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Lending Club

Discussion in 'Off Topic' started by austinEV, Oct 9, 2013.

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  1. austinEV

    austinEV Active Member

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    #1 austinEV, Oct 9, 2013
    Last edited: Oct 9, 2013
    After many promises to do so, I want to start a thread on one of my favorite investments, Lending Club.

    If you could have a risk free way to earn 8, 9, 10% annually would you do that? What do you do when TSLA has earned you millions and now you want to live on the interest? (I kid, but for some maybe not). It is a very handy way to park some cash you need for a while, or do like I do and turn yourself into a mini-bank and park all kinds of deposits, property tax, savings at pay myself fat interest. Read on for the many details and implications

    The basics: What is lending club?
    Lending club is a “social lending” company (like prosper, which I have not really looked into). It’s like a dating site for lenders and borrowers. Borrowers come the site to get unsecured (no collateral) loans for various reasons, but usually credit card debt consolidation. Since credit card interest is typically north of 20% they are happy to pay 17-18%. Lender/investors go to the site and sign up to fund borrowers. Lenders are screened twice, once by LC themselves looking at credit ratings, history, employment, etc. Then borrowers can screen them again based on their applications, picking who they want to lend money to. LC says they reject the vast majority of applications they receive. They assign a risk code A1, A2, A3, A4, A5, B1, B2 etc through G each with 1-5 sub groups. Based on this code the borrower pays some interest rate, lowest at A1, highest at G5. LC itself takes fees from payments but has no other interest in the borrowing/lending. So it is a hyper-efficient bank that connects people who have money with people who need some and takes the minimum vig. Contrast this to a regular bank which charges CC holders 22% interest and pays depositors 0.1% interest. I suspect banks HATE LC.

    How does it work?
    You make an account on the EXCELLENT lending club website. You connect a checking account and fund it. You invest in loans (issued or secondary notes, more on that later). You then hold notes (portions of debts) which pay monthly. Since the borrower is paying back principle and interest in every payment, you are getting mostly principal with some interest. Notes can be as small as $25. In the interest of diversifying risk most people choose to have many small notes from many people so defaults don’t hurt as much. Some notes will go late, and some will default and be written off. As long as you have enough money in play (think 10 to 20k) you will be diversified enough that defaults can be viewed as a numbers game. You have notes which are paying an average of, for example, 16% interest but with defaults you get more like 8-9%. You are now a banker!
    So LC pays better interest than bonds, div stocks (worse tax conditions, see below), and is more convenient. Your balance goes up a little every day since notes all have different pay dates. Some of the money is interest and some is principal you should reinvest. If you do need cash you can pull off the interest or some principal repayments too. That is, cash piles up at a fairly brisk pace. This is good for liquidity, and also bad because you have to come back and keep working on it to keep your money reinvested to prevent money from idling.
    If you ever needed more money, the LC notes are liquid with some caveats. They can be sold on the aftermarket. LC takes a 1% fee for such sales (buying is free). Note however, that in the aftermarket the borrower’s history is visible to everyone. So if you have a note with a steller repayment record and rising credit scores you can sell it at face value or above. If you have notes which are late, missing payments etc, the market value will be less than face value and you would have to discount it to make it sell. Generally though most of your notes will be in the middle and can easily be sold at face value (principal+accrued interest). You are now a bond trader!

    What is the downside?
    Nothing really. There is default risk, but you just have to bake that into the overall return and not sweat defaults. LC started before the 2008 recession so they have a track record including bad economic times. The worst thing about it is that it is a sort of hobby. You have to work on it a few hours a week to keep your money reinvested and maybe try to unload bad notes if you are into that sort of thing. Probably the worst thing is that you can’t put as much money in as you might like. I live in a state where you can only participate in the secondary market (more on that below), so I am limited in how much I can plow into it in any given day/week. I am working up my balance to see if I can find a pain point but I suspect it would be impractical starting at 100k unless you were willing to make it a defacto job (an easy one but still). I can still think of no better place for the $1M I won in the lottery tomorrow, if the goal was to produce income to live on. Note that they have regulations to not allow anyone to invest more than a certain percentage, think 10%, of their net worth in LC. They don’t have a way to check this so consider upsiding your net worth when applying.

