Every business needs money – it’s just a matter of how you are going to acquire the money.

Ways to Fund a Business

With the increase in capitalism, there are now more ways to fund a business. You could go to a bank that issues small loans for a business loan, or you could go an alternative route.

Peer to Peer Lending - Depending on your credit score and history, you could get a decent rate to fund your new business. While I don’t have any experience with P2P lending as a borrower, many of my friends serve as investors. It is a growing area and has lot of potential going forward.

Friends and Family - If the business is as good of an idea as you think, why not ask friends and family to invest? This may feel uncomfortable for some people, but many family members want to support those they care about. Just make sure that you are willing to do whatever it takes to pay it back.

Outside Investors - Another route would be to offer a portion of the business ownership to outside investors. You may be interested in creating a limited partnership, where you, the general partner, make all the decisions and the limited partners invest in the business idea. You can offer them dividends according to the number of shares or just a percentage of the value of the company. Make sure to do your homework before doing this option however.

Get Creative

The important thing to consider is that there are tons of opportunities for small business owners. It may take a lot of work to find funding, but it has a lot of potential and could be your ticket to financial security. Make sure to weigh the risk with the benefits and if you decide to go for it, don’t take “no” for an answer.

For me, this is unacceptable.

The primary reason for the change in transparency was to protect the borrower’s identity. Via Lending Club’s blog…

Lending Club investors have the ability to ask questions of potential borrowers before committing investments into their loans. This ability has raised concerns in terms of protecting the privacy and identity of both borrowers and investors. These concerns led us to adjust our Q&A mechanism for the benefit of both borrowers and investors.

Starting tomorrow, investors will only be able to ask questions from a predefined set that was created based on the most frequently asked questions logs over the last 2 years and reviewed and edited by our compliance team. As an investor, feel free to submit additional questions that you would like to see added to list to feedback@lendingclub.com.

I agree 110% that a borrower’s identity needs to be protected. No problem. I’ll bend over backwards to comply.

The Problem

What I vehemently disagree with is that Lending Club has positioned themselves so that my questions have to be pre-approved even though I’m investing my money. Moreover, I only get to select from a series of pre-approved frequently asked questions that were filtered through Lending Club’s compliance department.

Bottom line: if Lending Club doesn’t “approve” of my question, sucks to be me.

This isn’t a quarterly earnings analyst call with Goldman Sachs or General Motors, nor is it a politician’s press conference, where softball questions are predefined and the deck is stacked to make the party of interest look their best. It is a — it was a — place where a borrower could apply for a loan, investors could review the borrower’s personal finances, and ask any question they wanted (without compromising either party’s identity) to make a decision on the borrower’s creditworthiness as well as make a decision on the probability the borrower would repay the loan plus interest.

If that meant asking the borrower a few tough questions, calling BS on the the borrower’s cream puff answer(s), or he/she decided to tap dance around the question without answering it, we investors apparently no longer have a say in the matter. We just take what we’re given, and told to take it or leave it.

In my opinion, this greatly compromises an investor’s ability to outperform the benchmark index and raises the rate of default.

I’m Out

I had high hopes for Lending Club as they were the most progressive thing that happened in finance for many, many years. I’ve also been one of their most outspoken supporters over the last 2 years by posting my returns and assisting more new investors find their way than any other blogger I know by organizing a 100+ person investment club.

However, based on the new policy of reduced investor transparency, I will not be investing new funds, nor will I be reinvesting funds that are repaid.

I will also be closing down the Lending Club investment club of 100+ members, and the new P2P Lending Investor blog & forum is dead in the water. Apologies to those that found value in the club, but I don’t like anyone telling me what I can or can’t ask when it comes to my money and my investments.

In hopes of remaining neutral, I will not advise anyone to follow along with my decision, but instead of writing a dozen blog posts trying to persuade Lending Club to reverse their decision, it’s far more simple to vote with your money.

After posting my Lending Club investment strategy and returns for over a year now, I thought today was as good as any to post a quick summary and track my net annual return volatility.

