Are You Achieving Lending Club’s Average Expected Returns?

A funny thing happened to Lending Club's expected returns.....that is, the returns they expect us to earn on our loans across all loan grades.

They are going down.

How can you tell? Besides looking at your own statements, that is. They list it in their most recent 10k report filed with the SEC.

Asset Valuation Expert

I'm no asset valuation expert, but one of my clients is. As you know, I write about and for fintech for a living. Platforms along with service providers to the industry all ask me to write or edit content for them. In case I haven't said so lately, thank you. Without you readers, my writing business would not be possible.

Now back to the real expert. My client Max Fonarev, CEO of Sorbus Valuation Services, values assets for a living whether those assets are a business or a portfolio of investments like peer to peer loans. Loans can be tricky to value since we may only be on payment 6 of a 36-month note. How much is that worth?

He knows better than I do, so with his permission, I am reprinting his post here for you. You can find the original on his website. Click on the Schedule a Consultation button at the bottom of his post on his site if you want to talk to him. Tell him I sent ya :).

 

Max's Post

Buried deep in the LendingClub financial statements is a curious number. 7.2% is the investment return Lending Club believes their loans should earn for investors. The 2016 return estimate, the weighted average across all loan grades,  is down from 9.0% in 2015, presumably due to greater projected losses.  It is consistent with the investment returns reported by other asset classes.

This is from the most recent 10-k filing: (p.107) [See the weighted average discount rate column]

 

These rates of return, or discount rates, represent the company’s view on the returns their portfolio of loans should earn.  They are comparable to the investment returns reported by other asset classes and investment strategies.

Investment return numbers are hard to come by.  They are either highly proprietary, expensive to calculate or non-existent as investors are often sold a “story.” Definitive investment returns only come from calculations for a group of loans that completed all scheduled and expected payments. For example, investment return on 36-month loans originated in Q3 2017 cannot be known until Q4 2020.

Alternative measure of returns relies on valuing a portfolio of loans, while in repayment, at the end of each investment reporting period.  These are outstanding obligations, valued based on repayment and investment return expectations. This approach is circular since valuation requires estimating investment rate of return to measure investment rate of return.

Valuations of illiquid financial instruments are inherently subjective. Yet, this is the only method of tracking investment performance in existence.  Our earlier post (on the Sorbus website) illustrates that despite the subjectivity, portfolio valuations can produce highly reliable numbers.

In May 2017, Prosper went public with corrections to its investment return calculations. The returns dropped about 2%. The company called it a “glitch.” Note that Prosper provides current yields rather than the actual all-in investment returns.  Current yield is calculated by dividing coupon payments by the principal amount outstanding.  It ignores changes in the principal balance itself, which makes it vastly inferior to the true investment rate of return measure.

Below are some more examples where lenders disclose their own rate of return estimates:

Lender Point Estimate Return Range of Returns
LendingClub 7.2% 1.2% - 16.6%
Prosper 7.3% 4.0% - 15.9%
EZCORP na 9.0% - 22.0%

 

Correlation between asset classes can be as important as the rates of return themselves.  The correlation between marketplace lending credits and traditional asset classes is broadly assumed to be low, making marketplace lending desirable from the portfolio theory perspective. However, correlation cannot be measured without reliable investment return numbers, thus the true correlation is not really known at this point.  Once tech-enabled marketplace lenders build robust investment reporting systems, this growing asset class will become even more desirable as a fixed income investment than it is today.

Conclusion

What Max's post tells us is that the returns are declining and LC expects that. Calculating returns is also difficult for a professional like him for fixed income investments like these loans, let alone if we try to calculate this for ourselves. Lastly, while these platforms are generally transparent, these numbers have been buried and not talked about.....at all. Are they trying to hide this declining trend? I don't know but I'll be watching and you should be too.

 

About the author

Stu Stu Lustman, the author of this post, is a Credit Analyst by trade trying to bring Commercial Credit Analysis techniques to the world of Peer to Peer Lending. Check me out on Twitter, LinkedIn and Google+

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