I recently had the pleasure of interviewing Simon Cunningham of LendingMemo.com where he talked about his personal loan finding filters and the state of the industry. This was a great interview and shaped how I invest my own money on Prosper.com. He compares Lending Club and Prosper in the first part of the interview.
I’ve highlighted some things that stood out to me. Check it out for Simon’s tips:
Kriss: Thank you so much for joining us. Why don’t you just give us a brief background on you and your website?
Simon: Alright. Well, the site actually started as kind of like on one of these fan sites, kind of a casual thing that I was doing in my free time back in the day. And has since kind of blossomed into this larger mission to provide a space for retail investing to get involved in this new investment called, peer-to-peer lending. And so, one of the things about peer-to-peer lending that’s so beautiful is, it’s available to people who are unaccredited investors.
Simon: So, most alternative investments, most new investments require and investor to be accredited. They have to earn a large yearly income or some sort of other income requirment. And so, what’s so great about peer-to-peer lending is that it’s one of the first ones that’s actually open to just normal everyday people. And so they’re just really was need for a space to have education around that topic and a space for people to get introduced to peer-to-peer lending for the first time. And so, I really love this investment. I’ve been involved in this since late 2011, and just really realized that there’s this huge need for people like myself to kind of come together and have a discussion, and kind of explore this thing for the first time. So, yeah, that’s really the heart of what we do, is education around this investment.
Kriss: And how much are you yourself investing in peer-to-peer lending?
Simon: Well, all of my investments are public. So, on the site I give quarterly updates for my own investments and how they’re doing. Currently, I would say I have around $40,000. So that’s 20,000 on either platforms.
Kriss: And let’s talk about the platforms because the two that we talk about the most are Prosper and Lending Club.
Kriss: And you have investments on both platforms. What is the main difference between the platforms?
Simon: Yeah, that’s a really good question. A lot of people have that question because usually they’re presented with both options and they kind of just don’t know where to go.
Simon: The main difference is probably that Lending Club is probably more friendly and more, how should I put this, accesible to retail investors.
Simon: It’s website and interface is a lot better. They have something around like maybe four times the volume of available loans than Prosper has to retail investors.
Simon: So, I will say that most retail investors, meaning people with smaller dollar investors. Like let’s say the average investor might invest the amount about $12,000. They’re going to probably start at Lending Club. That said, Prosper offers a very comparable product and I would never go so far as to say like, you know, Lending Club is all you should ever do. I’m a huge fan of Prosper. They’re incredible talented people.
Simon: I think that they’re going to be ramping up more attention towards retail investing in the coming season.
Simon: That’s kind of what they’ve been talking about personally. But for the time being, even though maybe their interface is a little not as accessible as Lending Club, they’re actually quite a comprable product. And I’ve even earned a slightly higher return at Prosper because they offer a broader credit spectrum on that side of things. So, for instance, the highest percentage you can earn on a Lending Club loan…let me say this differently. The highest loans that they offer borrowers, are about 25 percent APR. But at Propser they offer it up to 30 percent.
Simon: Which obvioulsy are going to have higher default rate.
Simon: But the fact of the matter is that broader credit spectrum if you’re able to kind of figure out how to get access to it because it’s kind of rare on Prosper’s platform. It does, in my opinion, offers the opportunity to earn maybe 50 or 100 basis point above, you know, Lending Club. So, it’s just common sense. If you’re going to be diversified in this investment, it makes sense to try to spread your cash across multiple underwriters.
Kriss: And so, just for our readers who aren’t familiar with some banking terms, 50 or 100 basis point would effectively be a half percent to a full percent better returns on Prosper?
Simon: Yeah. I mean, if you take up the same strategy as I did.
Simon: Which is not necessarily the most common one.
Kriss: Right. Well, let’s talk about your strategy because it seems you’re doing really, really well.
Simon: Thanks. Yeah. No. I’m one of these, so, you know, our risk tolerance in life is always going to be related to where we are in life, right?
Simon: So, if somebody is, you know, a brand new employee and they’ve got three kids and they’re freshly married, they’re probably not going to be able to take on as much risk as somebody like me.
