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Four Thoughts on Consumer Debt Notes

by Peter Renton on October 23, 2012

This is a guest post from reader Josh Brooks. Josh enjoys talking about, studying, and investing in consumer debt notes. Between three accounts at Lending Club (9, 15, and 20 months old), he has personally hand-picked more than 4,000 consumer debt notes, and currently enjoys net annualized return of more than 16 percent in each account. You can reach Josh at 24jbrooks@gmail.com.

After much study and practical experience, I have concluded that consumer debt notes are the best investment available to small and retail investors, in terms of volatility elimination, risk reduction, and return on investment.  Four points articulate my rationale:

  1. The absence of volatility associated with investing in consumer debt notes is highly desirable, in terms of both maximizing rate of return, as well as managing the stress and anxiety of risking capital.
  2. When compared to the risk-return characteristics of some conventionally-accepted investments, it becomes obvious that consumer debt notes are the investment that offers the best return for the lowest risk.
  3. With a little internet skill, anyone can build a diversified portfolio of consumer debt notes that enjoys double digit returns.
  4. With a little more internet skill and some investing savvy, an investor can build a portfolio of diversified consumer debt notes that enjoys remarkable double digit returns.

The S&P 500 Compound Annual Growth Rates

To expand on these four points, I offer the following four figures and commentary, for your review and consideration.

Figure 1:  S&P 500 CAGR for 5, 10, 15, and 20 Years.
(http://www.moneychimp.com/features/market_cagr.htm)

Figure 1 shows the S&P 500 Compound Annual Growth Rates (CAGRs) for different intervals during the last 20 years.  Knowing what the stock market’s CAGR is and understanding what the CAGR represents does two things for us.

First, it provides us an average rate of return which we can use to compare to other investments.  For example, the worst-performing of my three Lending Club accounts enjoys a net annualized return of more than 16.00%.  Compare this to the best CAGR available in Figure 1 (7.82%), and it becomes easy to see why I have moved away from equities, toward consumer debt notes.

[Editor's note: It is important to remember that your Lending Club NAR may not reflect your real return. It is always useful to calculate your actual return on your p2p lending investments and not just rely on what Lending Club or Prosper tells you.]

Second, knowing and understanding the CAGR demonstrates the adverse effects of down years and market volatility on rate of return.  For mid- and long-term investors, down years and volatility are inherent elements of stock market investing.  Not only are these two elements very bad for a stock portfolio rate of return, but they can also be stressful to endure.  For example, after working so hard for their money, what investor likes to see an annual loss of 11.89% (2001), 22.10% (2002), or 37.00% (2008)?  Similarly, how emotionally and psychologically wearing is it to watch the stock market (and the value of an equities-based investment) bounce around, up and down, based on news and events that are most of the time completely unrelated to the equities held?  I do not enjoy either of these experiences.  As Figure 1 demonstrates, such events wreak havoc on the rate of return of an equities-based investment, and thus make the double-digit return possible with peer-to-peer lending a compelling alternative.

Along with Money Chimp, Investing Answers has an excellent CAGR calculator, which I use to experiment and learn more about the CAGR.

Comparing Prosper Notes to Corporate Bonds

Comparing notes on Prosper.com with Corporate Bonds

Figure 2:  Yield and Default Rates of Corporate Bonds and Prosper Notes
(http://blog.prosper.com/2012/09/17/august-2012-investor-monthly-update/)

I took Figure 2 from Prosper’s investor monthly update for August 2012.  As you can see, the yield of Prosper’s consumer debt notes is superior to high-yield corporate bonds by approximately seven percent.  Because yield (return) is much higher, it makes sense that default rate (risk) would be much higher as well, right?  Not so.  When compared to corporate bonds, Prosper’s consumer debt notes experience a default rate that is more comparable to B grade corporate bonds, despite offering a rate of return that dramatically exceeds even CCC grade bonds.

Based on what Figure 2 depicts, the risk/return characteristics of consumer debt notes are out of balance in the retail/small investor’s favor when compared to corporate bonds.  To say this another way:  with consumer debt notes, I can enjoy a superior return with far less risk than if I were to invest in corporate bonds or bond-based mutual funds.  Ask any competent financial advisor, and they will tell you that managing risk is one of the most important – if not the most important – aspect of a long-term wealth creation and preservation plan.

