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WSO CDO Update August 2012
 

Edmundo Braverman's picture
ST
(Human, 14,397
 
Points)
 on 8/20/12 at 10:09am
lending_club_logo_detail.gif

A bunch of you have been asking me how the Lending Club thing is going and after I mentioned it in Bonus Bananas a couple weeks ago I got a few more PMs for an update on the WSO CDO so here goes.

I'm doing something a little different this time around because I want to show you guys how the note aftermarket works. In my last update I mentioned that I'd been selling a few notes that looked like they were about to go sideways, and since then I've modified my investment criteria to include more risk - so the note aftermarket is an even bigger part of my strategy now. So far, it's working like a champ because my Net Annualized Return as of today is 13.78% overall, and 15.02% on my primary portfolio.

So what am I doing different? Well, based on some pretty basic analysis, I determined that D-rated paper had the highest return with the lowest default rate out of every grade offered. So I've gone heavier into D-rated paper over the past year. I still buy other grades (the only grades I will not buy are A and B because the return just isn't worth the risk IMO), but I concentrate on the D paper. In fact, I might as well just show you guys my secret sauce:

Here is my criteria for investing in Lending Club loans:

  • Loan amount $5,000 or less
  • 36-month term
  • No derogatories (late or missed payments) on borrower's credit for previous 24 months
  • Loan payment represents less than 10% of borrower's gross monthly income
  • Loan purpose is debt consolidation and loan amount must represent 80%+ of borrower's total revolving debt (in other words, I want the money I'm loaning him/her to clear their debt load - I won't lend someone $5,000 if they have $25,000 in credit card debt)
  • Just so there's no confusion, I'm not loaning anyone $5,000 - I only invest $25 per note
  • It is my belief that people are more reluctant to default on a smaller loan amount ($5,000) than they are a larger loan amount ($35,000)
  • I dump the loan at the first sign of trouble. To my way of thinking, there is absolutely no excuse for a late or missed payment when you owe me money.

These are admittedly pretty strict criteria. This means that on a good day I might be looking at a total of 20 loans out of the 2,000 or so Lending Club has on offer on any given day. But it works for me, and I think the proof is in the pudding.

Now, let's talk briefly about the WSO CDO. It's almost two years old now, and there's been some attrition. As I mentioned in previous updates, of the 10 loans we started with only seven remain. The other three got the boot for sketchy behavior. All three of those notes were sold for a profit on the aftermarket. So here is where the remaining seven stand today:


As you can see, one of the loans has already been paid in full. Thankfully, it was A-rated paper and wasn't paying us much in interest, so I'm glad to see it go.

There is a growing community of P2P investors who keep tabs on each other, and they're (we're?) a pretty interesting bunch. One of the more prolific is Nickel Steamroller. He's a great guy who has created a bunch of nifty tools for analyzing P2P lending, but he was having some trouble with defaults because he deployed a strategy of buying 60-month notes. When he and I compared notes (so to speak) he was surprised to learn that I pretty much never buy 60-month notes because I don't care to invest in people who need that much time to re-pay me. Then we got on the subject of selling bad notes in the aftermarket.

It was my turn to be surprised. He'd actually dabbled in the aftermarket himself, but on the buy side. He got absolutely hammered. His default rate was through the roof on the notes he bought. Maybe he was buying junk because of the attractive yield, I don't know. But when I shared my strategy of selling notes that had only recently showed signs of trouble, it was like a light went off for him.

I won't go into the strategy I shared with him here because this is already running long, but you can read it on his blog post here: http://www.nickelsteamroller.com/blog/2012/06/bala... down in the comments. I think a well-articulated disposal strategy is key to a high-return P2P portfolio, and thankfully there are plenty of hedge funds gobbling up notes in the aftermarket to provide the required liquidity.