Summary

• Outperforming Lending Club’s benchmark index of 9.7% by ~4.5%.
• Loan payments generate ~$250/month of cash for reinvestment.
• Defaults: 2 loans have defaulted and at least 2-3 more expected in the near future.
• Corrective Actions & Preventative Actions: defaults will crush your NAR.
• Winding down monthly deposits to lower amount.

Outperforming the Benchmark Index

Outperforming any financial benchmark in a single year is worth celebrating as any mutual fund or hedge fund manager will tell you, so I’m fairly happy with my investment return of ~14.1% NAR thus far.

It hasn’t been easy and I’ve burned more than my fair share of midnight oil filtering and reviewing each loan application one by one, but filtering the wheat from the chaff appears to have been worth the effort.

Reinvesting Principal & Interest

Even though my portfolio is in the low $8000 ballpark, it still generates a decent amount of cash to reinvest.

Allowing these funds to sit idle would hurt my NAR over the long haul, and since I have no interest in withdrawing funds or selling them on the FolioFN platform, it’s best to keep the high interest steamroller moving forward.

Defaults

Unfortunately for me, I don’t have a working crystal ball. Therefore, I can’t identify with a 100% degree of certainty that one borrower will repay their loan while a second borrower will default immediately after gaining access to their cash. Few investments, if any, work this way, and if they do, they’re probably FDIC insured.

So while some defaults are expected, I do as much forward thinking as possible to anticipate future potholes in the borrower’s path that might cause late payments, bankruptcy filings, or charge offs. Like any inexact science, as P2P lending appears to be, persistence and quickly adapting to new developments makes the difference between success and mediocrity.

Corrective Actions & Preventative Actions

Rule #1 of all of my investment theses is not to lose money, so now that the defaults and charge offs are beginning to pile up, it’s in my interest to review my strategy. That means reviewing what went wrong, why the borrowers chose to default (e.g. declaring bankruptcy making <10% of scheduled payments) versus couldn’t help but default (e.g. lost their job), and how best to filter these borrowers out in the future.

As of now, the only concrete conclusions I’ve came up with is to:

• Avoid the lower income borrowers (< $50,000) with cash flow crunch potential.
• Avoid those who don’t answer the Q&A section fully & completely.
• Avoid the >1 delinquency crowd.
• Avoid the high revolving credit balance crowd ($25,000+) where bankruptcy is a painful but profitable endeavor.

I’m sure this isn’t all metrics or warning signs to avoid, but considering that Lending Club has 250 to 500 loan applications in their database at any given day, I can afford to be highly selective in where my funds are invested.

Winding Down New Deposits

My investments at Lending Club began as a pilot scale experiment to see if my strategy is effective, if the time invested in an active management strategy was worth it, and if I had the endurance to keep reinvesting my profits (e.g. avoiding idle cash) over a time period of several years.

Now that my balance is in the $8000 range, I’m reasonably comfortable with saying that’s a healthy amount to accomplish my goals. This doesn’t mean I won’t be adding new funds, it just means I’ll be reducing them for the time being while reinvesting existing funds as borrowers repay their loans.

Please note that just because I’m reducing my deposits, members of my Lending Club investment club should not be affected as I will continue investing in 16-20 notes per month.

- 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.

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.

One static component of my constantly evolving Lending Club investment strategy is identifying borrowers who have a fairly long history of employment. In other words, that means:

1. the older the better (but not at or beyond retirement age).
2. 10 years plus with a single employer.
3. decades of experience often imply management material.

As the above graphic shows, there seems to be something to my original hypothesis:

The Labor Department’s household survey in December found that 28.2 million people over 55 years of age had jobs, an increase of 7.6 percent from three years earlier, when the recession was beginning.

By contrast, there were fewer jobs held by people in all age groups under 55, as can be seen in the accompanying charts. Over all, the number of people working was down by 4.9 percent.

As a P2P lending investor, this lends additional evidence that the older a borrower might be (within reason of course), the more likely they’re going to hang on to their job during a downturn in the economy. And why not? If you’ve worked 20-30 years in a chosen field, chances are you’re more experienced, more seasoned to the tasks at hand, etc., and senior management (of whom the 55+ is largely composed), the more likely you’ll be able to retain one or more sources of income.

