'Real' Interest Rate on Investment

In late 2013 when I first came to this forum, I talked about a 7% return, net of defaults, over the business cycle. That was based on what other "fixed income credit" products, such as HY corporate bonds, ABS, secured loan portfolios etc, have delivered over the past 30-50 years. I don't see a major reason to modify that view. I accept, however, that I could be wrong by 200bp on either side. Moreover, that is a cycle average and I would expect significant volatility in loan cohort returns, peak to trough.

The issue to some degree is that 2013/16 was probably a very good period to be a lender. First, it was mid-economic cycle, where credit tends to perform well since leverage has yet to build up and risk-free rates are low. Second, most P2P platforms were new and thus their loan portfolios had yet to accumulate the non-performing loans that eventually always drag returns down. Third, early on P2P platforms could originate their first loans from niches where there were good quality borrowers whose had valid reasons for paying very high yields. Finally, the natural growth of P2P lending meant there were always more buyers than sellers on platforms, so it was easy to recycle short-dated loans into longer-dated loans and avoid/reduce the default risk (i.e you could pick pennies up in front of the steamroller in the sure knowledge you could jump out of the way before it squashed you). The end result was that it was possible to generate double digit returns from double digit yields fairly easily. I was generating 17% doing underwriting on AC, 18% flipping loans on FC, 12%+ on a few other platforms like TC, SS etc.

The problem is that all the above conditions are far less valid today. We are clearly much closer to the end of the cycle than the middle and default rates are rising. In attempting to scale origination volumes, some platforms have turned to sectors like speculative propery development, ratcheting up the risk. Others have instead moved to lower yielding products. Most platforms have some hefty NPLs now on the books which had caused liquidity to dry up on some platforms, meaning the strategy of "passing the (exploding) parcel" doesn't work. It's also important to consider that if returns do turn out to be say 7% over the cycle, then if you generate say 10-12% from a buy-and-hold approach in the good years then by construction you are going to face a period where returns are 2-4%. In fact a period of negative returns would be very likely in the downturn.

I'm not sure I see a reason why SS should be different and buck the trend. It was very easy to extract 12%+ in 2014-16 (and even 17) but the corollary is likely lower returns going forward. Those high returns need to be paid for by someone as the underlying loans were very risky, with high default rates and weak recovery prospects. SS was founded by people with no background in the product they were selling so many mistakes were made. The model tended to a "pump and dump" strategy which suited them to grow volumes. At this point, SS is finally hiring some of the staff it needed in say 2015 which bodes much better. Nonetheless, it has a legacy portfolio of NPLs to deal with plus the fact it still hasn't got full FCA authorization, which has to a major concern given how easy it is to get authorization.