That’s pretty sweet.
But won’t there be a shitload of defaults if a recession kicks in ?
I would assume that only people with poor credit history would be willing pay these interest rates ?
I think these institutions are taking a more active approach with their fixed income investing, as opposed to the traditional bond ownership that most people think about. I don’t personally own any bonds, but if I did it’d be through a BDC. They invest in senior secured or second lien secured loans to US middle-market companies and have historical returns of 10%+ per year. Generally the majority of their portfolio is in variable rate investments as well, which is encouraging for the outlook. I think opportunistic credit is attractive as well. These hedge funds invest in streams of income, such as royalties or trademarks which have built in inflation protection.
I don’t think we need to think that far.
The FED has started tapering its open markets purchases of Treasuries. It is purchasing tens of billions less every week.
This has the effect of increasing yields so in a way, it has already started.
It is not apparent in Treasuries now because investors have been buying treasuries due to uncertainties.
So although the net effect is not very clear now, it is certainly a pressure.
If credit spreads remain equal the effect is passed through to corporate bonds, so although the picture is very mixed, there is currently huge price pressure on corporate bonds.
14% upside, 100% downside.
Probably better to create a portfolio allocation of high risk stocks and the risk free asset…
50%. i’m not really excited about holding much equity as Western world P/Es are 18-20x, the bull is 5.5 years old and Europe is likely entering recession again. IG bonds and prefs. fine with holding up to that much until the next break in the market. that said, new savings will go 100% to equity to bring my equity allocation up over time naturally, in case i’m completely wrong on the market. wife has a hybrid plan that is 60/40 but part of the allocation is some pretty juiced up stuff (PE, levered, etc).
Average credit rating per customer is 350. Expected default rate is somewhere around 80%.
That’s hyperbole, of course. But really, how confident are you that you’ll get paid back? Why would somebody pay you 14% when they can get an unsecured credit card for 10%? And if they can’t get an unsecured card, why in the world would you want to lend money to them?
Just a question : how much are these IG bonds yielding more than established dividend stocks ? I understand that you are willing to sit tight through a crash anyways ?
A friend of mine went to go work for a personal lending start-up firm a year ago. He told me the interest rates being charged to customers – I couldn’t believe it. Like you, I asked why not just use a credit card? Springleaf Financial, a publicly traded personal lending institution, has some personal loan asset backed security info memorandums on their investor relations page. These securities that are pooled together into ABS have weighted average coupon rates of ~27%, FICO scores of ~600, avg. balance of ~$3,000
Who are these people agreeing to loans with 25%+ interest rates? There are thousands upon thousands of these loans pooled together in these securities. I don’t have any experience in this space but it’s happening. I don’t know who in their right mind is paying that much interest…they must really need the cash.
the addiitonal yield is approximately 1.2-1.3% currently (both on a running yield and ytm basis) so you will do better in flat and down scenarios. not too worried about another runaway leg up but worried enough to keep 50% in large cap, less cyclical equities.
Regarding Lending Club, the majority of investors on the funding side are Hedge Funds and Institutional Investors – which should say something about the risk to reward proposition.
LC can offer nice returns you have to be able to judge risk well. also its ultra competitive now and algos get the best deals
Default rates on consumer credit are at all time lows… I would just fund the riskiest loans at the highest interest rates.
I’m not speaking from personal experience, though… I haven’t tried Lending Club yet.
It’s not just about the percentage of your entire portfolio, but it’s also about the TYPES of bonds you hold.
In other words,
You got to diversify yo’ bonds, nigga
Default rates would increase, yes. The amount of violatility is going to be correlated with the credit of the underlying. At 14% interest rate, I’m fairly conservative. You have to remember this is unsecured consumer credit, so 14% isn’t very high at all. The lowest interest rates are 6% and highest are 25%. To give you some insight, of the average 14% interest rate the average FICO is 720 and average annual income of 80,000 with a DTI around 20.
Now I have a barbell approach to risk, so I have 50-80% in relatively safe stuff with some higher risk stuff. So the averages miss this, but give you should insight.
This is not correct. I only assume people think it because they don’t have much experience with lending. Consumer portfolios are pretty straight forward. You can pull FRED data to see the aggregate trends over the past thirty years or so
Because they are trying to get out of credit card debt. Do you really want to argue the average credit card is 10% APR? You are purely speculating and then jumping to extreme conclusions without even simple research, so not sure it’s worth explaining. But if your actually interested, then I can. MLA personally hates exposure to consumer credit, so be careful he may blow up.
That’s what a lot of private equity, hedge fund, and institutional money is doing. On the opposite side, insurance companies are going for the super high FICO stuff. I personally am not risk adverse, but also not a huge risk taker – as a result, I don’t invest in the top 2/3 highest interest rate credit grades. My returns suffer compared to peers, but I think my lower violatility is going to compensate. Only time will tell and how long it takes for the next down turn (and if it is regional vs national. I’m pretty well diversified geographically)
roar! consumer credit bad! kaplow!
Sounds like a good time to be selling credit risk, not buying it.
You have to keep in mind that you don’t care about a borrower defaulting on you. This isn’t venture capital into a business. You are just taking a pool of homogenous consumer credit and making inferences based on how those variables have meant in the past. For example, I have roughly 1300 unrelated consumer borrowers. I group them in sub-portfolios of like types of credit and analyze the trends in those portfolio. You are concerned with pool characteristics (so does default rate go from 9% to 20%, but not does Bob pay or not)
I’ve been building a stress test for my portfolio. Last I messed with it, even if we have another 2008 recession I still may just break even. Banks have historically loved consumer credit because it’s fairly predictable, which is extremely important with their leverage. The problem with consumer credit is those banks incur high over head, due to the branch networks and related requirements. I outsource those costs for a servicing fee, which is why traditional banks are slowly getting into this as well.
The only unfavorable parts concerns consumer lending (ignoring credit risk of Lending Club itself, which is a seperate conversation) of it IMO are 1) liquidity and 2) tax treatment. The liquidity is fairly costly at 1%, but I routinely sell distressed notes and still have made roughly 8% returns on that due to the monthly amortizations and very few notes will be first payment defaults. The benefit of me only investing in 36 month notes means I have a large return of principal each month, mitigating small to medium sized needs for liquidity.
The second is tax treatment, which is a gray area and depends how you interpret the rules. For large, wealthy investors, some think the losses are capped at a certain dollar amount. So some have used legal structures to get around this.