    Primary funding and the aftermarket
    Depending on what state you live in you can sign up for initial funding of loans. I haven’t ever done this (I live in a state that doesn’t allow it) but I get that there are advantages and disadvantages in doing this. The advantage is that LC will set your investments and reinvestments on autopilot. You can set your risk profile (ratings) and they will sign you up for portions of new issue loans. That is nice, but your money is not working or accruing interest while they are in funding. While a loan is in funding, it is waiting for investors to sign up to meet the borrowers goal (say 10k). Until the 10k is met, the money is tied up.
    Anyone can participate in the secondary note market and if you live in a long list of states including mine, Texas, you must use the secondary market. This has advantages and disadvantages. The disadvantage is that it is a bit of a pain to do, and there may not be enough high quality notes to buy. Some nights I sit down with 2k to spend and spend $200 and stop and come back another night. Some nights it’s all you can eat and I can easily buy thousands. Also the website for secondary notes is HORRIBLE but there are helper sites (more below). One good thing is that notes bought on the secondary market immediately go to work for you. Finally, investing in the secondary market allows you to try to outperform the median investor by, for instance, only buying notes with 12 months of payment history, rising credit scores etc. Or you can get fancy and deliberately buy failing notes that are discounted too much by the seller. If you buy many notes at 5% on the dollar that are near default you only need a few to recover to net a profit. You are now a junk bond trader! See this guy’s good writeup on the topic: http://www.lendacademy.com/foliofn-lending-club-users/.
    Note that the aftermarket website is a cesspool of people posting notes for sale at outrageous markups, or wasting time by posting bad notes at uncompetitive prices. You HAVE to use savvy searching to find good notes fairly priced, or bad notes properly discounted. These notes are probably less than 10% of all notes listed. The vast majority of listings are trolls hoping you make a mistake. (I have attempted such trolling as an experiment, there doesn’t seem to be any money in it anyway, so why do they do it?). For instance you will see many notes with 1 payment left with a book value of $0.18 selling for $1.80 (or just $.23). If they get bought the seller books an enormous % profit but wow how bored do you have to be?

    My results:
    I have had around 20k invested since summer of 2011. The way I calculate it, I have done between 8-10% on a rolling 12 month basis. I only count my performance based on notes invested, because it isn’t LC ‘s fault if I let cash go idle (cash earns 0% interest). In the last 12 months I have earned about $154/month on about 18k of deposits (10% annualized) net of fees and defaults. So if you do win that $1M lottery that would be $8,333 a month. Not bad? You have to pay taxes on that at your top income level (more on taxes below).

    Results spreadsheet: View attachment LC_only.xls

    My strategy now:
    My strategy up to now has been to manually pick notes in the secondary (time consuming) and try to keep risk down. The last few months I have decided to worry less about risk and bend the yield curve up and see where I can get it. I have been buying more and more higher yielding, riskier notes. Now I am using interest radar(helper site) to find notes more automatically and have started a junk bond side portfolio.
    One thing that is really cool to do, if you are the sort of person who loves spreadsheets and accounting, is to turn yourself into a self-bank. I have the problem of a somewhat variable monthly income that I want to smooth out into an exactly the same monthly income. I also self-escrow property taxes (in TX this is large since we don’t have state income tax). So what I do is model paying my “bank” the monthly property tax payment (due annually) and insurance payments (due every 6 months) and other escrowing payments. I also pay into an employee stock purchase plan at work. I instantly flip the stock and book a 15% profit on the stock every 6 months. So I model withdrawing that amount every month (and deposit the every 6 month windfall from selling it). I add up the monthly deposits/withdrawals and it’s a net withdrawal every month into checking. As long as I keep an extra 20k in my LC account (just earning interest) the accounting is a breeze: the principal payments gather up enough cash that I can just stop reinvesting a few months before my prop tax is due, withdraw it and pay my taxes. This way all my idle cash is earning 8%! Once you start doing this you realize how many of these things you really have. If you have an extra few k sitting around for an expense in 2 months you can add it and you start become a super saver in a lot of ways. I take all the cash gifts my daughter gets and “deposit” them. She is earning 8% until she is old enough to appreciate it.

    The LC mutual funds
    One might wonder, why does idle cash at LC pay 0%? After all, they have access to a good safe source of simple interest. For that matter, why make us do all this manual crap at all? It can all be easily automated since it is much easier to aggregate these investments over say international corporate bonds which fund managers do every day? The answer is that they do this, but are very cagey about it. For one, you have to be a “qualified investor” (multi-millionaire), you have to invest at least 500k and they don’t seem to be open all the time. When I asked about it I had to insist I was a multi-millionaire (no) and even then I got tons of attitude about asking. I finally got a confidential book that shows the details. Curiously, they have rather lackluster yields of 5.5 to 8.5%. I have gotten the distinct impression from various questions that they have more investor interest than borrower interest. Rather than do the market thing and bring down loan interest for borrowers they seem to be erecting walls for borrowers: limiting investment size, limiting states that can do initial funding, limiting participation in the mutual fund, not making the secondary website better etc.

