Why I'm Giving Lending Club a Hard Pass

One of my resolutions for 2020 is to invest in a different asset every month.

In an earlier post, I wrote that peer-to-peer (P2P) lending is a good alternative investment.  And in a theoretical sense, this is true.  P2P lending offers an alternative to stocks or bonds and a return well above the risk-free rate.  It’s exactly what you’re looking for to diversify a portfolio.

And so I’d thought I’d start 2020 by investing in P2P lending.  

As I’d invest money I don’t need right away, my intent would be to re-invest the payments on the loan so as to receive the benefits of compound interest.  Essentially, I wouldn’t see this investment again for a while—20 or 30 years.

Last week, however, I took a closer look at Lending Club, the largest P2P company, and discovered something that gave me pause.

The Greatest Risk of P2P Lending

P2P lending companies facilitate loans between lenders and buyers. The companies allow investors to spread one investment over dozens of loans, which reduces the impact of one loan defaulting. Borrowers are vetted so you know the risk associated with the money you're lending.  

The greatest risk of investing in P2P lending, then, isn’t that a lender might default on a loan, but that the P2P business itself fails. If the P2P company goes bust, you will not have any of your money returned; neither the principle nor interest earned.

And risk isn’t to be avoided with investing: far from it.  In fact, assuming risk is the only way to receive a return higher than the risk-free rate, and make investing worth your while.

But the risk needs to be judicious.  

Lending Club: the Fundamentals

Lending Club is a public company and its financial statements are available online—including its income statement.

As the most basic objective of a business is to make money, when looking at the financials, it’s good to start with the income statement.

I don't like the look of these numbers!  

And at this first basic step, Lending Club doesn’t pass the smell test.  It’s been in the red for the past five years—the entire time it’s been a public company!

Lending Club's losses increased astronomically in 2016!

This loss substantially grew in 2016, to more than twenty times it was in 2015.

Lending Club Gets a Pass

An income statement like this makes me put on the breaks, HARD. A company deeply in the red may very well indicate more troubled times ahead.

I can’t even justify looking into other aspects of the financial statements (cash flows, debt to equity ratio).  Even if I dug up some remotely promising information, these large, consistent losses are too much for me to look past. 

—Lending Club may very well not be around 20-30 years down the pike when I’d be planning to recoup my loan, making this a totally reckless investment.

I'm Still Open to a P2P Lending Investment

I’m not entirely turned off to the idea of investing in P2P lending. 

The internet abounds in anecdotal stories of people earning a return well above the risk-free rate (including here and here and here).  And that's even with defaults on some of the loans. 

And, as stated on the Prosperity Podcast, a P2P lending investment should only be 10-20% of a portfolio--and of that, divided between companies.  So the risk can be hedged.  

But the problem is that P2P lending is a fairly new industry--the first company, Prosper Marketplace, started in 2005.  It's a bit of an unknown.  And as Lending Club is the only public company, it's the only one who has disclosed its financial statements. 

I can only wonder as to the financial state of other P2P lending companies.

I’d need to do a little digging before I’d invest in, say, Prosper or Peer Street.  I’d like to receive some assurance that the business seems viable.  Although I’m not sure how you can assess a company's financial health without seeing its financial statements. 

And You?

Have you invested in any P2P lending companies?  What’s your experience?