Simon: Who is single, who doesn’t have any children at this point in his life and who is younger. So, you know, I have this ability to take on more risks, and so, that’s what I’ve really done. I’ve approached this investment with the goal to earn the highest interest rate I could earn. So, that means, in may ways, seeking to enter into the higher risk, higher default rated loans that, you know, aren’t going to be…like in an economic downturn if the unemployment rate goes way up, these loans are probably going to be affected the most.
Simon: But I feel really comfortable. The unemployment rate seems fine and even in an economic downturn, I would be really surprised if I lost money. I think it would probalby just maybe dip below at some of the safer credit ones. But I don’t think it would actually go negative. So, I feel pretty good about that.
Kriss: So, how long have you been investing with peer-to-peer lending?
Simon: That would be over three years.
Kriss: So, you really started, really when the financial crisis and unemployment was still very high then?
Simon: Yeah. I did. But I also started smaller. Right? So, when I was, you know, starting out, I didn’t just dump 40 grand blindly into this thing. It was a kind of a trial and error approach. You know, I started out with very safe loan grades at Lending Club. I remember I even invested in some B grade loans which are very safe vehicles.
Simon: So, as I became more comfortable with this thing, which is by the way, a very common thing that many investors do. They start safe and then they sit there and then they realize, wow, this is an incredible investment. It’s secure. It’s safe. It’s consistent. Why in the world am I…you know, having 40 grand sitting in a checking account somewhere, or having, you know…
Simon: …I don’t know, $5,000 floating in some sort of index stock that doesn’t seem to go anywhere. Let me…
Simon: …put it over to peer-to-peer and earn a much better return. I mean, we need to realize that in 2008, the U.S. experienced it’s greatest economic downturn since the Great Depression, and peer-to-peer lending still managed to be positive. So, Consumer Debt is just this incredible vehicle. And this is the first time in history that it’s been accesible to the public. It’s always been the privilege of large banks to invest on a large scale in personal lines of credit. Peer-to-peer lending is the first time this have ever been available to the average people.
Kriss: Yeah. You actually had a great post about this, about consumer debt being one of the most profitable means.
Kriss: And if you really think about it from the consumer’s point of view, how does Capital One and all these guys afford to send us a credit card application every single day. Well, it’s because they’re making phenomenal returns on their money and basically this is how you can participate in that. I thought that’s a great perspective. So, another post, that I’m actually looking at your site right now which is great. The five simple ways to increase returns at Lending Club. And just from looking at this, it kind of seems to me that this would translate to Prosper as well.
Kriss: But let’s just run through these really quickly. Diversify your account to 200 plus notes. So, you’re taking on more risks by investing in some lower rated loans but you’re sort of spreading that risks by investing in a lot of different notes. Is that correct?
Simon: That’s correct. Yeah. If you invest in let’s say, you know, many investors who are brand new to this thing and they don’t research the importance of diversification, they will put their money, let’s say, $5,000 across five different borrowers and it’s a very easy mistake to make. And if one person defaults, I mean, that’s 20 percent of their money that’s immediately gone.
Simon: And when you’re in a negative 20 percent hole, it’s really hard to climb out of that.
Simon: I mean, I even know personally that there are, you know, people who are say a mature credit specialist who really had a goal to invest in the highest quality people they could find and then just invest in a very few of them because they believed in their ability to, you know, basically, price their own investment and then they are experienced people.
Simon: So, it’s a major issue. Defaulting loans are going to happen and the best way to combat that is to diversify your investment across hundreds of notes at a time.
Kriss: And so, for the beginning investors, let’s say, we start with $5,000
Kriss: Would you suggest that they invest just the minimum amount? Say, if that’s $2,500 would you suggest they invest $25 into 200 notes?
Simon: Yeah. That’s the most common approach that most people take.
Simon: If they really, really want to have a trial investment that gets them familiar with this thing, they can lower that diversification point to let’s say, 80 notes which would be, you know, like $2,000.
Simon: But if they do that, they have to stick in the safest A grade, safest rated loans available.
Simon: So, you can do it with less than that. You just really need to buckle down on your risk. So, it is possible to have a trial investment of $2,000 but you have to stick in the As.
Kriss: OK. Great. Great. And number two here on your list, is keep your account fully invested. So, you can’t make money if you’re just sitting on cash. You have to keep it rolling, right?
