An Updated Look At My Lending Loop Portfolio

The year was 2012. Or something like that.

Look, I can barely remember what I had for dinner last night. Never mind what happened nine years ago. Or seven years ago. Or maybe last week.

Whatever year it was, it was an exciting time. After a few years of stellar growth in the United States, peer-to-peer lending was coming to Canada. But the Canadian version had a bit of a twist. Instead of lending to dirtbag individuals who had exhausted more conventional means of financing, the Canadian version would be setting up loans for small and medium-sized businesses, companies that traditionally had been underserved by banks and virtually ignored by everyone else.

I was intrigued by the concept, so I threw some money into Lending Loop (which we’ll call LL for the rest of this post). After I made my first investment (of $500), the company promptly stopped accepting capital after being told by securities regulators they needed to iron out a few more kinks. That took a few months, but LL figured things out, found a few businesses to test the platform, and got up and running.

An interesting problem plagued the site at first. There was too much money chasing too few loans. Shitty businesses with pretty much no other place to turn were the only ones using LL, and even these loans would be funded within a day or two. I put some of my capital into these companies because I had no other choice.

After about a year, the marketplace started getting a lot better. There ended up being approximately 10-15 new loans a month on the site for a while there, including more businesses with solid balance sheets and that were involved in less cyclical industries. (Construction dominated LL’s loan portfolio at first. Restaurants weren’t far behind, either) So I threw an additional $1,000 into the platform, increasing my total commitment to $1,500. It was still peanuts compared to the rest of my portfolio, but that was because it didn’t have the long-term track record to justify a greater investment.

Then the same problem started happening again. There was too much money chasing too few loans. I’d look at a loan, think it over for a day or two, and then miss out as other investors threw their money in. So I did what the site suggested. I turned on auto lend, a feature that automatically invested in new loans that met certain criteria. I cast my net fairly wide, which means I included all loans from grades A to D as auto lend candidates, only avoiding the bottom E grade. I pledged $25 to each loan, hoping to build up a fairly diverse portfolio across all provinces and sectors.

Except Quebec. They weren’t allowed to participate.

And then I promptly forgot about Lending Loop. This was in 2018 or 2019. Then the pandemic hit, we moved, I changed jobs, and suddenly the play money I put into LL wasn’t very important any longer. I didn’t do a thing besides declare the income on my taxes.

After receiving my 2021 tax notice from LL, I decided to revisit my investment and see what happened with it. Did my set-it-and-forget-it strategy work? It did. Well, sort of.

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Lending Loop Update

First, the good news. Even after a few charge-offs and a few loans that are currently behind/delinquent, my $1,500 original investment has increased to a little over $2,000.

Here’s the breakdown for the last couple years:

2020

Income: $213.41Fees: $22.16Total Income: $191.25

Charged-off Principal: $23.98Recovered Principal: $0.02

Net Income: $167.29

2021

Income: $169.92Fees: $17.46Total Income: $152.46

Charged off Principal: $9.96Recovered Principal: $0

Net income: $142.50

Immediately, a couple problems emerge:

1. Hot diggity, those are some high fees. I’m paying more than 10% of the interest received in fees. In reality, it translates into about 1% of assets under management in fees, which isn’t terrible for a platform like this one

2. Earnings went down significantly in 2021 despite the economy recovering from COVID. That doesn’t make sense.

I did a little investigating. It turns out my portfolio weighting changed since I turned on auto lend. I left the portfolio fully invested in loans. I returned to find my asset allocation looking like this:

59% - Loans1% - Pending Loans40% - Cash

Huh? Wasn’t auto lend supposed to guard against this? The whole point of auto lend was to give me a small piece of virtually every loan that crossed the platform. Instead I’m sitting on a mountain of cash and basically zero new loans.

So I did a little digging. It turns out a common problem is once again impacting LL. There are so many investors with auto lend turned on that most loans don’t even hit the marketplace. They get funded by investors who have committed more than the paltry $25 I’ve pledged to each new loan.

And the little guy gets screwed again!

I’ve got a couple options. I can turn auto lend to a higher number (say $100) and see if that helps. I end up fully invested, albeit in a pretty concentrated portfolio. Assuming it works, anyway. The other option is to take cash out.

I opted for option two. I asked LL to withdraw most of the capital sitting in cash. I also deleted the auto lend plan I had in place and will withdraw funds as they become available.

(Aside: Lending Loop would be considerably more fun if there was a secondary market I could buy and sell into. But, alas, there is not.)

The bottom line

Lending Loop is still a neat concept, and I continue to think it can end up being an excellent way for investors to diversify into an asset class most have zero access to. But as it stands today, it consistently suffers from the same problem. There are too many dollars chasing too few loans.

How this hasn’t resulted in rates going lower is beyond me, but the interest rates charged to these businesses are stubbornly high. We’re talking 8%+ for the best ones, 10-15% for good, 15-18% for mediocre, and 18-25% for the worst businesses on the platform. In a world where fixed mortgages just went up above 3%, that’s a lot. Businesses should just tap into their owners’ increased home equity. Maybe they do, and the ones that can’t have to end up at LL as sort of a last resort.

If you want access to this part of the market, maybe the best way to get it is to buy shares in Alaris Royalty Corp (TSX:AD), which engages in something very similar. It makes loans to businesses, but these have a royalty component often built in. It’s the same type of investment but you get the proceeds as a dividend, not interest. And there’s zero work on your behalf. You just sit back, relax, and let Alaris lend the money out. That’s the way I’d get exposure to this.

Disclosure: Author is long Alaris. He still has about 60% of his investment in Lending Loop, but is actively looking to get out.