Can Someone Check My Math?

(See Other Posts about Lending Club Extension)

In my last post I announced the first release of a Lending Club Chrome Browser plugin I am writing. I am using it myself and making several improvements. One of the improvements is when you offer a Note for sale it will calculate the annualized return range for a given sales price (range because it could be sold any day from today to up to 7 days later). When I was converting my calculation from my Python script, I noticed I was not happy with the original calculation.

I'd really like to have your feedback on the calculation, and have a math check on it.

In precalculus I learned from Ms. Delores Dean that the basic formula when dealing with compounding interest, or rates of return, is:

A = P (R + 1) ^T

which reads Amount equals Principal times Interest Rate increased by One raised to Time in years. I also wanted to add in Tax, Fees and Payments made. So my final formula was:

S + P (1 - M) - T (S + P (1 - M) - I - FS) - FS = I (G + 1)^Y

The variables are as follows:

• S - Sales Price
• P - Payments Made
• T - Tax Rate (ie 0.395)
• I - Initial Investment
• F - Fee Rate (ie 0.01) on Sale
• G - Annualized Gain
• Y - Years Held
• M - Maintenance Fee Rate

If you love a simple math problem that requires algebra, please stop reading here and solve for S. If you love a math problem that requires algebra and a little precalculus, please stop reading here and solve for G.

Now an explanation of the equation above. So the actual amount of money you are left with (A in the first equation) is the Sales Price plus Payments Received minus Tax you'll have to pay minus Sales Fee. The Tax would be your Tax Rate (for a conservative estimate of your tax, I recommend using your short term capital gains rate) multiplied by the sum of your Sales Price and Payments Received minus your Initial Investment minus your Fees Paid. And of course the Fee Paid is Fee Rate times Sales Price.

Of note, I assume that the Payments Made needs to be reduced by the Maintenance Fees Paid. Lending Club states that this is 1%, but remember that it is rounded up, usually $0.01 for $25 Notes. I found that the lowest regular payment I've had this month is $0.61, which the fee ended up being 1.64%. So to be conservative, I put the Maintenance Fee (M) at 2% (or 0.02). Some Notes do not have a Maintenance Fee, but to be conservative (and keep things simple) we'll assume there always is one.

Let me know in the comments if there is a problem with this formula or how I am thinking about it.

Now that you've had some time to work through the math, did you get:

G = e^{log_e( (S + P (1 - M) - T (S + P (1 - M) - I - FS)) / I ) / Y} - 1

and

S = (I (G + 1)^Y - T (I - P (1 - M)) - P (1 - M)) / (1 - T - F + TF)

Let me know in the comments if you got something different.

Now the formula needs to be converted to JavaScript to actually be used in the Chrome Extension. Here is the JavaScript I had for S:

Math.pow(Math.E, Math.log( (salesPrice + (1.0 - maintenanceRate) * payments - taxRate * (salesPrice + (1.0 - maintenanceRate) * payments - investment - feeRate * salesPrice) - feeRate * salesPrice) / investment ) / years) - 1

and for G:

(investment * Math.pow(1.0 + annualGain, years) - taxRate * (investment - (1.0 - maintenanceRate) * payments) - (1.0 - maintenanceRate) * payments) / (1.0 - taxRate - feeRate + taxRate*feeRate)

Anyone see any problems with the JavaScript? Again, please leave a comment.

This is what I am looking at adding to the Sell Notes page using the Chrome Extension. It will add an Annualized Return column and calculate the return if it were sold as soon as possible up to the date selected for the expiration.

This is not a photoshopped image, this is a screen grab from version 0.2 of the extension.

Currently version 0.1 is available, and lets you filter the Browse Notes on FolioFN. When version 0.2 is ready, I'll post again with a list of the enhancements I have made, as well as the assumptions that go into it. I still have a few glitches to work out, but I am excited about 0.2.

Now with 0.2 I can completely ditch my old Python script that used Apple Events to scrape the web pages of Safari to see what I was seeing and calculate these things. Version 0.2 of the Chrome Extension will even one-up the script with a neat little feature that will save me so much time in selling Notes (I'll reveal that in the next post when I release it).

So if you'll do me a favor (and yourself if you plan on using or trying my Chrome Extension version 0.2) and look over my math. I'd really like this to be peer reviewed before I release it.

