As I’m sure anyone reading this is well aware, there are not many real value opportunities in the markets at the moment. That’s why I thought I’d highlight an alternative investment platform: Lending Loop.
Right now there are some cheap stocks out there, but great opportunities are few and far between. I’ve had to pay up for GARP stocks, like Stella-Jones and Clearwater Seafoods. I’ve had to tread into the waters of distressed lenders with Callidus Capital. I’ve been running stock screeners everyday, like this one by Norman Rothery.
But there is another option for Canadian value investors to still put capital to work these days. That’s through Canada’s only peer-to-peer (P2P) lending platform.
What Lending Loop Does
Lending Loop gives regular peasants like you and me the opportunity to loan money to Canadian small businesses. Small businesses go to Lending Loop when they need to borrow money for expansions, working capital, to consolidate higher interest debts, etc. Banks are often wary of loaning money to small businesses, which leaves higher interest methods of obtaining money like credit cards and private loans as the only option until Lending Loop came along.
Once the loan application is accepted by Lending Loop, they open up the loans to investors/lenders. Anybody can sign up, except the residents of the province that always gets excluded, Quebec. Once you sign up and deposit money, you can invest as little as $25 into a loan. This low minimum allows you to diversify across many loans, reducing your risk.
Signing up is very simple. You create your account completely online, the way you should be able to. You fill out an investor profile questionnaire, the same type you would at the bank when opening up an RRSP. Then to deposit money, you upload a void cheque or a statement from your chequing account to give Lending Loop your banking information. This allows Lending Loop to “pull” the money from your account, so in the future you authorize these deposits from your Lending Loop account rather than from your online banking website.Once you set up your initial deposit, you’re about 4 days from lending money.
There’s a marketplace that has all the loans currently open for funding. One problem Lending Loop has overcome is the number of loans available at any one time. As I write this there are eight loans open, and in the past week there have been several closed.
Each loan has an amount the business is asking for (obviously) as well as a limited time to be open to funding. There is one loan on the marketplace now that probably won’t get funded, a sign that the market is now big enough that lenders can vote with their wallets, not being forced to loan to poor businesses simply because there aren’t enough loans. If a loan doesn’t get funded there are a few things that can happen. First, Lending Loop can extend the time to fill the loan by 15 days. Lending Loop and the business can also (instead of the extension or after it) agree to loaning out a lesser amount. This would mean that the business receives less than they originally sought out for, and that lenders who committed to the loan would still get to invest in it. The other possible outcome is the business and Lending Loop agree to cancel the loan application, at which point everybody who committed money to it will have the committed money deposited back into their account, ready to be committed to another loan.
Once a loan has received 100% of the money they were asking for, the company presumably gets that money and you as the lender start receiving payments the next month.
As An Investment
Lending Loop does a pretty good job of giving lenders what they need in order to make sound investing decisions. You’re provided with two years worth of rudimentary balance sheets and income statements, enough to see how profitable a company is, whether they’re growing, and the sate of the balance sheet. You have to remember that these are small, private companies, so you’re unlikely to see a very strong balance sheet with good cash flows the way you are used to seeing with publicly traded companies.
There is also a bit of a story of the company, as well as sections where the owner states why you should loan to them, what they’re going to do with the money, and what they view their financial situation is like. This provides a bit more information for your investing decision.
And last but not least, lenders are able to ask the company questions. It is completely up to the company to answer the questions though, and some choose to completely ignore them. I’ve seen loans fully funded within days while questions went unanswered. Other companies, most I’d say, are very open with questions and it adds a layer of comfort while you decide to invest or not.
How Lending Loop Makes Money
Lending Loop takes 3.5%-5% of the loan value off the top as a fee, which comes out of the borrower’s end. When you see a loan for $100,000 the company only receives ~$96,500. Then Lending Loop takes 1.5% of each loan payment as a fee as well for processing the loans/payments. When you see that loan offers a 18.4% interest rate, you as a lender will actually receive a 16.9% return.
In the event of a default, they also reserve the right to charging a large fee for their efforts in collecting on the defaulted loan. However, they have collected on a bad loan in the past and not charged this fee, returning all money collected back to the lenders.
How I’m Investing
I have certain goals of what investment returns I need to be happy with an investment. While I wouldn’t turn down a 7% return (what you get from the “safest” loans on Lending Loop), I aspire for me. So I’ve been investing in loans rated B or lower. These offer a return of 10.7% if paid off in full.
The first thing I do is judge the reason that the company is borrowing money. If I don’t agree with the use of money, I’ll probably pass, within reason. If a profitable company with no debt wants to borrow money at 20% to switch to low flow toilets, I’m going to think it’s a stupid use of company money but I’ll still invest. But I’m a big fan of management teams I trust, and the use of the money is the biggest view into management’s mindset that I can get. If a company wants to buy out an existing shareholder to gain more control of the company, I see the logic in that. If it’s to take the lease of a store beside them in order to expand, I see the logic in that. To consolidate higher interest debt, logical. General working capital purposes? Then I’ll need some more information and ask some deeper questions.
I take a look at the income statement, focusing on cash flow as opposed to profit after tax. Even if a company isn’t profitable, it doesn’t eliminate the investment to me. I have confidence in my ability to know a proper income statement when I see it.
I look at the balance sheet to make sure the liabilities aren’t already astronomical. Lending Loop spells out owner’s equity, and judging by the Q&A section a lot of lenders only look at this and the profit number. But again, it’s a subjective matter of whether you like a balance sheet or not.
If I see any numbers that don’t really add up to me, I’ll ask a question. For instance, there’s a loan I saw where interest paid was high two years ago, low last year, and was high again this year to date, even though liabilities were roughly flat. Turns out this was the line the owners were using to signify their salaries. That would have been the last thing I guessed was the reason.
Lastly, I’ll Google the business name, looking for reviews and their website. I’d much rather invest in a profitable restaurant that has great reviews than one that doesn’t. I recently partly invested in a restaurant because a lot of the reviews said the food was great but it was a little expensive for the amount of food you get. As a lender to a business I like to hear that sort of thing, people not being completely satisfied with the value but still rating the experience highly and continuing to go back.
Lending Loop is a excellent way to diversify your investments, and should be reasonably uncorrelated form the stock markets, making it a good place to put some spare capital when you can’t find any cheap stocks. The platform is good looking and easy to use. Signing up is a quick process and it’s easy to both deposit and withdraw money. There are now a lot of loans available on the marketplace, as well as more and more opening up all the time. From what I’ve seen sometimes the interest rates don’t quite correlate with the risk of the businesses, so the market could be inefficient, allowing for smart money (smarter than me anyway) to take advantage and get outsized returns. Or maybe I’m bad at analyzing credit risks, that’s possible.
There are some downsides however. The disclosures are better than you’d expect from private businesses, but it’s still not great. A bigger issue than that is that this money is not invested in registered accounts, and interest income is fully taxed at your marginal rate. So even when I invest in 18.4% interest loans, after Lending Loop takes their cut and the government takes theirs, I’m going to be receiving somewhere around a 12% after tax return. Investing in Lending Loop should never be done before you’ve maxed out your TFSA and RRSP. According to their recent AMA on Reddit, they’re working on making Lending Loop eligible as TFSA/RRSP investments, but I’m betting that’s a long way off.
Lending Loop is a very small percentage of my portfolio, but I can see that growing if the conditions in the markets persist. Right now I’m very happy with the platform itself and the investment opportunities and returns.