Alternative Fixed Income: IncomeClub vs. P2P Lending
Peer-to-Peer (P2P) lending has grown considerably in recent years, fueled by borrowers seeking options to traditional financing solutions and big banks.
However, the growth P2P lending has experienced would not have been possible without a correlating amount of demand from investors.
P2P lending has also created new opportunities for investors seeking income, and willing to take on a little extra effort.
In a way, it’s similar to bond investing. After all, it’s really nothing more than lending money to another individual and earning interest on that loan.
How does traditional bond investing through IncomeClub compare to P2P lending?
A Closer Look at P2P Lending
After the Great Recession, banks tightened their lending criteria, making it more difficult for most people to get a loan. However, that did nothing to dry up the demand for loans. It only left people without access to funding methods. Even those with good credit took a hit.
The demand combined with a lack of availability led directly to the birth of online lending sites, such as Lending Club and Prosper. These sites offered members the chance to loan money and earn interest, and for customers to obtain the loans they need without having to go from bank to bank to bank with their hand out.
At first blush, it looks pretty simple. Investors loan to borrowers, and earn interest, while borrowers receive the funds they need. However, that’s not actually the case.
Borrowers apply for the loan through online lending sites, where they are vetted by due diligence. If they are approved, their applications are published and offered for funding. When an application receives enough commitments from investors, the third party bank, like Web Bank, actually originates a loan.
The loan is bought by special purpose vehicles (SPVs), actually, a company created by lending sites, which instead issues a note collateralized by a loan. Usually, notes have a small denomination, a little as $25. Lending sites file registration statements for the bulk of the notes with the SEC before they are actually issued.
Finally, those notes are sold to the investors who committed to invest in the underlying loan.
P2P lending platforms charge borrowers origination fees up to 5% and withdraw this fee directly from originated loans.
Comparing Bonds and P2P Loans
While some robo-advisors use algorithms to allocate client portfolios and usually rely on ETFs to implement recommendations, IncomeClub does not. We’re the world’s first robo-advisor to specialize in bond investing.
We use investment-grade corporate bonds, as well as some “BB” rated bonds to ensure our clients receive an optimum return on their investment, as well as to provide a firm end-date (maturity). All of our bonds are SEC-registered and openly traded on global marketplaces. They can be sold easily as well, due to their high liquidity.
Despite the fact that lending sites file a registration statement with the SEC, their notes are not actually registered securities, nor are they traded on public markets. In addition, they cannot be sold to other investors, or even to primary investors in all US states.
Finally, there’s no guarantee that an investor interested in getting out of the game can sell their portfolio of notes.
Loan Origination versus Investment Advisors
At IncomeClub, we provide our investors with a specialized, transparent, fiduciary investment management service, and we are registered with the SEC.
This means that we put our clients’ interests first, each and every time.
Loan originators are under no such obligation to do so. They only sell notes. These notes are backed by loans that originate in their own system, and there is often a lack of quality due diligence.
More and more, P2P lending sites fund billions of dollars in loans to borrowers with little in the way of income verification, or even identity verification. This creates a significant risk that is transferred directly to investors.
Risk management requires investment diversification. P2P notes can definitely help with risk management in this way, due to their low denominations.
However, while bond investing was once dominated by high-cost options, things are changing today.
Many dealers, firms, and brokers now offer bonds via electronic marketplaces, for much smaller denominations, sometimes as little as $1,000.
This provides the means to diversify further and reduce risk across an investment portfolio.
Fees for Account Management
All lending sites charge their investors an annual management fee of 1%.
However, at IncomeClub,fees start as low as 0.25% for accounts with under $100,000 in assets.
For accounts with more than this, our fees are as low as 0.20%.
P2P Loans Defaults Increasing
At first glance, it might seem like the P2P lending industry is pretty stable, but that’s deceiving. In fact, the rate of default is high, and accelerating due to the lax vetting procedures put in place by these sites.
In point of fact, P2P lending sites might be guilty of the same practices that caused the Great Recession in the first place.
As an example, consider that Lending Club’s average default rate in 2015 was 4.36%. While that was low, the very next year saw a significant increase. This was caused by the fact that many borrowers were simply taking out loans to pay off high-interest credit card debt, and then taking any excess cash and spending it.
Essentially, they dug themselves a new hole. In May 2016, Lending Club’s stock collapsed by 25% in a single day after reporting massive loan write-offs.
In contrast, the default rate in investment-grade bonds is virtually zero.
What Should Investors Do?
Yes, the P2P lending market can be attractive.
However, investors must understand the high risks here. At IncomeClub, our argument is the predictability of returns.
If you set a targeted date for an investment portfolio, you know precisely when you’ll receive your money, as well as how much you’ll receive.
We also ensure that all portfolios are tailored to individual investor’s risk profile, goals and time horizon.
Yes, having both options is a good thing, but P2P lending is definitely not for everyone, particularly those who crave stability and predictability.