In the mean time, I'm really having fun using this. I spend so much less time on the FolioFN site and will have fewer human errors.

If I haven't mentioned it yet, please leave me some feedback on the math above.

Thanks.

Alright, I'm Ready To Share

(See Other Posts about Lending Club Extension)

I've been documenting my Lending Club experiece and have been mentioning a script that I use. This script only worked on Mac machines with the Safari browser. I have since started using Google's Chrome browser, and only launched Safari for doing Lending Club business. So to do my Lending Club business in Chrome, I have started writing a Chrome Extension that helps me decide on loans to buy.

This extension is in beta and I make no assurances as to how well it works.

Install Note Browser Filter (click on this link in Google Chrome)

(Note: A slight majority, almost 1/3 of the visitors of this blog are running Chrome, followed by another almost third for FireFox. Also about 2/3 of the visitors are on Windows. I'm hoping this solution works for a majority of the visitors to this site.)

After clicking the install link, there may be a button at the botton of the window asking you to confirm you want to install the extension. Click the "Continue" button and then the "Install" button to install the extension.

This extension will add a button to your toolbar (the red square with the green dollar sign). Clicking this button will reveal extra filters you can apply to the Browse Notes page on FolioFN. You can highlight rows that are out of the acceptable range with whatever color you want. If you specify 000000 as the color, the row will be removed.

For instance, I have it remove duplicate Loans (only the first instance is shown), Loans I already own a Note in, Loans that have Imperfect Status (not Issued or Current), had less than $15 Outstanding Principal or more than $25 Outstanding Principal, Notes that have less the $0.20 of Accrued Interest, Notes that have a Markup of over 10% or Notes that have a Yield to Maturity under 16%.

I also highlight 36 Month Notes in red, Loans that have less than 20 Day Since Payment in orange and Loans with less than 25 Remaining Payments in yellow.

So you sort your Notes the way you always have, and after about 5 seconds it will filter out or highlight the rows for you.

Below is a screen shot of the tool in use. I did not edit this image. Notice it says it is showing Notes 1 - 60, but only 8 Notes are actually showing. Alternating unfiltered rows have green and white backgrounds (to let you know the extension is running, FolioFN uses alternating blue and white backgrounds).

Feel free to leave comments here or email me if you have suggestions or defect reports. I plan on using this on a regular basis, so this is not just something I am throwing out there. I will also be adding features like auto-fill for the Sell Notes page and determining more stats about your performance.

How I Use Lending Club Portfolios

In my January post Six Months and I'm Reaching A State of Peace, I stated:

I feel like I'm emerging from the Fire Swamp, and now it's time for Prince Humperdinck, I mean Tax season. (Maybe I will name my portfolio Buttercup).

Well, I took that suggestion and segmented my Notes into Princess Bride themed Portfolios.

The Humperdinks are the Late, Default and Charged Off Notes. These are the Notes that you know you don't want around but you probably can't get rid of them. The Rugen Portfolio holds the pre-Grace Period and Grace Period Notes. These are insidious Notes that don't sound all that bad, but can lead to more Humperdinks.

Then we have the Buttercup Portfolio. These are the newly acquired Notes that have no or one payment. They have not proven themselves. Then there is the Wesley Portfolio. These are the Notes that have never had payment problems and have payed me at least twice.


This segmentation helps me avoid looking at Humperdink Notes (Late or Charged Off) while paying attention to the insidious Rugen Notes (Pre-Grace Period or Grace Period). And I can look through my good Notes (Buttercup and Wesley) for Pre-Grace Period Notes by sorting by Payment Due Date and look at the Notes for Collection Logs at the bottom.

Seven Months In And Things Are Slowing Down

(See other Monthly Status Updates)

Seven months have passed and I am now starting to feel the results of the Late Notes that are now Charged Off in my Net Annualized Return. 16.36% is still in the neighborhood of my target 16%. I still have six Late Notes that I am steeply discounting, but it appears that they rarely sell.

I've received enough interest to offset the complete loss of the Charged Off and remaining Late Notes assuming they are all worthless. The total interest I've received amounts to 6% of the money I deposited. Now we are on to start growing again (back to the beginning).

