Peer to peer lending

[fanmail]

After having read this thread now about 3 times, I have a few questions. I'm sure I will go to the LC website and try to get some answers there as well.

1. What is the cost to join/do business?

2. How easy is this to fund through an IRA? This seems very inefficient if done in a taxable account.

3. Is there a noticable difference between having say, 400-800 loans, or 1900 like CFB has?

4. Is the filtering process something you just figure out over time?

5. Why wouldn't people just borrow $ from a bank at a presumably lower rate?

[cute fuzzy bunny]

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Originally Posted by fanmail After having read this thread now about 3 times, I have a few questions. I'm sure I will go to the LC website and try to get some answers there as well. 1. What is the cost to join/do business?

They'll pay you $300-$1000 to join, depending on how much money you invest. They paid me a grand for putting in 50k, 2%. They're allegedly picky about who joins, some states don't allow it (because banks drove legislation in those states to prevent it), you need a high net worth and its not supposed to be more than 10% of your net worth. I meet the criteria, but I did or saw nothing about how they could have come to the determination, other than they asked me and I said "Yes".

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2. How easy is this to fund through an IRA? This seems very inefficient if done in a taxable account.

Haven't done it, since I want to have access to the income, and thats a lot harder inside of an IRA.

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3. Is there a noticable difference between having say, 400-800 loans, or 1900 like CFB has?

There is a difference between 400 and 800 (nobody with 800 loans has lost money so far, but some with 400 have had minor losses), but probably no difference between 800 and 1900. More diversity, but it seems pretty well maximized by 800-1000 loans.

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4. Is the filtering process something you just figure out over time?

I read data on Lendstats and Nickel Steamroller, and improved my filters over time. I found very little quality stuff online, since teaching other people how to best compete with you for the best notes is a little counterproductive. I'm apparently overly helpful, and stupid.

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5. Why wouldn't people just borrow $ from a bank at a presumably lower rate?

Because the bank rates are higher. Most of the debt I hold is 17-21% interest from people paying off 25-30% rate credit cards. A lot of these folks would end up with the same 25%+ rate on an unsecured loan from a bank. Making one smaller payment with less interest rather than struggling with the minimum payments and high interest rates on multiple loans/cards is quite appealing.

[fanmail]

Thank you CFB, very helpful. Is having your LC account in a taxable account difficult in any way? What does that do to your total return?

[cute fuzzy bunny]

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Originally Posted by fanmail Thank you CFB, very helpful. Is having your LC account in a taxable account difficult in any way? What does that do to your total return?

Well, you have to pay income taxes on it as ordinary income (like regular interest), minus any taken losses. I don't have a mortgage or car payment (even though the interest rates are appealing now) so my financial profile is so low I rarely have to pay any taxes. So my piddling little bit of LC income isn't a problem for me.

Now if I were working, or collecting six figures in pensions, or some other income bearing process where I don't really have any investment risk at all because my income can pay my bills, I probably wouldn't do this at all. If you are retired and want to earn a good steady income from your 3-5 year emergency cash, with the ability to reinvest the income or turn the knob and take it when your other investments are on the soft side, then I think its a good thing. Plus its an interesting learning process and you can spend either very little time with it or on a rainy day tinker with it. While I don't think that investing is a hobby, this can be a little of both.

Two sides to my decision to participate: about 9 months ago, married to a woman with an income that met our spending needs, wanted something extra from my loose medium term emergency cash...liked this for that purpose. Currently, divorced with no income at all other than dividends (which are okay, but don't pay the champagne and lobster bill), I want growth on my cash that exceeds inflation (preferably 'and then some!') and if we hit a slough in the stock market (where the rest of my money is) I'd like to take as much income that this throws off and defer selling at a loss.

You're quite certainly putting your money at risk vs a CD or short term treasuries, but both of those are ALREADY losing 2-3% a year to inflation and carry some risk/encumberance. I'd rather take my chances on doing well with it and making good money vs just standing around and taking it in the shorts.

[cute fuzzy bunny]

One other thing about the 'rewards' for joining. I can give anyone a $300 joining bonus and I think its for just putting 10k in the account, even if you don't use it. Sadly, I'd get nothing for this, but its better than the $100 or $200 that most smaller investors can offer.

Whats better is if you look for the 1.5-2% deals for larger investments. Once again, LC doesn't pay existing lenders for referrals, but if you want to sock $50k into this like I did, your first thousand bucks worth of 'oops' is on them.