High Interest Notes at Lending Club

Figure 3:  Lending Club Net Annualized Return
(https://www.lendingclub.com/public/steady-returns.action)

The blue dots in Figure 3 depict the average net annualized return of Lending Club consumer debt notes by grade of loan.  This is an approximate rate of return that an investor can expect on a properly diversified portfolio of notes in that grade, after defaults.

As you can see, even with no critical analysis or filtration, a retail/small investor can easily earn double-digit returns (again, after defaults) by investing in lower-grade notes.  For example, when browsing for notes, I use Lending Club’s filter tool to limit my browsing to only those notes rated D5 through G5.  This shows me consumer debt notes that will pay 19.72% to 24.89% interest, which with a default rate of approximately 6.25% (for D5 grade notes) to approximately 10.50% (for G5 grade notes), should net me a pre-tax rate of return from 13.47% to 14.93%.  If you have a diversified, repeatable investment that is performing at this level (or better), please feel free to share it with me.

Analyzing the Lending Club Data

Figure 4:  Lending Club Statistics
(https://www.lendingclub.com/info/download-data.action)

Figure 4 shows the statistics page on Lending Club’s Web site.  Talk about transparency:  the complete loan data file allows any investor to download a sanitized (no personally-identifiable information), detailed list of every loan funded.  Does any debt or equity investment you have provide this level of transparency?

Using the filtration and sorting functions in Microsoft Excel, we can work this data to identify those loan characteristics which might indicate or predict a higher default rate, and then create browsing filters to exclude these loans with these negative characteristics when we invest.  By doing this, we can design a filter that further reduces the risk of default, which can result in an increase of return above 15.00% (pre-tax).

For example, my recent analysis of loan purpose using Lending Club’s CSV file revealed that small business loans have a ‘bad note’ (default, charged off, late 31-120, or payment plan) rate of 17.43%, for 60 month notes, grades D5 through G5.  In contrast, notes with the loan purposes of debt consolidation and credit card refinance have ‘bad note’ rates of 8.74% and 5.59% respectively.  Based on this analysis, if I avoid notes with the loan purpose of small business, I will experience less defaults (on both an absolute basis, as well as compared to Lending Club’s loss rate models), and thus enjoy an increased rate of return.

Does this work?  For me, the proof is in the pudding:  I currently manage three Lending Club accounts, and by applying this methodology (along with other risk reduction and return-enhancing techniques), I have been able to enjoy net annualized returns that are currently more than 16.30%, 17.70%, and 18.50%.  It is important to note that my accounts are still young (9, 15, and 20 months old), but so far, by employing this risk management, the net annualized return I enjoy is increasing (as a result of picking better, higher rate notes), instead of decreasing (as a result of defaulting notes eating into my rate of return).

In summary, investing in consumer debt notes enables me to eliminate volatility, minimize risk, and maximize return on my money invested.  I am constantly on the lookout for a better investment, and when compared with what else is available to the small and retail investor, consumer debt notes are the best option for me.

{ 45 comments… read them below or add one }

Roy S October 23, 2012 at 8:24 pm

Two quick things…

1. Please match up the rate of return with age of the age of the accounts rather than just listing both in ascending order.

2. Have your accounts gone through downturns in the market? I think it is difficult to conclusively say that the results you have received in fewer than 2 years can be extrapolated across 20 years and a few market downturns. How would a 2008-like downturn in the market (caused mainly by people who overextended themselves) affect your return, and future returns?

I think you are putting an overly positive spin on p2p lending…and this is coming from someone who is positive on the outlook of the industry.

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Bilgefisher October 24, 2012 at 7:49 am

Roy,

I tend to agree. While I think the industry has some really positive aspects, the debt is not secured and there has not been enough time to see long term trends. I have bank reserves and I have p2p reserves. I use one for liquidity while the other gets me decent returns while building for my other investments. I also have tax concerns for the future. If passive income tax increases, then p2p will lose some of its value to me.

Jason

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Josh Brooks October 24, 2012 at 5:33 pm

Roy S,

Thanks for the comments. Here are my responses:

1. 9 months – 18.50%, 15 months – 17.70%, and 21 months – 16.30%. While increased defaults do account for some drop in return as these portfolios age, I would also credit the younger portfolios with having a higher net annualized return, because I began experimenting with the techniques I mentioned about six months into my investing. For example, there are still B, C, and D grade notes in my oldest portfolio, but only D, E, and F in my youngest. For the last 45 days, I have limited that to D5 through G5 only. And again, my net annualized return keeps climbing, which indicates that the adverse effects of defaults are being outweighed by the positive effects of my risk reduction and return enhancing strategies.