I've sold 2.7 times as many Notes as I currently hold (of course using the proceeds to buy more Notes). My median annualized return on Notes sold is 32%. If you weight the annualized return by days held (the longer held the more weight you give to it's annualized return) my Notes Sold have an average of 58%. This sounds great, but the raw gain, Cash Received (Sale + Payments) vs Cash Paid, is 1.9%. This has probably been impacted most by by selling off of Grace Period and pre-Grace Period Notes at a discount and buying a bunch of pre-Grace Period Notes at a premium before realizing they were pre-Grace Period.

When ranking the risk of my Notes (which I use to determine asking price when selling, 16% - 32%), I weighted most heavily (5 times the weight of the least weighted):

• Accounts Now Delinquent
• Delinquencies in Last 2 Years
• Delinquent Amount
• State (Bad: SC, OH, CA and FL Good: WY, ME, with other rated in between)
• Inquiries in the Last 6 Months
• Months Since Last Delinquency
• Status of the Note (Issued, Current, Fully Paid, Grace Period, etc)
• Public Records on File
• Revolving Line Utilization. I am adding to that 

I am now increasing the weight of the Grade of the Note to the same level (was weighted the least, now weighted 5 times higher). I have an uncomfortable number of G Grade Notes. I would rather sell those than hold on to them.

Lending Club has also been making some changes, or rather FolioFN, specifically to the way Browse Notes works. On the positive side they got rid of the confusing checkboxes for Rate and replaced it with a Range. Much better.

On the downside, they now no longer include Issue Notes when viewing Never Late. This makes me sad. I really like Issued Notes, and now they are hard to find. Well, they are hard to find the way I was looking for Notes.

I now choose Notes by looking at everything. I sort first by Yield to Maturity (click once to sort ascending) and then I sort by Remaining Payments (click twice to sort descending). This gives me newly issued Notes with the highest Yield to Maturity. I then look for the Accrued Interest over $0.50, meaning the Note will soon (hopefully) make a payment. This way I get the first payment (which is mostly interest) and hold it just a short period of time before I get that interest. Then if it sells, I get a (mostly) interest only payment, get my Principal back and a premium in a small period of time.

I am not buying exclusively Issued Notes, as there are some great deals in the rest of the Notes. Those I just chose Never Late only and sort by Yield to Maturity. I'm not sure how much of a mix between Issued and Current Notes I'm going to buy. I'll still need to play with that.

Bottom line is that I have taken some lumps (and still waiting for 6 more Notes to be Charged Off) and am still at my minimum target. I look forward to clawing my way back up above 18%.

Six Months and I'm Reaching A State of Peace

(See other Monthly Status Updates)

So I've gone from flying high to 14 Late Notes (one is now in Default). I was able to sell one of the Late Notes pretty early on. One of the Notes came current (and immediately sold, now that it was not Late and steeply discounted). I don't expect to sell any of the Late Notes I am currently holding before they go into Default. I have steeply discounted them, but it appears that Late Notes just don't sell, especially this Late.

I did have one Note finally go into Default (Charge Off). However, I did get some money from collections ... and then the collection fee ate that recovery up.

I went through and looked at the Notes that were Late and noticed something ... I had three Notes from one Loan that went Late! Three Notes! Not just one or two, Three! I went through my list of Notes and sorted by Loan number. I got pretty good at looking at the last digit to see quickly where I had Notes from the same Loan. I culled out another half dozen from back in the day before I watched for duplicate Notes.

So, lessons learned. First, check the Note before you buy it to make sure they haven't already failed a payment (apparently they still show up as never late). Second, make sure you do not have more than one Note from the same Loan (or Notes worth more than $25). Third, treat Grace Period as the plague. Grace Period sells, but Late does not (only 7% of my Late Notes sold while Late).

As far as returns, Lending Club is still reporting my NAR above 20% (although I am considering those Late Notes as Charged Off already. I've sold more than twice as many Notes as I currently hold, so about every three months I cycle through Notes. Of the Notes I hold, they are worth an average of $24.88. I've held them for almost two months on average. Of the Notes I've sold, I've held them for an average of 19 days (almost three weeks). My median annualized return on Notes sold is 33%, however I like to use a Days Weighted Average (the longer I hold it the more it is weighted) which is 72%.