People who have income generally pay their bills, and thus, making you a prime P2P lending loan applicant in the eyes of my loan filters where I’m earning 15.6% NAR at Lending Club.

Source
Floyd Norris
New York Times
Older Workers Are Keeping a Tighter Grip on Jobs

Since then, lots of supporting evidence has manifested. Not only from state governments eying bankruptcy court as an easy fix for their budget woes, but federal legislators are currently drafting new laws that would allow states to file for bankruptcy protection, settle existing debts for pennies on the dollar, reduce pension incomes for retired government officials/workers.

Couple highlights:

• Vallejo, California. Vallejo city officials are attempting to pull a General Motors (e.g. settling existing bond holder debt at just 5 to 20 cents on the dollar.)

The city of Vallejo, California, proposed paying some creditors as little as 5 percent of what they are owed, making it the first general municipality that would fail to fully repay its debts in bankruptcy.

General unsecured creditors would collect 5 percent to 20 percent of their claims under the plan of adjustment filed late yesterday in U.S. Bankruptcy Court in Sacramento, the state capital.

No city or county has used federal bankruptcy laws to force creditors to take less than they are owed, according to Bruce Bennett, the lead lawyer for Orange County, California, when it filed the biggest municipal bankruptcy in the U.S. in 1994.

Vallejo’s plan assumes the city can’t provide essential services, like police and fire protection, while also paying its debts, he said. Should the city succeed, the case “may become an important precedent,” Bennett said in an interview.

The creditors, who include retirees and former employees, would be paid $6 million over two years. The plan must first be voted on by creditors before U.S. Bankruptcy Judge Michael S. McManus decides whether to approve the proposal.

“While the city regrets that it cannot pay a higher percentage, the fact is that the city lacks the revenues to do so while maintaining an adequate level of municipal services such as the provision of fire and police protection and the repairing of the city’s streets,” Vallejo said in the filing.

• Camden, New Jersey. One of the nations most crime ridden cities is laying off half of it’s police officers.

About 335 workers, representing one-sixth of the local government work force, lost their jobs, according to Mayor Dana Redd. It was worst in the public safety departments, where nearly half the police force and close to one-third of the city’s firefighters were laid off.

• Newly proposed legislation preventing federal bailout of state pensions.

“My bill really sends a warning shot across the bows of the states to get their fiscal houses in order,” he said. “It’s intended to wake up the states, wake up the public, to let them know they can’t just run to the federal government to bail them out.”

Gingrich said in a November speech in Dallas that he’s urging House Republicans to introduce a bankruptcy bill “so that states like California and New York and Illinois that think they’re going to come to Washington for money can be told, ‘You know, you need to sit down with all your government employee unions and look at their health plans and their pension plans.’”

“Frankly, if they don’t want to change, our recommendation is you go into bankruptcy court and let the bankruptcy judge change it,” he said.

States were left out of a Depression-era law that lets municipalities reorganize their finances under Chapter 9 of the bankruptcy code. No legislation has yet been introduced to allow states to seek court protection from creditors.

What this boils down to is state and federal policymakers are working behind the scenes to come up with a new way to allow states declare bankruptcy and get out from under crushing debts. Obviously, existing jobs are on the chopping block, but this could also affect retirees living on a state pension

Bottom line if you’re a P2P lending investor: lending money to a federal or state employee isn’t a sure thing.

In my opinion, a P2P lending loan to state government employees are just as risky as private sector jobs until the economy rights itself. Moreover, depending upon the state (in particular – California, Illinois, New Jersey), a state government employee with just a few years on the job might be a higher risk than someone with equivalent experience working for a multinational, publicly traded corporation.

For example, we are no longer limited by the middleman services of…

• The music/CD/record store –> we can use iTunes, Napster, Pandora or YouTube
• 6 o’clock news –> we can select from one or more of tens of thousands of different websites.
• Realtors –> we can use Craigslist for housing swaps, legal websites like LegalZoom for deed swaps, or fee based attorneys in conjunction with title companies at cheaper prices.
• Banking & Loans –> we now use P2P lending businesses like Lending Club, Prosper, CommunityLend, where investors pool their money to invest in prospective borrower’s loan and simultaneously bypassing traditional banking establishments.

