Risks

[John]

Here are some of the major risks I see with P2P loans

Interest rates go up after I have locked into a loan
The borrower does not pay
Borrower pays off early
Lending Club goes under

The last one is the hardest for me to get a handle on.  What is likely to happen if LC were to go under.  I see lots of other institutions go through scandals and it never seems to turn out good for the investor.  Has anyone looked into this?

Also, what ways could LC fail?  Are there any indicators one should watch for?

[Lloigor]

Interest rates aren't likely to go up fast enough to worry about being locked into a 3 year (or 5 year with a corresponding 3-5% rate increase) term, in my opinion.

The borrower not paying is what we all try to minimize, it is clearly your primary risk factor.  Some hope for remedy, some sell at any sign of trouble.  Devise your own strategy.

Borrower paying off early is a hit, but a small one.  If they pay in full in month one you'll probably lose a few cents to fees.  I had a D4 pay in full in month two, I still made $0.52 after fees, or 2.08% over two (perhaps as much as three including funding, approval, and payment processing) months.  It may not be what you were planning on, but I'll take that happening 10 times over a single missed payment.

According to the documents on their website, there is a successorship arranged that would provide for continued loan servicing and payments to investors.  I do not know if that information can be independently verified, but I have no reason to doubt its validity.  I don't know what would happen to undeployed cash and whether more of the borrowers would default with a different collection team, though.

The risk I take note of that you didn't mention is liquidity.  Notes can be sold, but if you want to keep your shirt you will need a period of time to sell them and get your cash, should you need it.

[rawraw]

Interest rates aren't likely to go up fast enough to worry about being locked into a 3 year (or 5 year with a corresponding 3-5% rate increase) term, in my opinion.

I disagree about rate shocks not having an impact.  If you look at the ranges of historical rate shocks over a 1 year period, they can get quite large (+400 bps).  But these are short term notes, so the earnings impact is small or large -- depending on the grade you invest in.  But this is a risk of any fixed income product.

What will be interesting is if LC adjusts to rates and then you have to liquidate at a loss on Folio.  This is the real risk.  Unrealized losses are unrealized until you need to cash out before maturity.

[Randawl]

1. Interest rates go up after I have locked into a loan
2. The borrower does not pay
3. Borrower pays off early
4. Lending Club goes under

1.  Indeed a risk, others above discussed it.
2.  The top risk to consider in my opinion.
3.  Not a risk in my view.  This represents an opportunity to reinvest these funds into your current strategy, which presumably offers a higher ROI or reduced rate of loss compared to the strategy those funds were previously invested (you learned from your mistakes).  In addtion and more importantly, your internal/overall return will now be increased if you are able to invest these funds in a note of similar or increased value due to amortization of the interest.  For example, Situation A:  The return in the instance in which you have one note paid off 6 months in and you reinvest those funds into a theoretically identical or superior note and that one gets paid off in 6 months, as well.  Situation B:  That same note is not paid off in 6 months but rather it is held to maturity (3/5yr).  Situation A offers appreciably higher returns.
4.  They have a BRV (Bankruptcy Remote Vehicle) in place.

[DanB]

Randawl............Actually, LC does NOT have a Bankruptcy Remote Vehicle in place for retail investors. Prosper just introduced theirs a week ago.

[yojoakak]

Randawl............Actually, LC does NOT have a Bankruptcy Remote Vehicle in place for retail investors. Prosper just introduced theirs a week ago.

'tis true!

Our arrangements for backup servicing are limited. If we fail to maintain operations, you will experience a delay and increased cost in respect of your expected principal and interest payments on the Notes, and we may be unable to collect and process repayments from borrower members.