I feel like I'm emerging from the Fire Swamp, and now it's time for Prince Humperdinck, I mean Tax season. (Maybe I will name my portfolio Buttercup).

Low Risk, High Return Lending Club Strategy (For Some States)

While I love the great state of Texas, I am disappointed in their regulation of citizens investing in Lending Club. There are many states that prevent their citizens from funding Lending Club Notes, and unfortunately I live in one of them. At the end of this post, I have a summary of a strategy I think will give huge returns for those in states who can fund notes, with really low risk.

Lending Club is offering a No Maintenance Fee for the life of loans over $20,000. The added bonus is that loans of that amount have the highest return, in general.

So for those who live in a state that allow them to fund notes, if you focus on funding notes in the $20,000+ range, not only do you get an average return of 10.29% (as opposed to 7.42% to 9.9% for lower amounts), but you get a 1% boost from not having the maintenance fee.

Now if you funded a $25 share of the loan to minimize risk exposure, the maintenance fee could be as high as 1.7%, because it is 1% of your payment, rounded up. Since $25 shares payments can be as low as $0.60 (possibly lower) that would be $0.01, rounded up to the nearest penny, which is about 1.7%.

To get the best returns with the least risk, fund notes in the Grade E and Grade F range. While these Notes have higher theoretical risk, there are ways to mitigate those risks we'll talk about later. Grade G Notes can go way too low of a return, while not getting much better high range than Grade F (as well as the average return is worse).

To continue to maximize your return, you can fund 60 month Notes (versus 36 month Notes). Lending Club gives a higher risk value to 60 month Notes, which translates into higher interest rates, 2.05% to 4.5% higher (see interest rate factors). True, the longer term Notes have more risk, but again there is a way to mitigate that risk.

So now we get to the risk mitigation, the FolioFN trading platform. This is where those who are in states that can fund Notes can help (and benefit from) those in states that do not allow us to fund Notes.

There seem to be two major camps of loan buyers. Michael at Nickel Steamroller focuses on highest Discount. This approach looks for the steepest Discounts or lowest Markup on Notes as opposed to highest Yield to Maturity. This approach appears to get you the most for your money.

The second approach is looking for the highest Yield to Maturity. This approach assumes that if the Note is held until it matures, and it does not default, you'll get the highest return. Of course, with Grade E and Grade F notes at 60 months, that seems like a bit of a stretch.

Yield to Maturity seems to be a very popular method of choosing Notes (hence the Nickel Steamroller post warning against it). It is the approach I use to maximize my return. I've heard many people wonder why people would buy a newly funded $25 Note for $26.50. The three reasons I can think of are (a) they are looking for the Note to be held to term and not default, (b) they are looking to sell the Note to an (a) at a slightly higher premium or (c) a combination of (a) and (b).

I am a (c). I buy mainly Grade F Notes with a smattering of Grade E and Grade G (yes, I know G is a lot riskier with lower return). I tend to also buy some mature Grade C and Grade D on occasion when I have under $20 available to buy Notes. I also buy mostly 60 month Notes. Both the Grade and the term of the Notes I buy is not really a conscious decision, but a byproduct of buying the highest Yield to Maturity Notes.

Strategy

So to maximize potential return, here is my recommendation for those who can Fund Notes:

Buying Criteria

1. $20,000+ Loans
2. $25 Notes
3. Grade F Notes (22%+ Interest)
4. 60 Month Term

Selling

Upon Funding, sell the Note at a 5% Markup. You'll get an immediate 5%, assuming it takes a month from the time you pledge the money for Funding to the time you get the money back from the sale. Annualized that would be more than 50% return. This cuts your risk because no Note will ever default because you sell them before their first payment.

For example, say you Fund 4 Grade F 22% 60 month $20,000 Loan Notes, spending $100 (4 x $25). You offer each Note at $26.25 (of the current top 60 Yield to Maturity Notes, 6 of the 14 $25 Notes are offered at over $26.25). Your funds (after FolioFN takes their 1%) are at $103.92. If that took 30 days, and then you reinvested the $100 in the same way, after 7 months you'd have $127.44. Then you start funding 5 Notes with the same criteria. In 5 more months, you'd have $152.09. For the year, you'd have over 50% return.

