In November 2015 I tried an investing experiment. I invested $2500 each in Lending Club and Prosper, and chose an auto investing option that put me at a medium level of risk where I could expect annual returns in the 10% range, after some write-offs for nonperforming loans. Both sites spread out your risk by buying small slices of many loans, and both reinvest the money as loans are repaid. So how’d I do?
I’ll start by saying that investing in these peer-to-peer micro loans (the face value of most notes is $25 or so) would make an interesting hobby for a numbers geek. There’s a lot of information on the websites, both historical and projected, and once you’ve invested you can drill down to the details of each loan (though, obviously, not to the detail of the borrower’s identity). Prosper initially appears more user friendly and click-and-forget but actually has more options when you get down in the weeds. For example, it allows you to specify that you will only lend to somebody who is employed. On the other hand, while both sites let you specify whether you want to make 36-month or 60-month loans or both (down below I’ll explain while that is important), only Lending Club will show you how your projected return varies with your choice.
I actually started writing this post back in March of 2017, and cited the following inquiry I sent to Lending Club at that time:
I opened this account around 11/15/15 with $2500. The value of the account is currently $2376 which is a net annualized return of –4.06%. If I back out past due notes my NAR is still just 1.76%.
By comparison, I invested $2500 in Prosper at the same time and my NAR with them is 11.42% with a total account value of $2736. Not knowing whether they adjust for past-due notes I looked up the itemization and found that three of 76 loans were past due (but less than 30 days, none longer than 30 days) with a total value of $130. If I take the drastic step of writing off those three loans my account value is $2606 which is still way above my returns with LendingClub.
In both cases I selected a middle range of loans which was projected to yield returns of around 10%.
When I look at the scatter chart of accounts with similar rates of returns at [gated page on website] my returns are far below almost all other Lending Club investors.
What is wrong with my account? How can I adjust my automated investing so I make money, rather than lose money?
I am happy to talk about this on the phone, but wanted to put the facts in writing to give you some background first. If you can give me a complete reply in writing that’s great, otherwise let’s set up an appointment next week to go over this on the phone.
Thank you, Otis Maxwell
A few days later, Lending Club answered as follows:
Thank you for your email. I have reviewed your account and noticed that you have allocated most of your funds towards the riskier loans of grade C and below. This is one of factors that can be affecting your return since those loans are known to have a higher charge off rate.
I went to their “Edit Allocation” page and found that indeed I had somehow created a “custom” allocation. I changed it to a “platform mix” with most of the notes grade C or higher, but of course that only affects new loans. Since then five months have passed, and we now have 21 months of history. My total account value at Prosper is currently $2837 which is a 7.2% annual return. At Lending Club it’s $2515 for a 0.38% AR. Those rates are without adjustment for delinquent or charged-off loans. Less than $70 of my Prosper loans are delinquent and only one, for $24, has been charged off. At Lending Club $600 in notes have been charged off and $169 is currently delinquent. The average rates on my Lending Club loans are higher, which is why the account value difference is not more that it is.
It might be that Lending Club is more rigorous in its charge-off procedures in response to their widely reported management and cash flow issues in 2016. I have now changed my allocation to 65% B and 35% C notes, the same ratio as at Prosper, so we’ll see how that affects returns going forward. But (especially considering I was originally looking at 10% returns) how great is Prosper’s 7.2%, which drops to 7% when I back out past due notes? (These numbers are net of fees, by the way.) In recent times you could have done much better in the equities markets, obviously, but also worse with conservative bond investments. I guess I feel like I do when I win back the cost of my entrance ticket at the Saratoga Race Way. I’ve had some fun experimenting with peer-to-peer lending, the process was easy, and I’ve made a little money.
However, there’s an 800 pound gorilla in my portfolio: what do I do when I want to get the money out? I have to turn off my automated reinvestment instructions and wait for all the loans to mature which will take 5 years (or 3 years if I’d selected only shorter term loans at the beginning, with a slightly lower NAR). During this time my annual return is going to steadily drop until it finally reaches zero. You could also resell the notes. Both Prosper and Lending Club contract with a third party, Folio, as a trading platform, which offers this fascinating disclaimer (especially the part I am going to put in bold type) to the buyer:
Purchasing Notes on the Trading Platform is inherently risky as the asking price is set by the seller, and may be priced higher than the remaining return expected on the Note.
Purchasing Notes with a negative Yield to Maturity or with large markups are almost certain to return less money than the price you will pay, producing negative returns on your investment.
There are various reasons a current Note holder chooses to list a Note for sale. Often Note holders are simply looking to liquidate their holdings; they may place Notes for sale at or slightly below par value (i.e., below the remaining interest and principal remaining on the Note). However, other sellers may be seeking to profit on their sales. They may price Note above its par value, either in the hopes that a buyer will view the Notes as very valuable or because they may hope to profit from a lack of buyer’s insight. They may hope that the buyer will not realize that the price has been set so high, or they may hope that a buyer will not be paying close attention to the price set.
Please be wary of Notes that are priced at high premiums.
In addition, the original interest rate set by Lending Club was based on the borrower’s credit attributes at the time the loan was requested and may no longer represent the underlying risk of the Note. While the underlying risk may have increased, the interest rate has not and may not offset the risk a buyer undertakes when purchasing a Note.
Since the Note was issued the borrower’s attributes have most likely changed, among these could include changes to credit score, income, employment, credit utilization, debt-to-income, and many other important factors. You should buy a Note only if you understand and are comfortable with these risks.
There’s some crazy talk in that. But as I’m looking to be a seller and not a buyer, I’ll likely need to price my notes a bit lower than their face value AND I’ll need to pay a 1% service fee to the exchange on each transaction. So I can certainly expect my NAR to dip to perhaps 5.5% for my Prosper portfolio by the time I’m done. (I’m assuming these $25 notes will be harder to sell, and thus require a larger discount, than notes with a higher face value.) That’s still better than a treasury bond or CD.
If you’re still with me, I’ll answer my question: from evidence to date, Prosper does a better job of managing its loan portfolio. They offer all the functionality of Lending Club (except for that glitch about the projection of return by loan period, which is informational and doesn’t affect your actual return) as far as I can tell. So no reason not to go with them. Now that I’ve balanced my criteria so they are apples-to-apples across the two services, I’ll report back in a year or so. I’ll also tell you about my experience (if any) in reselling loans.
Meanwhile, here’s a wild card: Kiva. This not-for-profit is a platform for making micro loans to entrepreneurs in developing countries. You don’t get paid interest but you do get your money back (according to Kiva, 97% of loans are repaid) and you can either withdraw it or use it to fund another loan. Less profitable, but possibly more satisfying, than the peer-to-peer options we’ve been talking about today.