2. You have a very valid point here. My two thoughts:

First, I think that our best estimate of what will happen is to look at what happened to the credit card industry during the 2001 tech bubble bust and the 2008 great recession. I would think that this would be especially helpful if you limit your note buying to credit card refinance and debt consolidation.

Speaking about credit card defaults during 2008, from: http://www.nytimes.com/2008/10/29/business/29credit.html?pagewanted=all&_r=0:

“Currently, the total losses amount to 5.5 percent of credit card debt outstanding, and could surpass the 7.9 percent level reached after the technology bubble burst in 2001.”

Assuming credit card default rates are normally around 1.5% (this is just a swag, we can find the real rate with a little research), the above numbers would equate to an additional default rate of 4.0% to 6.4%, on top of the default rate that you could normally expect.

I’m not sure that this estimate is entirely accurate or valid, but I do think that an estimate like this, which looks back at the credit card industry during 2001 and 2008, may be helpful and predictive and modeling the effects of a downturn.

Second, if I have enough warning that the economy is again collapsing and recession is at hand, I will liquidate my notes (starting with my highest risk first), and move into cash.

Any further discussion or feedback on these thoughts are appreciated. Again, thanks for reading and thanks for the comments.

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Roy S October 25, 2012 at 2:10 pm

1. Taking a quick look at Lendstats front page, the average ROI for D – G loans is between 8 and 9 percent. While still higher than the A – C grade loans, it is also half of what your current–and much younger–portfolios are returning. As with most portfolios, the older it is the lower the ROI it generally shows. It will be interesting to see whether your newer portfolios maintain a higher ROI at the 21-month mark as your older portfolio is currently performing.

2. I’m not certain whether revolving loans are comparable to installment loans. Ironically, in this recession people were making their credit card payments before their mortgage payments. Obviously, each downturn will play out differently and so it is difficult to know how these loans will actually perform.

The problem with liquidating your portfolio when the economy is going through another recession is that just about everyone else figures they’ll do the same thing…and they all realize the economy is in a downturn at about the same time. Yes, people saw the dot-com bubble and the housing bubble, but when they started to pull out so did everyone else. Right now we are seeing a commodity bubble (thanks in large part to the Fed and TARP, QE1, QE2, Operation Twist and Shout, QE3 and everything else I can’t quite remember at the moment), but I haven’t seen people pulling out yet. I am seeing another recession (not that we are actually out of this one) before the end of 2013, but I think many others are seeing it, too. The main problem is noticing AND acting before everyone else does–a very difficult task for even the most sophisticated of investors. Good luck to you!

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Josh Brooks October 27, 2012 at 4:28 am

Roy S,

Many good points in your post and responses, which I appreciate and will certainly include in the mix as I continue to learn and grow in consumer debt notes and investing in general.

With regard to your recession call, what are you seeing that makes you bearish? Similarly to your recession call, the ECRI (as well as many others) have been calling for a recession for three or more quarters, but the economy continues to limp along. Thoughts?

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Roy S October 29, 2012 at 10:18 pm

There are way too many things to list, so I’ll hit the big ones of both fiscal and monetary policies as well as government policies and regulations (federal, state and local). Basically, if we weren’t the US and if we weren’t able to print our own money, we would look a lot like Greece. (I also don’t trust a lot of the federal economic numbers, like unemployment and inflation rates)

Honestly, I’d like to see a Volcker-like recession but also with draconian fiscal spending cuts. I think that would be the preferable route. We would experience a deep but short recession. I also don’t view recessions as bad. Long, drawn out recessions/depressions are. But short ones (even short, severe ones) are not bad in the long run, nor are they unavoidable–I know everyone thought Clinton had beat the business cycle, but that is impossible. I know a lot of people think tax rate cuts are good, but spending cuts are better and then tax cuts in the form of reducing regulations is second–yes, regulations are taxes IMHO.