Simon: Yeah. And a lot of people don’t realize that. You know, they’re sitting here…they don’t realize how much cash can bring their account down.
Kriss: Right. And if we were to invest today, let’s say, you would start seeing cash back into your account within 30 days. Correct?
Kriss: So, that’s something you kind of need to stay on top of and start reinvesting right away.
Simon: Yeah. And sites like Lending Club and Prosper have actually done a really good job of setting up automated tools so that any available cash is reinvested into additional loans. But a lot of people they don’t enable those very quickly or they, you know, kind of put that off. So, for most people it’s maybe a minor factor but for people who don’t really pay attention to it, it can become a pretty big thing.
Kriss: Great. So, number three here is, increase the risk in your portfolio. So, this is where we really you get to the heart of the matter where you’re investing in higher risk, lower rated loans.
Kriss: And for those who aren’t familiar with Lending Club. It’s rated A, B, C, D, E and then F, G. And you really seem to be trending toward the higher risk stuff, in the D’s, E’s and F’s. Is that correct?
Simon: That’s correct. Yeah.
Kriss: Great. Let’s talk about the filters.
Kriss: This is really important because there are thousands of loans to find.
Kriss: And your fourth point here, you really talk about the filters. Walk us through that.
Simon: Well, you know, there’s thousands of loans avaialble and they’re not all the same, right? So, they’re people who have defaulted loans. And people who have had a bankruptcy. And people who are unemployed for two years versus five years. And people from California versus Kentucky. You know, there’s a lot of different borrowers to invest in. So, you know, do we just blindly choose whatever is avaiable to us? And what we’ve actaully seen is if we run some statistics on historical data, is that certain cross sections have histroically performs better than others. And for a long time we tried to describe why that was happening. And basically we realized that it is…Lending Club, they’re pricing these loans. Right? They’re just setting these interest rates for each of these borrowers using very complex algorhythms, and they’re very good at that. But that said, there are some borrower attributes which are really hard to price accurately. So, filtering is basically being honest about the fact that Lending Club, despite being a very excellent company and are doing very good at pricing these loans, sometimes can’t price the loans as accurately as they want. And so, for instance, setting inquiries to zero, you know, inquiries being the amount of time the person has applied for credit in the past six months.
Simon: Has been a filter that historically, even to this day, you know, I studied those even for loans that have orginated in 2014. Borrowers who have zero inquiries are still performing better than borrowers who have one inquiry even when they’re the same loan grade.
Simon: So, they have the exact same percentage loan, yet, this one population is earning a percent or a half percent higher returns. So, you know, we just need to be honest about the fact that for the time being, Lending Club pricing, it’s 99 percent accurate but there’s this one percent that we can really take advantage of and boost our returns for the temporary. I don’t know if this is going to stick around. I assume it’s going to go away with more time. But for now, this is a really interesting and fun way to boost our return.
Kriss: And if we think about that actual person who’s borrowing this money…
Kriss: He’s probably somebody who tends to be a little bit younger and doesn’t have a lot of credit history. And so, that will down-rate them according to Lending Club and Prosper, is that correct?
Simon: Correct. Yep. That’s correct.
Kriss: They’re not credit shopping. Meaning they’re not going after a bunch of credit cards .
Kriss: Because they don’t have a lot of inquiries. So, it tends to be somebody who’s low-rated simply because they don’t have a history.
Kriss: And they’re not going after a lot of credit. So, they’re probably a fairly saavy person because they’re coming to Learning Club first, presumably.
Kriss: And they’re trying to find a lower rate than they would from virtually any other source. So, this is a fairly, smart young person who’d like to borrow some money to consolidate what is probably some kind of debt. Is that accurate?
Simon: Yeah. I mean, are you reading into the inquiries equal zero filter here?
Kriss: Yeah. I’m trying to kind of picture what the scenario is of this person.
Simon: Yeah. I wouldn’t read too much into it in that way. You have to realize, that filter is just meaning that they haven’t had a credit inquiry in the last six months.
Simon: So, the person could be 56.
Simon: With, you know, 17 credit cards and he just haven’t applied for a line of credit in the last six months. What a filter is is taking advantage of mispricing on Lending Club’s behalf.
