Steadfast FinancesLending Club Loans: Separating the ‘Wheat from the Chaff’

Lending Club Loans: Separating the ‘Wheat from the Chaff’

Filed in Investing 101 , Peer to Peer Lending , Small Business 17 comments

I’m a great believer in luck, and I find the harder I work, the more I have of it.

– Thomas Jefferson.

Like all things in life, if you’re willing to roll up your sleeves and do a little bit of work, the chances of something good happening are in your favor. It doesn’t happen every time, but chances are, you’ll be rewarded on a regular basis if you work intelligently and persistently.

Case in point, this stellar loan application from a Lending Club borrower in search of small business funding. Had I not been actively searching for loan applications using my Lending Club spreadsheet filtering method (which contains every “in funding” loan application in the database), I doubt I would have found it.

Small Business Loan: Marketing Director opening a Paintball Course.

click to enlarge images

Here’s why I, and those who saw my #P2PLending tweet (note the Twitter hashtag), loved it so much:

  • High credit score: 750 – 779.
  • Fairly small loan: $13,800.
  • Low monthly payment: $336/month.
  • High salary: > $100k earner.
  • Has some seniority at his job: a Marketing Director with 8 years at a Silicon Valley company.
  • No history of past delinquencies or public records.
  • Has virtually no existing credit card debt.
  • Debt to Income is < 10%.

His personal finance metrics are about as perfect as a Lending Club investor can ask for, in my opinion, and meets my Lending Club investment strategy on every criterion. Plus, being a marketing director (see loan description), he has the professional skill set and, more than likely, the contact list to promote his new business before the place even opens.

Personally, I’m not a huge proponent of investing in small business loans because, generally, borrowers are taking out additional credit to support an unproven business idea, most borrowers fail to give enough detail about their small business idea to my liking, nor do they have the extra income to cover the monthly payments if their business tanks. However, in this case, this borrower’s loan application looks about as perfect as you can get.

Only time will tell is my thesis is correct, but borrowers of this quality is just one more example of why I consider actively searching for Lending Club notes versus the passive investing option a superior strategy. In other words, the harder I work at finding superior borrowers, the more “lucky” I get in finding them.

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Posted by CJ   @   21 February 2011 17 comments
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Feb 21, 2011
1:18 pm
#1 Richard :

great minds, my friend, great minds

Feb 21, 2011
8:01 pm
#2 Dan B :

Then again 100k a year is no big deal for someone that’s been at his job for 8 yrs in the Bay Area. Tracy is a s***hole of a town that is only 1 step away from a name like Modesto the foreclosure capital of the US) The only people who work in Silicon Valley & live over there are people who can’t afford to live in Silicon Valley. Because no one really enjoys that commute!

Feb 21, 2011
8:16 pm
#3 Matt SF :

I can respect a guy who commutes into work, lives in a cheaper area and pockets his dough.

Feb 25, 2011
1:06 am
#4 Allen :

I’m not sure about this sentiment for five reasons:

1)Money value of time I chose to live in a smaller/more expensive house close to town and use the time to run my business. The shorter commute allows me to make a few hundred extra dollars each month.

2) Monthly auto expense Living close to town saves me hundreds in gas,tolls, and maintenance.

3) Deductions: House versus Auto Most of us can write off little or no auto expenses, while the majority of American homeowners can still deduct mortgage interest.

4) Depreciation vs Appreciation The car will almost certainly depreciate (faster if you drive 24K miles annually), but real estate has historically gone up in value. Even in a falling real estate market urban housing prices have typically fallen less than those farther from town.

5) Money is a renewable resource, time is not You can borrow more money, but you can’t borrow back time wasted on the road.

If my time outside of “8-to-5 work” was financially unproductive (e.g. playing Wii, watching the tube, etc..) it would make more sense to trade commute for mortgage. I think many suburban road warriors are just trading a smaller mortgage for a higher auto bill.

Are the country folks really “pocketing the dough” or are they being taken for a ride?

Feb 21, 2011
10:06 pm
#5 Dan B :

Perhaps…………but then I live in the Bay Area & I wouldn’t lend money to anyone who has a mortgage in Tracy unless it’s a 3 yr. old mortgage or a 15+ yr. old one.
And I too could respect a person who endures a long commute & pockets his money………..but then that person doesn’t normally run around asking for small loans at high interest rates. You know, since his pocket is full of all that “saved money”.

Feb 21, 2011
10:19 pm
#6 Matt SF :

My mistake. I should have included he sank 70k+ of his own savings in his business, got 15k from a family member and needed this amount for safety equipment.

I definitely see your point though. Knowing the area a borrower lives in gives one an upper hand in the lending business.

Feb 22, 2011
3:06 pm
#7 Brian :

I agree that personally sifting through loans gives you far better results than any of LC’s automated tools.

I’m curious how much you invested in this note? I never go over the 25 dollar minimum no matter how good the application seems. My moto is to find Good looking applications and then spread my money max between them in 25 dollar chunks. I can see how if you are investing a large sum of money… say 20k plus the 25 dollar limit may not be optimal vs. how long it would take to invest it all in solid applications.

