The Great Divide in P2P Lending: Institutional Demand and the Little Guy

The Great Divide in P2P Lending - Institutional Demand and the Little Guy - Great Chasm

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.

You can check out all my P2P investments on their respective pages: Lending Club and Prosper

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.

The Great Divide in P2P Lending - Institutional Demand and the Little Guy - Loan volume for Prosper 2009-2013

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.

The Great Divide in P2P Lending - Institutional Demand and the Little Guy - Fractional and Whole Loan Amounts Issued 2009-2014

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.

The Great Divide in P2P Lending - Institutional Demand and the Little Guy - Percentage of Loans Issued to Insititutions

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 Great Divide in P2P Lending - Institutional Demand and the Little Guy - Number of Fractional Loans Issued since 2009

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 workingBeing 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

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  1. I have mixed feelings. Above all, I think this is a good problem to have that may be rectified as the platforms grow. I was reading in the Lending Club IPO prospectus that there is something like 300+ billion in credit card debt that is eligible to be refinanced by LC loans. At the same time, LC has only done 6 billion in loans. I’m hoping that as LC goes mainstream, they will continue to grow their numbers at the same crazy rate, bringing lots of new borrowers on board (Super Bowl commercial!). Of course, that could bring more lenders in as well. Dunno. In any case, I feel very comfortable holding LC stock for the very long term.

    Like you, I’ve been involved for years and fondly remember the good old days when loans would sit around for days before being funded. Sigh…

    • You’re right, the market size for unsecured credit is huge, however there is a reason why Lending Club is expanding elsewhere. More profitable loans that are being limited to institutional investors only. More money, less headache, win for them. Not that this is a problem, they are running a business after all, but it is something to be aware of when investing.

      Long-term, Lending Club is going to be fine, that isn’t a concern. Recognizing the shift of importance, and the management decisions that impact the smaller investor, will be crucial in managing the expectations and returns of your investment.

      Love having you stop by Mr. 1500 to share your thoughts.

  2. I use Lending Club and have noticed that the good loans (grades E-G) are high in demand and are fully funded within hours, sometimes even minutes or seconds. So yes, institutional investors are squeezing out the little guys. The paucity of loans is concerning. I have about 8k in my LC account and will not add anymore because of cash drag. Even getting my interest and repaid principal reinvested is becoming problematic. I might decide not to reinvest anymore and just take the cash out as they are paid. Stocks are much better investments.

    • Certainly the demand for high grade notes is high, however it is a bit misleading because the quantity of notes sourced and issued in those two grades are much lower than other A-D. Perhaps revising your strategy or utilizing automatic investing, if you aren’t already, might be the best places to start to add more volume and reduce the cash drag.

      Stocks are a completely different type of investment. The two are not comparable unfortunately.

      Thanks for sharing your experiences, and best of luck as you decide on what to do going forward.

      • The return on A-D loans is too low. Automatic investing might help. I want a decent return on my money and it makes no difference whether the investment vehicle is bonds, stocks, commodities, etc. Right now, stocks offer much better value with lower risk than p2p loans. Default is low right now due to favorable economic conditions, but once the next recession hits, borrower will default en masse and these unsecured junk debentures will be worthless. That is yet another reason not to invest anymore in p2p loans. Returns on LC and prosper loans during the 2008-2009 recession were pretty low.

        • Out of curiosity, JTF, what is a “decent return” on your money? And if you think defaults will be worse when the economy falters, how do you think stocks will fare?

          P2P Lending is not right for everybody, and ultimately that’s something for you to decide for yourself. I am happy with the success I’ve had and will continue to add capital to my accounts. Best of luck to you.

          • For me, decent return is 10%/yr or more with small chance of permanent capital loss. Stocks can drop a lot during a recession, but if you stick with quality, they will almost certainly bounce back. On the other hand, once an unsecure bond defaults, you have lost 100% of your money permanently. And the bad thing about junk bonds is that they tend to default en masse during recessions, so diversification offers little help. Good luck to you.

  3. I haven’t given P2P lending much thought because I didn’t know much about it, This is to learn. I will have to followup reading some of your other P2P posts. I have to agree with you that business is business and sometimes what is being done has to just be accepted as such.

    • P2P Lending is not for everyone, however, it can be a great piece of a portfolio given its relatively consistent yields and steady returns. As with any investment, doing your due diligence is extremely important.

      Thanks for stopping by LFT!

  4. I noticed the lack of loans on Prosper, but didn’t realize it was due to institutional investors. Though, as I have less than $500 invested in LC and Prosper combined, I admit that I haven’t given this much thought. Nevertheless, it’s an interesting subject. Thanks for bringing it up, and I think I’ll do some digging of my own.

    Happy New Year!

    • Seraph, the shortage is most certainly a result of overallocating loans to institutional investors to the point where their growth has exceeded the growth of Prosper as a whole. Pretty interesting stuff. I’m sure as things stabilize retail investors will start to see an increase in their allocation, however, when and how much remains to be seen.