… the list of examples can go on for a while, but you get the gist of the idea.

Disintermediation of the Financial Industry

The financial industry, however, has been relatively immune to disintermediation effects (the rise of online discount brokers aside) thanks to the Herculean efforts by national governments to bail them out at the expense of taxpayers. But, as more entrepreneurs begin to chip away at core business areas, the disintermediation of the finance industry is well on its way.

Highlights from The Financial Reformation:

The 16th century invention of Gutenberg’s Printing Press was revolutionary. Suddenly, vernacular translations of the Latin Bible were widely distributed. The spiritual smokescreen which kept congregations dependent upon on the Church was removed. Seemingly overnight, it unleashed knowledge and power to the people, rendering the traditional role of the high priests and cardinals obsolete. No longer did man need a broker between themselves and God.

The same effects are begin generated by the microprocessor [and the Internet].

[video trailer for SIBOS 2010]

As a brief history lesson to cement just how revolutionary an invention the Gutenberg Printing Press, and later, the Gutenberg Bible, really was:

It should also be noted that the dissemination of the Christian Bible written in the vernacular — the language of the land — did not go without serious societal and cultural turmoil. In fact, merely possessing the Bible written in the English language was a serious offense, usually punishable by death for a prolonged period of time.

One revolutionary scholar, William Tyndale, was the first to translate the Latin Bible into English and disseminate the English Bible to the masses much like the illegal bootleggers of the Prohibition era. The Catholic Church, in their hopes to retain their monopoly as the single broker between Heaven and Earth, branded Tyndale a heretic and a criminal, and sentenced him to death as were all religious criminals in western Europe of that time period — to be burned at the stake.

Of course, Tyndale’s public execution was a warning to the people that commoners and members of the lower class should never cross swords — and especially pens — with the interests of the Church. So the next time you read a King James Bible, try to imagine that the gentleman who first translated the majority of it was burned alive so you could worship the Christian God without a centralized authority.

For more detailed information, please review the PBS Documentary: Battle for the Bible.

Obviously, in modern times, such abuses of authority would never be tolerated because we live in a democratic society where people presumably have the power.

But, as those of us who have followed the disturbing trend of Too Big To Fail within western capitalism know all to well, those who hold and control immense centralized powers will not relinquish those powers voluntarily. More than likely, they will likely use any and all legal (or illegal), political, and capitalistic means at their disposal to retain their power.

Moreover, now that formerly nascent financial innovations, such as peer to peer lending, person to person banking transfers, perhaps one day even the “Bank of Facebook“, are becoming more mature and perhaps even going mainstream, banking middlemen will not sit idly by and be completely cut out of the loan origination and lending business (e.g. loan fees, mortgage points, the cash cow of compounding interest, ability to earn the interest rate spreads on deposits, etc.).

Whatever the outcome, it will certainly be fun to watch the status quo dependent banking establishments, now considered as Too Big To Fail, go head to head with constantly evolving financial innovations whose sole purpose is to take away their Golden Goose of using money to create more money. Especially when a growing collective of individual users — you and I — are finding out that it’s in our best financial interests to treat the old banking establishment as nothing but a speed bump on the road to progress.

My Lending Club investment portfolio is continuing to look fairly impressive as we close the books on 2010.

Summary

• Net Annual Return is up to 15.64% NAR. My highest observed NAR was 15.69%, but as of today, I’m up 61 basis points or 0.6% from last quarter.
• Zero defaults or charge offs. However, the day is certainly fast approaching (one Ch.13 bankruptcy filing, 5 notes 31 to 120 days late, 1 note 15-30 days late). Plus, no one likes a show off.
• Risk has increased slightly to the more risky, high grade notes. The number of 15%+ notes has increased by 2% (based on the percentage of Grade D notes and higher) from last Lending Club update.
• The 5 year vs 3 year note percentage has increased slightly to 62% vs. 38%, up from last quarter numbers of 55% vs. 45%.
• Lending Club “investment club” has ~45 people.

Detailed Analysis

For those who want to look under the hood and kick the tires a little bit, here’s a more detailed look at the what’s, where’s and how’s.