Feb 22, 2011
3:14 pm
#8 Matt SF :

I just did $25. My strategy is similar to yours… I pick the best looking candidates, and spread my money among those in $25 increments.

I’ve got one note that I accidentally invested $50, but that was because I missed the “already invested in” icon next to the note in the purchase/checkout process.

And you’re right about deploying large cash amounts too quickly. Many of the late paying notes and defaults I have (just had a 2nd one default this week), were from the period I was trying to invest $1000/month.

Maybe I’m just too conservative for my own good, but I like to go slow and cherry pick from the cream of the crop.

Feb 22, 2011
8:20 pm
#9 Mike :

I do not plan on ceding the job of loan picking to Lending Club at any point. If a loan defaults, I have nobody to blame but myself. I do look at the part of the country the borrower resides in, and try to avoid the top five states with respect to foreclosures. This borrowers’ numbers overcame that fact, in this case. I would’ve put more than $25 into this loan when I first started out, but I’ve learned to stick to this limit regardless of how bullet-proof a loan listing appears.

Feb 22, 2011
9:22 pm
#10 Dan B :

Once you’re diversified to 400-500 notes or so it really makes no difference whether you’re investing $25 a note, $100 a note or any other figure per note…… long as it’s the same figure for each note going forward. In fact it makes little sense to have 2000 notes of $25 each (as an extreme example). Not only is that a huge drain on your time, but it also becomes pretty much impossible to be anything but “average” performance wise.

Feb 22, 2011
9:46 pm
#11 Mike :

Statistically correct, but I won’t feel as bad when that $25 investment defaults compared to that $100 note. The time drain point is well taken, and partially for that reason I am not putting any new money into either of my Lending Club accounts, which have around 700 notes altogether.

Feb 23, 2011
11:57 pm
#12 Dan B :

@Mike…Hey, I hear you. But in many ways I think that we’re all being rather immature in our approach, myself included.
At some point soon this “I’m still experimenting” approach should end & this is either a good investment or it isn’t. And if it is then we shouldn’t be gun shy with our per note cash allocation.

Feb 25, 2011
12:15 am
#13 Allen :

I’ve sliced and diced all 22+ Megs of the LC loan data they publish. The other metrics you mention above are nice, but the 37,000 loan history suggests only two direct predictors for default rates.

1) the FICO score: 660-678 scores are 3 times more likely to be late or default compared with 780+

2) loan length: 36 month loans are 5 times more likely to be late or default than 60 month loans

These two metrics appear to be independent so a FICO 670 borrower for 36 months is 15 times more likely to leave you hanging than a 780+ applying for a 5 year loan.

Although other factors are loosely correlated (e.g. interest rate, home ownership, state, income, debt to income, loan purpose) the two above show the most direct correlation.

Note: The number of delinquencies in the last 2 years is important (those with 3 delinquencies have twice the default rate as borrowers with none), but it is strongly (neg.) correlated with the FICO score, so there is no additional independent metric.

I also thought that monthly income would be a factor, but for the middle 81% (those reporting between $2400 and $10800/month there is almost no statistical difference in default rates).

Feb 25, 2011
9:35 am
#14 Dan B :

Allen………….but you forget 1 thing. 5 yr loans have only been around for what 10-11 months, so of course there default rates are going to be low.

Feb 26, 2011
12:02 am
#15 allen :

Dan, you raise a good point. Since they are so new, I have small-sample issues with the 60-month loan data

Looking ONLY at the 36 month loans, 70% of defaults occur within the first 12 scheduled payments, 54% (334 of 616) default within the first 9 months (Based on the balance remaining). 5% (28 loans) never made a single payment!! Ouch.. That’s just out and out theft!

That tendency should give me enough data about the younger 60 month loans to extrapolate. So far, 100% (14) of defaulted 60-month loans are occurred within the first 7-9 months. If the same trend continues as the 36 month notes, I expect the 60-mo default rates to rise from 0.144% to around 0.8% — still a third less than the 3 year notes (2.34%) — simply because the monthly payments are 40% less, all other things being equal.

Even with limited data, it’s enough for me to seriously consider the risk involved with 36-month loans.

Feb 26, 2011
8:06 am
#16 Mike :

Another point to consider when comparing 36/60 month loans is the extra two years incurs additional ‘event’ risk such as job loss, divorce, illness or bankruptcy. Nonetheless, I’ve been seeking out the 60 month loans because they incur a lower service fee, and their lower monthly payment should be easier for most borrowers to pay. Only time will tell if the lower default rates observed so far turn out to be statistically significant in the long run.

Feb 27, 2011
9:23 pm
#17 Dan B :

I checked & as it turns out 60 month loans have only been around for 9 months (end of May 2010) It would be wise to wait until there’s at least a couple of years worth of 60 month loan data before making any predictions or extrapolations.

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