Lending Club increased interest rates just days after the Fed raised the Fed Funds rate by 0.25%, being one of the first in the industry to do so. However, an environment with interest rate hikes is foreign to P2P investors and many of us have questions on its implications. Here are our thoughts from a few angles:
Loan Interest Rates
We expect interest rates to rise inline with, and promptly after, future Fed rate hikes. Since Lending Club also adjust interest rates periodically based on market conditions and model changes, they will likely piggy back a Fed rate hike to make the net changes. However, do not expect the rate adjustment to benefit every grade level by the same amount. For example, our most recent Fed rate hike and Lending Club rate adjustment had a weighted interest rate change of 0.25% across all of its loan grades, but the changes were mostly in the mid- and high-risk grades. Lending Alpha’s strategies are expected to see a +0.23% to +0.46% interest rate increase for the latest adjustments, which a good thing:
Higher interest rates mean a higher cost of financing for new borrowers. We don’t expect interest rates to move up quickly, and any move will be gradual (+0.5% to +1% per year). The net impact to the borrower due to financing cost should be minimal due and would imply that it’s a small contributor to any increases in default rates.
Investor returns should increase due to the higher interest rates, especially those employing strategies that optimizes for rate changes over time (like Lending Alpha’s strategies). We could see default rates stabilizing in the near future, supported by an improving employment environment.
Lending Club Corporation
Lending Club generates the bulk of their revenue from loan originations and higher interest rates is negative to their business as cost of borrowing increases with the interest rates. Lending Club will continue to create new consumer loan products such as Direct Pay Loan to reach new population segments to continue growing their (personal loan) business.