• Investor Performance. Based on Lending Club’s metrics, I rank in the 91% percentile of investors in the $5,000 to $10,000 range. For how long this performance lasts, I have no idea considering a few defaults and/or charge offs are lurking around the corner, but a 90%+ NAR performance is personally rewarding since I spend quite a bit of time on the LC database running filters, asking borrower questions, going above and beyond in the due diligence arena, etc.
• Account Balance. The total balance is up around $2000 because I invest anywhere from $100 to $150 per week. This is a hedge against my optimism surrounding P2P lending because I feel if I dump too much money into the platform too soon, I will settle for notes that might not meet my conservative criteria. Therefore, I am only investing in the “cream of the crop” notes each week that are in 15%+ NAR spectrum. If I can’t find 15%+ notes, I dip into the 10% to 15% group.
• Portfolio Composition: Term Length. The 5 year notes present a bit more risk due to the extended terms of repayment (i.e. time to total repayment), but based on my metrics, I see little to no added risk due to the type of borrowers I’m selecting. Based on my strategy of job security, a borrower who keeps his/her job presents little difference in 3 year note or 5 year note default rate. Plus, I get an added bonus of a 0.5% to 2.0% bump in my ROI. (Note: I could be 100% wrong making these assumptions.)
• Maximum Diversification. Per my original Lending Club investment strategy, I’m only investing $25 per note. Put simply, I put as few eggs into each basket as possible. I can think of little reason to put more than $25 into a note other than you’re high net worth investor with $20,000+ to quickly deploy.
• Portfolio Composition: Grade. Based on the last quarter decision to focus on 15%+ NAR notes, I’ve seen a slight uptick of 2% in the percentage of Grade D, E, F and G notes. This doesn’t mean that I’m buying the super risky in Grade G notes as one might first suspect, but it means I continue to find some great borrowers in the higher Grade D through G range, if you base your investment decisions on job security as I do (e.g. a registered nurse with 5 years of experience is superior to a retail store assistant manager with 5 years on the job).
• Late Payments / Defaults / Charge Offs. I’ve consistently had a few late payers every month, but until now, the borrowers I’ve invested in righted the ship within 30-60 days. Obviously, now that my portfolio is becoming more seasoned and I’m approaching the 300 note mark, the zero default/charge off streak was bound to end sometime. To give some description of what’s happening with the 31 to 120 days late category: 1 note is a Chapter 13 bankruptcy filing where no court ruling has been issued as of yet (borrower only made 3 payments), 2 notes are on payment plans beyond the due date, and 2 are late with no explanation and contact cannot be made with borrower.

If you have more specific questions or you want further explanation of data that I failed to include, don’t hesitate to ask in the comments section below.

Lessons Learned

I often get questions about how I invest or tips/hacks that aren’t widely published in the blogosphere.

Here are a few quick tips I’ve learned the hard way:

1. Don’t invest too much too fast. I know the temptation of investing in something new and cool is difficult to fight, but as with most things in life, exercise some patience by easing into P2P lending. Learn the ropes, get comfortable with the concept of investing in P2P lending before investing $10,000 into your account and end up investing $1000 per person. In my opinion, that’s the wrong way to go about it.
2. A faster way to review Lending Club notes. The LC database and filters allow investors to screen notes very quickly and are of tremendous value. However, if you are an Excel junkie as I am and you want to see some very specific data without clicking on each individual note your filters churn out, try downloading the active Lending Club loan spreadsheet method.
3. Beware the perpetually indebted. Borrowers with a high revolving credit balance (> $25,000), borrowers with 6+ credit inquiries in last 6 months, borrowers with a leverage ratio (high debt to income), and borrowers who find themselves in a cash flow crunch. These are the borrowers who have a high probability of skipping payments, missing payments, and if too many debts pile up too quickly, the chance for a default/charge off is increased.
4. Not all government employees are safe bets. Contrary to public opinion, a government job no longer implies more job security than a private sector job. Most municipalities across America are experiencing revenue shortfalls, and in response, they are cutting costs where they can. This means everything from teachers, police officers, firefighters, etc., are all on the chopping block. So just because you see a loan from a police officer with 5+ years on the job, he or she is not a sure thing.
5. Anyone can file for bankruptcy protection. I mistakenly believed that certain professions would avoid filing for bankruptcy more than others. My first bankruptcy filing (a Chapter 13 bankruptcy) was actually filed by a dual income couple of law enforcement officers. I thought that law enforcement would have never filed for bankruptcy unless absolutely necessary, but being that they filed after making 3 monthly payments out of 60, it makes for an interesting “they knew how to game the system” conversation.

