Steadfast FinancesMy First Lending Club Loan Default

My First Lending Club Loan Default

Filed in Banking , Investing 101 , Peer to Peer Lending 6 comments

They say you always remember your first more than the others…

So yes, after 1 1/2 to 2 years as a Lending Club investor, I finally got hit with my first default where a small $24 loss took my pretty little 15.64% NAR out behind the woodshed to a tune of 0.86%. A 14.78% NAR and 1 default out of 300+ notes is still very respectable in my opinion, but considering that I have 8 loans 31+ days late, I’m naturally feeling a bit more cynical about my current portfolio of borrowers.

Ironically, my first default came from someone working in a profession that I never suspected would take the easy way out of reneging on their financial obligations: a dual income family of law enforcement officers. Apparently they elected to go the Chapter 13 bankruptcy after making a measly 3 out of 60 payments. I can only hope no serious ills came to them since they do work in a very dangerous profession, but if they gamed the system, my faith in the system just took another hit.

I’m not what you would call “well versed” in the legalese of bankruptcy law, but it’s my understanding that one of the caveats of Chapter 13 bankruptcy is the borrower must repay their creditors at little to no interest. However, after 5 months of waiting, it looks like Lending Club has been unsuccessful in coaxing money from the trustee handling the case. Whether they can recoup the loan principal, or any future funds for that matter, is unknown at this time.

I don’t plan on changing anything major to my original investment strategy or reducing my weekly contributions, but I do expect I’ll review and opine with a few members of the Lending Club investment club to see what conclusions we can infer (I’m reluctant to say prove) from my first default, and potentially, identify any significant variables present in this note to avoid them in the future. In other words, more analysis to come.

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Posted by CJ   @   7 February 2011 6 comments
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6 Comments

Comments
Feb 7, 2011
1:08 pm

Matt,

Obviously, you’ve been doing this a lot longer than I have, but have you been noticing a “quality creep” to the downside in the loans on offer lately? I’m wondering if the growth in P2P lending is bringing in a disproportionate number of investors to borrowers.

What I’m talking about is that it seemed (to me, anyway) like a couple months ago there were many good loans with a variety of criteria to choose from. Now I’m seeing loans at 90% funded after less than 48 hours with low credit scores, high DTI and utilization, and no qualifying comments from the borrower nor questions asked or answered.

And now the maximum loan amount has gone up to $35,000. It just seems like there’s more (maybe by a lot) investors looking for notes than there are quality folks that want to borrow.

I came across what I would consider a reasonable risk a couple weeks ago, submitted a question before I invested, and the loan was fully subscribed before the borrower had a chance to answer.

What do you think?

Feb 7, 2011
1:29 pm
#2 Dan B. :

I’m more than a bit confused about the Ch. 13 obligations too. My current understanding is that they are required to show a “plan” of repayment that can be adjusted by the court. The court can then “charge off” any part of the debts that it deems to be beyond the debtors ability to pay now &/or into the foreseeable future. Or it may keep the debts in the books but set a repayment schedule well into the future, at no interest of course.

In practical terms, I’ve heard that any payments might take many months to years & that the bottom line is likely to be nothing to 10-15 cents on the dollar.

Also keep in mind that p2p companies are NOT required to pay us any money that is paid to them after the term of the original loan expires. What this means in practical terms applies not only to cases of such as a Ch.13 but also to late loans. For example, let’s say you have someone who is still paying his loan on time every month but missed a couple of payments at some point. Unless he worked out a payment plan this person will reach his 36th month (on a 3 yr. loan) still owing the couple of months he missed. We don’t get any money beyond that 36th month. Just FYI.

Feb 7, 2011
2:14 pm
#3 Matt SF :

Good observation EB!

I think I can go along with the majority of that sentiment, but I don’t necessarily think it’s a “bad” thing, even though it will likely make our jobs harder. Ex) More work, but more room for top echelon investors to stand out. Or who ever gets lucky. Either works.

I think the most logical justification of the quality creep would be standard growing pains of a nascent industry going mainstream. With the growing popularity of P2P lending (at both Lending Club and Prosper), the Everyday Joe’s are hearing about new means of financing and investing. So it’s not just the web savvy and financially astute showing up to borrow and invest, but it’s the entire “move your money” meme sick of making < 1% on their savings and the Everyday Joe’s who have the credit scores to make it past the underwriting standards.

As far as quick funding loans, I think it’s a lot of new investors with an itchy trigger finger and little idea how to do due diligence. I imagine I was the same way back in 1998 when I had a SureTrade account and 10 grand to invest in $JSDU and $AMCC. Even Ron Lieber’s latest column on P2P lending mentioned hedge funds where throwing $500k sums at Lending Club, so like any industry that has golden goose potential, the money will flock to the returns. In other words, the easy days of taking a week to review a loan are long gone.

So if I run into a loan where the borrower fails to answer a question, I just ignore it and move on to the next one. I also have a really tight set of filters, so I take the entire 300-500 loan application database, and I can whittle it down to 20 notes in no time. Of which, I might pick 4-5 per week.

But, for the active investors or diversipickers (people who only invest $25 per note but actively filter & screen notes), I anticipate LC will become much like a stock picker’s market when the S&P Correlation Index is low. We’re going to have to do some serious due diligence and screening if we want to outperform Lending Club’s benchmark index return.

Perhaps we can no longer rely on broad market variables to keep us in the green, but our research or lack there of will allow us to grab some alpha. (One of the reasons why I formed the investment club.) Alternatively, perhaps an improving economy and lower unemployment rate will boost the benchmark by lowering defaults so we might not have to worry about the macro as much.

If only I had a working crystal ball.

Feb 7, 2011
7:54 pm
#4 Mike :

You should still be proud of your above average ROI. I hope your 8 lates return to current status. I’ve had a couple of defaults due to bankruptcies as well, and they all hurt, but none more so than the first. I am amazed at the number of loans with borderline metrics that are at 75-80% funding by the time I see them. Many of these have absolutely no loan description other than the loan title, and most have no questions asked. I suspect some really deep pockets arrived at LC within the last few months, thanks to incentives and publicity. Not sure if this is a good thing or not…

Feb 7, 2011
10:30 pm
#5 Brian :

With my personal strategy I never let loans get that late that they risk default. I just sell them on the note trading market for a very slight total principal + interest loss while in “Grace Period” (usually still an overall profit when including payments).

That way I don’t have to worry about defaults… even if it means I lose a couple percent to prematurely selling loans to people with a bigger appetite for risk.

I’m currently sitting at 9.7% interest (after LC fees) after 1.25 years and initial 10k investment.

Jul 27, 2011
9:20 pm
#6 ar :

so you have the information- most filing chapter 13 are in full 100 % repayment of their obligations. i have noticed however that instead of making claims, LC chooses to “charge off” their losses instead of recover for you, the investor. i have been researching why this is, and can only come up with each investor may have to recover their loss independently?! any ideas??

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