Saturday, December 19, 2015

P2P Investing - Lessons Learned from Our Loan Book

We present some of the lessons we've learned about investing in P2P loans based on our experience investing in the Funding Circle Platform. The key takeaway for investors is that it is important to select loans carefully, build a diversified portfolio and take into account the relationship between risk and return and how the trade-off varies among the rating categories.

One of the platforms we invest on is FundingCircle (UK).  We've been investing there for two years with our Symfonie Lending Fund.  Our loan book has more than 500 loans.  This represents about 4% of the loans outstanding on Funding Circle's platform.

We don't use auto filtering mechanisms.  We choose each loan by hand. We make credit decisions based mainly on the information we get from the Funding Circle website, combined with some fact and reality checks we do on our own.

We're particularly interested in our Funding Circle loans because like the SymCredit platform we operate, Funding Circle focuses on loans to small and medium sized businesses.

Lesson 1:  Be diversified but selective

Being diversified is important.  In P2P lending especially a bad outcome can result in total loss of capital invested.  Diversification spreads the risk among many loans, so the chance that one particular loan will cause a large loss are reduced.  A well diversified portfolio should achieve a return consistent with the overall risk level.

For example, if on average a portfolio of loans offers gross return of 13% and the overall portfolio loses 5% due to defaults, the investor will generate 8%.  A well diversified portfolio will be a subset of the overall loan and should have performance similar to the overall loan pool, on average.

A good credit manager can outperform the overall loan pool by using sound judgement and avoiding loans that are likely to run into trouble.

This is the point where I get to brag a little!  Apparently, we are Symfonie are doing a decent job in the selection department.  Our default rates are generally better than those of the overall Funding Circle pool.  Either we are lucky or smart.
Default Rates
Risk BandFC All LoansSymLend Portfolio
A (Low risk)2.8%0.0%
A+ (Very low risk)0.9%0.0%
B (Below average risk)4.6%5.8%
C (Average risk)5.1%4.4%

Lesson 2:  Take Risk Class with a Grain of Salt


This was my philosophy from the day I began investing in P2P loans and it remains my philosophy to date.  Many class A loans are riskier than they might seem at first glance.  Many class C and D loans are less risky than they might otherwise seem.  Why?

The secret is in the scoring model the platform uses.  Scoring models are numbers driven and don't speak to fundamental issues underlying the business. In the land of the micro economy the health of any small or medium sized enterprise can change in a matter of weeks of months.  The catalyst is almost invariably a change in the top line.  Market conditions change, sales decline, fixed costs remain and the entrpreneur doesn't have enough cash to whether the storm.

Very often credit models are sensitive to balance sheet figures, especially equity value, short and short term debt. These are not always so meaningful however. I've seen businesses that have millions of dollars in sales and millions in profits and are wonderfully stable but have no retained earnings, perhaps even negative earnings. These businsess are C and D rated.  Peel the onion however, and you realise these businesses will be solid year in and year out.

In my view the risk/reward trade-off favors loans in class B/C/D and consequently my portfolio is varies significantly from the overall population of Funding Circle's loan pool.

Breakdown by Number of Loans
Risk BandFC All LoansSymLend Portfolio
A (Low risk)28.6%6.7%
A+ (Very low risk)22.0%3.1%
B (Below average risk)23.0%14.8%
C (Average risk)17.6%43.4%

Lesson 3:  Risk Adjusted Returns Matter!

Risk and return generally go hand in hand.  The art in credit management is to identify loans that offer relatively high risk adjust returns.  Successful P2P investing means peeling the onion of credit quality and looking past the cover of the book.

Look at the Funding Circle Class A and and B average returns and average default rates.  A funny thing happens when you cross from A loans to B loans.  The average interest rate climbs by 1%.  But the default rate in the B class - that increases by 1.8%. Class B loans don't look like such a great deal!

Cross into the Class C loans and look - magic!!!! Class C loans have 1.3% higher return on average than class B loans but only 0.5% higher average loss rates. The difference is even more striking when we compare Class D to Class A.  We pick up 3.6% in gross yield but we only give up about 2.3% in loss rate.  That's a good deal any day of the week.