      Have a Happy New Year yourself, and thanks for stopping by.

  5. I can’t buy new loans through Lending Club any longer (change of residency and lack of desire to use FolioFN), and I think that’s not really a bad thing. I only had $300 in Lending Club as an experiment, and it’s time to let that experiment run it’s course and go back to the stock market where I have more knowledge and a better comfort level.
    I don’t think that institutional lenders are all that bad, especially as it helps grow the P2P companies. Each individual lender just needs to be a little bit faster in choosing which loans to select. I think LC offering their automatic investing can help that to some extent for the folks that qualify.

    • Yes, PA is a bit behind in allowing direct investment. Sorry to see that you’ll be ending your experiment, but everyone must invest in a manner that suits them, and no two people are alike.

      I agree, I don’t think they are bad at all, as they provide the scale in which opens up the space to greater innovation and progress. Plus it greatly eliminates the going concern risk that was around a few years ago. Any sort of automated investing is the way to go, and the only way to compete in a crowded marketplace.

      Thanks for sharing your thoughts!

  6. I don’t fund loans directly as my strategy with Lending Club is to pick up seasoned loans that have 10 payments in them off the secondary market. I haven’t seen a drop in available notes… yet. I have a feeling that it will come though. I understand business is business but LC will lose its charm and place if it goes pure institutional investor. At that point is it really any different than other lenders?

    • Utilizing the secondary market is an easy way to avoid the limitations of the primary market, so I’d imagine you haven’t seen too many issues there. It will be interesting to see how the secondary market changes as Lending Club expands to all states (it will at some point), and institutions are the predominant players. Prosper is much more impacted by institutional demand than Lending Club at this time.

      And no, fully institutional, LC will will become just another B2B investment service with offering available only to those with access, high levels of capital, etc. Not all that atypical for financial institutions. Cheaper to service, faster to scale, and more profitable are all pretty easy selling points.

      Thanks for sharing your experiences PMU!

  7. Excellent article. Thanks for your research and depth on this timely topic. Bravo!

    After a year with Prosper and starting with $10,000, my total is now $15,000 with $1520 made from interest. I averaged about 11.5% return in 2014. Not bad considering this was a learning period and I experimented with different filters. I spend about ten minutes a day for a selection of one or two new loans. Primarily using A,B, and C loan categories, I have over 600 loans with only 4 defaults for 2014. So I feel good about my results in the past year.

    In general, I find that P2P Lending is more stable than investing in the stock market where daily noise screams out with daily ups and downs. I am getting returns of 11% also in the market by using high dividend paying stocks but with a great deal more drama thanks to the drop in oil prices (REITS, MLPS, BDCS). Primarily, Prosper or P2P Lending provides a great diversification tool for my retirement account.

    And…I agree with your findings. The quality of loans for the individual investor have diminished even in the past year. My goal is to wait until a 12-15% loan is available. It’s obvious that the best loans are being siphoned off by institutional investors. If I drop my range to 10% or more, there are many loans available to match my filters. I look forword to your follow-up article.

    (One note to add…P2P is not for everyone, primarily because it is more difficult to cash out in a day as compared to the stock market. More like owning a rental property where it often takes years to receive decent rental income. Otherwise, I totally recommend P2P as another bucket for a mostly passive income source.)

    • Sounds like you’ve had a pretty successful experience so far, especially given your focus on A-C loans. While you’re account still needs to age to reflect its long-term returns, you’ve already seen a glimpse of the success that can be found in P2P lending. There are certainly risks involved, much like any investment, but I believe these are mostly factored in currently. Given the glut of investor demand, a challenge that these companies need to be aware of is lowering interest rates to attract borrowers, but still maintaining consistency in underwriting to compensate for the risk involved is difficult and a delicate balance must be maintained. If not, any dip in the economy would see a strong response by borrowers, increase defaults and costing folks the high returns people are accustomed to now.

      You’re absolutely right, P2P lending is not for everyone. People must evaluate what is important in their financial life and how they want to accomplish their goals. Like yourself, I view P2P as a nice compliment to my other investments, and provides a level of passive income to supplement my desire for financial independence.

      Thank you for sharing your thoughts and experiences David, it is much appreciated.

  8. W2R,
    Interesting article. Thanks for providing this information. I’ve looked at P2P lending in the past and thought it looked interesting. Unfortunately, my home state seems to frown upon this activity and choices here are limited. The situation you describe makes me less enthusiastic about P2P, so I suppose I won’t worry about it for now. If the laws change here at home, I’ll reevaluate then.

    Dividend Gravy

    • Sorry that your state doesn’t allow investing, I think it is shortsighted on their part, but hopefully in the future this is an investment class that you will be able to participate in and add income diversification to your retirement plan. While the research above doesn’t show Prosper in a great light, it has not tempered my long-term belief in this industry and asset class. As you evaluate things in the future, let me know your thoughts and experiences.

      Thanks for stopping by Steve.

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