Friday, August 19, 2011

My Initial Lending Club Strategy

I look for a minimum of 16% return per year. So my strategy with Lending Club was initially to fund a bunch of F rated notes (default/return rates: A 1%/6%, B 3%/8%, C 5%/10%, D 6%/11%, E 6%/13%, F 8%/14%, G 11%/15%). I looked at the data and decided I could get 16% holding those notes. I was glad there was a way to cash out, trading notes, but wasn't interested in trading frequently.

Then I found out I lived in a state that does not allow funding of notes. So I stated to look at buying notes. My strategy became to look for notes that are not, and have never been, behind, with the lowest premium, and the highest return. Pickings can be slim if you are picky.

And speaking if picky, I do look at the notes to see what is behind them. I look for people paying off, or consolidating credit cards or other debt. Lending Club stats show these to be low default loans. I also look for home owners, although info let in renters some times. I'll buy notes other than consolidation, but I really shy away from "start a business" and purchases.

When looking to buy a note, I filter out anything that is less than 17% and sort by premium. You can buy notes worth hundreds, or even thousands, but I'm looking for anything up to just over $25. Initially it was to diversify my default risk, but it has come to be key to my trading strategy.

I try to make sure all of my money is in a note at all times. Your money can't work for you if it's sitting on the couch.

I'm also a big fan of a concept, Make-Me-Move. The idea is that you are not emotionally tied to your house (or in this case note) and would sell it, for the right price. So my spreadsheet calculates at what price I could sell each note for in a week and get a 16% return per year rate, taking into account selling fees (1%), taxes (15%) and payments received so far. This is then my Make-Me-Sell price, the idea being I could get a guaranteed 16%+ return without worrying about default.

My theory is that defaults generally don't happen at two times, the beginning of a loan and the end. At the beginning they have full intention of paying every month for three or five years. But then after a while, life happens. If they survive life hapenning, they get to the exciting time of "It's almost payed off!" the most dangerous years in a loan are the middle ones (or one in the case of a three year note).

So if I can buy new notes or notes about to finish out, I'll lower my risk of default. Hence why I set all my notes to a Make-Me-Sell price.

My spreadsheet also has a risk calculation. It is based on several factors, but determines how risky I think the loan is. The riskier notes I set their Make-Me-Sell price for 16% APY. The notes I'd like to keep, I still have a price, but it could be up to 80% APY. In other words, I don't want to be a day trader, but if you really want it, you're going to pay a high premium.

You may be asking why I set a 16%-80% return if sold at the end of the week. Why not month (which is what I do for stocks)? I'm not fond of the small window, I'd much rather a month. Foliofn only allows sell orders to remain in effect for seven days. This is ok when you have 15 notes, but not 800 (or for that matter 80). I think I will sort my spreadsheet by risk factor when the number gets unwieldy, and only offer my 15, or 30 most riskiest loans for sale.

This cycling through of my worst loans helps me ward off the most likely defaulters (assuming my risk calculations have any real world worth) and lock them in at 16%+ APY. The + comes in because the calculation of price assumes it is sold in seven days. However, when they sell it is usually not on the last day. Time value of money makes the actual APY more than 16%. Of course the longer I hold a note, the less those seven days makes a difference.

That is the basics of my initial strategy. Within a month of actually acting on this strategy, I saw some things that needed to change. So next up, how I'm changing up my strategy for month two.

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