
Lending Club Can Be a Better Bank Than the Banks - stygiansonic
http://www.bloombergview.com/articles/2014-08-27/lending-club-can-be-a-better-bank-than-the-banks
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donohoe
I've taken out two loans with Lending Club over the last 3 or 4 years. Each
time I've compared the rate with my bank (Citi) and others, and each time LC
has been competitively cheaper.

Citi advertises "Get a fixed rate ranging from 8.99% APR to 20.74% APR." and
my rate with LC has been typically 7.86% APR (forget exact decimal place
figure). The 8.99% rate with Citi assumes they give me the best rate - not
guaranteed.

Its fast, friendly, and I can repay early at no penalty.

Extremely satisfied.

~~~
radmuzom
Ultimately, their sustainability will depend on the cost at which they can
raise funds. Banks can raise funds cheaply through deposits (and many other
sources like wholesale funding which may be at a higher cost), which they lend
out at slightly higher interest rates than they pay their depositors. Given
that LC is not a depository institution, the only way I see them providing
lower interest rates is they have figured out a cheaper source of funding - or
burning investor money to do this which is not sustainable and the big banks
will defeat them eventually. The moment you start taking deposits, you will be
regulated like any other institution and they need to compete with other banks
on the same terms. Another aspect is that banks are in the business of risk
management, so it is probable that LC has figured out a better way to manage
their risks than existing institutions - again, this is something where
existing institutions have enough resources to catch up easily.

~~~
nether
> Given that LC is not a depository institution, the only way I see them
> providing lower interest rates is they have figured out a cheaper source of
> funding - or burning investor money to do this which is not sustainable and
> the big banks will defeat them eventually.

LC is peer to peer lending. I have $47k invested in LC notes. They save money
by having fewer brick & mortar offices and mainly relying on credit score to
assess borrowers.

~~~
conistonwater
If they mainly rely on credit scores, how will they remain competitive with
lenders that have more information about the borrower, or has the resources to
develop a business relationship with the borrower? Everybody else has access
to credit scores too, you know.

~~~
rtpg
it might be that credit scores are cheap enough (or rather, finding more
information is expensive enough) that they're the local maximum in terms of
possible profit from the transaction.

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7Figures2Commas
> But all of the things that make banks scary don't apply. A run on Lending
> Club is not possible; nobody can pull their money out of notes or
> certificates. And if a lot of loans go bad, that will hurt the investors in
> those notes, but Lending Club as an entity won't be insolvent or even have
> any losses at all.

This is true, but one should recognize that for Lending Club to sustain itself
over time, it must be able to acquire borrowers and sell notes. There are a
number of events that could put a dent in both supply and demand.

On the demand side, if and when there is a recession, defaults will almost
certainly rise and it's likely fewer investors (retail and institutional) will
be eager to take on new credit risk. If and when interest rates rise, funding
these loans may become a lot less appealing. One must also assume that at
least some borrowers, particularly those who are heavily indebted, are
themselves vulnerable to interest rate increases, so I wouldn't be surprised
to see rising rates negatively affect the repayment performance of certain
types of portfolios.

> There's another point that's a flip side of this one, which is: Equity-
> funded banks are great at lending. Lending Club is perfectly able to make
> loans, and apparently at cheaper rates than banks.

Lending Club is perfectly able to make loans, and apparently at cheaper rates
than banks, because yield-chasing investors are currently willing to misprice
risk. What happens when the music stops?

~~~
nullc
> Lending Club is perfectly able to make loans, and apparently at cheaper
> rates than banks, because yield-chasing investors are currently willing to
> misprice risk. What happens when the music stops?

Very much this— I've been a lending club 'lender' for a number of years now,
and for the last 9 months or so have had a very hard time obtaining
practically any notes.

People are hyper eagerly funding notes which my models suggest have very poor
risk adjusted performance. (And, if anything, I'm concerned that my models are
too conservative— since they're based on historic LC data and lending club has
been reaching out to less and less credit worthy lendees).

As a result I'm slowly reducing my amount in lending club as notes return
funds and I'm unable to invest it effectively. It was neat in the beginning,
but it's a pain to report taxes on, and the decreasing risk adjusted returns
make it much less attractive than it used to be.