Basically, a recession is just a realignment of resources. What ends up happening is that generally resources are skewered towards investments with greater and greater diminishing returns. The 2008 recession was partially caused by there being a lot of housing built up in the economy. Builders were building homes at an incredibly fast pace. People kept seeing their housing prices increase because housing was “such a great investment opportunity.” Etc. What needed to happen was for those resources to be put to use somewhere else more productive in the economy (as determined by market forces). The problem is that you had a lot of people and businesses who also needed to be realigned in the economy. And what do people do when they see their jobs or their businesses disappear, they cry to the government to help them. Why do you think there are so many people constantly crying about manufacturing jobs going overseas? They can’t handle change, and they think we should still be producing typewriters so they can keep their jobs rather than them retraining and getting a different job–job loss sucks, but we can’t hold back society on account of someone losing their job. (I’d rather see more money going to retraining people rather than outright welfare, but that is my personal opinion)

With all the focus on the US presidential election, I think the big issue that no one really recognizes is that one way or another, we will be going through another recession. It doesn’t matter who you elect in terms of avoiding another recession–maybe in terms of trying to avoid another recession, but not in actually avoiding one. The question is, “How is the US going to handle going into another recession?” Are we going to go into it actively and finally let the market correct, or are we going to be dragged through it kicking and screaming. I prefer the active approach rather than the alternative that I see as a longer and more drawn out recession.

On a side note, I have heard people saying Obama has squeezed businesses so tightly that if Romney were elected that businesses are just ready to burst open like a shaken up can of soda. I don’t believe this to be the case. I think we still need to actually go through a correction first, since the government has not yet let us go through one. And I refer back to the active approach of de-leveraging, drastically cutting spending, tightening monetary policy, and getting rid of business regulations as the route to take. There is nothing more hated to politicians than a recession (…well, maybe being forced to spend less money), and I doubt either will go through all the necessary steps. One or the other might take some of the necessary steps, but I think the next recession will also be drawn out, regardless of who wins.

This is, of course, all just my personal opinion…

Reya March 15, 2013 at 5:59 pm

I agree that the spin is crazy off because of the age of the volume of loans–they do NOT reflect true default rates. Real returns over a 5 year period will be less–FAR less. I’d say half on average.

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Bryce M. October 24, 2012 at 9:11 am

“along with other risk reduction and return-enhancing techniques”

Such as selling off bad picks once you see them to a sucker in the secondary market? Or are you holding on to all your loans?

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Josh Brooks October 24, 2012 at 5:35 pm

Bryce M.,

Yes, selling notes on the secondary market is one of my risk reduction and return-enhancing techniques. Among others, I attempt to sell 31-120 late notes, and notes with irregular payment histories.

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Peter Renton October 24, 2012 at 5:02 pm

Gentlemen, Thanks for your comments. I have sent Josh a request to respond.

Roy, The one thing that is uncertain is that if we have another 2008-09 recession what impact will this have on our returns. If we look at loans issued in 2007 on Lendstats it shows a 0.1% return on this notes. Now, the underwriting model has improved significantly since then but until another recession happens we can’t know. Our returns will certainly drop, but whether it is a 2% drop or an 8% drop is unknown.

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Dan B October 24, 2012 at 6:53 pm

If my “mission statement” were to “teach the world about peer to peer lending” then I would say that this is by far the most irresponsible post regarding potential returns. Of course if that was my mission statement, I would never allow such an article on my blog.

What is even more startling is that the author seems to imply that these already inflated return numbers may even improve over time! I can suggest a few reasons why these numbers are not sustainable, but more importantly, that they are not even reflective of true ROI today.

But it is not my job to set things straight here . In my opinion it is the job of the person who allowed this article in the first place. As evidenced by most of the comments so far, most experienced observers are having little trouble detecting BS when they read it. These are my final words on this topic. .

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Peter Renton October 24, 2012 at 8:04 pm

Wow Dan, I think that is some of the harshest criticism I have had from you and that is saying something. Here is my position. I consider this an op-ed piece. I state clearly that it is not coming from me and that this is one person’s opinion. Should I censure his opinion because it happens to be very rosy? You obviously think so. I disagree.

So, I invite you to provide your own op-ed piece for the blog. As long as you adhere to certain standards of conduct (no personal attacks on any individuals) I will be happy to publish your opinions, positive or negative, as long as they further the conversation. Which is what I consider this piece did.

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Dan B October 24, 2012 at 9:01 pm

Peter……………For whatever reason you don’t seem to appreciate the difference between merely commenting about a post (which is what I’m doing right now) & providing someone a forum for publishing an article (which is what you’ve provided this author). I see no disclaimer or statement in your author intro that suggests that the authors views do not reflect your own. In fact by regurgitating the author’s claims you lend more credence & stature to his claims.

