Recently, the first Lendingclub default appeared in my account. It may not be a big deal at first, but considering that I have a second loan more than 30 days over due things are starting to get ugly. A single loan default in my portfolio of 134 notes represents only 0.86% of my net annualized return, but if you add a second one we are talking about 1.72% hit, which means that my portfolio currently yielding at 9.33% can go down to 7.61%, not a good thing.
This is how my 134 notes are currently distributed:
- 124 Issued & Current
- 8 Fully Paid
- 1 Late 31-120 days
- 1 Default (already charged off)
This first default was from a guy who requested $8,000 for “vacation.” I never make loans for “vacation”, but I made an exception with this loan because the candidate was rated A5, so on paper everything looked good, surprisingly though he became my first default. After 3 completed payments the borrower disappeared, Lendingclub tried to collect the money for 5 months and finally charged off on January 3 claiming that the borrower couldn’t be located anymore.
My motivation to invest in Lendingclub was to help other people through financial difficulties, it is my way to help underprivileged Americans to get their head above water. In this case, I assume the borrower had a legitimate reason to default. In his original listing he said he needed the money to visit his mother, pay some debts and help his family. He also said part of the money will be used to pay for his mother’s medical expenses. I am glad my money was put in good use, even if it wasn’t returned. So as long as that was the real reason for this default, I don’t really care about it, no one is immune to bad things in life. According to the original listing in Lendingclub he worked for 4 years at Shelly’s Big City, a restaurant in Manhattan that was closed in 2011. Most likely a lost job was the cause of this default. After all he lost his job in one of the hardest hit industries in the nation: the restaurant industry.
Anyone regardless of his or her credit score can become the first default in your portfolio, so it is always a good idea to implement some good practices that can help protect your investment. I implemented a suited of changes after this default to make sure my investment choices are on track and good standing.
- Allocate my portfolio to low risk borrowers, 84.8% of my portfolio is allocated to premium borrowers (A & B) with credit scores above 679.
- I use filters to select my loans. This is a wonderful tool in Lendingclub that can help you to select qualified borrowers who meet criteria that are important to you. I have 8 different filters on my account that I use based on what I’m looking for. I won’t describe each screen, but the following things are fairly common among them:
- Inquires in the last 6 months: 1, I don’t want to lend to people that have been shopping around for other loans in previous months, if they have applied several times to different loans it could be a sign that they may have a more serious trouble.
- Home ownership is mortgage. I like to lend to people with stability. Generally people who have a mortgage can’t get away with your money as easily as people with no real estate attachments. A borrower that defaulted on my account had no real estate property, he was renting. A property can also act as collateral for me, if people are really in financial trouble they can always sell or take out a home equity loan, sometimes with better terms that other kind of loans.
- Minimum length of employment: 2 years. I like people with stability, people who move constantly from job to job may have difficulties establishing long-term relationships and that can be challenging in tough times. I like to loan to people that have been at the same company longer than 2 years, especially if the company is publicly known. I avoid borrowers working for “Peter & John Associates” or similar companies that nobody knows.
- Credit Score above 679. Even though I have lend to some people with lower scores that is just probably less that 2% of my portfolio. A low credit score is always a bad sign. If I lend to someone with a low credit score is because I see clear signs that they want to get out of trouble, eg. have a steady job and a mortgage. Otherwise these loans are very risky. I don’t recommend having more than 5% of your portfolio in loans to people with low credit scores.
- Loan purpose: refinancing. I honestly believe credit cards are a ripoff, anything above 10% interest doesn’t make sense to me, some cards can charge almost 30% interest based on your credit score. I only use credit cards to redeem points for traveling or purchases, but I pay the balance off every month. That’s why I always prefer to lend to people that want to consolidate their debts, if they realize that dealing with banks is not the smartest thing, I like to help in the process. When banks realized they can be avoided they will rethink what they are doing. Lending club is a new way to fight these financial corporate abuses probably more effective than spending nights at Zuccotti Park. Let’s lend money among ourselves and see what happen.
- No public records. I don’t think this point needs much explanation, but I don’t want lend to people that have been charged with any kind of illegal activity or wrong behavior in the past.
- Months since last delinquency: 24 months. As I said before no one is immune to bad things in life. For one reason or another you may find yourself in trouble. So no defaults are not important for me, but if someone has defaulted I want to see clear sign that the are moving in the right direction now.
- Revolving credit utilization less than 35%. For me it isn’t important how much credit available people have, what is important is how much of their available credit they have used. I don’t want people whose revolving credit has been used 50% or more. This is a clear sign of mismanagement and lack of responsibility. When people reach this level of debt, it means something is going wrong.
- Get rid of bad loans before they default.Before your loans go bad you can get rid of them through the trading platform, this is the safest way to avoid defaults in your account. When you use Lending Club’s trading platform you will be able to see if the credit score of your borrowers have improved or deteriorated. If any of the credit scores in my portfolio have deteriorated, I sell them at a nice discount on the trading platform. I usually give 4% discount on these loans, which allows me to sell the note at the same price of my original investment (par value) or a little bit above. For example I have an original loan of $25 at 36 months, the borrower had made 11 payments for a total of $8.91 ($0.81 each payment for 11 months, including capital and interests). The outstanding principal balance on this case is $19.12 because the payment to capital have been only $5.88 and the rest have been interest $3.03. If I’m able to sell the loan I get to keep those $3.03 I have collected already of interest. To setup your asking price consider the interest accrued to date when you are selling the loan, the Lendingclub trading platform gives you this number so you don’t need to worry about that.The par price to sell this loan would be $19.3; $19.12 outstanding capital + $0.18 accrued interest to date. Because I want to get rid of this risky loan I discount 4% of its price, so the final price I offered is $18.50. If I get to sell the loan for that amount my final income would be $27.41 ($18.50 final price + $8.81 already received), in other words I would be making $2.41 or 9.64% of my original investment, of course much less than the original 15.99% promised but at least I’m taking the risk off my shoulders. You also need to consider than Lendingclub will charge you 1% for the transaction so keep that in mind as well. For me is an excellent trade off, I can secure my profits while getting rid of a very risky loan. By doing this on a regular basis you can keep only premium borrowers in your account minimizing the risk of default.Just keep these simple tips in mind and you will protect your Lendingclub account from default.
All my articles are based on value investing advice. If you enjoyed this post, please consider joining my mailing list below. NO SPAM, NO DATA SHARING. You can also follow me at Covestor where you can replicate my trades and track the performance of my model portfolio against the S&P 500.