I’ve been using a peer to peer lending service called Lending Loop for several months now. It allows businesses to access financing from lenders all across Canada (except in Quebec due to excess regulatory hurdles.) There’s about 6,800 investors using the platform so far. I thought I’d share my thoughts about investing in Lending Loop. Discuss the advantages and risks. And answer some common questions readers may have about the process. 🙂
- Website design and easy to use.
- Responsive support.
- Using technology to solve business problems.
- Reasonable projected returns (5% to 10% pre-tax) on investment given the risk involved.
- Alternative asset class that is not highly correlated with the stock market.
- Transparency and thorough reporting.
What can be improved
- It’s currently not eligible for RRSP/TFSA 🙁 This is a problem due to the asymmetric tax disadvantage of debt instruments.
- Font on site can be hard to read due to small size and low contrast with background, especially the Q&A sections in the Marketplace.
- Limited financial history for borrowers. It would be nice to see 4 or 5 year history for more established businesses.
- Lack of a discussion forum. It could be beneficial for lenders to have an online space to correspond openly with each other about loans in the marketplace. The Lending Loop subreddit has restrictions about what information can be communicated.
Full review below…
What is Lending Loop?
There are many small and medium size businesses in Canada that have trouble raising money to expand their operations. Applying for debt can be a challenge because traditional banks are hesitant about lending money to entities with erratic income streams such as restaurants, contracting, etc. Large financial institutions generally can’t allocate the appropriate resources to underwrite small deals with the sophistication they require and struggle to price them according to the actual risk. As a result a lot of high quality deals simply fall through the cracks.
This is where Lending Loop (LL) comes in. It’s a crowd sourcing platform that raises money for growing Canadian companies. Based in Toronto, Lending Loop is Canada’s first (and currently only) fully regulated peer-to-peer lending platform. It operates an online marketplace that connects small and medium-sized businesses that are looking for debt financing with Canadian investors. It allows all investors, regardless of wealth or income, to access a high-yield fixed income asset class.
How Does Lending Loop Work?
Businesses can apply for a term loan product with flexible terms. The amount could be as small as $5,000 and as large as $500,000. Most loan durations are from 3 months to 3 years, but some can be as long as 5 years. Once approved, the loan goes into Lending Loop’s Marketplace where investors have 30 days to fund the project. If the loan becomes fully financed before the funding period expires, the loan will go through a finalization stage for a few days before it starts going into scheduled payments.
Investing with Lending Loop is safe, in the sense that it is a properly regulated company with government oversight. Lending Loop is registered as an Exempt Market Dealer in most provinces. But of course the individual loans on the platform are subject to scrutiny and due diligence just like any other investment. So it’s up to individual investors to decide which companies they want to lend to.
Registering on the Lending Loop site as an investor is a pretty simple process. I filled in some online forms and provided some personal information such as my address and Social Insurance Number (for CRA purposes.) Then I answered an investor questionnaire to assess my personal preferences and risk tolerance. I obviously got the “very aggressive” result. 😀 The last thing I did was connect my TD bank account with Lending Loop using the information from my cheque book so I can transfer funds back and forth. The entire process takes about 1 to 2 weeks.
The overall site design is pretty clean and easy to navigate. The main dashboard page gives a broad overview of my account situation.
The Marketplace is where all the action is. 🙂 This is where investors can shop for the best loans. There are usually around 5 to 10 different loans looking for funding at any given time. The companies are listed in order of when they first appear on the marketplace. There’s a brief description about each business, and the nature of their loan.
Clicking on any individual loan will take you to the detailed page where you can see the company’s financial details, what the owner intends to use the loan for, and other Lending Loop investors who have already committed to investing in the loan. There’s even a Q&A section within this area where lenders can ask the borrower questions.
About the Loans
The funding process begins with a loan application. Borrowers are required to be incorporated or a partnership for at least 1 year and have generated a minimum of $100,000 in annual revenue. Once this minimum criteria is met, Lending Loop’s credit assessment team performs a formal review of the loan application.
Lending Loop uses its proprietary evaluation and scoring system to assess a company’s creditworthiness. Factors in the credit evaluation may include:
- A business credit score obtained from a credit rating agency, which may take into account payment and delinquency history, delinquency patterns, years in business, years borrowing, the business’ size, and industry segmentation, among others;
- Various financial metrics such as the business’ debt service coverage ratio, debt-to-tangible net worth, and working capital ratio, among others;
Once a loan is approved it is added to the Marketplace and assigned a Lending Loop Credit Rating. This rating, consisting of a rating from A+ through E, is intended to quantify the level of risk associated with a particular listing and corresponds to an estimated loss rate for the loan. The higher the rating the lower the default risk. 🙂 Here is a look at the Lending Loop interest rates for each risk band.
