A Club For Lending (Part 4): Advanced Strategery I

P2P lending is picking up popularity, as noted by this recent article in the Wall Street Journal.

With that said, I’m rested and relaxed after my vacation in Korea, and raring to continue my much-awaited series on investing in Lending Club.  The introductory posts are here and here, with my first post on strategy here.  Note: that last post lays out my final filters, how I decide which loans to fund after they have passed all my initial tests.  The final filters are fairly straightforward, I choose to fund loans that (1) have higher interest rates, (2) have 3 year lengths over 5 year lengths, and (3) have smaller total loan amounts.

A quick note before getting to my primary filters: naturally I want to invest in P2P loans in the most efficient way possible.  However, there are certain filters that interest me that aren’t available on the Lending Club website.  I could go through each loan one by one and filter out the ones who don’t pass all my criteria, but that would take a long time each day and would be prone to error.

That’s why I use the “Download All” feature to download every loan on Lending Club into an Excel spreadsheet each day (explained here).  I then created another Excel spreadsheet that automatically filters loans based on criteria that I’ve developed.  Creating this filtering Excel spreadsheet took a few hours, but now means that I can find and invest in loans that pass my criteria in <10 minutes each day.

Now without further ado, let’s finally look at my primary filters.  Items in bold and red are filters that the Lending Club website cannot perform.  And remember, I’m trying to do what banks didn’t do in the lead-up to the financial crisis.  That is, I’m trying to filter out borrowers likely to default so that I can maximize my returns. 

1.  Remove loans if borrower employer is not specified

Strangely enough, this is not something that you can filter on Lending Club.  I like to check out borrower’s employers before investing in loans, and that’s obviously not possible if borrowers don’t list them.  If the employer is not listed, I’d rather not look at the loan.

2.  Remove loans if borrower has had any delinquencies in the last 2 years

If the borrower didn’t feel the need to pay back his recent obligations, why would he pay back this one?

3.  Remove loans that have borrowers with job tenure less than 3 years

A person with a more stable career will more likely be able to pay off their loan than otherwise.

4.  Remove loans with application amounts greater than $30,000

The maximum amount that a borrower can ask for in a loan on Lending Club is $35,000.  I feel that if someone asks for more than $30,000, they’re just seeing how much money they can borrow and I don’t have as much confidence in their ability to pay back the loan.

Another tactic with loan amounts: I like to see loans that are not rounded off numbers.  That is, I’d prefer to fund a loan that asks for $9,650 over one that asks for $10,000.  Why?  It shows that the borrower has a handle on exactly how much money he needs to get out debt, leading me to believe he is more likely to honor his obligation.  The IRS uses the same method when determining who to audit.  If someone has an income tax deduction for $4,873 he is less likely to be audited than someone who deducts $5,000.  The IRS figures that the $5,000 deduction is just a guess.

Next week I’ll explain a few more of my primary filters.

The information available at Michael Grabowski is for your general information only and is not intended to address your particular requirements.  This information is not any form of advice by Michael Grabowski and is not intended to be relied upon by users in making any investment decisions.  Michael Grabowski is not liable for any loss or damage which may arise directly or indirectly from use of or reliance on such information.

Second South Korea Update

This will be my last Korea update, next week I'll be back in the USA with a post continuing my Lending Club series.  I'm a little disappointed because I won't be able to make it to the Korean Demilitarized Zone during this trip.  Turns out you have to apply for this far ahead and instead of demilitarized zone it should be called really, really, really militarized zone.  I'll get to it on my next trip.  For now, though, a few more things that I've noticed in Korea.

4.  There are no tips anywhere!  Not in cabs, restaurants, hotels, or anywhere.  Koreans don't even know what to do when you give them a tip.

For example, I went to the royal palace at Gyeongbokgung and had a tour guide named John.  John was a twelve-year-old student who took the job to practice his English skills with foreigners.  He did a great job and when the tour was over I gave him a small tip.  He just looked at the money confused.  My girlfriend had to explain that it was an American custom to provide tips for good service.

I have to say, without tips life is a lot easier.  You pay the cab fare and you're on your way.  No haggling and no hurt feelings, just a quick and easy transaction.  Nice.

5.  I don't care for traditional Korean bathrooms.  They don't have bathtubs or shower curtains, just a small drain in the floor.  Koreans take showers in the bathroom and water gets everywhere, on the toilet, on the floor, etc.  They have sandals that you wear in the bathroom because the floor is always wet, but just put in a damn bathtub with a shower curtain and make life easy.  This makes very little sense to me.

6.  I really like all the different cuisine I've had a chance to sample here.  Green tea ice cream, Korean barbecue, the dozens of different types of kimchi, even live Octopus a la Oldboy.  I love the spiciness of a lot of the dishes.  I could probably have a full post just on Korean cuisine, but I'll leave it at this.

South Korea Update

A quick update from South Korea!  I am on vacation here through next Sunday.  I'll continue my series on Lending Club when I get back, but for now, three things I've noticed in Korea.

1.  The subways in Seoul are both very clean and usually packed to the brim with people.  Makes sense, Seoul has more people than New York City (although Seoul has a lower population density).  I heard that people would be pushy, but I haven't found that to be the case.  I'm probably getting the sanitized treatment because I'm bigger than the average South Korean, though. 

Another feature I like on the subways: maps on the train with a moving LED light showing your train's position.  A little thing that really helped this tourist out.

