LendingClub is a fundamentally different offering from the other robo-advisories that we have reviewed in this series. San Francisco-based LendingClub is a peer-to-peer lending institution founded on Facebook in 2007. The client buys fractional three and five-year loans after reviewing multiple criteria through a search function, receiving income as an unsecured lender without protection against default by borrower or institution. LendingClub also offers a platform to obtain a loan, as well.
The company came public on the New York Stock Exchange in 2014, after registering its loans as fixed-income securities, and it makes money through service fees charged to borrowers and lenders.
A $1,000 minimum is required to open a taxable or retirement account. Multiple clients share individual notes with a $25 minimum buy-in and receive monthly principal and interest payments. The program is not approved in all states, and returns are taxed as personal income rather than capital gains because they don’t meet IRS criteria. LendingClub has added business and auto refinancing loans in recent years, but clients cannot participate in these debts.
LendingClub counts as a digital-first investment platform, but the algorithms are mainly focused on matching investors with private loans. This is a unique approach, but there are also some important caveats you should be aware of before jumping in. We will start with some relatively recent developments.
Founder Renaud Laplanche was ousted as CEO by the LendingClub board in 2016, forcing internal and government reviews as well as class-action suits. In September 2018, Laplanche settled SEC fraud charges relating to “improperly changing some of the company’s lending products to make it look more healthy,” agreeing to leave the securities industry for three years and to pay a $200,000 fine.
A History of Regulatory Issues
LendingClub was fined by the SEC for misrepresenting the quality of some of its loans.
The company was ordered to pay a $4 million penalty for the problems that occurred under the leadership of Laplanche. In the firm’s defense, the SEC stated that LendingClub “promptly fixed the problems and provided extraordinary cooperation with the agency’s investigation.” However, the scandal has taken a major toll on the company’s NYSE stock listing, with shares trading at around 13% of the IPO price in May 2019.
Unique approach to investment
Allows investors to invest in private loans
Fully disclosed methodology
The possibility of monthly income
No financial advice
No protection against company default
Cyclical asset exposure
Fallout from SEC enforcement actions
The program isn’t licensed in Alaska, New Mexico, North Carolina, Pennsylvania, or Ohio. A number of other states do not allow Note buying through LendingClub but permit trading on Folio’s secondary market. Steep eligibility rules will deter many applicants, with the platform requiring at least $70,000 in annual gross income and $250,000 in net worth in licensed states, except for California (LendingClub’s largest operating state).
a) annual gross income of at least $85,000 and net worth of $85,000
b) net worth of $200,000
California clients can invest up to $2,500 if they don’t meet either requirement, while investors in all licensed states cannot buy notes in excess of 10% of net worth.
The setup process doesn’t ask lifestyle questions or look at age, assets, or risk tolerance, leaving portfolio choices to the investor, who must provide a credit profile authorization statement. Clients pick an investment strategy, but they are limited to the automated investing option and whether or not to make regular contributions. LendingClub supports individual and joint taxable accounts as well as traditional IRAs, Roth IRAs, trust accounts, custodial accounts, corporate accounts and rollovers from qualified retirement plans.
Clients can also trade notes on the secondary market through broker-dealer Folio Investing. A separate trading account has to be established, and several states do not permit participation. LendingClub states that there’s no guarantee of liquidity through this venue, and it’s hard to determine the risk of using the account even though it’s adequately documented in marketing and disclosure statements.
LendingClub does not provide financial advice. As a user, you have to make all buy, sell, and other investment decisions, apart from the automated investing program, which is also customer-driven. You can break down accounts into as many portfolios as you choose in order to meet specific goals, but there are no goal tracking or planning resources other than basic performance data.
The account management page displays a bottom-line loan summary and breakdown by security. A pie chart slices allocation by loan grade, while a second summary box details average interest rate, earned principal, earned interest, and borrower payments. The interface also allows clients to set alerts, opt into automated investing, access the trading platform and transfer funds to or from the account.
The “Build a Portfolio” function provides robust search and filtering capacity that can reject re-listed loans or loans without the borrower’s verified income. You choose how much total cash to invest and how much to invest per Note, and this generates an average interest rate display that’s broken down by loan grades. Additional options can spread exposure across different loan grades and terms.
You can set up the automated investing program by choosing investment grades, term settings and minimum note size. When the service is turned on, the system buys notes for the portfolio when cash builds up to a sufficient level. The cash accumulates from the monthly principal and interest payments. You can still make manual purchases after choosing automated investing, and the service can be turned on or off at any time.
Investors get fractional ownership of unsecured three and five-year personal loans after reviewing the loan’s grade, interest rate, and term based on LendingClub’s analysis of credit score and other credit-worthiness indicators. Marketing materials state that “hundreds of data points” are evaluated in a borrower's loan application. Investment grades are sub-divided into 35 classes and interest rates, ranging from A1 (best) to G5 (worst). The prospectus provides microscopic detail on LendingClub’s underwriting methodology, but major headings indicate that the company only accept borrowers with:
- Minimum FICO score of 660
- Debt-to-income ratio of below 40%
- Debt-to-income ratio within an acceptable limit
LendingClub also requires a credit report with at least two revolving accounts, five or fewer credit inquiries in the past six months, and minimum credit history of 36 months. Income verification is conducted on a discretionary basis, and LendingClub acknowledges that the balance of borrower agreements are made “without obtaining any documentation of the applicant’s ability to afford the loan.”