These interest rates are what the borrowers pay. Lenders are charged a servicing fee amounting to an annualized rate of 1.5% of the outstanding principal amount owed on a loan every time a monthly payment is made. For example, if a loan rated B has a posted interest rate of 11.5%, then investors can expect to actually receive 10% yield on their investment if all goes well.
All loans are amortized using the declining balance method over the term of the loan. So similar to a mortgage, the loan is paid back in monthly installments with principal and interest until the loan balance is gradually paid off. All Lending Loop interest rates for loans are fixed.
Small loans under $30,000 are usually funded very quickly, within a couple of days of being published on the marketplace. But larger deals worth $150,000 or more can take weeks to fund or sometimes fail to become fully funded so the loan doesn’t go through and committed investors get their money back.
Currently there aren’t any liquidity options as there is no secondary market, so lenders would be fully paid back only at the time of the last payment.
As an Investor/Lender
For lenders, the minimum deposit required to start investing in loans is $200 to a Lending Loop account. But loans themselves are funded with $25 increments so $25 is technically the least amount an investor may invest into any one loan.
There are 3 types of investors according to Lending Loops FAQ.
- Non-Eligible Investor
Limits annual investment contribution to $10,000. Does not require any income or net worth criteria.
- Eligible Investor
Increases annual limit to $100,000. Requires a phone interview and proof of income over $75,000/year, or $400,000 net worth, or some variation of that.
- Accredited Investor
No contribution limit. Requires proof of either $200,000 annual income or $5,000,000 net worth.
More details about investor classes can be found on Lending Loops FAQ page. Lenders can change their investment status at any time. I’m currently an eligible investor.
After the end of each calendar year, Lending Loop will provide lenders with a summary of their income interest (T5) and capital losses earned through the platform for investors to include on their personal tax return.
How Does Lending Loop Make Money?
Lending Loop has 2 primary revenue streams. (Information below from 2017 Reddit AMA)
1) On the lender side it charges a 1.5% servicing fee (annualized). This is essentially a spread on the rate the borrower pays to lenders and what the lenders’ receive. This fee exists for two reasons:
- In the event Lending Loop goes out of business, there will be a spread for a third party servicer to collect a fee to continue to service the loan book.
- This fee makes up a large amount of Lending Loop’s overall revenue which means it incentivizes the company to list and originate loans that have a high likelihood of repaying.
2) On the borrower side, LL charges an origination fee that ranges from 3.5% to 6.5%. This fee encompasses all costs to originate the loan including: credit reports, government searches, third-party data collection and fees to register the security. This fee is only applied if the loan request is successfully funded. (more details
Additionally Lending Loop will charge fees when collecting late payments, and dealing with collections in the event of default.
- NSF – Lending Loop may charge a fee of up to $25.00 if a payment is returned as NSF.
- Late Payment – If the borrower misses a monthly repayment and is unable to rectify it within 1 business day, the payment will be considered as overdue. Late payments that are not rectified within 7 days will incur a fee equal to 15% of the outstanding loan payment(s) which will be charged to the borrower.
- Collection Fee – The collection fee may go up to 35% of the amount recovered if a collection action must be taken.
More details about Lending Loop fees.
Potential Risks Associated with Lending Loop
Like any investment, there are risk involved with Canadian P2P lending, especially when the posted interest rates can be very high. Here are some risks to be aware of.
- Default Risk – A loan could go bad and the borrower refuses to pay. Lending Loop does have a loan recovery system in place. But in these situations investors will only get a portion of their principal back.
- Management Risk – Lending Loop could run into financial or management problems internally. Fortunately any money in an investor’s Lending Loop account is fully protected as it is held in trust in a dedicated account at a Canadian Chartered Bank. If Lending Loop goes bankrupt, lenders using the platform will not lose their money. But it will be an inconvenience.
- Liquidity Risk – Notes issued by Loop Funding may never become liquid, so investors are expected to hold each loan to maturity.
Because crowdfunding small business loans is so new to the Canadian landscape investors should use caution when investing with Lending Loop. Personally I would not feel comfortable putting any more than 5% of my net worth into a peer to peer platform at this point in time. That’s why I only started with a $20,000 investment, just to test the waters. But over time as P2P becomes more established I may increase my exposure to this type of investment.