Loss Adjusted Returns
FC All Loans - Gross ReturnBad DebtAdjusted Return*SymLend PortfolioAdjusted Return*
A+ (Very low risk)8.2%0.9%7.3%
A (Low risk)9.5%2.8%6.7%
B (Below average risk)10.5%4.6%5.9%
C (Average risk)11.8%5.1%6.7%

* The data above are purely illustrative. Funding Circle gross returns and bad debt are based on statistics supplied by Funding circle.  Adjusted returns refelect the simply substraction of gross return and default rate. Default data for Symfonie Lend are based on actual portfolio results.  SymLend adjusted returns are the simply subtraction of gross return and the actual bad debt.  Past performance is no guarantee of future success.  Investing in P2P loans involves risks that investors should consider carefully prior to investing. 

Lesson 4:  Getting Good Performance is Labor Intensive!

Investors can take comfort in the thought that if they select a sufficiently diversified portfolio (Funding Circle reccomends at least 100 loans) they will be about the average return for the overall risk category or for the platform as a whole.  In principle there is nothing wrong with adopting this strategy and Funding Circle provides a set of automated investment tools.

For the investor who wants to try for something better there is no substitute for hard work.  You have to review each loan, and do a bit of homework.   That takes time a modest amount of credit expertise and probably a greater amount of credit instinct.

A good alternative might be hire a professional advisor to manage your Funding Circle Portfolio or to invest in one or more the increasingly available P2P loan funds.

I won't pass judgment on the others funds.  But the fund I manage I most certainly can vouch for.
For a comprehensive view of Funding Circle's performance statistics click here.

For more information about the Symfonie Lending Fund, click here.

Special credit for this post goes to Evgeny Ishchenko, our Symfonie Capital P2P loan portfolio analyst.  Thanks, Evgeny,  for building our portfolio statistics engine.

Breakdown by Number of Loans
Risk Band FC All Loans SymLend Portfolio
A (Low risk) 28.6% 6.7%
A+ (Very low risk) 22.0% 3.1%
B (Below average risk) 23.0% 14.8%
C (Average risk) 17.6% 43.4%
D 7.6% 32.0%
E 1.1% 0.0%

Thursday, December 3, 2015

My P2P Loan Report Card

Two years after I made my first P2P investments the results I am generating are generally better than I initially expected.  The best returns I have generated are on Lending Club and Prosper..  Generally my performance is in line or better than the returns report by the various platforms.

 Nearly Two Years of Monthly Results 

It's now been two years since I made the first P2P investments for Symfonie Capital.  I dare say that makes our boutique Symfonie Lending Fund a verteran within the unverse of funds available to most investors.

Like many investors I approached this asset class with caution.  I was sceptical.  It's still early days, but I am officially moving my outlook on P2P lending from sceptical to cautiously optimistic.

I invested the fund initially into three platforms - Lending Club (US), Prosper (US) and Funding Circle (UK).  I added a fourth platform  - Bondora (Estonia).  However, the allocation was quite small and I was not satisfied with the intial results. They look great on paper and impressive on Bondora's website.  But I remain sceptical and hope that time will prove me wrong.

Put Statistics into Context

It's important to stress the difficulty of statistical comparisons.  Platforms report results in various ways and no two platforms use identical calculation methodologies.  Common presentation in the US is presentation of "seasoned" loans, meaning loans outstanding for more than 10 months, when default rates generally start rising.  Many platforms annualise the figures.  Actual performance can differ significantly from extrapolated or annualsed results.  The way platforms report and manage problem loan also influences performance reporting.

Lending Club - My Star Peformer

I've said many times in my periodic fund updates that Lending Club is arguably one of the most solid and reliable P2P platforms.  One of the most important criteria we have when we select a P2P platform is that we can be confident that loans will peform in a way that is consistent with their classification.  The loans I buy perform in line with or better than the overall performance Lending Club indicates can be expected given their risk rating.

I'm a portfolio manager.  I don't like surprises.  If I buy loans rated class A and I get the loss rates I would expect from class B, C or D, I feel like I went to the grocery store and bought sour milk.  At Lending Club, so far the milk has been fresh and tasty.

At Lending Club our porfolio is heavily concentrated around the B and C, modest risk loans, which we believe offer the best risk/reward ratio. 

According to Lending Club seasoned loan portfolios are generating returns annually beteween approximately 5.4% and 9.4%.  Thus far it looks like the Symfonie portfolio is producing results at the higher end of the range.  We  our among the outpeformers!   