The following is a snapshot of my FolioFN aftermarket account for this month so far. It'll give you an idea of what it looks like, and you can see the loans that I've sold so far this month and what their status is:

Thanks to this strategy, I've still never had a default. You can see that I have one note for sale currently, and that its status is In Grace Period. There is a 10-day grace period for a borrower to bring his loan current before he pays a late fee. Fortunately, loans which are In Grace Period are still considered Current for the purposes of the aftermarket, so this loan will display to buyers searching with the strictest criteria (many people won't buy a loan in arrears for obvious reasons).

If you skip down to the loans I've sold this month, you'll see that two have slipped into In Grace Period, and that one is already 31-120 Days Late (pretty much no hope for the guy who bought that one). The last one is Fully Paid. Sometimes a borrower will miss a payment because he's arranging to pay the loan in full. I've had this happen three or four times now. But I had no way of knowing and only saw the missed payment. So I sold this note for $16.50, which was a profit for me. Then the note paid off, and I think the buyer got even less in the payoff. So that really kinda sucks for him.

The Cancelled Sell Orders section is just what it sounds like: sales cancelled by either myself or the buyer. Evidently a buyer has the right to rescind a sale in the pending period if a payment is made (which obviously affects the yield on the note). So that's what happened there.

I think that about covers everything. If I've missed anything or if you have any questions, hit me with them in the comments.

Tags:

Comments

In The Flesh's picture

Interesting stuff--thanks for

HF
(Neanderthal, 2,812
 
Points)
 on 8/20/12 at 9:28am

Interesting stuff--thanks for sharing! It's incredible how many ways there are to make money, even in this market.

Head of Metal Website: www.headofmetal.com

https://twitter.com/headofmetal2012

Working9-5's picture

How do you file your taxes

ST
(Gorilla, 613
 
Points)
 on 8/20/12 at 10:02am

How do you file your taxes when it comes to profits made from this? Or do you go under the radar, sending it to paypal for buying things online?

Looks cool. I just might spend my weekend setting up an account and portfolio of loans.

CNBC sucks

"This financial crisis is worse than a divorce. I've lost all my money, but the wife is still here." - Client after getting blown up

WallStreetOasis.com's picture

Fortunately, loans which are

EN
(Human, 12,074
 
Points)
 on 8/20/12 at 10:06am

Fortunately, loans which are In Grace Period are still considered Current for the purposes of the aftermarket, so this loan will display to buyers searching with the strictest criteria (many people won't buy a loan in arrears for obvious reasons).

so what happens when buyers figure this out and prices adjust for this? :-)

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trazer985's picture

Eddie, can you give a little

ST
(King Kong, 1,746
 
Points)
 on 8/20/12 at 10:18am

Eddie, can you give a little breakdown on the risks involved on this? It seems too good to be true. Are there any facilities in place to hedge your exposure? Do they crowd source each loan, so instead of 100 people borrowing 1000 dollars off 100 people, with each person financing 1 loan, they split the amounts across all lenders?

Is it open to all comers or is it minimum investment of X + americans only?

T

Edmundo Braverman's picture

WallStreetOasis.com: Fortu

ST
(Human, 14,397
 
Points)
 on 8/20/12 at 10:39am
WallStreetOasis.com:

Fortunately, loans which are In Grace Period are still considered Current for the purposes of the aftermarket, so this loan will display to buyers searching with the strictest criteria (many people won't buy a loan in arrears for obvious reasons).

so what happens when buyers figure this out and prices adjust for this? :-)

Been waiting for it to happen, but it hasn't happened yet. Might have something to do with the statistic that 86% of all In Grace Period loans become Current again, so it represents an acceptable risk. Just not to me.

Kenny Powers's picture

awesome post, was thinking of

O
 
Points)
 on 8/20/12 at 10:41am

awesome post, was thinking of doing this with a similar site - prosper.com .

pick em, lick em, stick em

Edmundo Braverman's picture

trazer985: Eddie, can you

ST
(Human, 14,397
 
Points)
 on 8/20/12 at 10:53am
trazer985:

Eddie, can you give a little breakdown on the risks involved on this? It seems too good to be true. Are there any facilities in place to hedge your exposure? Do they crowd source each loan, so instead of 100 people borrowing 1000 dollars off 100 people, with each person financing 1 loan, they split the amounts across all lenders?