The company receives income through origination fees to the borrower and service fees to the investor. LendingClub has issued more than $29 billion in loans since 2015, with its highest exposure in California and Texas. Grade quality has improved over time, with more than half of 2019 loans graded “A” or “B,” while the majority of 60-month loans in their fifth year (2015) held grades below “A” or “B.”
Loan and default breakdown by percentage (Q1 2015 through Q1 2019):
- Total loans: 100%
- Fully paid: 36.03%
- Current: 35.35%
- Late: 1.05%
- Charged Off: 7.09%
Loan breakdown by reported purpose (Q1 2019):
- Credit Card Payoff: 22%
- Refinancing: 45%
- Other: 33%
Average Interest Rate (Q1 2019):
- 36-Month Loans: 11.43%
- 60-Month Loans: 14.29%
- All Loans: 12.67%
LendingClub insists that risk is lowered through diversification by spreading risk across at least 100 notes with different grades, but that doesn’t meet Modern Portfolio Theory (MPT) attributes for diversification. The program has not been tested in a recession, depression, or bear market. In addition, there is no asset diversification because all loans fit into the consumer credit asset class, which is notoriously cyclical.
LendingClub touts 4% to 8% annualized returns between 2008 and 2019 throughout the website, but that’s misleading because the fine print indicates that 20% of investors with less than 100 notes have lost up to 8.75% per year while more than 99% of investors with 100 or more notes have earned positive returns. Although LendingClub doesn’t meet MPT and is solely based on one asset class – debt – the quality of information it makes available for potential investors is admirable. If you are a relatively seasoned investor who is comfortable reviewing the methodology and looking for a risk capital investment, then LendingClub could be a strong candidate. However, investors with a low-risk tolerance, less experience or a limited amount of capital should be very cautious.
LendingClub is strictly hands-off when it comes to helping you with portfolio management. The company does not create or manage portfolios, other than following customer orders through the Automated Investing program. LendingClub provides no recommendations or advice about portfolio contents, management, or long-term strategy. It does rebalance your portfolio in the sense that it will automatically reduce cash holdings by reinvesting it into notes according to your initial specifications. There’s no tax-loss harvesting because investment profits are reported as regular income rather than capital gains.
LendingClub offers dedicated mobile apps for iPhone and Android operating systems, with slimmed-down account management functions that may not replace the need to log on to a personal computer. Both operating systems provide additional security through two-factor authentication.
The website is easy to navigate, highlighting major account features and services. Contact information can be difficult to find, hidden in the “About Us” section. Support and educational resources are useful but repetitious, regurgitating the same marketing claims about investment philosophy, procedures, and returns through multiple links. Even so, a deeper dive into secondary pages will reward you with a plethora of details about methodology and account functions. We highly recommend that anyone looking at LendingClub review the methodology for yourself. They are upfront about some of the gaps that can skew what, on the surface, looks like a reasonable risk-return tradeoff.
We found LendingClub customer service to have some long wait times. Customer service hours are listed from 7:00 a.m. to 5:00 p.m. Pacific time, Monday through Friday. Clients can contact LendingClub by telephone or email, but there is no live chat.
Three contact attempts at various times during the business day produced an unacceptable average waiting time of six minutes and 40 seconds to reach customer representatives who had little or no knowledge of basic program details. A useful FAQ answers most questions, but the prospectus includes many undisclosed details.
Education & Security
The “Investor Education Center” is just a retitled FAQ about the program, which is duplicated by a HELP app. A blog serves as the site’s real educational portal, with useful articles about marketplace lending but little coaching or goal planning. The website uses 256-bit SSL encryption, but there’s no Securities Investors Protection Corporation (SIPC) insurance, excess insurance, or other protection against catastrophic losses. To put this bluntly, you have no protection against the company defaulting and taking your portfolio with it.
Commissions & Fees
LendingClub offers you low fees, but the investors ultimately end paying for any borrower defaults. In this context, the fee offers little protection and is mostly for the service of matching private loans to private investors. LendingClub charges a 1% service fee on “amount of payments received by the payment due date or during applicable grace periods.” It also charges a collection fee of up to 40% to obtain funds from delinquent loans.
Is LendingClub a Good Fit for You?
LendingClub presents a high-tech approach to fixed-income investment, but there are three major risk factors you need to be aware of:
- Investors are dependent on underwriting and collection practices that may not work in an economic downturn.
- The portfolio isn’t diversified because exposure is taken solely in the consumer credit asset class, which is highly influenced by the economic cycle.
- Investors have no protection against loan or company default.
In addition, LendingClub provides no investment advice and locks out less experienced customers through high suitability requirements. This practice indicates that the company wants sophisticated investors who can absorb large losses, despite marketing text that’s geared toward smaller retail clients. Given all the drawbacks, prospective clients should proceed at their own risk because they could potentially lose 100% of their investments.
If you fit the mold of a well-capitalized, sophisticated investor seeking a high-risk, potentially high-return fixed-income investment, then LendingClub may be a fit for you if you’ve exhausted all your better-regulated options like corporate debt. If this doesn’t describe you, it is probably better that you give LendingClub a wide berth.
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