P2P lending company Lending Club was in the news lately. After the discovery of some internal control problems, its CEO resigned. Some institutional investors stopped or slowed down buying its loans, which reduced Lending Club’s funding for new loans. Lending Club announced a layoff of 12% of its workforce.
The case for investing in P2P loans is that of a loan shark. Borrowers pay high interest rates; after the company takes a cut, you get the rest of the interest. The borrowers for one reason or another (a) can’t get a loan from elsewhere; or (b) can’t get a loan as quickly or as easily from elsewhere; or (c) can’t get a loan at a lower rate from elsewhere. Because of their dire strait, the interest rate they pay when they get a loan from a P2P lending company is quite high, as high as 15%, 20% or more.
You justify profiting from the borrowers’ misfortune by saying the interest rates they must pay elsewhere are even higher. So you are actually helping them when they borrow from P2P lending to pay off the higher-interest loans they currently have.
P2P lending grew fast, but it’s still relatively small in overall consumer lending, even among the borrower population who must pay high rates. For each person borrowing from P2P companies, probably 10 or more people are borrowing from other places, paying higher interest rates. Here’s a question:
If you see investing in P2P lending as attractive, why not invest in those other companies who have more borrowers paying even higher interest rates?
As a part owner of these other companies, you get 100% of the net profit from the higher interest rates paid, after the cost of doing business, default, collection, and recovery.
What are those other companies?
Credit Card Issuers
Banks issue credit cards. Many people carry a balance, at very high interest rates. Bank of America, Chase, Citi, American Express, Capital One, Discover, and Wells Fargo all have large credit card portfolios with billions in outstanding balances. These are all very large publicly traded companies. As an owner, you benefit from the interest paid on the credit card balances carried at high interest rates.
Some of these banks have substantial other operations besides credit cards. You would be buying into those other operations as well if you own them. Among the companies mentioned above, American Express, Capital One, and Discover have more of their business in credit cards.
Consumer Finance Companies
If American Express, Capital One, and Discover aren’t pure enough in lending to consumers at high interest rates, there are also other companies that specialize in consumer finance.
Synchrony Financial (SYF) offers credit through retail stores, doctor/dentist offices and so on.
OneMain Holdings (OMF), through its Springleaf and OneMain brands, offer personal loans and auto loans.
Credit Acceptance Corporation (CACC) offers auto loans through car dealerships to consumers with poor credit. Interest rates are high and the loans are secured with the threat of a repo.
Santander Consumer USA Holdings (SC) offers auto loans to subprime borrowers. The interest rate can be 17% APR or higher.
SLM Corporation (SLM), also known as Sallie Mae, offers private student loans. Interest rates aren’t as high as those on credit cards but these loans are very hard to default on.
All these companies are worth at least $1 billion. There must be other smaller players as well.
Equity vs Fixed Income
Some may say buying the stock of these companies is investing in equity and P2P lending is investing in fixed income. Other than having the cost of marketing and underwriting rolled up and expressed as a percentage of the loan, I don’t see a fundamental difference between lending to consumers through credit cards or subprime auto loans and lending to consumers through P2P. In each case, the profit drivers are interest rates and default. If you are able to maximize the gap between interest rates and default, you win.
Already In Index Funds
Astute readers would realize all these companies lending to consumers at high interest rates are already in index funds. Through a total market index fund you already own a small piece in each. You are already profiting from the misery of consumers paying 12% on their auto loans, 19% on their credit card balances, or 25% on personal unsecured loans. The question now is whether you should invest more in this part of the market.
Is this part of the market more attractive than other parts? What do you know that makes you think yes or no? Just the high interest rates aren’t enough. You must also properly account for risk. If the economy turns bad and borrowers lose their jobs, default will jump higher.
Why then do you see a lot of talk about investing in P2P lending? Remember picks and shovels. Allegedly during the Gold Rush era those who sold picks and shovels to gold miners made more money than the gold miners themselves. The same is true here. It’s more profitable to help others invest in P2P lending than investing in P2P lending themselves.
[Photo credit: Flickr user doug solomon]