We have made arrangements for only limited backup servicing. If our platform was to fail or we became insolvent, we would attempt to transfer our member loan servicing obligations to our third party back-up servicer. There can be no assurance that this back-up servicer will be able to adequately perform the servicing of the outstanding member loans. If this back-up servicer assumes the servicing of the member loans, the back-up servicer will impose additional servicing fees, reducing the amounts available for payments on the Notes. Additionally, transferring these servicing obligations to our back-up servicer may result in delays in the processing and recovery of information with respect to amounts owed on the member loans or, if our platform becomes inoperable, may prevent us from servicing the member loans and making principal and interest payments on the Notes. If our back-up servicer is not able to service the member loans effectively, investors’ ability to receive principal and interest payments on their Notes may be substantially impaired.

https://www.lendingclub.com/fileDownload.action?file=Clean_As_Filed_20121128.pdf&type=docs

[rawraw]

1. Interest rates go up after I have locked into a loan
2. The borrower does not pay
3. Borrower pays off early
4. Lending Club goes under

1.  Indeed a risk, others above discussed it.
2.  The top risk to consider in my opinion.
3.  Not a risk in my view.  This represents an opportunity to reinvest these funds into your current strategy, which presumably offers a higher ROI or reduced rate of loss compared to the strategy those funds were previously invested (you learned from your mistakes).  In addtion and more importantly, your internal/overall return will now be increased if you are able to invest these funds in a note of similar or increased value due to amortization of the interest.  For example, Situation A:  The return in the instance in which you have one note paid off 6 months in and you reinvest those funds into a theoretically identical or superior note and that one gets paid off in 6 months, as well.  Situation B:  That same note is not paid off in 6 months but rather it is held to maturity (3/5yr).  Situation A offers appreciably higher returns.
4.  They have a BRV (Bankruptcy Remote Vehicle) in place.

#3 also has a negative side.  The type of loans offered (like an increase in public records anyone?) or pricing could change.  It is a real risk and shouldn't be downplayed.

[Peter]

The last one is the hardest for me to get a handle on.  What is likely to happen if LC were to go under.  I see lots of other institutions go through scandals and it never seems to turn out good for the investor.  Has anyone looked into this?

Also, what ways could LC fail?  Are there any indicators one should watch for?

This is a standard question that many new investors have. The good news is that it is relatively easy to gauge the health of Lending Club because they are regulated by the SEC and have to make their financials publicly available. Also, any news that might impact investors also has to be released in an 8-K filing.

So, we know that LC has over $50m in cash on their balance sheet and no debt other than the notes. But there are risks at Lending Club, something unforeseen could happen that could threaten their business model. But we would likely get some warning.

Now, as I just share on the blog yesterday Prosper has just introduced bankruptcy remoteness for all investors. I have a feeling that Lending Club will do the same thing this year. This will add another layer of protection for all investors rather than just the large investors ($500K or more) that currently enjoy that protection at Lending Club.

[John]

After thinking about it some more, I should have added the risk of ignorance (on my part or any new investor).  Fortunately this forum is a great tool for minimizing that. Thanks to all for the great feedback.   

[greek]

John this was helpful and if anything makes me study the possibilities of the secondary market more.

[Randawl]

Randawl............Actually, LC does NOT have a Bankruptcy Remote Vehicle in place for retail investors. Prosper just introduced theirs a week ago.

Thank you for reminding me of this.  My mind got mixed up thinking that LC's plans (as noted by Peter) had already occurred.     Doh! 

#3 also has a negative side.  The type of loans offered (like an increase in public records anyone?) or pricing could change.  It is a real risk and shouldn't be downplayed.

Good point.  And that risk is realized most heavily in situations when you are investing that "new" money (the early payoffs) during a period in which, in the future, will end up proving to be a time similar to the 2008-2009 default periods - investing into an acute downtrend.

My view is that, due to the current credit market default rates/trends, including the near record high MPR (monthly payment rate) of around 22%, we are in an environment that will offer similar or lower loss rates than that of the past few years.  I respect and welcome alternative views to my statements.  Love the discussion! 

Source:  http://blog.unibulmerchantservices.com/u-s-credit-card-defaults-keep-falling/

After thinking about it some more, I should have added the risk of ignorance (on my part or any new investor).  Fortunately this forum is a great tool for minimizing that. Thanks to all for the great feedback.

Amen to that!

Kind regards