Kriss: I see. I get it.
Simon: Back in the day, filtering was a lot more along the lines of what you’re talking about, people with business loans, people who had higher bankruptcies. I mean, if you could find a safer versus a riskier person, they just gave you a better return because there was mispricing all over the place.
Simon: But nowadays, try to think about this less about the borrower themselves and think about this more like the pricing engine of Lending Club.
Simon: Meaning, the computer that’s assigning these interest rates, or certain filters is not totally locked in. And so, we have this ability to take advantage of the maybe slight mispricing that that computer is making.
Kriss: So, it more of a marketing inefficiency?
Simon: That’s exactly what it is.
Kriss: Great. Awesome. OK. Well, and in researching peer-to-peer lending, you go to a site like lendstats.com and it actually lists people and their returns. And they’re people just getting outlandish returns.
Kriss: Eighteen, 19, 20 percent. Is that kind of return sustainable? It seems really out of whack from what…you know, you kind of report a 10 and a half to 11 and a half percent return which is phenomenal.
Kriss: Are higher returns really sustainable?
Simon: No. So, first of all, Lendstats, that site is not being maintained anymore.
Simon: So, that’s all data that’s out of date. Back in the day Prosper actually published, not only was borrower’s data completely open to the public but investor data was as well. So, you could kind of, you know, set up a score board for which investment was earning the highest return and then these investors would kind of gamefy this thing and they’d try to outperform each other on a yield basis. So, that was kind of fun.
Simon: But they took that functionality away which I think was, you know, it was kind of sad. But I understood where they were coming from. I wish they’ll bring it back someday but we’ll see. So anyway, a lot of people may earn a 18 percent return at the very, you know, early, early week of their account because they just haven’t had, you know, borrowers. If they lend the borrower $25 and the borrower just immediately default on the loan. So, they never make a single payment, you’re not going to see that default for 30 days.
Simon: Because, you know, they’re going to have 30 days grace period and then they’re even going to have a couple weeks before the loan starts to get marked as late.
Simon: So, as a result you’re going to have this large period where there might be bad loans in your account, you have no idea that they’re there. So, your account might, you know, cheerfully tell you that you’re earning an 18 percent return, particulary if you’re investing in really risky loans. You know, for the temporay being, your return is going to reflect the interest rate you’re giving these borrowers. For instance, I invest in people with a 22 percent interest rate.
Simon: You know, on the riskier side of things. And so, for the first maybe, you know, three weeks in my account being out there, well, the first four weeks once the payments are coming in, my ROI might tell me, you know, 22 percent or something ridiculous, you know. You give it enough time and things start to equalize. They start to pan out. And eventually most investors, after their account starts to season, are earning a five to nine percent.
Kriss: Great. Thank you so much for talking to us again, Simon.
Kriss: Just one kind of last question discussion I have is philosophically, our audience is very much looking for alternative investments.
Kriss: Some of them are fed up with Wall Street. Some of them are fed up with the returns of Wall Street. Some of them are just plain bored. Do you think peer-to-peer lending can kind of fill that gap? Could give them, you know, is a kind of feel good stuff and obviously, the returns are nice. Just tell us why you got into it and why you like it.
Simon: I think peer-to-peer lending is the most enjoyable, simple, and boring way to put your excess cash to work. There’s this great quote that I read the other day that said, “if investing is exciting, you’re doing it wrong.”
Simon: You know, I mean investing should be, you know, and I totally believe that. Investing should be like going to the dentist. You know, it should be something that is normal. It should be a part of our life that is required. And, you know, banking, back when it was a good moral, good thing in our country it was actually kind of boring. I mean, you know, if you were a banker in the early 1900s, it wasn’t this, you know, giant windfall, golden parachute situation. It was actually a very boring, you know, common place, kind of janitor experience for these people.
Simon: They were very smart, very intelligent but it was, you know…and that’s kind of what peer-to-peer lending does, is it brings it back to its roots. But instead of there being a class of bankers who are sitting in front of your cash for you, you become the banker. And so, you get to be that boring guy who’s sitting there. You know, checking in on his numbers every three months and seeing that nothing’s changed. And what’s so great about peer-to-peer lending is that it empowers you. You are your own manager of your own account. But it’s also very simple. You’re not sitting here trying to figure out derivatives and options trading, or whatever. You’re just simply loaning money to people who deserve it. And you can trust Lending Club and Prosper. At least, I think so for the time being that these loans that they’re issuing are to high-quality, prime rated people who are responsible. You know, you can’t invest in these people unless they pass these certifications by Lending Club and Prosper.