If you have a lessons learned experience to share, please let the group know.

The Lending Club Investment Club

As a few of you know, I head up a pseudo “investment club” via an email list where a few of us (e.g. around 45 investors to date) share ideas and highlight individual notes that we believe will pay off in full plus interest. This isn’t an official investment club per se, but it’s a quick and easy way to use groupthink and crowdsourcing to hash out ideas, expedite the investor learning curve and identify notes that a single individual might miss.

If you wish to be a part of the investment club, please let me know in the comments section below or send a quick email using the contact page with whatever questions you may have.

Quarterly Lending Club Investment Portfolio Updates

April 2011 Update: Shutting Down My Lending Club Investments over Q&A Change

December 2010 Update: Currently earning 15.6% NAR on Lending Club investment portfolio.

September 2010 Update: Currently earning 15% ROI on my Lending Club investment portfolio.

June 2010 Update: Currently earning 14.2% ROI on my Lending Club investment portfolio.

March 2010 Update: Currently earning 13.6% ROI on my Lending Club investment portfolio.

Think again…

It must really suck to work for credit card companies like JP Morgan Chase, CitiBank, or Bank of America, when customers are leaving one of your cash cow businesses because management can no longer offer competitive interest rates. Or worse, well known risk analysts and fraud investigators are calling for the destruction of your brand, as well as suggesting that some Too Big To Fail banks would be insolvent if forced to use Plain Jane accounting standards.

But, perhaps one of the greatest things about being a P2P lending investor, aside from making a 15% return on my P2P lending investments, is that you are constantly getting a from-the-trenches view of what is happening at the consumer, banking, and dare I say, cultural level.

Which is why that I believe P2P Lending will become a major player over the next decade because I sincerely believe the high credit card interest rate policy post Great Recession has left such a bad taste in consumer’s mouths that the ire and outright hatred will last for many years to come.

To me, the P2P lending investor, it makes perfect sense to give as much information as possible (without compromising your personal identity to investors) to quickly attract as many new investors as possible by providing basic information, such as: job description, how long you have worked in your profession, your monthly budget, a brief explanation of what the loan will be used for (especially if it’s a business loan), etc., etc.

Granted, this isn’t a Lending Club requirement and many P2P lending investors will not care if this information is included on the application. But, in my humble opinion, going the extra mile is often something that makes the difference between getting your loan request fully funded versus partial funding.

Perhaps I’m too old school for my own good, or I like some semblance of a personal handshake, but I honestly feel more comfortable lending to those who actually take pride in completing their Lending Club loan application and make a proactive effort in the due diligence process without the investor having to grab hold of the proverbial “information rope” in order to pull as much basic information from the borrower as possible.

Case in point: this superb loan application from a borrower applying for a debt consolidation loan to refinance existing credit card debt at a lower interest rate.

[click to enlarge image]

As you can see, the borrower goes above and beyond in the loan description section by anticipating as many of the top Lending Club investor questions that were pertinent to his loan application.

Personally, as the Lending Club investor, such a loan application gives me more confidence in the borrower’s intent to fully repay his promissory note on time, every time. Of course, a borrower filling out a loan application to this degree does not mean that he or she will have a repayment metric of 100%, but I personally feel people who have a well thought plan, an organized budget, and takes the time to illuminate investors about their personal finances and/or financial goals, will have a lower rate of default than someone who throws up a loan application doing as little work as possible.

Disclosure: I did not invest in this Lending Club loan as it does not meet my typical Lending Club high yield investment strategy, but thought it deserved highlighting because it’s one of the best loan applications I’ve ever seen in the Lending Club platform. Also, I omitted the borrower’s employer to preserve the borrower’s anonymity to Lending Club investors only.

