Lending Club

An Update on Peer to Peer Lending through Lending Club

This has evolved over time into one of my most favorite investments. It am targeting this fund to become an income stream during a Bear market. That means that I have 18 months of cash so I can avoid selling market funds during low pricing periods.

Here is why I like this investment:

First of all, the returns crush any CD or money market. This regularly returns over 8%. Over time, a static portfolio, will return 5% if you don’t reinvest funds in new notes, but I enable auto invest, so the monthly payments are used to buy more notes. These $25 notes are a part of someones much larger loan, so each monthly payment is $.75 to $1.50. By reinvesting, for about every 25 notes, I get enough to buy a new note. That does a couple things. It reduces risk of default by spreading it over many notes; I have well over a thousand notes. It also provides higher return because people tend to default later in the loans life. That is strange because the best time to default is at the first payment. The penalty is the same as later, but you get the most money. Human nature is that most people have good intentions, and try to pay off debt, but may eventually they may choose to default.

Second, the funds are what I call semi liquid. On one end of the spectrum is real estate, which is very static, and the other end is money market which you can access within a few days. If you stop re-investing in LC and have payments accumulate in cash, you can access the cash in equal installments. That will provide the income stream I am looking for.

Lastly, all data represented is net of any fees, which are 1%. You don’t have fund transfer fees, mutual fund management fees, financial planner fees, etc. There are not multiple people taking a dip in your wallet! I don’t know if there are origination fees on the borrower side, but it does not impact my returns.

The data is available at a detail that is impressive and its also easy to understand. The most prominent item on the summary page is your adjusted estimated net annual returns. This takes into account the interest rate of your loans, the age and current status of each loan. It discounts your returns based on a historical model using every loans current status. As your money churns, this number stays accurate to your current portfolio. You can also see the pre loan evaluation, the loan grade before issue, and the payment history of every individual loan. Will I ever dig into a mutual fund, looking at individual stocks and judging their PE ratio? No Way! For some reason, I am willing to spend time doing deep dives in this portfolio. It turns out people are getting loans for two reasons: debt consolidation and medical expenses.

Also, you know I always preach that you have to look at taxes. In the case of Lending Club, you will receive a 1099 at the end of the year that reports the interest earned, minus fees associated with the account.

My evaluation to date, which of course can change, is that Lending Club has become a sticky portion of my portfolio in the under 10% category, and has a very useful spot as a potential income stream during a stock downturn. My concern is around unemployment rate. If people start to loose their jobs, charge offs could increase.

I encourage you to think about each portion of your investment, understanding risk, return, liquidity, and tax status. My result may be different from yours, and I don’t claim to be 100% accurate. I am a simply a user of the product.

The Original Post:

In one of my searches on side hustles, I found an interesting niche of peer to peer lending, or what is basically crowd funding of unsecured loans. My first reaction was not positive. I had watched documentaries of the sketchy behavior of unsecured loan companies, where people who were in tough spots were taken advantage, and basically had their life ruined. Title loans, pawn shops, and payday and title loans all fell into the same category for me: business that charge ridiculous interest rates to people that can’t afford basic living expenses. As I dug into this more, my opinion swayed.

The most recommended site appeared to be Lending Club. This is a crowd funding site where investors fund unsecured loans which are graded and managed. The rates charged here are based on probable ability to repay. Interest rates range from 6-8% for grade A loans, to 23-29% for grade D loans, but the effective rate after defaults for all grades is just less than 5% over the life of the loan. That is a fascinating number. Those in the low grade loans have massive default rates, so to achieve a reasonable return, the high rate is clearly justified. Lending Club provides stats, by class, and adjust loan criteria regularly to ensure that performance. I did not know this!

I started investing here, with my favorite method, which is a small amount and get a feel for performance, access and information, and have become a huge fan.

Loans, graded from A to G, with 5 sub grades each, are given to applicants with interest rates that range from 6% to 30%. The interest rate of my personal portfolio today is 11.6%, meaning I choose the higher grade loans, focused on A and B level. After non payments, or charge offs as they call them, that 12% should eventually hit 4.7%. In the first year, my return has been over 10%, but most loans don’t get charged off till later, and with 1-2 year terms, it takes over a year to see the actual returns.

I use automated investing, and the loan positions are only $25, so I have hundreds of loans. The more loans you have, the less variation and less risk to an individual charge off. The site has good analytics to show you this model. Payments received each month are re-invested, based on my % of loan grade choices. Its no effort, but I still look at it regularly and play with analytics they have available. Based on these analytics, I chose a higher grade portfolio for risk reduction, and after I was comfortable with the site and its functions, i soon invested enough to get over the 200 loan mark to reduce variation. I have currently gone well beyond the 200 loan threshold. Lending Club has a $44 billion dollar history, and regularly reviews loan grading methods, and has analytics on major economic upturns and downturns. I find this history, and their publications, a valuable source of information that I don’t get elsewhere. If the SnP 500 takes a 20% dip, it doesn’t translate to a dip in these returns. This fund is not impacted by auto sell triggers which are so prevalent in the market today. If you see a downturn where unemployment spikes on the other hand, you can expect to get hit.

Keep in mind I have a ‘pattern’ in which I like to invest. I want to try something out at a low commit level, and proves it does as advertised. If all is well, the performance is as stated, and it looks like they provide simple and easy tools I can navigate, I increase my exposure. If I don’t like it, then see you later. Also, I look for things that tend to cycle at different times. I don’t want my entire portfolio to cycle as the stock market cycles. The current correlation between the bond and stock market is very high, so standard portfolio theory, 100 minus your age for stock exposure, may not be the gold standard. If you do have to invest like that, you better being doing it with a low fee account.

With the focus of the industry on the millennial investor who is extremely comfortable on line, there is a growing industry of high tech investment options, like Lending Club, but also in Private Equity, which previously was relegated to the $multi million portfolios. These tend to be low entry point to start, with high on line content and control, and almost always have an app on your phone where you can transact at least 80% of your business. If you are smack in the middle of the investment world, with a standard portfolio of stocks and bonds, not getting access to private equities or other high end investment options, you now have ways to get out from under the standard Financial Advisor model. These things were just not available 10 years ago.

Solid returns, hands on modeling data, little work required, vast financial history, etc, so whats not to like about Lending Club? These funds differ from my investment portfolio in that I cannot put in a request, and over the course of a week, get access to my money. You can trade your loans, but risk loosing money. If you want your cash, you terminate auto re-invest and let the money come in as payments are made and the loans clear. I put this in my bucket of illiquid investments and treat it as such. Its not the largest part of my portfolio, but it may actually be the most enjoyable, while delivering great returns.