    Secondary websites
    There is a discussion forum I have not read enough: http://www.lendacademy.com/
    The pretty good investment helper site: https://www.interestradar.com/

    The latter requires a monthly fee but it’s worth it. Since the secondary website is so awful it is very time consuming to search. Using interest radar, you can set up search criteria to find just the notes you want and they help you buy them (clunky, but works). They also have clever ready-made search criteria you can use, particularly useful for junk-bond buying. I have started to use them for buying deeply discounted failing notes to see if I can profit from that. They say they do 18% with such strategies. Note that whatever search you set up, you will find notes being snapped up before your eyes. This is the apparent restriction; you may need to just buy what you can on any given day and check back tomorrow (or reduce your criteria to be less picky).

    Taxes
    As a final note, the income you earn is taxable at ordinary income rates. Worse, LC doesn’t actually help you with this. By law, if you earn interest from any source of less than some IRS threshold the institution doesn’t have to issue a 1099-div. LC (or the IRS) views each *note* as an instrument for this threshold. So may get tax docs for a few large notes if you splurge on but generally will get nothing. So you have to do manual accounting. Me, I just add up all the profits, losses, fees etc and come up with one profit number and put that on my return. May not be 100% right but defendable in an audit.

    LC vs Dividend stocks:
    The thing that worries me is that I can easily show that a conservative portfolio of dividend paying stocks will outperform LC for taxable accounts, depending on the assumptions you use. While conservative div stocks will pay out 3-5% div yield, the stock itself tends to go up over time, the div payments tend to go up over time, and the taxes on the dividends and stocks held over 12 months is taxed at a very favorable rate. While it is a whopper of an assumption to say that stocks will appreciate 3-4% a year, it is easy to show that simple dividend stocks are better, particularly when you try to model indexing for inflation. If you were to try to maintain your balance relatve to inflation, you would have to reinvest a portion of your LC interest back at the rate of inflation. Stocks tend to index to inflation on their own. I would be interested to hear other people’s take on this.
     
  2. Jonathan Hewitt

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    I've been using it since August and really am impressed so far. One idea I had involved when it's time for me to get a Model X. When I sell my Tesla stock to pay for it, I can instead take out a loan for the entire purchase and put the money in lending club. Each month I can withdraw enough to make the payment and end up with more money than when I started! All without the risks involved with investing in stocks.
     
  3. austinEV

    austinEV Active Member

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    #3 austinEV, Oct 9, 2013
    Last edited: Oct 9, 2013
    I am doing that very thing, for model S and my house actually. Its rate arbitrage. I am borrowing the car cost at 2.7% and will try to earn more than that. Same thing with our mortgage. I have the cash (nice, I know) but our mortgage is 3.6%, and much lower if you factor in tax subsidies. So I am using a combination of bond mutual funds, div stocks and LC to try to produce income to make the payments. So, in this basket of income investments I am going to try to push up the amount of LC until I can find the point where it's not sustainable.

    As for ending up with "more money than when I started", it doesn't work that way. You will end up with some money but not all of the original principal. Say you have 100k in cash and you earn 10% in LC and borrow all of the amount for 3%. (really you can't finance 100% but its an example). You would be making $833 per month but your payment will be (3%, 60 month) is $1800 per month. So either you eat into your principle to complete the payment, or take the difference from your pocket but in neither scenario are you left with a car and $100k in the bank. You would need $216k to make enough at 10% to cover the payment with just interest. This all neglects tax.
     
  4. rolosrevenge

    rolosrevenge Dr. EVS

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    I started doing Lending Club in 2008 and had a lot of defaults during the worst of the recession which brought my Net Annualized return pretty to around 2%. I've been doing better lately and it's up to nearly 4%. I'm thinking of putting more money in it and I really appreciate your analysis.
     
  5. johnnyS

    johnnyS Member

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    I find this interesting. What is the typical time for an investment to pay off? Are there different maturities on these notes? I always have some cash around that I could invest short term.
     
  6. austinEV

    austinEV Active Member

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    They do 3 and 5 year loans. But you can pick up notes that have less time on them if you want. If the original share was $25 then it might be payed down to say $10 and its like a 12 month note.

    The investment pays immediately, accruing interest.
     
  7. Jonathan Hewitt

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    Eh, I have a lot of loans that are more than 30 days late and turned over to collection agencies...most likely will default :/ Effective NAR right now is like 2%. Maybe I chose a too risky mix of loans.
     
  8. hiroshiy

    hiroshiy Active Member

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    I was very interested in LC when it's announced, but it only accepts U.S. residents. There's a similar service in Japan, maeno.jp, which gives me 5-7% NAR before Japanese 20% tax, but lenders there provide some form of collateral such as publicly traded stocks or the land, so it seems pretty safe so far. I invested(?) around $40K but will increase the position, as I'm not good at stock investing :)
    So far for a few years I participated there were no defaults, just one late payment.
     