Symfonie Lending Fund - Returns from Lending Club Loans

2014 2015 9M
Pre-charge off return 12.2% 7.7%
After charge-off return 12.2% 6.3%

Funding Circle UK - Wide Selection of Business Loans

We began investing in Funding Circle after we setup our Lending Club and Prosper portfolios.  We started with a small, relatively undiversified portfolio.  As luck would have it, one of the first loans we selected, a distributor of bottled water, defaulted just four months after taking the loan.  We lost 3% of our investment.  The overall impact on the Fund was neglible. 

Since that time we've diversified our portfolio significantly into more than 400 loans.  Generally speaking we select the higher quality range  - categories B and C that offer gross returns of 9-10% and net returns around 5% - 7%.

A second part of our strategy is to focus on secondary market loans.  Funding Circle provides liquidity by enabling investors the possibility to sell their loans.  This enables us to put money to work more quickly and select businesses that have demonstrably made timely payments. 

According to Funding Circle, nearly 50% of investors generate returns of 5%-7% annually. About 20% of investors manage to get as high as 8% and a few less fortunate wind up with as little as 4%. We seems to be about par for the course - nothing to get excited about, but nothing to be ashamed of either.

Symfonie Lending Fund - Returns from Funding Circle Loans

2014 2015 9M
Pre-charge off return 9.4% 7.1%
After charge-off return 3.8% 4.0%

 Bondora - the Jury is Still Out

Our performance at Bondora looks stunning at first glance - 19% in 2014 and 14% year to date.  Peel the onion a bit more and I am not so sure about that, however.

We invested an almost negligible part of of our portfolio at the start of 2014.  At the time the holding was less than 5%, but now it may as well be near zero.  Like many other P2P funds we are starting to inflows into our cozy little boutique.

What makes us sceptical at Bondora is the way Bondora treats non-performing loans.  At Prosper and the Lending Club a non-performing loan is one that is more than 120 days late paying.  Those are charged off.  Gone. Goodbye.  Nice knowing you.  That's the consumer loan market for you.  It's a numbers game.  On average about 1.5% of class A consumer loans become delinquent more than 120 days.  With high risk G loans the figure is more like 15% - 20%. 

Bondora has a completely different approach.  When Bondora borrowers stop paying Bondora takes a friendly, engaged, active approach and works with the consumer to reschedule the debt. When the workout and rescheduling action fails Bondora can take legal steps and obtain what is called  "Execution."  This is common throughout Europe and there is an army of legal practictioners who are empowered by courts to force debtors to sell assets.  In many cases Executors can get bailiffs and seize assets or garnish wages.  The threat of execution sends shivers down a debtor's spine so many debtors will gladly sign on to ammended repayment schedules.

So what is the real performance of the rounding error of a portfolio I keep at Bondora?  Tough to say!  The headline Bondora trumpets is that its lenders are making 17%.  But I think the reality is very different.  If I were to write off the amount of my Bondora loan portfolio that is rescheduled or more than 120 days late, my return to date would be less than 2% to date.

The truth is probably somewhere in the middle.  When I find out for sure I'll let you know.

Results from our Bondora Experimental Portfolio

2014 2015 9M
Pre-charge off return 19.0% 3.1%
After charge-off return 14.0% -0.5%

Prosper - Delivering Good Results

New management took over at Prosper last year and in our view the results are positive.  Prosper re-engineered its credit model and is delivering results consistent with what is indicated by the risk ratings.  For me  as an investment manager this is important.  I need to know what I can expect from a pool of A loans and what I can expect from a pool of C loans.

Our strategy at Prosper has been to focus on the higher quality ranges of loans in the B and C category.  These have yields between 8% and 12% typically and I can usually expect 6% - 10%.


2014 2015 9M
Pre-charge off return 12.1% 8.2%
After charge-off return 10.6% 5.5%

The Bottom Line

P2P loans give investors access to an asset class that has traditionally been the domain of banks and finance companies.  The return prospects are certainly compelling.  At the same time, caution is required. Each platform presents its results different and each platform has different lending standards. Diversify risk among loans and among platforms.

If you want to know more about our Lending Fund, click here!

Friday, November 20, 2015

The Sym Philosphy on Consumer Loan Selection

Welcome to my P2P lending blog!  When my colleagues asked me to begin writing a P2P blog my first instinct was to refuse.  Volumes have already been written on the subject and an ever growing number of people are devoting their careers to following the P2P lending industry.  I am reminded of the California gold rush and I find no small irony in the fact that the two largest P2P lenders in the world today - Prosper and Lending Club, were founded in California.

But having managed a P2P Fund over the past two year and having reviewied dozends of platforms for potential investment I think now there is far more to say than has been said. P2P platforms come in all shapes and sizes.