By allowing this person the ability to publish this article on your blog without at least a full disclaimer & then subsequently taking a value neutral position is in my opinion a major disservice to new investors who may not be aware that return numbers such as these are way over the top & unsustainable. It is, in my opinion, not good enough to simply state that this is someone’s “rosy opinion” & leave it at that. Not good enough at all, if one is trying to properly “teach the world about peer to peer lending”. If you can’t reflect on this & realize the error in judgement made then I don’t know what else I can say. These are definitely my last words on this.

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Peter Renton October 25, 2012 at 7:05 am

Dan, It is clear that you continue to think I lack poor judgment and that this blog provides a disservice to investors. Of course, you are entitled to your opinion and you are free to stop reading and commenting at any time.

Here is my opinion. These returns are indeed possible by any investor in Lending Club. Are his returns likely to remain this high going forward? No. Is it possible? Yes. The average interest rate on D5 through G5 notes issued by Lending Club since Jan 2011 is 20.57%. Does this mean investors should expect a 20% return? No. But I agree with the author’s point that it is not difficult to achieve a 10% by investing in those loan grades. And some investors will do much better than that.

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Dan B October 25, 2012 at 10:12 am

Peter……..Do not put words in my mouth. On the contrary, I think that on average this blog provides a tremendous service to investors. I think that it is this specific article that provides a disservice to investors by suggesting returns that are not really attainable long term.

Are these types of long term results “possible” at Lending Club? Sure, in the same sense that it is “possible” that the world will end in December of this year. Is it probable or likely? No, of course not. You disagree, yet I see no evidence from any of your Lending Cub accts. that you’ll come remotely close to these numbers long term. And if you, the “expert” aren’t achieving these numbers then why would you suspect that others can?

Yes, I think you are doing a disservice to investors by allowing the article, & a disservice by subsequently attempting to stifle criticism of it & of you. Everyone realizes that they are free to stop reading & commenting here at any time. Who knows, maybe someday you will get your wish. Your roundabout suggestion that I can leave anytime is interesting in that I can only assume that it applies to anyone else that questions your judgement. And make no mistake, I am questioning your judgement in this specific case.

I’m trying to do the right thing by pointing out unreasonable & unrealistic expectations to readers & new investors here. I am doing my small part by looking after investors’ best interests & by extension protecting the industries “flank” from criticism that expectations were set unreasonably high, unreasonably optimistic. Because, as you know, we’ve been down that unrealistic road before. If all this requires questioning your judgement on occasion & when necessary, then so be it.

Peter Renton October 25, 2012 at 2:26 pm

Dan, I certainly didn’t mean to stifle discussion – but when there is aggressive criticism of my judgment I feel the need to defend myself. I admit that sometimes I tire of the personal criticism I receive regularly from you and I don’t handle it very skillfully.

I agree I should have put more detail in my editor’s note about making sure these are real world returns. I should have added that an 18% real world return is not an achievable long term goal. And probably I should have edited the article as Ray suggests below. I accept responsibility for that.

As for my own returns my goal is to get to a 13-15% real world return that is sustainable over the long haul. I believe I am target to achieve that goal. Now, I invested my first $85,000 in p2p lending in conservative notes and only changed my strategy about 18 months ago. So, it is going to take time for me to get there.

What is lost in all of this is the main reason I agreed to run the article in the first place. That is comparing investing in p2p lending as an investment to stocks and bonds and how it compares favorably.

Roy S October 25, 2012 at 2:41 pm

@Dan, In my opinion, I think it is a great option that Peter allows people the opportunity to write for this blog. Peter made clear of this opportunity in the past (to everyone regardless of their point of view), and I believe that it is very clear that the opinions are of the author and do not necessarily reflect Peter’s views. I know people like to have these disclaimers, because without them they cannot come to that common sense conclusion on their own.

The problem I see is that the people who are drawn here are generally going to be those who have a positive view of their returns and are very optimistic about this as an investment option. I doubt very much that we will see someone come on here who has a negative return or who is overly negative. Even as negative as you sometimes get in the comments section, I have always gotten the impression you like p2p lending as an investment option.

@Peter, You need to put a disclaimer on every one one of Dan’s comments so that we know that the views expressed in his comments don’t necessarily reflect the views of this blog. ;-)

Regarding the article, I think the returns are possible. I’m not so sure about the long-term viability of receiving those returns. More than anything, what concerns me the most is people attempting to achieve the highest returns possible with less thought about the risks associated with attempting to achieve those returns.