  9. austinEV

    austinEV Active Member

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    Big news. They improved the secondary market webpage. Now they have an easy slider to tailor the amount of markup/discount you want to allow. So critically, you can exclude big markup loans. Also, you can choose a range of YTM (yield to maturity). So you can do a really good job of finding good notes by eliminating big discounts (will be bad somehow when you dig in) and big markups, say 2% limit. Then choose notes with increasing credit scores and shop away.

    - - - Updated - - -

    Did you make sure they weren't fishy when you bought them? Here is my status. Most of my late notes are deliberately bought "junk" notes bought at a deep discount. (I will lose money on these trades by the way... I am not smart enough currently to make such a ploy profitable).

    LC_cap.PNG
     
  10. Jonathan Hewitt

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    As far as the 31-120 category, 4 of them I bought on purpose for a nice discount that had some not so great payment history so I guess those are my own fault. The other ones looked good to me (good payment history, no bad comments on the collection log, payment wasn't pending). I'm not sure if there's other fishy stuff I should be looking for or not. Due to all these underperforming notes I've extra careful lately and have been looking at things like large credit score drops or suspicious sounding loan requests on the original listing page.
    lcnotes.png
     
  11. austinEV

    austinEV Active Member

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    My gut feel is that you are fine. I have about 50 to 150 in write off losses each month which is like 2 to 6 notes. It all works out.
     
  12. Jonathan Hewitt

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    Cool, thanks! It seemed real high to me but after you showed your distribution it made me feel a bit better.
     
  13. austinEV

    austinEV Active Member

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    Yeah it can upset you at first when you start getting defaults. Don't spend your time steaming about deadbeats. It's just a numbers game.
     
  14. Jonathan Hewitt

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    Thanks! While we are on it, what kind of mix of loans do you have letter wise? I would be more than happy to get the ~9% you're achieving. It looks like the best loans to get are D, E, and F as far as best compromise between defaults and interest rate. Most of mine are C, D, and E with the rest compromising B, F, and Gs except for a small percent of As just because I felt like it.
     
  15. austinEV

    austinEV Active Member

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    I have more "E" than anything. I haven't bought an A or B in years. My average note is 16.6%. The last 3-4 months I have not bought anything with a YTM of less that 14% or so, trying to bend the yield curve up. So far so good, my trailing 12 month average return is now over 10%.


    Capture.PNG
     
  16. austinEV

    austinEV Active Member

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    Well, I have begun my great scale-up. I intend to have a 6 figure account soon. I deposited a big chunk of cash, and got to really see the limit of the marketplace, at least on this one day. I found I was able to buy almost 20k of notes before I had bought out the notes that met my criteria, which was:

    YTM of 13% or more
    at least 10 payments made
    no collection history, no late or missed payments (one grace period, long in the past ok)
    credit score higher than when applied
    less than 0.5% mark-up

    That is about it. I haven't been scrutinizing other loan details, like loan purpose or geography for a while. I figure payment history is the most potent indicator of quality. I did find that most of the notes I bought were on the large side, about $200, which I am fine with.
     
  17. swaltner

    swaltner Member

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    I sure wish I could participate, either in the primary market or secondary market on Lending Club. As a resident of Kansas, and not having the income/assets to be an accredited investor, I'm blocked from both types of purchases. :(
     
  18. austinEV

    austinEV Active Member

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    I blew through 8000 tonight. It would seem my concerns about the marketplace being limited is unfounded.

    I also like the new selection options on the folio site that I am not using the interest radar tools at the moment. However they have a flexible auto sell tool which allows you to set up rules for it to automatically post notes for sale. Right now I am doing:

    90% off late 30 to 120 days
    55% off late 16 to 30 days
    5% off grace period
    5% markup for current loans

    These are based off of there actual stats about the chance of recovery in these situations. At those rates I am getting an advantage statistically. They aren't flying off the shelves but a few sell every day. These should help me in the long run and it's easy.
     
  19. Jonathan Hewitt

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    #19 Jonathan Hewitt, Nov 22, 2013
    Last edited: Nov 22, 2013
    Is that auto sell a feature of interest radar?
     
  20. Uncle Paul

    Uncle Paul Member

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    I used to be in the consumer credit lending business. Most of our defaults were caused by borrowers that had situational disruptions in their lives. Divorce, death, health problems, incarceration, loss of job etc. Most of the time you never see it coming. They would pay well month after month, then all of a sudden…nothing.
     

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