One way to classify P2P platforms is by whether the platforms focus on consumer loans or business loans. Consumers as a group behave differently than businesses as a group. Here are some of the rules when I look at consumer-based P2P platforms :

1. The risk/reward curve flattens, perhaps even turns downward.  What does this mean in practice? It means there's no real good reason to select pools of higher risk class D and E loans.  You get no real pickup in yield but the likelihood of default dramatically increases.

2. High quality ranking (i.e. A), does not necessarily mean most likely to repay.  In practice, the default rates I've observed with my "A" quality loans has been actually higher than in my "B" quality loans.

3. Watch the DTI - Debt to income ratio is an important item.  It measures the amount of the consumer's monthly debt payment to the consumer's monthly income. The higher the DTI, the lower the consumer's disposable income, and the greater is the liklihood that the conusmer will have difficulty with loan installments.

4. Short term doesn't necessarily mean lower risk - On the one hand, it's true that more things can go wrong in the long run than in the short run.  On the other hand, all else equal, the consumer borrower with a five year term will have a lower DTI than a consumer borrowing with a three year DTI.

5. Jobs matter - Certain types of jobs are inherently more stable and more secure than other types of jobs. For example, civil servants, university professors, police officers, fire fighters, accountants, doctors, lawyers and medical technicians have either highly specific skill sets or benefit from built-in job security.

6. Don't judge a book by its cover.  For example, many "A" loans are actually "B" loans, but due to the platform credit scoring system are graded "A."  At the same time, many "D", "E" or "F" actually have better credit fundamentals than the grade indicates.  They are bargains.  They offer a relatively high rate of interest, coupled with a relatively low probability of default.

7. Platform lending criteria are extremely important. The story of Prosper and Lending Club reminds me of the Charles Dickens' Tale of Two Cities.  Both platforms started at about the same time.  However, in the early years Prosper had a consistently poor lending model.  Investors experienced poor returns and returns that were not consistent with the rated credit quality.  Lending Club in contrast, delivered solid returns.  In recent years Prosper has signficantly improved its credit process.  How you do you judge a platform's lending criteria?  Firstly, you have to look at the returns over time.  This is why I almost never invest in platforms with a short operating history.  Secondly you have to ask questions of platform management and read the platform materials carefully.  Quality platforms will disclose their credit statistics transparently and will document their credit procedures.

8. Pay attention to credit history. Platforms should report credit bureau information on the conusmer borrowers.  You can see history of missed payments (delinquencies) and in the US, "public filings," meaning that the consumer had filed for bankruptcy and debt relief.  One school of thought is that the conusmer has learned a hard lesson and going forward will manage credit much better.  This is in part why E and F loans can perform better.  Many of the conusmers in this category understand well the need to improve their credit scores.  On the other hand, many of these consumers have unstable credit profiles.  I tend to avoid the lower ranking loans and I almost never buy loans when I see more than 1 or 2 delinquencies in the last 10 years.

9. It's a numbers game. The conusmer loan business is driven mainly by statistics.  Lenders have a limited set of information and they use highly automated processes.  Credit decisions are made by computers based on statistical banking models.  Every lender expects there will be a certain number of bad loans in each portfolio.  The key to success is that the lender is receiving a rate of interest that compensatest for the defaults.  So for example, each borrower pays 10%.  Each year 2 of each 100 loans goes bad (i.e. a 2% default rate).  Using simple math, the lender generates 8% per annum return. The important thing is that the lender should have a widely diversified portfolio so the lender's return is driven not by the performance of individual consumers, but by the statistics of the overall pool.  The more loans that are in the pool, the better. For this reason many platforms enable investors to take advantage of automated filtering tools that basically enable investors to simply "buy the index."

Peer to peer loans available on quality platforms such as Lending Club and Prosper enable many investors to gain access to an asset class that over many years has served banks well. The key risk for investors is that the P2P platform changes its credit processes over time and fails to deliver returns consistent with the estimated risk level.  Pay close attention to platform performance, diversify your portfolio.  Spread your investments among several platforms.  Or better still - find a good P2P fund.  More and more of them are coming to market all the time.

Note:  Your money is at risk whenever you invest in P2P loans, so invest carefully ask questions and invest only what you can afford to lose.  Returns from P2P loan pools may vary widely over time, depending on macro economic conditions. 

Feel free to e-mail if you have questions or concerns.