I did go to somebodies web page that had the 2% link on it, but didn't see anything from LC. I emailed them and said I thought I had a referral and what was the status, and the guy just said "Eh, don't see it, but our best offer that month was 2%, so here it is".

Nice. Same guy (John Steward, and he's not impressed with "I love your comedy show" jokes) has been quite responsive to me in specific emails, usually getting back to me in hours. Very helpful.

[Nords]

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Originally Posted by fanmail 2. How easy is this to fund through an IRA? This seems very inefficient if done in a taxable account.

You'd have to find an IRA custodian that would agree to let you run this in a self-directed IRA. That's possible, yet likely to be extraordinarily painful to obtain the approval. They'd be very concerned about the legal liability of agreeing that you might be capable of managing your own money.

Ironically the IRA custodian would quickly rubber-stamp a request to put your IRA funds into an institution that invests in P2P lending.

I don't know enough about self-directed IRAs to be sure they can even invest in P2P lending. But investing in startups and real estate with a self-directed IRA is quite a hassle.

[cute fuzzy bunny]

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Originally Posted by Nords You'd have to find an IRA custodian that would agree to let you run this in a self-directed IRA. That's possible, yet likely to be extraordinarily painful to obtain the approval. They'd be very concerned about the legal liability of agreeing that you might be capable of managing your own money. Ironically the IRA custodian would quickly rubber-stamp a request to put your IRA funds into an institution that invests in P2P lending. I don't know enough about self-directed IRAs to be sure they can even invest in P2P lending. But investing in startups and real estate with a self-directed IRA is quite a hassle.

Lending club offers their own IRA's. I haven't used one, but its stupidly simple to do. They also do rollovers and the like.

https://www.lendingclub.com/public/i...ccounts.action

[haha]

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Originally Posted by cute fuzzy bunny I don't have a mortgage or car payment (even though the interest rates are appealing now) so my financial profile is so low I rarely have to pay any taxes. So my piddling little bit of LC income isn't a problem for me.

People say this around here all the time. But it makes no sense to me.

How can a single man have enough income to buy utilities, pay RE tax, eat and have a little R&R without paying tax? I've never been a particulary high earner, but I have paid taxes every year since I was 22. The only way to not pay tax is to not make any money. And somehow, that just is not hugely appealing.

Ha

[Khufu]

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Originally Posted by 67walkon I'm tiptoeing in. The initial investment was $2,500 and I plan to track it for a year or two to see how it does. If it is going okay, I might put some more in,

This is a defective strategy for identifying risks where the biggest risk is a systemic crisis or a recession, i.e. both highly destructive and rare. You might go through years of tiptoeing without encounter such an outcome. It would be like driving without seatbelts for a year. Probably nothing bad would happen, so you would conclude the risk is small. But then when a car crash does occur the effect is all out of proportion to its low frequency.

The p2p loans are not truly diversified any more than the home mortgages turned out to be in 2008. As a group they will have higher default rates during a recession.

[cute fuzzy bunny]

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Originally Posted by haha People say this around here all the time. But it makes no sense to me. How can a single man have enough income to buy utilities, pay RE tax, eat and have a little R&R without paying tax? I've never been a particulary high earner, but I have paid taxes every year since I was 22. The only way to not pay tax is to not make any money. And somehow, that just is not hugely appealing.

Glad to show you my tax returns, but its legit. After deductions, I usually pay little or no tax against no withholding. I do make an effort though, since about 90% of the money I pay in taxes is wasted on worthless crap and I'd like to spend my own money on my own worthless crap.

New tax plans next year could make it harder to do, but when half my income is qualified dividends and the other half is adjustable, its not that hard.

I live in a nice house in one of fortune magazines "50 best small towns to live in america", drive a nice car, eat good food and generally have anything any other middle to upper middle class person would, but since I carry no debt I can easily keep my taxable regular income to under $15k, plus the dividend load of roughly an equal amount. If I added in a house payment and a couple of car payments, then I'd need 50-60k and then I'd pay taxes.

[pb4uski]

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Originally Posted by haha People say this around here all the time. But it makes no sense to me. How can a single man have enough income to buy utilities, pay RE tax, eat and have a little R&R without paying tax? I've never been a particulary high earner, but I have paid taxes every year since I was 22. The only way to not pay tax is to not make any money. And somehow, that just is not hugely appealing. Ha

It would be quite easy if you are living off savings (including principal). The standard deduction for MFJ for 2012 is $11,900 and the personal exemption is $3,800 so the first $19,500 for a married couple isn't subject to income taxes.