Simon: Unless the borrowers pass their underwriting standards. So, basically, everybody has passed the standard. So, everybody has something of a trustworthy investment according to Lending Club and Propser. And I think historical performance has shown that to be true. So, you know, there’s a lot of different reasons people get in. But I would really say, the top three for me personally, and what I’ve seen people love about this is first just the solid return. You have a consistent investment that gives you between, you know, if you want to stay on the really safe side, a five percent return. Most investors are earning seven or eight percent which is wondeerful in this kind of crazy economic climate. Then on top of just great yields, or great returns, you have this ability for peer-to-peer lending to be a very simple thing. I mean, you’re literally lending money to people and they pay you back. Lending money to people, they pay you back. That’s all it is.
Simon: And for most Americans, that’s pretty easy to understand. Right?
Simon: And then finally, what I really like about it is it’s a feel good investment. Eighty-five percent of these people you’re lending money to, are using your money to get out of debt. They’re reconsolidating their, you know, 19 percent credit card into a 13, 14 percent peer-to-peer loan and the average loan percentage at Lending Club is 13 percent. And so, you are part of that process that sets them free from the journey of, you know, seven, eight different credit card bills arriving at different times. They miss a payment and the percentage goes up and all these things.
Simon: You’re actually issuing them a line of credit which is a stable fixed rate. Their interest rate never can go up even if they’re late on their payment. And it’s a fixed term investment, a fixed term loan, meaning, you know, in 36 months, they will be debt-free.
Simon: And you’re going to be part of delivering them into being debt-free. So, you know, great returns…
Kriss: Could potentially turn their life around. Yeah.
Simon: Yeah. That’s right. I mean, you know, investors get a great return that’s easy to understand. And then at the same time, they’re helping borrowers get out of debt. It’s an incredible investment.
Kriss: That’s awesome.
Simon: And it’s really in its infancy right not but I really imagine this thing getting better and better with every passing year, and more accessible to average American which is pretty amazing that this thing is available to unaccredited, average people out there. And I’m just a huge proponent of its space.
Kriss: That’s awesome. One last quick question. I know I told you the last one was the last question. But what do you think about the Lending Club IPO? Lending Club is the biggest lending platform right now for peer-to-peer investing.
Kriss: They’re talking about initial public offering. What are your thoughts on that?
Simon: It’s great. I mean, you know, basically, Lending Club sat down with Renaud Laplanche the CEO of Lending Club and asked, you know, what’s the whole reason you guys are doing this? He said, it really all boils down to marketing. And I mean that in the best sense of the word. They just want to get the word out. They want to talk about peer-to-peer lending on a national stage and having an IPO which is, you know…the filing they set up with the SEC would make this one of the top internet IPOs in American history.
Simon: So, this would be a huge day for peer-to-peer lending. And myself as a person who wants people to get involved, Lending Memo is dedicated to getting people in this space. We would see an IPO as a huge opportunity to spread the mission and the product that we’re so passionate about. So, yeah, I don’t care too much about, you know, the whole advantage of it being a public company.
Simon: But I do really care very deeply about the reputation of this thing, and about it becoming more popular.
Kriss: And an IPO will attract more investors and more borrowers.
Simon: That’s correct.
Kriss: And it’ll help the industry grow, right?
Kriss: Wonderful. Well, I want to give you a plug. Simon, you’ve got a phenomenal website. You’ve got a free book. You’ve got a free video course that we’re going to link to at the bottom of your interview. We really appreciate your time. If you want to hang out for just 30 seconds after I stop recording here, I’d like to talk to you about one thing. But just really appreciate your time, Simon. You’ve done a great job on the website. We’re going to keep coming back to your site, keep taking about it with the Franklin Society folks. And thank you so much.
So, what do you think? Is peer to peer lending the future of personal credit and personal investing? Leave us a comment….