all notes in portfolio: 242 days
Interested in chatting or exchanging ideas about P2P lending? Send me a message on twitter.com/thomasdelong
Lending Club and Prosper have raised a combined $210M from institutional investors according to a recent article from the Wall St. Journal. The money is largely being placed into index funds that either focus on higher grade loans, or invest broadly across all loans on the platform such as Lending Club’s Broad Based Consumer Credit Fund.
For anyone interested in learning more about P2P Lending you can find a great introduction in this Wall St. Journal Article on P2P Lending by clicking the link below:
Prosper’s “seasoned returns” show my portfolio earning 22% y/y. After over a year of P2P investing the results have been promising, and though I have 3 notes that have defaulted, and 5 notes that are likely to go into default (out of a total of 160 notes), I continue to believe it is possible to earn 10-15% y/y by investing in consumer credit.
Seasoned returns on Prosper only include notes that are over 10 months old, which offers investors a more accurate picture of their actual return because it allows enough time for bad notes to default (can take many months). Many of the notes that are going to default do so within the 10 months after issuance and then returns start to stabilize as defaults decline.
- Seasoned returns: 22% y/y (will likely drop to 10-15% y/y)
- Notes: 158 – equal weighted, hand picked
- Late notes: 5 notes past 30 days late
- Charge-offs: 3
- Average age of all notes in portfolio: 218 days
Lending club is likely spending at least $13 million per year on sales and marketing based on their 10Q filing, and that number is growing quickly.
$16 million per year on “sales, marketing & customer support” ($4m per quarter)
- $1.5 million for sales/support staff (conservative guess, 20 people at $75k/yr)
- $1.5 million for other sales expenses (travel, etc.)
= $13 million on sales and marketing
* According to their 10-Q filing, for the quarter (only 3 months) ending September 2011 lending club spent over $4 million on sales, marketing, and customer service. This is a run rate of $16 million per year (4 quarters * $4 million per quarter = $16 million per year).