~~~
nether
> It was neat in the beginning, but it's a pain to report taxes on, and the
> decreasing risk adjusted returns make it much less attractive than it used
> to be.

The taxes are the biggest issue right now I think. There's no faculty in US
tax code for reporting earnings on this kind of investment. If I heard right,
I think some people lost _all_ of their returns in 2012 due to written-off
notes? I believe all of my returns (over the past four years) were taxed at my
normal income rate. People have just been guessing at how to report their
earnings in TurboTax. Haven't heard of any audits thus far...

Also, as far as risk-adjusted returns go, it still beats equities, right?

~~~
7Figures2Commas
> There's no faculty in US tax code for reporting earnings on this kind of
> investment.

That's not true.

> Also, as far as risk-adjusted returns go, it still beats equities, right?

The S&P 500 was around 1,140 at the beginning of January 2010. It's now above
2,000.

If you had bought SPY in January 2010, you'd be sitting on a gain of around
75% not including dividends. SPY is highly liquid (more than 80 million shares
trade hands on any given day) and optionable, so you can exit your position
quickly if necessary and easily hedge your position if desired.

Needless to say, comparing the S&P 500 to a pure debt instrument is like
comparing apples to oranges, but if your goal is to maximize risk-adjusted
returns, you have to compare asset classes.

Obviously, this isn't 2010. The market today is a lot harder to navigate. On
the whole, equities look expensive and with a shift in interest rate policy
almost certainly coming, the debt markets are tricky. As Sam Zell recently
said, "This is the first time I ever remember where having cash isn't such a
terrible thing."

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11thEarlOfMar
Lending Club will not have trouble raising capital or finding borrowers
because it is a lower-cost operation than banks. As such, it can reduce the
spread between the yield 'investors' earn and interest rates borrowers pay,
making it more attractive to both. The growth of their total loan activity
bears that out: 5 Billion in total loans over the last 5 years. 1 Billion of
that in the last quarter.

The key to their business is in their ability to accurately forecast the
default rate of borrowers. The more they can predict the performance of the
loans, the more 'fixed' the income seems to investors and the more attractive
it is. They do predict default rates for loans and inform investors what those
rates are for each loan. Over time, I'd expect their statisticians and big-
data analysts will be able to refine the models to be highly accurate.

I've been experimenting with LC as an investor for about a year and a half. So
far, my loans are performing about 1% better than Lending Club forecast they
would. I attribute that to an improving economy.

~~~
foobarqux
> about 1% better than Lending Club forecast they would. I attribute that to
> an improving economy.

Probably just statistical variation.

~~~
11thEarlOfMar
It was over 120 loans. All at 17.25% with a forecast 4.95% default rate. 0.5%
fees. Actual return after 18 months is 13.85% with 5 defaults.

~~~
foobarqux
Maybe not, I don't feel like modelling the math right now to see if it could
be statistical variation.

(I don't understand your numbers though. Forecast return was higher than
actual?)

~~~
db48x
Presumably because there were 5 defaults when 5.94 were predicted. On the
other hand, if any of those 120 loans are still outstanding, then they could
still default later.

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spiritplumber
Banks started off as lending clubs.

I ditched BofA, signed up with a credit union, and enjoyed fantastic service
since. If you don't want to risk these guys in case they get screwed over by
regulators, talk to your local CU!

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chiph
> Lending Club is not a bank. So it's not subject to banking regulation, which
> means that it can do a core function of banking much more efficiently than
> an actual bank can.

Are the various banking regulatory agencies in agreement with that? (FDIC,
Federal Reserve, Comptroller of the Currency, Thrift Supervision, as well as
the various and sundry states)