Here are a couple of my personal opinions that may or may not reflect the view of Peter, Dan, the author of this article, other commenters, viewers and just about anyone else who may have read or just glanced at my comment (Is that a good enough disclaimer?)…

First, I think it is important to diversify between a lot of different investment options.
Second, it is important to diversify within this investment option. While I, too, have a relatively young portfolio. I have diversified within my portfolio to where I currently have some of every grade of Note at Prosper with the lowest percentage of my portfolio being AA and E notes making up 8% of my portfolio each (16% combined between the two). I am currently sitting at a 14.5% return using the XIRR function in Excel. This may change either for the better or for the worse depending on a whole lot things outside of my control.
Third, it is probably better that you diversify even between Prosper and LC–something which I admit I haven’t yet done.
Fourth, not every investment option is a good investment option for everyone. Don’t just be lured in by the returns. Recognize there is risk. Recognize your own level of risk. Different people have different risk tolerances. Recognize that it is possible (though as Dan points out, while possible it may not be probably) to lose all you money in this investment option…just like every other investment option.
Fifth, due diligence cannot be overemphasized when it comes to risking your money.

I’ll leave it at that. I think I’m only entitled to a top 5, not a top 10. ;-)

Peter Renton October 25, 2012 at 4:51 pm

Good points Roy. Your comments about risk are appropriate. If we fall off the fiscal cliff and go into a deep recession these are the notes that will be hit the hardest and who knows how far returns will go down. I am prepared to take that risk, fully aware of the consequences, but in an article like this those risks should have been stated explicitly.

Reya March 15, 2013 at 6:10 pm

Those are fake, paper returns that evaporate when the true default rates come in. They are illusory. I believe that a true return of around 11% is possible, but it is NOT possible without filtering and without leveraging principle repaid into new loans. The true average ROI on any well-picked portfolio is pretty much going to be under 12% and likely under 10%….while a loan-grade-optimized ROI is going to be under 7%, probably under 6%. Look at ONLY mature 36-mo loans on Nickel Steamroller, and you’ll see how much depends on filtering. A lot of your analysis is distorted by the heavy weighting of relative;y new loans throughout the site.

Josh Brooks October 27, 2012 at 4:38 am

So what I read here is that Peter offered Dan B the same guest post opportunity that he extended to me, and Dan B fished. It makes sense, though: it is much easier to stand on the sidelines criticizing others than it is to put your own thoughts up for discussion.

Dan B, if you do decide to man up and write a guest post, perhaps you can title it: “I’m a negative nancy, Peter is irresponsible for encouraging discussion, and you will lose your ass with P2P lending.”

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Dan B October 27, 2012 at 8:42 pm

If I had to write a guest post response to every fool who comes to the internet bragging about unsustainable & unrealistic returns then that would be a full time unpaid job. But if I did write a guest post response to Josh’s article I think I might title it something like……………”Why You Should Listen To Peter Renton’s P2P Advice & No One Else’s, Not Even Mine & Certainly Not Josh Brooks”.

Everyone here knows that I obviously don’t agree with everything Peter does or says & may even on occasion question his judgement. But I have no reason to question his honesty, competency, integrity or agenda here.

Ultimately, new investors/readers can decide for themselves whether they agree with my assessment about Peter …………….& after reading your article whether they can say the same about you Josh.

Ray October 25, 2012 at 11:20 am

@All,

I’m not going to argue, but we all know this returns aren’t sustainable or even remotely possible over the long term. 10-14% is much in the ballpark. I remember when I had 26% returns with 500+ loans and then as they matured that quickly dropped to 13% range.

Lots of “stuff” in the guest post, but the author left out some information.
“Hand picked 4,000 loans”. Is this the loans in the 3 portfolios? Which is the amount of loans in each of the portfolios? Unless I missed something this is very important information. Is it 100 in one, 1000 in another and 2,900 in the last?

The line I dislike the worst is this one:
“Does this work? For me, the proof is in the pudding: I currently manage three Lending Club accounts, and by applying this methodology (along with other risk reduction and return-enhancing techniques), I have been able to enjoy net annualized returns that are currently more than 16.30%, 17.70%, and 18.50%. It is important to note that my accounts are still young (9, 15, and 20 months old), but so far, by employing this risk management, the net annualized return I enjoy is increasing (as a result of picking better, higher rate notes), instead of decreasing (as a result of defaulting notes eating into my rate of return).”

The author is basically claiming his rates are going up and will continue to go up.
Come update us in a year when all your rates are down and your article is proven to be incorrect.