Plus dividend and capital gains are not taxed at such low levels of income.

Add in a HSA deduction for transfer of taxable account money to a HSA and it is even higher.

[cute fuzzy bunny]

Ding ding ding! We have a winner. My fixed bills like property taxes and utilities and basic food are around 12k. I can spend another couple of grand a month and still fly below the significant taxation level. Besides I leverage the crap out of cash back, rewards and other stuff. I'm getting $585 this month from "spend xxx on your card in the next xx months" deals, just got my $300 executive bonus check from Costco (I love being paid to shop somewhere), and I use 2:1 restaurant deals out the wazoo!

My favorite fancy restaurant has a $10 off $50 from my recycling rewards, and costco sells their gift cards, $40 for a $50 card. So I can get a very nice meal for $30.

I just take money as a finite resource at this point, and a penny can be pretty well pinched without too much work. The stupidest thing you can do right now is hand over your hard earned money to the government.

Believe me Ha, life is going to be pretty good around here, but I look like a poor person from an earned income perspective...Lending Club and my last penfed cd's are my only "ordinary" source, most of the rest is dividends and capital gains.

Now, they go fooling with the tax law next year like they may, and it'd get a little uglier if they cut off the free qualified dividends and capital gains for low income investors

[haha]

Well, I said a single person. One person living alone spends quite a bit more than twice what a couple spend.

I guess the other question I have about this is how does it happen that one can perpetually live off a portfolio that is making no money? Say the allocation is 50:50. So 50% of the porfolio pays current income. It doesn't matter whether this is in a taxable account, or an IRA etc. If you are going to spend the income to live, you are going to be fully exposed to tax on what you spend from the fixed income part-either as Sched B interest, or withdrawals from retirement accounts.

If all your fixed income is taxable interest, but you supplement it by principal drawdown, you had better hope for continuously falling interest rates. Or eventually rates will turn, but you will have depleted your principle so badly that you have little money left to benefit from the rising rates.

The same principle holds for stocks. If you are always spending principle, the vagaries of the market will see to it that sooner or later you have mortally depleted the principle.

This obvious truth has been obscured by the Alice in Wonderland post 1982 markets. Most of us here have been conditioned by the rapid, Fed stimulated rises after our two 21st century setbacks, such that on an emotional level, we no longer really believe in the possibility of markets going down, and staying down.

Since Alan has appointed me official board pessimist, I will say that this does not have to be true. I am not nutty enough to make predictions, but I think the possibility that we have constructed a faulty or incomplete mental map should be considered.

I just saw CFB's post. One thing different in our situations is that I am forced to have a certain amount of income by RMDs and SS payments.

Ha

[AnilG]

Hello,

I noticed some traffic coming to my Random Thoughts blog from this forum and then saw a chart posted from one of my blog post.

I thought that I may be able to answer any questions you may have about Lending Club, my experiences and any clarification on the analysis I have done and shared through by blog posts.

Just to address question of 36 mo versus 60 mo loans, I personally do not invest in 60 month loans as none of 60 month loans have matured yet so any default rate analysis is incomplete at best. Also, the default rate for 60 month loans is higher than 36 month loans when compared on the basis of same point in maturity cycle.

Overall, I am very excited with the potential of peer to peer lending. It offers investors another asset class and opportunity to invest in consumer lending. Consumer lending has been a big money maker for banks and I don't see a reason p2p lenders can not be beneficiary from it too.

Thanks.

Anil

[cute fuzzy bunny]

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Originally Posted by haha Well, I said a single person. One person living alone spends quite a bit more than twice what a couple spend.

After jettisoning my wife, her $65k car, $300 haircuts and so forth, I have to disagree. I can live quite comfortably on less than half of what we spent during our marriage. Much less.

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I guess the other question I have about this is how does it happen that one can perpetually live off a portfolio that is making no money? Say the allocation is 50:50. So 50% of the porfolio pays current income. It doesn't matter whether this is in a taxable account, or an IRA etc. If you are going to spend the income to live, you are going to be fully exposed to tax on what you spend from the fixed income part-either as Sched B interest, or withdrawals from retirement accounts.

No bonds, and very little ordinary income in my portfolio. Its all qualified dividends, capital gains, and just enough ordinary income to sit below the taxation ceiling.

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The same principle holds for stocks. If you are always spending principle, the vagaries of the market will see to it that sooner or later you have mortally depleted the principle.