Is it open to all comers or is it minimum investment of X + americans only?

T

Traze,

The way it works is crowdfunding. Let's say you want to borrow $5,000, so you apply for a $5,000 loan from Lending Club. That $5,000 loan application is then put out to LC investors who are free to invest as much or as little in your loan as they deem prudent. The minimum investment per loan is $25, so as an investor your maximum exposure to one particular borrower is the amount you invested in that individual loan. I never invest more than $25 per loan.

As for hedging, there's no true hedge available at the moment. In other words, I can't go buy a SWAP on my portfolio. I think this will change as P2P lending becomes more mainstream (there's currently about $1.2 billion in total outstanding loans between Lending Club and Prosper and they're originating ~$80 million a month in loans between them). I think there will be growing demand for SWAP protection and someone will eventually fill the void, but with only a billion total outstanding the market just isn't big enough yet.

Prosper is making noise about getting into the mortgage racket, and that could be a game changer of sorts because at least that would represent secured debt. Up to now, all P2P lending has been unsecured and collections on defaults therefore nonexistent - which is why I have such a hair trigger when dealing with these borrowers.

I believe you have to be an accredited investor to invest with Lending Club; at least you did when I signed up two years ago. Beyond that I'm not aware of any restrictions.

Bearearns's picture

Can you explain what in the

(Orangutan, 275
 
Points)
 on 8/20/12 at 11:04am

Can you explain what in the world would prompt someone to buy a loan with a principal balance of $25 for $25 after the loan has gone into grace period? Essentially he must have been quite sure the loan would come through. Any idea what would give him that indication?

trazer985's picture

Do you get any perks for

ST
(King Kong, 1,746
 
Points)
 on 8/20/12 at 11:14am

Do you get any perks for referring people? Affiliate or whatnot, before I sign up.

Scott Irish's picture

trazer985: Do you get any

O
(Orangutan, 369
 
Points)
 on 8/20/12 at 11:20am
trazer985:

Do you get any perks for referring people? Affiliate or whatnot, before I sign up.

seconded, this is great info and I'm going to wade into the LC market soon

freeloader's picture

Eddie - I'm surprised by the

PE
 
Points)
 on 8/20/12 at 11:29am

Eddie - I'm surprised by the loan size metric. I avoid smaller loans like the plague and since I've found those have higher default rates, and only look for loans requesting $10K or above. I actually think the psychology is opposite, people are more likely to default on a small loan if they think "it's just a small amount".

D through F loans are my bread and butter, I actually have more towards E and F rated loans.

freeloader's picture

trazer985: Do you get any

PE
 
Points)
 on 8/20/12 at 11:30am
trazer985:

Do you get any perks for referring people? Affiliate or whatnot, before I sign up.

$100 referral fee, I believe.

Bearearns's picture

Eddie, if you could comment

(Orangutan, 275
 
Points)
 on 8/20/12 at 11:34am

Eddie, if you could comment on this, it would be appreciated.

Or more specifically have you gone through a tax period with Lending Club. Just wondering if any insight on this.

Bearearns's picture

Just to get some

(Orangutan, 275
 
Points)
 on 8/20/12 at 11:51am

Just to get some perspective/debate on something.

If I buy say Annaly Capital Management(NLY), which gives me a 12.92%....... Lending club is saying that buying the stock is just as risky as lending money to these internet peers. Now given if lending club members payoff that pay loan principal. It is not guaranteed that your principal investment in NLY will be the same at the end of your investment timeframe.

However, if structured with a put selling or buy stock sell call strategy, one could get anywhere between 13-20%(estimate) not including underlying price movement of stock.

Has anyone thought of this?

Edmundo Braverman's picture

Ok, I'm gonna knock all the

ST
(Human, 14,397
 
Points)
 on 8/20/12 at 11:52am

Ok, I'm gonna knock all the questions out in this comment:

Trazer (and others): Lending Club has an affiliate program, but I never bothered to sign up. My bad.