2.  Everything talks to you.  GPS, elevators, toilets.  Everything.

3.  People are fit.  Spent a few days in the wonderful Jeju Island walking around all the tourist traps.  One activity was fairly strenuous, walking up Sunsan Ilchulbong Crater, a fairly steep ~200 meters.  Nevertheless, Koreans appearing to be 50, 60, and 70+ years of age were making the hike.  My girlfriend's relatives here are mostly in their late 40s or early 50s, but they all appear to me to be in their early or mid 30s.  So maybe those Koreans that I saw in Jeju were actually 70, 80, and 90+ years of age.

Their healthiness I think is due to their diet and exercise (surprise!).  Korea is famous for its barbecue,  but Koreans eat a ton of fruit and vegetables.  Furthermore, Koreans walk and bike everywhere.

I still have a lot of fun things ahead of me in Korea.  I am especially looking forward to visiting the DMZ, but it may not be possible.

May Monthly Update

Monthly update time!  For my blog:

In the month of May, my blog earned $7.11, a nice increase from the $.87 I earned in April.  Here are my Lending Club returns:

A quick description: my Net Annualized Return (NAR) is new because my Interest Received is $0.00.  My loans are still young, my first interest payment is due on 6/7/2011.  Once my loans start paying out, then I will have a better reading of my real NAR. 

I have $5,000.31 in Lending Club (the $.31 was an initial transfer from my bank to Lending Club for verification purposes).  So if I have received no interest, then why does the last column, Account Total, state $5,115.14?  This total includes $100 I received for investing $2,500 in loans after being referred by a friend.  The extra $14.83 of Accrued Interest is an approximation.  It is about the amount of interest that I would have received if the interest paid to me was continuous instead of discrete, monthly payments.  For accounting purposes, I prefer using the discrete, monthly payment way (if I can’t use the money, why should I account for it?).  Once I have some good numbers I’ll show you how I account for my NAR next month.

The information available at Michael Grabowski is for your general information only and is not intended to address your particular requirements.  This information is not any form of advice by Michael Grabowski and is not intended to be relied upon by users in making any investment decisions.  Michael Grabowski is not liable for any loss or damage which may arise directly or indirectly from use of or reliance on such information.

A Club for Lending (Part 3): Basic Strategery

I was initially worried about posting my Lending Club investment strategy out in the wild.  Why would I give the ingredients to my secret sauce for free?  But my secret sauce isn’t so secret, it’s really a combination of a lot of different strategies that I’ve read, mostly the strategy from Matt at Steadfast Finances. 

Interesting enough, Matt no longer invests in Lending Club because of a rule change that allows you as an investor to only ask a few pre-approved questions to borrowers.  This isn’t a deal breaker for me considering that both these questions and loan descriptions are not verified by Lending Club.  I use my filters to examine if a borrower is credit worthy and then use the question and loan descriptions to filter only if there is something egregious there. 

For instance, recently there was a loan that otherwise passed my filters but was entitled “Get out of debt free card”.  That doesn’t exactly inspire confidence that the borrower is going to take this obligation seriously, so I didn’t fund it.

A few quick notes before we get into my filters.  These loans are a fixed income instrument.  So if everything goes perfectly (borrowers pay in full and on time), you will at the most get back the interest rate at which you lent your money out.  Defaults cut into this return on investment. 

For simplicity sake, let’s say I lend out $100 each in 100 different interest only loans all at 10% interest.  So I have lent out $10,000 and over the course of a year I at the most can receive $1,000 in interest, for a 10% return on investment.  Now let’s say 2 of my loans never make any payments and default.  I lose my $200 outlay on these two loans (I have a 2% default rate) and will never get the $20 in interest I expected from these two loans over the course of the year.  So my return is now $1,000 - $200 - $20 = $780, giving me only a 7.8% return on investment.

So defaults are pretty important.  But my investment goal IS NOT to minimize defaults, it IS to maximize returns.  I’ve seen a few people invest only in A1 loans on Lending Club because they have the lowest default rates but they also have the lowest interest rates, currently around 5.5%.  Maybe it’s just me (and it probably is, because these loans are not having trouble getting funded) but I wouldn’t give a personal loan for 3 to 5 years to Mother Theresa at 5.5% interest.  Just a few years ago savings accounts with no risk of default were yielding that much!  Why would I lock up my money for such a long time at such a low interest rate in a personal loan?

Let’s finally get to my filters.  We’ll start at the end.  After I have applied all of my primary filters (which I’ll get into in next week’s post), I then filter by

 

1.  Interest rate:  This only makes sense, right?  If a bunch of loans pass all my tests, then I want to invest in the loans which will net me the greatest return, the ones with the highest interest rates.  Naturally, these loans will have a higher risk of default but I believe that my filters will minimize this risk, resulting in a higher return on investment.  So the bulk of my loans are around the C grade of 14% interest.

2.  Term of loans:  Some people prefer to invest in 5 year loans because they have higher interest rates and borrowers make lower payments for the same loan amount.  I dislike 5 year loans because they lock up my money for an additional 2 years in a most likely rising interest rate climate. It is also an additional 2 years where the borrower can face divorce, job loss, etc.  For these reasons, I choose 3 year loans over 5 year loans with all other things equal.  However, 3 year loans are few and far between, so this is my portfolio composition.

3.  Loan amount (monthly outlay):  Say two borrowers are exactly the same in every respect, except that one wants a loan for $10,000 to consolidate his consumer debt and one wants $20,000 for the same purpose.  The first borrower will have a lower monthly outlay and I believe he will have a smaller chance of defaulting, so with all things equal, I will choose to fund the first over the second.

Next week we’ll dig into my primary filters.

The information available at Michael Grabowski is for your general information only and is not intended to address your particular requirements.  This information is not any form of advice by Michael Grabowski and is not intended to be relied upon by users in making any investment decisions.  Michael Grabowski is not liable for any loss or damage which may arise directly or indirectly from use of or reliance on such information.