Online Lending: High-Yield Investing for a Low-Yield World
The recent vote on the part of the U.K. populace to separate from the European Union sparked a massive wave of interest and speculation around the world. Much could be said regarding the political trends behind the outcome, the wisdom or folly of such a move, or the long-term economic prospects of the United Kingdom and greater Europe. It is likely too early to forecast long-term consequences based on a single vote, or even whether the magnitude of the Brexit will be particularly large. However, what is clear is the short-term reverberation felt in global financial markets and the near-certain prolonging of a low-yield period across the world. In such a market, investors must work harder to seek out desirable yields at reasonable risk. The fixed-rate term loans issued by online lenders to consumers and businesses provide an attractive product for such investors.
Yield Curves Over Time
In the graphs below, we see the yield on U.S. treasury notes of various duration since 1990, as well as a close-up on yields since the beginning of 2016. As we can see, we are in the midst of a prolonged low-rate environment, and the events of the past 2 weeks have caused yields to fall even lower.
Of course, low rates on government bonds are not unique to the United States. Let’s examine the analogous curves from other large economies.
Indeed, we can see that money is cheap throughout the world, and investors looking for yield on fixed-income assets do not seem to be getting it from central governments. In today’s market in particular, loans to consumers and small businesses present an attractive and stable yield opportunity.
Listed Interest Rates for Online Consumer Loans
Below, we chart the daily range of listed borrower interest rates for the two largest providers of online consumer loans, LendingClub and Prosper. As we can see, rates range from a low of above 5% to a high of over 30%, rank-ordering by the risk of the borrower as measured by the originator-assigned credit ratings.
Next, we chart the originators’ stated expected loss numbers by grade and term. Of course, real-world performance may vary due to a variety of factors, and wise investors will take care to stress test their assumptions. Nevertheless, if loans perform as expected, there is ample spread between expected interest income and expected loss.
The Orchard Index vs. Traditional Investment Returns
The Orchard US Consumer Online Lending Index measures the aggregate investor-experienced return of loans originated by major online lenders in the U.S. The index aims to track the cash-on-cash returns that would be experienced by an investor buying a dollar-weighted slice of all outstanding loans. As we can see in the graph below, the Orchard Index exhibits solid performance over a multi-year period. Particularly when compared to traditionally-popular equity and fixed-income indexes, online consumer loans stand out for their ability to achieve solid returns with relatively low volatility.
The Vibrancy and Resilience of the American Consumer and Entrepreneur
The chart above paints a compelling picture of new business creation on a steady rise since the post-recession trough of 2010. Indeed, despite a tumultuous period around the globe and a hype-filled election season where candidates repeatedly focus on everything going wrong in the country (obviously to convince you to vote for them to fix it), the United States remains a great investment, sought after by investors across the globe. At Orchard over the past 6 months, we have seen an uptick in demand from international investors for U.S. credit, including from clients in China, the U.K., continental Europe, Israel, Argentina, and Canada. 240 years after our Declaration of Independence, the future of the United States looks bright, and the American people remain a great investment.