What you should have stated is something along these lines:
I hope to be able to maintain my current rates of return, but I doubt that I will be able to maintain my increasing rates as the accounts age, but I will keep everyone informed. I would not put all your eggs in one basket, but P2P is here to stay and grow, and high rates of return can be obtained, but over the long haul, that actual rate is yet to be derived.

Hey, what’s another day without some disagreement.

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Peter Renton October 25, 2012 at 2:31 pm

Ray, Point taken. In hindsight I should have made a more detailed editor’s note about this section. I will make a point to invite the author to do a follow up article in 12 months so we can see how his returns are holding up.

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Josh Brooks October 27, 2012 at 4:44 am

Ray,

Thanks for the honest input. After reading your post – specifically those excerpts that you quote back to us – I realize that my writing is a little sensational, and more value-laden than I intended. I will focus on improving this in my future writing projects.

Additionally, based on your comments, I have put a reminder on my calendar, to provide an update in twelve months. By doing this, we can let time arbitrate the disagreement.

Again, thank you for the meaningful feedback.

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Rastas October 25, 2012 at 2:24 pm

Dan….what you need to put in your mouth is a cocktail and Chillax. Look forward to reading your Op-Ed. Do the work.

Peter…keep up the great job! Your site continues to be a resource and add value to the world unlike many others who just pontificate with envy.

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Roy S October 25, 2012 at 2:50 pm

Best comment so far! I think Dan usually makes valid points (even when we disagree), but (as I’ve said before) he generally doesn’t phrase what he says in the most receptive way. He is too blunt, provocative and antagonistic. A little tact can go a long way. Instead his good points get lost in the argument that ensues.

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Dan B October 25, 2012 at 2:57 pm

Or perhaps it is because I choose to be deliberately blunt, provocative and antagonistic.

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Roy S October 25, 2012 at 3:19 pm

I’m sure it is deliberate. I’m just saying that it is also unfortunate.

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Dan B October 25, 2012 at 9:54 pm

Roy S……….For the record, I doubt you have any idea as to my motivations. But regardless of that, you’re supposed to be on my side Roy! Somewhere around here I have a screen capture of a post you wrote which states something to the effect that I, Dan B, am always right. You’re not by any chance doing a flip flop on that, are you? :)

Dan B October 25, 2012 at 2:54 pm

Rastas………..Is this your first post here? How charming. I can see you are going to be a real asset here.

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Josh Brooks October 27, 2012 at 4:46 am

Here, here. Well said, Rastas.

Dan chills, and Peter continues to provide this very valuable service. This has my vote as best reply.

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Rastas October 25, 2012 at 3:00 pm

Dan….I personally have $2 million+ in Lending Club and Prosper with Net returns in excess of 12%. (This includes 20% A grade)…….Happy to “school you” anytime.

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Dan B October 25, 2012 at 3:04 pm

And my returns are in excess of 15% at LC after 3 years. Sounds like you should take classes from me.

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Peter Renton October 25, 2012 at 4:40 pm

Rastas/Dan, Comparing your oversize…returns…isn’t furthering the conversation. And Dan this is why I am in complete agreement with Roy. Your antagonistic approach is polarizing and unnecessary. And worst of all, as Roy says, because of it your good points get lost in the argument that ensues.

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Dan October 25, 2012 at 6:35 pm

Just some thoughts. Years ago, my economics teacher always told me, “the greater the risk, the greater the reward”. Another tidbit was, try to “invest” in a growing company. Lending Club meets that criteria. After 14 months, my wife is currently earning 9.8% with her Roth IRA. Withdrawls are tax free. My IRA is at 10.17%. I’m thrilled to death with these results. These results were based on filters utilizing common sense such as good FICO scores, length of employment, length of credit history, debt to income ratio and many others. I give a ton of creedence to FICO scores. The fact that insurance companies use them to give you the best rate and perspective employers use them for hiring is a telltale sign of their importance! The facts are, that people with GOOD FICO scores have proven themselves to be reliable when it comes to a lot of issues. While there is still some uncertainty regarding the economic situation until after the election, Lending Club is on the verge of exploding with growth. To me, this is a “no brainer” win win situation for investors. Thanks for letting me throw in my 2 cents worth.

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Josh Brooks October 27, 2012 at 4:53 am

Glad to hear that you have found an investment that is right for you, Dan.

