Friday, August 16, 2013
Peer Lending Advisors had another great month in July. Below you’ll see our net returns, which reflect interest net of losses. The returns reflect the entirety of loans we have acquired, and as we have ramped up in 2013, the portfolio has become more heavily weighted toward newer loans, which have a different charge-off curve than seasoned loans. Please note that past performance is not a guarantee of future results.
July return: 11.52%
July was another great month. We earned an annualized return of 11.52%. This brought the average return for 2013 up to 10.91%.
There are several factors driving slightly lower returns (but still incredibly strong) in 2013 vs. 2012:
- Loan availability: Acquiring new loans remains incredibly difficult on both Lending Club and Prosper. It has taken diligence and raw horsepower to invest in the top loans on the platform
- Revised risk model on Lending Club: Lending Club revised their risk model and reduced the interest rate on several classes of loans: the loans we focus on and have the best risk-adjusted return (B, C, and D loans). We estimate this will have a 50-100 basis point impact on our net returns in the long term. The short-term impact has been minimal as these loans are still a small portion of the portfolio
- Credit policy changes (see below):
We changed our credit policy in January and reduced our activity on the secondary market. Previously, we were using the secondary market to help supplement our purchases of loans as we were ramping up investment. However, we observed that our credit model couldn’t evaluate the credit worthiness of borrowers as effectively as on new loans due to older credit information.
In January, we stopped making purchases and wrote down several of the loans in our portfolio. Beginning in May, we continued to see some weakness in existing loans purchased on the secondary market, so we have been making continual write-downs when we observe weakness. We estimate that these loans have had ~100 basis points of impact on our portfolio in 2013, and we anticipate another ~100 basis points of writedown through the rest of 2013 as these loans continue to run-off.
Risk-adjusted returns remain strong
Each month we run scenario analysis to estimate how our portfolio would hold up in a recession scenario. We look at the toughest recession scenarios to ensure our portfolio would hold up and remain, at a minimum, net neutral with no capital loss. Note that there are no guarantees.
We estimate that our return would remain strong in a recession similar in size to the “Great Recession” of 2008, and drive annual returns between 6.5% – 8.0%. This is tremendous performance, considering most asset classes would experience huge capital losses. For example, the S&P 500 lost over half its value in 2008, and home prices declined 50% in some areas.
We don’t invest in high risk loans specifically because of the risk of recession. While focusing on E-grade loans and above could goose short-term returns (you’ll see many bloggers brag about high returns in this category), on a risk-adjusted basis these loans are junk. Interest rates would need to be above 40% to make many of these loans profitable in the long term. Could you imagine if the default rate on these loans merely doubled? Lenders would be under water. At Peer Lending Advisors, we triple and even quadruple losses in some scenarios to ensure portfolio resiliency.
Peer Lending Advisors will continue to stay out of this market, which will make our short-term returns appear lower, but strengthen the resilience of the portfolio.
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