Bearearns: This is just a guess on my part, but this was a brand new loan and the borrower missed his first payment. I imagine whomever bought the note from me at par was convinced that it was a bank error or something along those lines (which does happen occasionally). Also, the remaining payments total $40.58 over the next 60 months, so I guess the ROI was attractive. If you're wondering why I have a 60-month note when I said I only buy 36-month notes, it's because I did an experiment by buying a number of notes Lending Club recommended to me based on my history. As you can probably guess, I won't be doing that anymore.

As for tax treatment, it's straight interest income.

Edmundo Braverman's picture

freeloader: Eddie - I'm

ST
(Human, 14,397
 
Points)
 on 8/20/12 at 11:59am

Febreeze's picture

How bad is it that I keep

(King Kong, 1,151
 
Points)
 on 8/20/12 at 12:21pm

RIP WSO Chat.

Febreeze's picture

btw Eddie, there is a

(King Kong, 1,151
 
Points)
 on 8/20/12 at 12:26pm

RIP WSO Chat.

Edmundo Braverman's picture

Income is verified by Lending

ST
(Human, 14,397
 
Points)
 on 8/20/12 at 12:34pm

Febreeze's picture

Edmundo Braverman: Income is

(King Kong, 1,151
 
Points)
 on 8/20/12 at 12:45pm

RIP WSO Chat.

Bearearns's picture

Thanks any comment regarding

(Orangutan, 275
 
Points)
 on 8/20/12 at 1:08pm
fuquamarine's picture

Eddie - Great to see this

CO
(Monkey, 34
 
Points)
 on 8/20/12 at 1:18pm
WSOusername's picture

Good stuff here. I wonder if

 
Points)
 on 8/20/12 at 2:04pm

GBS

freeloader's picture

fuquamarine: Eddie - Great to

PE
 
Points)
 on 8/20/12 at 2:06pm
kobalt's picture

Edmundo

(Baboon, 100
 
Points)
 on 8/20/12 at 3:07pm
freeloader's picture

kobalt: Edmundo

PE
 
Points)
 on 8/20/12 at 3:37pm
Febreeze's picture

freeloader: kobalt: Edmun

(King Kong, 1,151
 
Points)
 on 8/20/12 at 4:44pm

RIP WSO Chat.

MailmanBitesDog's picture

I haven't delved into the

IA
 
Points)
 on 8/21/12 at 3:10am

My WSO Blog --
My Wordpress

shifty_farker's picture

Is there any (legal) way to

(Chimp, 15
 
Points)
 on 8/21/12 at 5:25am
Edmundo Braverman's picture

@Mailman I add fresh money to

ST
(Human, 14,397
 
Points)
 on 8/21/12 at 8:15am

freeloader's picture

MailmanBitesDog: I haven't

PE
 
Points)
 on 8/21/12 at 11:58am
GetOnTop's picture

freeloader: You know there is

AM
(Baboon, 132
 
Points)
 on 8/22/12 at 1:18am
freeloader's picture

Well, the dataset is for all

PE
 
Points)
 on 8/22/12 at 1:02pm
Sandhurst's picture

The fuck - there are hedge

IB
(King Kong, 1,242
 
Points)
 on 8/26/12 at 3:38am

"There are three ways to make a living in this business: be first, be smarter, or cheat."

Edmundo Braverman's picture

Sandhurst: The fuck - there

ST
(Human, 14,397
 
Points)
 on 8/26/12 at 5:05am

Cries's picture

So...over the last day or two

IB
 
Points)
 on 9/25/12 at 1:43am
Edmundo Braverman's picture

I've thought about blending

ST
(Human, 14,397
 
Points)
 on 9/25/12 at 2:40am

Cries's picture

Edmundo Braverman: I've

IB
 
Points)
 on 9/25/12 at 6:53pm
Edmundo Braverman's picture

I'm in the same boat you are,

ST
(Human, 14,397
 
Points)
 on 9/26/12 at 2:27am

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