~~~
IgorPartola
Well, LC doesn't do deposits, so it is not doing partial reserve banking. I
suppose there could be extra regulation attached to what they do, but I don't
think it is much different than a message board that connects buyers and
lenders at its core.

~~~
dragonwriter
While LC is not a bank -- and not subject to banking regulations -- its not at
all a "message board that connects buyers to lenders". While it initially was
something like that (and still has some superficial resemblance to it),
lending is a tightly regulated industry, and there'd be a very narrow market
if it it tried to _actually_ be that, rather than being the lender itself and
selling notes tied to its loans (essentially, a key part of the service LC is
providing is dealing with the regulatory compliance with regard to lending.)
This is the same model as is used by other superficially "peer-to-peer"
lending services (e.g., Prosper.com)

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aianus
Can you invest in Lending Club if you don't live in the US? It doesn't mention
anything in the terms of use but they ask what state you live in when you sign
up. Can I just put a friend's state or something?

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dragonwriter
> Can you invest in Lending Club if you don't live in the US?

No. And not if you live in certain parts of the US, either. And, in the states
where it is available, there are additional restrictions.

[http://blog.lendingclub.com/is-lending-club-available-in-
my-...](http://blog.lendingclub.com/is-lending-club-available-in-my-state/)

[http://kb.lendingclub.com/investor/articles/Investor/What-
ar...](http://kb.lendingclub.com/investor/articles/Investor/What-are-the-
current-State-and-Financial-Suitability-
conditions/?l=en_US&c=Investor%3AEligibility&fs=Search&pn=1)

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stygiansonic
I really liked the observation that in exchange for your deposit (investment
in a note) not being liquid (secondary market notwithstanding), Lending Club
is able to match the maturity of their assets and liabilities, thus
eliminating this portion of risk from themselves. Theoretically, this could be
one of the causes for the lower rates borrowers can obtain and the higher
returns that investors get. (Obviously a portion of the higher returns come
from the lack of liquidity offered by the notes)

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juanplusjuan
I always wondered why big banks didn't get into the business that Lending Club
started. I figured that it was due to inefficiencies in the consumer credit
model that made it such that "high risk" borrowers were ineligible for secured
loans and that LC found a better way to accurately measure that risk. Who knew
it came down to accounting?

~~~
dragonwriter
> I always wondered why big banks didn't get into the business that Lending
> Club started.

LC didn't start it, it followed a number of other generally similar "peer-to-
peer" lending services (Prosper.com is the first US one I'm aware of -- about
two years before LC -- and ISTR there was at least one UK one about the same
time as Prosper).

And banks don't get into it because it would involve risking the resources on
a new business whose _success_ outcome would be driving customers to account
choices where the bank keeps less of the income from lending.

If the quasi-peer-to-peer-model becomes popular, banks will grudgingly get
into it because then the choice will be between giving up _all_ of the money
to competitors rather than giving _some_ of it up to investors in quasi-P2P
loans, but they'd rather not stamp their imprimatur on the model while it
still might fail to become a significant factor in how people invest and seek
loans.

~~~
technotony
Zopa was the UK one. It launched before Prosper and is a really interesting
case study for why you should launch first in the US and not your random
smaller home market. As a result they were late to launch in the US and as a
consequence lost the larger market, which is why lending club is IPOing first.
One major reason they had to withdraw from the US was because they had an
existing (working) operation in the UK they couldn't take regulatory risk: the
other US operations launched with an illegal model and later got shut down
while they restructured, Zopa tried to launch a legal, but less attractive to
users, model and failed to gain traction as a result. Really interesting
startup case study!

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novalis78
Interesting - so Lending Club does not actually work like BTCJam. I did not
know that.

~~~
snapclass
Use BTCJam and Lending Club. LC is amazing and I am happy with my returns. BTC
seems like a scam as the reputation of borrowers means very little in their
willingness to repay. I've seen many people build their reputation in order to
borrow more and then bounce.

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flavio87
snapclass - although this happened a lot in the past, we are now curating the
platform much more and also our repayment rates are in the 85% area. If you
diversify well and go for A/B rated borrowers you can definitely make very
positive returns.

We are now doing around USD 1M per month, are growing the number of borrowers
rapidly - which allows for more diversification and better returns (on
average)

~~~
novalis78
Hi flavio87 big fan of BTCJam here - have to agree, you guys are doing a much
better job on filtering out people - the idea of having borrowers pose with
their passport was great. 85% seems to fit my own observations so far, maybe
close to 90% depending on your level of scrutiny. Keep up the great work!

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kaushalc
In India we call it chit fund.

