This is another post that falls under that general 'Is it safe?' category that we get asked by those who don't invest in p2p loans. Some of these people are interested in investing so for them as well as for those of us who want to know for our own evaluation of risk we will keep delving into this topic. Today it is Lending Club. What happens if LC goes bankrupt is the question.
At this stage, especially after the large Google Ventures investment of $100 million in mid 2013, the likelihood of this happening has gone down drastically. With this in mind, let's address the questions of what can happen versus what will happen. First, retail investors like you and me.
Are Retail Investors Protected?
In a word, No. Generally, investors are not protected in the event of Lending Club itself going bankrupt. However there are some protections in place. Lending Club itself tells us some of what we can expect right here.
What Will Happen: Backup Servicing
In the event of an LC bankruptcy, a backup servicer, the Portfolio Financial Servicing Company (PFSC) would come in and take over the servicing of the loans. This is already written into their agreements and their prospectus. The backup servicing is limited and cannot be assured that it will happen or that the servicer can adequately service all outstanding LC notes (Prospectus from Apr 2013, p. 22).
What Will Happen: WebBank's role in the process halts
WebBank is the official issuer and then assignor of the LC loans. They are a Utah based Industrial bank. Industrial banks may or may not be FDIC insured and have more liberal rules about what they can do with the deposits. WebBank is FDIC insured.
Industrial banks are common in the equipment finance business as a company sets up an IB to collect deposits and use those funds to fund equipment leases. No new loans can be issued or assigned when in bankruptcy so despite WebBank being a completely separate entity, their role in the LC lending process ceases until there is resolution for the existing loan pools.
What Can Happen: LC's assets are bought by another company
Given the size and scope of some of the outside investment in LC, especially Google and LC's known intention of going public, this is a very real possibility that if LC goes bankrupt that their assets are purchased by another company. If that happens there is likely to be minimal disruption to all investors especially us little guy retail investors.
What Can Happen: All contracts with LC (including our loans) are voided by a Bankruptcy Court
No one knows what will happen if a peer lender goes under because it hasn't happened yet. Under typical loan agreements where a party files for bankruptcy, the standard course of action of a BK court is to void all contracts and each creditor has to line up to show the strength and amount of their claim. Per the prospectus, this filing from April 2013, we see that the holder of any note (thats us) has an unsecured claim against LC that 'may or may not be limited in recovery to the corresponding member loan payments.' The notes are not secured by any collateral or guaranteed or insured by any third party (Prospectus, p 13).
What Will Happen: BK requires that LC stop payment on all notes
Per prospectus (page 22), even if the funds are available the BK filing precludes LC from making payments. All payments must stop. Some of this has to do with the just above that all contracts could be voided
If this all sounds like it's uncertain with lots of if's and but's, that's because it is. There is tremendous power in the Federal Bankruptcy Court. They can allow lots of things that help or hurt us as retail investors in Lending Club loans.
Are Institutional Investors Protected?
After extensive talks with LC Institutional sales directly as well as having one of my Investment Management contacts call them, we have found out that the story is a little different for institutional investors. Institutional investors have a fixed fund they invest in, which is only open for a certain period or dollar amount of funding. Then this funding closes and they open the 2nd fund a couple months later called (for the sake of argument) LC Institutional Fund 2. Per LC Institutional Sales, there is an average of 4-6 months lag time between initial interest and when an available fund opens up for the institution to invest its money. March or May 2014 is when the next fund will open given no big changes in the marketplace.
This background was important to point out to show you that institutional investors actually invest in a fund set up by LC, that they can then use to buy the loans they want in whole or in part like we do.
Unlike retail investors, institutional investors ARE protected in a bankruptcy. Each of these LC Institutional Funds is held in trust and the trust being a separate vehicle from the lending platform protects it and its interests in the event of a BK.
What Will Happen: Like with retail investors, no new loans will be issued and no new institutional funds will be set up
This probably goes without saying but no new funds will be set up in the event of a Lending Club BK.
What Will Happen: Self Servicing of Loans
While the trust structure protects institutions from a bankruptcy, since all of Lending Club's activities have to stop, there is no servicing of the loans. The institutions still own these loans in trust but they now have to service the loans themselves or hire a new servicing firm to service for them. While that is a pain for them, they are protected.
The question of whether we are protected or not in the event of a Lending Club bankruptcy is not really black and white but lots of gray. Retail investors technically have no protection but the reality is more like a partial protection with potential for minimal disruption all the way up to loss of majority of remaining principal
Institutional investors have it a little easier as they have a clear and definitive protection due to the trust structure of their investment vehicles in the platform. However, it's not smooth sailing for them either as they would then have to service or pay to get serviced their existing loans in their portfolios.
Thankfully, this is something that with each passing month and year seems less and less likely or at least less likely without some kind of full resolution like an asset purchase by an existing investor in LC.