The idea is to keep a ~5 year cash buffer in front of your equities, but even without that, if the market fell by half and stayed there, I could live quite well eating my portfolio until I'm in my 80's. Then I have an expensive house I could sell, and my 77 year old dad has a paid for house and a six figure bond portfolio that I'll inherit some day. Hopefully a long time from now. And I'm eligible for social security in ten years. I'm also seriously considering some sort of part time job in a year or two, preferably one that'll give me access to cheaper health care.

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we no longer really believe in the possibility of markets going down, and staying down.

Considering we've basically gone sideways for 15 years, have near zero savings/interest rates and have spent plenty of money bailing out everyone who screwed up while doing nothing for those who have made prudent decisions, I believe in anything!

[brewer12345]

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Originally Posted by cute fuzzy bunny This is simply high grade junk investing for income. Whats the rule there? 5% spread over treasuries means buy? Sounds like I need to beat .3% for 3 year treasuries and .6% for 5 year treasuries. I think I'll do that handily.

This is most definitely *not* high grade junk. You loss given default is close enough to 100% that we might as well use that number. Recoveries on even the unsecured stuff (junk bonds) run at 30+% in the worst of times (periods of high defaults) and if you are at all sophisticated about buying junk you usually do better than that. Junk bond issuers also have to file very extensive SEC reports, so if you do your due diligence you know a lot about the issuer, its prospects, and where you stand in the line to get paid if things go poorly. Junk bonds also typically have substantial restrictive covenants which protect the bond investor (to some extent). Unsecured notes to individuals have none of this. You basically have the cushion of a fat interest rate to cover the losses, and I find the losses tough to get my arms around.

5% spread over treasuries in junk is when I start to sell, not buy.

[NW-Bound]

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Originally Posted by haha I guess the other question I have about this is how does it happen that one can perpetually live off a portfolio that is making no money? ... I just saw CFB's post. One thing different in our situations is that I am forced to have a certain amount of income by RMDs and SS payments. Ha

I don't think anybody here has claimed to live forever on a portfolio that generates no income. But of course we can delay taxes on that income for the first few years we ER.

For example, I thought of starting 72(t) withdrawal, but then realized that I had enough after-tax money to live on way past 59-1/2, the IRA withdrawal age without penalty. Still, the income generated from that after-tax money will not make up the 3.5%WR (of total portfolio) that I am aiming for. This means that I will have to live off some of my after-tax principal. Of course the principal portion that will be spent has already been taxed, and the income generated from the after-tax principal should be very lightly taxed now that I have no earned income, though I have not bothered to figure it out yet.

Eventually, I will pay more taxes when the 3.5%WR comes completely off IRAs and 401Ks. Same as you, there has never been a year in my life when I did not pay taxes. So, do not feel bad that we have figured out some magic way that eluded you.

PS. I have not thought of the tax on the RMD of the before-tax accounts, if I will be so lucky as some of the runs on FIRECalc predict. "To the right and up", as some here have said.

Oh la la! Now, it is nice to have that problem, to have the tax pain of a decamillionaire. I hope that will be true, and also that I will live so long. Thirty years is a long time (the FIRECalc default run time), yet it can pass in an eyeblink.

[cute fuzzy bunny]

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Originally Posted by brewer12345 This is most definitely *not* high grade junk.

Fund view: Junk manager Lorenz thrives on low default rate | Reuters

"According to Moody's Investors Service, default rates for "speculative grade" U .S. securities -- those that carry ratings lower than Baa3 - - stood near 3 percent on June 30, after peaking near 15 percent in 2009."

Almost the exact same default rates seen in well selected LC notes. Argue all you want, but the exposure is about the same. I held the vanguard high yield fund for quite some time and don't recall ever seeing defaulted bonds get paid, but maybe I wasn't paying a lot of attention.

Perhaps I'm an idiot, but a 17%+ return with a ~5-6% default rate seems pretty high grade to me.

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5% spread over treasuries in junk is when I start to sell, not buy.

Sounds like a personal preference, since the vast majority of investment advice is exactly what I said it was, don't buy high quality junk unless you're getting at least 5% over treasuries. I'll get somewhere between 8 and 11% over treasuries, and given a decent fund like vanguards high yield is paying less than 5% right now...tell me again why this is a bad thing?

I'm still mystified as to why everyone freezes up on the defaults. Most likely every investment everyone owns has losses built in. As long as you're outrunning the defaults, whats the problem again?

[brewer12345]

I can tell I am talking to someone who is certain, but perhaps others will benefit from a discussion.