Could be!

Last night’s episode of The Simpsons entitled “Loan-A-Lisa” explored the basic concepts of microfinance and how everyday investors, like you and I, can lend to entrepreneurs who can’t, or won’t, get financing from traditional banking establishments.

I’m probably biased in this “going mainstream” assessment, since I’m a P2P investor at Lending Club myself, but the growing popularity suggesting P2P Lending going mainstream is a very real possibility.

Quarterly Lending Club Investment Portfolio Updates

December 2010 Update: Currently earning 15.6% NAR on Lending Club investment portfolio.

September 2010 Update: Currently earning 15% ROI on my Lending Club investment portfolio.

June 2010 Update: Currently earning 14.2% ROI on my Lending Club investment portfolio.

March 2010 Update: Currently earning 13.6% ROI on my Lending Club investment portfolio.

Even though P2P Lending has been a profitable alternative investment for me (e.g. 15% returns in my Lending Club portfolio), it’s tough to forget that there are real life people on the other end of the transaction. Something that you rarely get buying 100 shares of Exxon Mobil or your biweekly contributions to a low cost index fund.

Quarterly Lending Club Investment Portfolio Updates

December 2010 Update: Currently earning 15.6% NAR on Lending Club investment portfolio.

September 2010 Update: Currently earning 15% ROI on my Lending Club investment portfolio.

June 2010 Update: Currently earning 14.2% ROI on my Lending Club investment portfolio.

March 2010 Update: Currently earning 13.6% ROI on my Lending Club investment portfolio.

~ ~ ~ December 2010 Update: Earning 15.6% NAR on Lending Club Investment Portfolio. ~ ~ ~

Once again, I’m pleased to report positive results for my Lending Club investment portfolio.

Summary

1. My Net Annualized Return is 15.03%.
2. Zero defaults thus far. I’ve have had several borrowers test the grace period allowance, and only one hit the “30 days late” mark, but all caught up after being contacted by Lending Club.
3. Two loans have been paid off early over last year.
4. Five year notes outnumber three year notes 55% to 45% respectively.
5. I’ve increased the balance of Lending Club account by 1.5 fold. The 5% cash back bonuses and 1.5% bonus on recurring deposits offers were too good not to capitalize on.
6. Forming a LendingClub.com investment club.

Detailed Analysis

As with any performance update that doesn’t show any real blemishes, it’s only natural to want to look under the hood and ask questions. So here is a more detailed look at the what’s, where’s and how’s.

1. Account balance. Feeling more comfortable in my original Lending Club investment strategy, as well as an inability to say no to Lending Club’s “free money” promotions, I decided to accelerate my investment plan. If you saw a $50 bill lying on the street, you would be a fool not to pick it up, so if you’re wondering why my account balance ballooned in size by 150% from last quarter’s update, blame LC for enticing me with free moolah. 
2. Weekly recurring investments. I’m still proceeding with recurring weekly investments, but at an increased rate of $125 per week. As Lending Club’s popularity extends more into the mainstream financial community, the number of loan applications that meet my investment strategy is getting easier to find. Not only am I able to find all I need, I’m getting to the point where I find myself cherry picking between some very solid notes in the 14% to 22% NAR range. Investing $500 per month also qualifies me for a 1.5% cash back bonus on recurring deposits, which exceeds most interest rates on Plain Jane checking/savings accounts.
3. Diversification. Per my investment plan, I’m only investing $25 per note to achieve maximum diversification but I am hand picking my notes versus using Lending Club’s automated investing model. This is considered by some to be the “diversipicker” investment strategy, where I’m attempting to spread my risk across as many notes as possible, but only investing in notes that meet my investment criteria. (Note: I made a mistake several weeks ago by investing in the same note twice by failing to pay attention to the “previously invested in” icons in the checkout menu.)
4. Focusing on notes greater than 14% NAR. Over the past two to three months, I’ve shifted my risk to Grade C notes and higher. This is perceived to be higher risk based on the borrowers FICO score, however, I would argue the risk of many of these higher credit risk loan applicants is less than or equal to Grade A & B loan applicants simply based on their profession, job history, job security, payment histories, etc. My theory is those who keep their jobs, and have a solid history of repaying their debts, will repay their Lending Club loan.
5. Making 15% NAR is a new goal. With the quality of borrowers who are borrowing money in the Grade D notes and higher, I think making 15% NAR or higher is a realistic goal.  This depends upon several factors — minimizing defaults, selecting high job security borrowers, etc. — but I think it can be done by investing in people who have, fairly or unfairly, have a credit score that is not reflective of their credit risk. (FYI: Lending Club quantifies my NAR in the 87% investor percentile based on this chart.)
6. Three year notes versus five year notes. The popularity of five years notes among loan applicants has taken off far faster than I anticipated. This is due, at least in my opinion, to the attractive nature of making lower monthly payments, which in turn, makes it easier for the borrower to service their debt along with their recurring monthly living expenses. Some investors avoid the five year notes, but from my thesis of investing in those with an in-demand profession and a solid job history, I consider it a minor risk by extending the term of the loan for an additional two years. From my vantage point, it’s a benefit for me, the investor, because I get to make a higher interest rate on a borrower, who not only pays a slightly higher interest rate, but will pay more interest on capital borrowed over the lifetime of the loan if he/she only makes the minimum payments.