Caveats

This strategy is based on current market conditions. If too many people flood the market with high Yield to Maturity Notes, you'll have to reduce your Markup to get your Notes sold. I in no way guarantee that this strategy will work as described as the market place can change dramatically based on a number of conditions.

This is a win-win for those in states that can Fund Notes and those in states that cannot. It gives us in non-Funding states a nice stream of Notes to buy. It gives a nice low risk, high return for those in states that can Fund.

Why Lending Club is a Scam (Hint: It's not)

First they ignore you, then they laugh at you, then they fight you, then you win. 

Mohandas Gandhi

My parents visited us for Christmas. I owe a lot to my parents. From my father I learned the importance of temperance and striving for a spiritual life. From my mother I learned frugality and efficiency. With my father I often discuss politics and philosophy. With my mother I often discuss finances and investing. This particular visit, I mentioned that I was investing in Peer to Peer lending. The first thing she said was, "It's a pyramid. Get your money out while you can." This took me aback, but after thinking about it, I wasn't surprised. One of the common phrases I heard growing up was "never be the first on your block."

This leads me to Peter Renton's No Google, Lending Club is Not a Scam post (sociallending.net). It got me to thinking. Why would someone search for "Is X a scam?" While pondering this idea, I read Seth Godin's How much are you going to tip? post (sethgodin.typepad.com). This example he gave struck me:

There are two couples at the table, the waiter has brought separate checks and the credit card holder turns to the other credit card holder and tries to find out how to coordinate the tip.

Why?

I mean, if they were out just the two of them, would they ask what people at the other table were going to tip?

I've heard it said that all you need to have an opinion is a mouth. I guess the internet-age equivalent is, to have an opinion all you need is internet access. Searching (or is it googling) is an art. Using it for research on anything can be misleading at times, but especially for new and disruptive ideas. There is the idea of the S-Curve (see Wikipedia Diffusion of Innovations).

The S-Curve is a visual representation of the Gandhi quote at the beginning of this post. A very small number of people in society adopt a new idea. At first no one pays attention to it. Then it starts growing from just the innovators to the early adopters. This is where people laugh at you, as Gandhi said.

Next as the early majority starts joining in, those who see it disrupting status quo start whisper campaigns against it, as well as those with ill intentions see an opportunity to make a quick buck. Somewhere between early adopters and early majority, the government usually steps in with regulations. They want to make it "safe" for everybody. If it can survive the whisper campaigns, the malintent opportunists and the regulations, then we get the late majority and finally the laggards. My parents advice to "never be the first on your block" places you firmly in the late majority to laggard stage.

There is nothing inherently bad about being a late majority or laggard. And most people are not 100% in any of these categories (I believe my parents were the first on their block to have Magic Jack phone service). Some people are laggards just because they were born too late (I am a TV and telephone laggard). Most people tend towards late majority and laggard as they age (things just change too quickly).

With investing, while there is risk in being an innovator or an early adopter, it is matched with a large reward. If you are investing before the early majority hits, you can benefit from the surge. For those who are constantly investing as innovators or early adopters, you understand that there is risk and you expect to lose sometimes.

There is only one way to learn, through experience. There is only one way to get experience, through mistakes. However, there are two types of mistakes, your own or someone else's. If you rely solely on your own mistakes, it will be a tiring, expensive and demoralizing experience. You will find the most success in using a balance of the two. Try to learn all you can and at the same time, take some action. Expect to make mistakes.

So back to the idea of a scam. There are two types of "scams." One is when the other intentions of the other party of to take as much of your money as possible without giving you equivalent value. The second, and more pervasive in internet "scam" searches, is when the other party has full intentions of giving you the stated value, but the person puts the blame of their lack of education behind the word scam.

So is Lending Club a scam? You'll probably find more and more in internet searches as Lending Club grows, and for them, they feel they were scammed. For those who educate themselves, learning from their mistakes and those of others, you'll know if it is a scam, or you will get some valuable experience.

(In my opinion, Lending Club is not a scam. I believe that they have full intentions of helping their customers receive as much benefit as they can from their investment. Oh, and for my mother, it is regulated by the Securities and Exchange Commission.)

For help in finding Notes in FolioFN or selling Notes before they mature, see posts about Lending Club Extension.