If you go mooch around Moody's site you are likely to come up with some of their historical recovery data which will give you an idea of what junk bond investors have typically received when their bonds go into default. Hint: the most knowledgable investors I know of expect about a recovery of ~25% even on Lehman's crappy unsecured bonds. Since you didn't own individual bonds and are not deeply involved with the asset class, its not surprising that you were not aware of the range of recoveries that are typical.

I am (at times) an enthusiastic investor in all manner of risky securities, including junk bonds. In fact, when they are priced right I really like junk because I can underwrite individual credits with a reasonable degree of certainty since there is a lot of information available on most issuers. I also especially like junk bonds that have collateral or significant structural/covenant protections because they limit what the borower can do with the money the bondholders loaned them. In contrast, the P2P stuff gives you pretty scant details about the borrowers and you have absolutely no protection if they decide to walk or flake. Note that not all consumer lending is like this, even in the subprime space. Subprime auto loans were pretty solid even in the last 5 years because the loans were secured by the only means of transportation the borrowers had (Bubba needs the truck to get to work) and they had note yields of 16% or so. That translated to lower default probability, meaningful (50% or so) recoveries upon default, and big interest income to offset the inevitable losses. You only have one of these three legs of the stool with P2P.

We are also in a not-stressful (I wouldn't quite call it benign) environment for consumer credit. Most of the bad, old paper has blown up already and the sun is (mostly) shining. Given the extremely short history of P2P, the complete lack of collateral or covenants on these notes, and the limited information you have on the borrowers, there is no really good way to comfortably predict the downside risk (defaults) in the event of a recession or other speed-bump. Your 5% assumed default rate could go a lot higher in a hurry.

Now it is possible that things will be hunky dory in the land of P2P, but nobody can say that with certainty. I would not take too much confidence in the presence of institional money in the P2P space, either. Much of the hideously stupid bad behavior I see these days in the junk market is perpetrated by (drumroll, please) institutional investors. Most of the idiotic behavior in structured securities (CDO, CLOs, Subprime MBS, etc.) prior to the bust was also driven by institutional money. In fact, if I were LC I might be tempted to let the institutions cherry pick the available notes, leaving generally lower quality stuff for the retailers.

I hope that P2P lending works out for all who engage in both the borrowing and the lending, but from where I sit it looks no different from the other forms of foolish yield-chasing I see.

As for when to get in and out of junk, I think this pretty much sums up my views: Life, Investments & Everything: Dumpster Diving In The Junk Bond Market – Part 1 At the moment the main high yield spread indices are just a hair over 5% (and falling), while issuers are on a frenzy of pounding out new bonds with ever lower coupons, ever looser covenant packages, and ever higher leverage levels. I have recently seen multiple issues of junk that have little or no covenants and allow the issuer to pay scheduled coupon payments with new bonds instead of cash, using the proceeds to pay a dividend to the owners of the issuer. It does not get much dumber than that. That is your competition for P2P, and standards typically get lowered to equal levels everywhere that institutional money can flow. This is all a very clear sign to me that I want to be very, very leery of anything credit-risky with an above average stated yield.

[cute fuzzy bunny]

Clearly there are warts and risks, but I'm still waiting for someone to tell me what else I'm supposed to do with 5 years worth of cash, other than shove it in a mattress or put it in a checking account or other cash instrument paying 1% or less. Still not hearing anything.

You're also still sweating the defaults. I don't care, and I suspect that most people who have read and understood the p2p process don't either.

I'd guess that most of us own mutual funds containing bankrupt companies whose stock went to zero. No recovery there either. It seems most people don't care about that either. Must be some kind of psychological block involving the inability to offset loss with gain.

I've said several times that I expect defaults to go higher in a bad market, and I wish I had collateral on the notes. That having been said, a 200 point drop in your fico score and being denied credit for 7 years is a pretty good stick.

Should I see default rates like were experienced in 2008/2009, and are well documented...I'd still make 2-3%. Still better than anything else that isnt equities.

For what its worth, I don't really put too much into the institutional money, other than a lack of it would be something I'd wonder about. Plenty of institutions are full of stupid people. My main concern is the point you brought up about the big money getting to cherry pick and the rest of us scrambling for scraps, which is close to whats happening now. They don't get to cherry pick, but when they step in and wipe out the note inventory, its a scramble for whats left.

But back to the original point, if you're heavily invested in equities (and I am) and bonds look like a bad place to be since rates are low and when they rise it'll get ugly...and you need a cash buffer, and nobody is paying a damn thing for cash...just sit there and take it or do something about it?