Closing Thoughts

Naturally, I’m ecstatic about a 15% NAR performance. Whether or not it lasts, is anyone’s best guess. I’m betting it does, but like any unproven strategy, it’s unwise to count chickens before they hatch.

Screening and reviewing hundreds of promissory notes isn’t easy by any stretch of the imagination, but if you have a sound investment strategy and willing to invest the time to review loan applications from borrowers you believe to be credit worthy, Lending Club is, at least based on my results thus far, superior to nearly all fixed income investments I’ve encountered.

Also, I would be remiss to say I’m somewhat obsessive about selecting superior notes. I probably invest a minimum of one to two hours each week screening, filtering, reading Q&A sections, and asking questions to potential borrowers. Thus far, I would argue my obsessiveness has paid off.

The Lending Club “Investment Club”

For anyone interested, I’ve formed a pseudo investment club with a few personal finance bloggers and other Lending Club investors. Once or twice a week, we share ideas, via email, on the notes we believe are going to pay off in full, plus interest. If you would like to be included on this email list, leave a comment in the section below or send me an email via my contact page.

I’ve also collected a sizable Twitter list of P2P lending investors, P2P borrowers, and employees (and a few founders) who work for multiple P2P lending companies across the globe. So if you’re interested in learning more, or just “auditing the course”, both the email list and the Twitter list might be an easy (and free) way to pick up a few tips here and there.

Quarterly Lending Club Investment Portfolio Updates

April 2011 Update: Shutting Down My Lending Club Investments over Q&A Change

December 2010 Update: Currently earning 15.6% NAR on Lending Club investment portfolio.

September 2010 Update: Currently earning 15% ROI on my Lending Club investment portfolio.

June 2010 Update: Currently earning 14.2% ROI on my Lending Club investment portfolio.

March 2010 Update: Currently earning 13.6% ROI on my Lending Club investment portfolio.

Lending Club’s Recurring Deposit Bonus Details

• Earn 1.0% cash bonus on recurring monthly deposits of $200 to $499 per month.
• Earn 1.5% cash bonus on recurring monthly deposits of $500 or more per month.
• Schedule and maintain a recurring transfer of more than $200 a month.
• Invest your transferred funds within 60 days of the transfer.
• The bonus will be paid on a trailing three-month basis on or before the 15th of the month.

(The enrollment image pictured above will be posted in your account summary page.)

The best part, aside from earning a 1.5% cash bonus in 60 days or less, is the rate of return on the cash bonus is equivalent to, or slightly higher than, interest rate returns for so called “high yield” savings accounts. For example, my ING Direct account is only paying around 1.1% at this time.

Granted, investing in a P2P lending account, such as Lending Club, isn’t anywhere near as safe as keeping your cash in a FDIC insured account. But once you’ve found a Lending Club investment strategy that works, an additional 1.5% cash bonus on top of earning 14% to 15% NAR on your Lending Club investments is a pretty sweet deal.

Let the E*Trade Baby beat that!