Why Are Lending Club Yields Starting To Head Down?

Lending Club recently sent me an email about their borrowing rates moving lower. The lowest rate offered to the highest quality borrowers is now only 6.78% APR for a 3 year loan. Lending Club is the leader in the peer-to-peer lending space, where individual borrowers can ask "strangers" to fund loans. Ironically, there are plenty of "strangers" willing to lend money. Lending Club is having trouble with getting more borrowers.

Yields Will Be Coming Down By 0.2% On Average

In a move to attract more borrowers, Lending Club has lowered its average rate. The CEO of Lending Club, Renaud Laplanche, said he believed that on average rates would come down by 0.2%. While this was good news for borrowers, this doesn't look like good news for lenders. If borrowers are being paid less shouldn't investors be making less?

This is the question that I ask Laplanche at the Lendit conference. His response (paraphrasing his answer) was twofold:

1) Not necessarily. He argued that reducing rates might attract on average a higher quality borrower to the Lending Club platform. Higher quality borrowers would mean lower default rates on loans. The lower yields on loans might be offset by lower losses on loans.

2) Yes. There has been a large gap between the perception of risk of default for Peer to Peer loans and the actual loans. The perception of risk is much higher than the actual risk. Over time the perception of risk will closer the reality pushing rates lower.

Why I Think Yields Will Be Coming Down Quickly For Peer-to-Peer Loans

The Lendit Conference, a conference dedicated to P2P lending, was sold out with the average ticket costing a few hundred dollars. Most conference attendees were from hedge funds and financial firms. There was no shortage of deep pockets at the conference. One of the buzzwords of conference was "securitization" or grouping individual loans together into new "securities". Bottom line, institutional investors are now actively involved in the peer-to-peer space. While the "stranger" that loaned the money was once a retiree in California, the stranger is increasingly becoming a hedge fund in Manhattan. As these funds see good results, they will pour money into lending. As the supply of money will be greater than the demand for loans, Lending Club will continue to reduce rates to attract more borrowers.

What Should You Do

The good news is that the process that I describe has just started to happen. Peer-to-peer loans still offer a fantastic return. That return will go down over time but, returns can fall a long way before they become average. Peer-to-Peer loans have an expected return around 8% after default (by Learn Bonds' calculations).

For more on peer-to-peer loans see our free course on the topic here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.