Friday, November 10, 2017

Why I Am Pulling My Money Out of Lending Club and Prosper

I suppose I should keep you in suspense and make you read to the bottom of the article to find out why I am pulling my money out of Lending Club and Prosper, but I'll break the rules and tell you up front:  I am pulling my money out of Lending Club and Prosper because I'm losing money.

What Are Prosper and Lending Club?

Prosper and Lending Club are "Marketplace Lenders" or "Peer-to-Peer Lenders". They are businesses that use the internet to connect people with money with people who want to borrow money.  Unlike banks which risk their own assets, marketplace lenders risk investors money.  Prosper and Lending Club make money via origination fees and monthly processing fees.  

Prosper, in its current form, began in 2009; Lending Club started in 2006, and pretty much took its current form in 2008.  Both specialize in unsecured personal loans.

What Risks Do Investors Bear with Lending Club and Prosper?

As with any debt instrument, investors in Lending Club and Prosper bear the risk of default--they have no guarantee that the loan will be repaid.  They also bear a limited amount of interest rate risk--the risk that interest rates will rise in the future, leaving them with an investment that pays less than market rates, which could cause the value of the notes on the secondary market (where those who own Lending Club notes can sell them to others). 

The credit risk, the risk of default, is what is getting me (and other investors) now.  As my brother the car salesman said "I can make money lending money to any group of people, I just have to price it right".  In the money lending business, interest rates have to be high enough so that those who do pay cover those who don't.  

Investors in both Prosper and Lending Club had minimal earnings during the financial meltdown that started in 2008.  Defaults were high compared to interest rates and lenders did not earn much.  However, as the economy improved, so did earnings.  Mr. Money Mustache started investing in Lending Club in September, 2012. Like most investors, his initial returns were very high because it takes time for loans to default.  By September, 2015, when the first notes he purchased were fully mature, his return had dropped to 11.99%.  A year later, it was 10.18%.  By October, 2017, MMM's lifetime returns had dropped to 7.72$ and his experience was similar to mine--his monthly interest was being consumed by defaults.

Clearly right now, the pricing on those notes is too low--the people who are paying are not paying enough interest to cover the defaults. Lending Club investors have become victims of the law of supply and demand.  Two years ago investors complained that they had too much cash in their accounts--there were not enough notes in which to invest. In order to attract more borrowers, Lending Club lowered interest rates, because they believed investor returns did not have to be that high to attract enough investors.  Now they are beginning to raise them again because defaults are too  high--and right now, unemployment is low and overall, the economy is doing well.  If things take a turn for the worse, these unsecured loans will be some of the first people quit paying.  

What Am I Doing With the Money?

Most of it is going into a diversified portfolio of Vanguard mutual funds.  That is a sensible, low-cost investment that has stood the test of time.  It may not garner me clicks on my blog, but year in and year out, it gives results.  

I'm going to play with a little bit of it and buy some individual stocks via Robinhood, a commission-free broker.

*Part of Financially Savvy Saturdays on brokeGIRLrich.*

1 comment:

  1. "I can make money lending money to any group of people, I just have to price it right" So do you think Lending Club and Prosper will get the interest rates and supply/demand figured out in the long term, or will they be doomed to eventually fail?