One word of caution: using Lending Club’s CSV file, I analyzed 60-month notes, grade D5-G5, and found no meaningful difference in the ‘bad note’ (default, charged off, payment plan, late 31-120) rate between notes of different FICO scores. That is, with regard to a certain FICO score predicting or correlating to a certain default rate, it isn’t happening on Lending Club for 60-month notes, grade D5-G5.

Better predictors of default include loan purpose (I avoid small business and education), inquiries in the last 6 months (I use two or less), and delinquencies in the last 2 years (I use zero).

Thanks for the reply, and happy investing.

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PeerLend October 25, 2012 at 10:44 pm

My only real takeaway from this article and discussion is that so many people are figuring out that you can juice your LC returns by selling non-performing loans (which appear to the buyer to be performing – nice one, LendingClub!) that that “technique” probably won’t work for long…

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Josh Brooks October 27, 2012 at 5:05 am

PeerLend,

I don’t know what their strategy is, but there is one or more investors out there that will consistently buy a note that is 115 days late for $2.00 or $2.25. Are they counting on a certain percentage of successful collections?

For example, an investor can buy ten 90+ day late notes for $22.50. If 30% are successfully collected, and 50% of ($20.00 for this estimate) principal is returned to the investor, a profit-making method could be realized.

10 notes x $20.00 principal x 30% collection x 50% principal returned = $30.00

If anyone knows more about this, I sure would like to understand it.

In either case, between P&I collected before the note went bad, and the $2.00 or $2.50 I can get on the secondary market just before it defaults, I can recoup about 25% of my initial investment. Obviously, this is not fun or profitable, but it beats just letting the note default.

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Julie October 29, 2012 at 8:31 am

Hi Everyone,

I appreciate Josh’s guest post and as usual, I try to read through the comments, because I think that is one of the best things about blog posts. So, all the women in the room stopped reading around 9:01pm (Dan’s second comment) and presumed their p2p activities with the enlightenment that took you gentlemen and your male egos a few more hours to work through.

By the way, I’m not a feminist at all, just cognizant of the differences between the sexes, especially in the ways in which we deal with finances.

I wish investors could filter for gender on LC and Prosper. I think it would be interesting to compare return rates based on gender.

Happy Investing,
Julie

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Dan B October 29, 2012 at 10:06 am

Your post is my favorite so far, as I found it extremely educational. So you feel comfortable speaking for “all the women in the room”, yet you’re “not a feminist at all”.
I can only speak for myself of course, but I want to thank you for educating me, because up until this moment I thought that speaking for “all the women in the room” (or the planet for that matter), was precisely what the vast majority of feminists do. So again, thanks for setting me straight. :)

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Mia November 3, 2012 at 7:47 pm

I’m a woman, and a feminist, and Julie doesn’t speak for me. This woman has read and enjoyed all the comments and believes Dan’s bluntness provides an important service. (This woman is not affiliated with Dan and this message was not approved by anyone.)

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Reya March 15, 2013 at 6:25 pm

Good grief. Not me either.

I think she actually flipped her hair and stomped her foot while writing that.

Sheesh. Sorry, Julie, I actually think about what people say. And sorry, but Dan’s right on this one.

Peter’s blog is great, but I think he gets swept up in enthusiasm and in hype sometimes.

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Roy S October 29, 2012 at 9:39 pm

I don’t think that is possible, Julie. I don’t know the practices of acquiring sex related info, but the Fair Lending Act does not allow discrimination based on sex. So, I’m assuming LC and Prosper will never reveal that information or in any way make it seem as though they are in violation of the Fair Lending Act. I think it would be interesting to compare return rates on a number of factors that may in fact be illegal to discriminate on the basis of, but I would assume higher default rates among certain demographic groups.

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Peter Renton October 29, 2012 at 11:17 am

While it is fine for us to have some disagreements I always appreciate it when these conversations maintain a professional tone. Some of these comments are clearly not doing that.

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Reya March 15, 2013 at 6:19 pm

With modeling, you can see what happens over time. If you have a single lump-sum investment and invest it at once and then reinvest the proceeds, you end up getting a really absurdly high return the third year before the last of first set of the loans come due, and then it drops precipitously, almost by a third. So even someone really stinks at this p2p lending, their third year is still going to look pretty decent if they start with a lump sum, and they’ll think they are brilliant, and then they won’t understand what “happened” in the 4th year. Nothing did–the loans were just full mature, is all!

If you don’t get at least 15% returns in the 3rd year after a lump-sum investment, your true ROI over time isn’t going to be in the double-digits at all.

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