The best way to invest in Lending Loop
As a non-traditional investment, Lending Loop may not be for every investor due to its unique set of risks and relatively short operating history. But if you decide to invest in this platform, here are 3 strategies to consider. 😀
- The Low Risk Strategy
Only invest in loans in the A or A+ risk bands. This will give you a blended account yield of roughly 6% per year, net of fees. Setting aside 1% as the cost for loan loss provision the expected pre-tax return on this portfolio is 5% per year.
- The Indexing Strategy
Invest the same amount of money in everything that appears in the Marketplace. For example, if you fund your account with $1,000 to start out, you could commit $50 to every loan until you run out of available funds. This will give you a diversified portfolio of 20 different loans of varying risk bands. Average expected net return is 6% to 7% per year.
- The Selective Strategy
Analyze each loan for its own merit and research the underlying company. This method is most time consuming, but you’ll have a better understanding of what you’re getting into.
You can also use a combination of these methods or come up with your own way.
Liquid’s Custom Approach – For 8% Annual Return
Personally I’m primarily investing within the risk bands of B to C. This is because higher quality loans in the A range do not offer very attractive yields. But D and E loans are usually too risky for me. A blend of B and C loans gives me an average gross yield of roughly 13.5%.
After the 1.5% servicing fee, my net yield is 12.0%.
According to a study written by Dr. Edward Altman from the University of Toronto, and a Moody’s report, the average default rate since 1970 for corporate junk bonds rated B to C has been 8%. The average recovery rate is about 50% on these types of bonds. Lending Loop predicts the default rate on its platform is about 5% for a 3 year loan.
Given the above information, I have decided to price my loan loss provision at 4%. This is the amount I should set aside in the event of loan defaults.
Therefore, my net yield of 12% minus the 4% cost of expected long term defaults, gives me an overall portfolio return of 8% per year. I started with $20,000 at the start of this year. My goal is to have $21,600 or 8% more in my LL account by the end of the year.
My progress so far has been slow as I did not invest the entire $20,000 at once. There weren’t a lot of loans to choose from in January, but there seems to be a more consistent flow of borrowers now. I typically invest $500 to $1,500 per loan to maintain a diversified portfolio. I currently have 20 loans. Each one pays me monthly.
I’m earning $200 per month of interest, plus $800 in principal. I plan to reinvest this money every month into new loans that are created. So far none of my borrowers are delinquent on their payments and I hope it stays that way. 🙂 I scrutinize each loan before committing money to it. I look at the company’s balance sheet and income statement and decide if it’s appropriate or not to its risk band. Sometimes I would invest in a D+ loan, but most of my portfolio is filled with B+, B, C+, and C.
Here is a preview of what I currently hold in my peer to peer lending account.
Lending Loop is a legit investment platform. I like it overall. It’s a much needed service in the Canadian business world. LL currently employs about 10 people. I expect it will continue to grow as it attracts more borrowers and lenders over time. So far they have gotten over $80 million worth of loan applications. But they have only accepted about 3% to 4% of them. This shows the Lending Loop team is fairly strict about what they allow into the Marketplace to get funding, which is good.
It’s hard to find attractive investments these days in stock and bond markets because everything is so overvalued. So building a diversified portfolio of small business loans with good yields seems like a favourable option right now. Plus if you’ve ever wanted to know how much money a family restaurant or a small retail store makes, you can get that learning experience by investing with Lending Loop. I’m pretty confident I can make the expected 8% return with my loan strategy. Otherwise I wouldn’t have borrowed so much money to throw into this investment. 😉
Lending Loop investments remind me of mortgage investment corporations. Both are short term, debt investments with high yield. Except LL allows for all types of business loans, not just for the real estate market. To conclude, traditional banks won’t price loans beyond high double digits as it introduces significant reputational risk. Which is why I believe P2P lending is here to stay in Canada. Lending Loop has shown that it can be done. Hopefully there will be more participants to enter this market so competition can lower the cost for investors. 🙂
[Update 2018] I have been using Lending Loop for over a year now. The platform currently has about 15,000 investors, which more than twice the amount when I published this initial article last March. They’ve added an auto-loan feature which is very convenient. So far I’ve invested in a few dozens loans and none have been delinquent. My annual return is double digits for 2017. To see more, here’s my 1 year Lending Loop update.
Random Useless Fact:
High IQ does not necessarily mean high job performance. Emotional intelligence (EQ) has shown to be a better indicator of career success.