Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Market Insanity

Is Peer to Peer Lending a Bubble?

Peer to peer lending—the online marketplaces that allow anybody with some extra cash and an Internet account to become a hard money lender–is hot right now. The companies in the field report breakneck growth, but some of their financial numbers indicate this growth could be symptomatic of a bubble and a lousy economy.

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Industry leader (and one of the few publicly held players in the arena) Lending Club Corp (NYSE: LC) reported a year to year quarterly revenue growth rate of 109.6% on March 31, 2015. That far exceeded the rates reported by traditional banks on the same day.

The numbers show that business is booming for peer to peer lenders while traditional banks are struggling to grow market share. Some examples include:

  • Bank of America (NYSE: BAC) reported a revenue growth rate of -6.04%.


  • Wells Fargo (NYSE: WFC) reported a revenue growth rate of 3.17%.


  • Citigroup (NYSE: C) reported a revenue growth rate of -2.33%.


  • JPMorgan Chase (NYSE: JPM) reported a revenue growth rate of 3.67%.


  • US Bancorp (NYSE: USB) reported a revenue growth rate of 1.98%.


It looks as if traditional banks are having a hard time maintaining revenues and attracting new business. Yet Lending Club’s revenues are skyrocketing, which indicates that it is attracting a lot of new business. That situation is not indicative of a healthy economy nor of the “economic recovery” the media keeps claiming is here.

Is Lending Club’s Success a Symptom of a Lousy Economy?

What does this tell us about the economy and the future of lending? Well, it could be an indication that the economy is in far worse shape than we thought.

One reason why Lending Club’s business is so good could be that large numbers of Americans simply lack the money or the good credit records necessary to borrow from traditional banks. Okay, some of those loans could be good risks because there are a lot of people with “bad” credit scores that have plenty of money out there.

There are also a lot of Americans that simply do not want to deal with traditional banks because of the Great Economic Meltdown of 2007–2008. Some of them may not trust banks either, because they got burned during the mortgage crisis or could not borrow money when they really needed it. Quite a few of these people could be good credit risks that simply do not want to do business with a bank.
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Despite those speculations, we still have disturbing indications that large numbers of Americans are in such lousy straights financially that they cannot qualify for a traditional bank loan. That does not sound like a healthy economy to me.

Traditional banking and lending might no longer be viable businesses in large swathes of the United States because of income inequality. The only way to make money is to issue risky loans based on cash flow; in other words, hard money loans. Okay, such loans can be a highly profitable business, but they are also far riskier than traditional bank loans.

That means peer to peer lending seems to be sitting on some very shaky ground financially. It could also be a bubble; one reason why money is flowing into it is that it is one of the few profitable segments of lending left. That too is a symptom of a very unhealthy economy.

Does Lending Club Make Money?

The truly bothersome and frightening thing about peer to peer lending is Lending Club’s Net Income figures. Despite its “revenue growth,” Lending Club’s income has fallen dramatically over the past year.

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When it went public in December 2013, Lending Club reported a net income of $7.308 million. By March 2014 its net income had fallen to -0.03 million, and by March 2015 Lending Club’s income was -$31.97 million. That could be telling us that the more loans Lending Club makes, the more money it loses.

One reason for this could be that it keeps loaning out the money it makes from the loans. That could make peer to peer lending like a pyramid scam, a con job in which a fraudster uses new suckers’ money to pay off his previous marks. Eventually all pyramid scams collapse when the shyster runs out of new victims to milk.
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It is not just the net income that’s rather scary at Lending Club; the company reported a return on equity figure of -7.89% and a profit margin of -7.85%. That indicates that Lending Club’s profits decreased by nearly 8% despite its revenue growth.

Okay, what about cash from financing? Well, that figure is actually pretty good. Lending Club reported a cash from financing figure of $1.116 billion in December 2013 that grew to $1.199 billion in March 2014 and $2.195 billion in March 2015. The amount of cash Lending Club made from financing has nearly tripled, which is good because financing is how it is supposed to make money.

The problem I have with this is that the income keeps shrinking as that number increases. Something does not seem to add up here; it seems as if the money goes out faster than it comes in.

There is one other good figure at Lending Club. It had $874.13 million in cash and short-term investments on March 31, 2015, a huge jump over March 2013, when it had just $64.6 million, and March 2014, when it had $51.3 million.

Lending Club does have a lot of cash coming in, but one has to wonder how reliable that cash flow is. After all, many of Lending Club’s products are essentially subprime loans, and we know how risky those can be.

Is Peer to Peer Lending the New Subprime Lending Bubble?

Lending Club is behaving a lot like the subprime mortgage lenders did 10 years ago. It is spending lots of money on advertising to attract lots of new investors, which is attracting a surge of new loans.


It is also attracting lots of competition, including some of the biggest names in finance. The Wall Street Journal reported that Goldman Sachs Group (NYSE: GSP) is the latest organization to join the peer to peer frenzy by setting up its own peer to peer marketplace.

Other competitors in the sector include the privately held Prosper, Google Inc. (NASDAQ: GOOG), privately held Square and PayPal, which will soon spin off from eBay Inc. (NASDAQ: EBAY). Lending Club currently has an alliance with Google to offer such loans.

Just like subprime mortgages, peer to peer lending is attracting a lot of cash, but it is on very shaky financial ground. It has some of the characteristics of a classic bubble. One of these is financial desperation; money often flows into bubbles in bad economies because there might be nowhere else for it to go. To make matters worse, desperate investors might be willing to bet on just about anything to get a decent return.

A big danger here is that the burst of lending is driven by all the people that have some money but cannot get a traditional bank loan. When that pool of people, which is probably huge, gets exhausted, the revenue growth could stall and the bubble could burst.

A worse scenario could occur if large numbers of borrowers start defaulting on the loans or if the loans get exposed as risky. If large numbers of investors suddenly try to pull out of peer to peer or try selling their paper at a loan price, we could have a sudden collapse.

Such panics are one of the main features of bubbles. Bubbles, after all, are driven by desperation.

Instead of being a cutting edge financial instrument, peer to peer lending could show us how lousy our economy really is. When it collides with reality, peer to peer lending could trigger a new economic crisis rather than a new boom.

Disclosure: the blogger owns shares of eBay Inc. which currently owns Paypal and Bank of America.