What started out as a mere curiosity ultimately lead to something slightly disappointing and fairly substantial, although not entirely unexpected. After noticing some cash languishing in my Prosper account, albeit not much, I decided to look into the reasons why I wasn’t getting my cash reinvested as fast as I would like. My first thoughts were to ask myself some questions. Were my filters not working, was my automatic investing somehow broken, was loan volume falling? The short answer? Yes, the quantity of loans were falling, but not because Prosper was struggling. In other words, institutional demand and the associated loan allocation.
Sound familiar? For those veteran investors in peer to peer lending, people have been griping about loan availability for years while remembering the “good ol’ days.” Too often folks have complained about the “pinch” or “shortfall” of loans due to the “big guys” or “corrupt management”. Let me state clearly, this post is not to bemoan the involvement of institutional investors who have discovered, and now dominate, peer to peer lending. This is more an observation of what has happened as a result of this growth in demand and the response from Prosper and ultimately how it affects the regular retail investor.
What Makes an Institution a Desirable P2P Investor?
In the positive sense, the dollars that institutional investors have brought to the table have been instrumental in bringing the industry this far and have added tremendous value to the companies by bringing scale. Retail investors, while important in the beginning as a proof of concept, are now a cost liability, as it takes a tremendous amount of resources to maintain and support those with a much smaller average account size. Financial advisors deal with the same issue. Why have 100 clients with just $250,000 when you can have 20 with $1,250,000. Less work, time, and cost, all for similar revenues. As loan brokers, Prosper and Lending Club make money by origination fees mostly, so loan volume is paramount. Find a way to scale faster, and more importantly, cheaper, and cash flow is immediately improved.
The Little Guy… Just Like Me
Before I go further, let’s quickly cover the backstory on my involvement with peer to peer lending. I first heard about Lending Club shortly after they opened up shop in 2007, and began to follow their progress, and by extension, Prosper as well. After following them for a couple of years, I opened an account in 2009 and have been happily (mostly) invested since.
I started small and expanded my investments from one small taxable account with Lending Club to now having approximately $18,000 invested. I believe greatly in the ability for the average investor to receive solid returns, and that a small bit of filtering can lead to even more favorable returns. Time has change some of these things, but by and large, the concept and returns for the risk taken have proven fairly positive.
So back to the institutional demand side of this, and how all this fits together and impacts the regular retail investor. My focus was on Prosper since the data is more readily available and where my research began. All the data below has been sourced from the freely available loan data provided by Prosper.
Institutional Demand and the Changing Landscape of P2P Lending at Prosper
Historically, up until 2013, Prosper was a retail platform. You can see the history of Prosper pretty succinctly in the below chart starting with Prosper 2.0, when they exited the quiet period in 2009. While I’ve excluded 2014 for practical scaling reasons, the growth, decline, than growth again, is pretty evident. The current management of Prosper came on board at the beginning of 2013 after growth stymied under previous leadership during 2012. This is evidenced by the decline in volume in the second half of 2012.
When the new management came on, they presented a 100-day plan for reversing the downward trend and increasing loan volume. Ron Suber, now President, but previously Head of Global Institutional Sales, shared that his focus was on institutional investors. This push began what has now been a 21-month facelift of the dollars that invest on the platform.
Again, as I mentioned above, this is not to bash institutional funding, but more to understand the overall impact on loans available on the site and what this means for retail investors.
While putting together the numbers below, I’ve segregated retail and institutional demand by comparing number of investors per loan. While not perfect, given the existing rules against a retail investor capturing 100% of an available loan on the retail platform, this gave me a pretty quick and dirty means of segregating the two. The below chart shows the total loan volume, by dollar amount, for each type of loan.
While staggering in the chart above, the best view is really taking a percentage of the loan volume made up by the whole loan amounts. Going from zero percent in February of 2013 to over 92% in 2014 is an incredible percentage gain, and is shown in the chart below.
While gains are great, ultimately, what affects retail investors isn’t the percentage being absorbed by institutional investors, but the resulting impact on what is left over and available to invest. In other words, if all of your growth is funded by one source, the other source will see no gains in volume. Worse, is when the funding of one source is increasing faster than the overall growth in volume. This is the scenario Prosper has been in the past two years.
After facilitating approximately four and a half times as many loans in 2014 versus 2013, retail investors have had the opportunity to invest in 12.7% fewer loans. Sure, total retail loan amounts are up by about $8 million, but with 2,000 less loans available, across all grades, there have been significantly fewer opportunities for those looking to find loans. Since most retail investors invest a fixed amount per loan using some sort of criteria, reducing the quantity of loans is far more impactful than simply increasing the total dollar amount of loans issued.
This reduction in loan quantity is shown by the below chart. As I mentioned before, 2014 will end up with approximately 2,000 fewer loans made available on the retail platform. By and large, loan quantities for retail investors have been on the decline since 2012.
The trailing quarterly average in the chart above takes the previous three quarters plus the one just ending to determine a rolling average. What is shocking is how much this has declined since the peak in mid-2012. During 2012, $153 million of loans was issued, yet the highest volume in terms of quantity was available for retail investors, 19,108 loans. As there are still a couple of days to finalize 2014, we likely fall over 4,600 short of that total, while issuing $23 million more in loans. It must be noted that there were many institutional investors who were investing on the retail platform during this time, yet all investors were able to have a piece of these loans.
One would hope some changes would be made moving forward to balance the growth between retail and institutional investors, but that remains to be seen and that hope has yet to be rewarded over the last two years. No one is expecting 50/50, but some proportionate fraction would be great, as opposed to the reduction in quantity we’ve seen so far. Prosper will have grown approximately 350% and 260% year-over-year from 2013 to 2014 for loan amount and number, respectively. Retail investors have seen growth of 4.3% and contraction of 12.7% for the same two factors. Fairly disparate.
Reality Check: It’s Just Business
Let me be clear, being crowded out by institutional money is not isolated to just Prosper. Like millions of other folks, they are trying to run a business and follow the dollars. I place no blame on management for working to maximize revenues while minimizing cost. They aren’t in the business of charity, but are in the business of making money. And boy is it working. Being cognizant of how this impacts you should help guide your P2P investment, as it will impact your filters and criteria. As I begin to review my current criteria, and how it might need to change moving forward, this is something I am taking in consideration. Stay tuned for part two where I evaluate how this has impacted my investment criteria and the effort required to stay fully invested.
This is the first of two parts about institutional demand and the impact on the retail investor. The second part will focus more on my personal investment criteria and the impact the above scenario has had on the availability of loans while trying to stay fully invested.
What are your thoughts on institutional demand in peer to peer lending? Good, bad, or indifferent? Have you seen or experienced the pinch from having fewer loans available to retail investors?
Flickr: Konstantin Nikolaev