This is the second guest post from long time reader, Josh Brooks. His first post was one year ago and here he provides an update on his Lending Club portfolios as well as some more discussion points.
One year ago, Peter was nice enough to let me submit a guest post titled Four Thoughts on Consumer Debt Notes. That post generated a lot of good discussion and debate from Lend Academy readers. One point offered was that the rates of return I presented were characteristic of young portfolios, and were not sustainable. It was suggested that I provide an update in one year, so here it is.
We (my wife and I) still have three Lending Club accounts (that I manage): one regular account, her Roth IRA, and my Roth IRA.
Note: Lending Club’s Net Annualized Return (NAR) calculation accurately reflects my own internal Rate of Return (RoR) calculations, and is therefore, I think, an accurate metric for measuring investment effectiveness for the purposes of this post.
|LC NAR Oct 2012||LC NAR Oct 2013||Account Age||Average Note Age|
|Regular Account||16.3%||15.6%||32 mths||12.9 mths|
|Wife's IRA||18.5%||17.8%||21 mths||8.0 mths|
|Josh's IRA||17.7%||16.5%||27 mths||12.2 mths|
As you can see, the NAR decayed over the last year by 0.7%, 0.7%, and 1.2% respectively, but remains above 15% in all three accounts. This decay in NAR is in all likelihood the result of an increase in the total number of defaulted notes in the portfolio (as the portfolio ages, the total number of defaulted notes will increase, even if the default rate remains the same). Also, using the portfolio analysis tool at Nickel Steamroller, we can see that my three portfolios are still young, so further NAR decay can be expected. However, assuming a NAR decay of 1.0% per year, I still believe that a long-term, stabilized NAR of 13.0% or 13.5% is possible.
Four More Thoughts on Prime Consumer Notes
In addition to an update on my portfolio, I wanted to also offer the following thoughts, for readers’ consideration:
1. I have stopped selling very late notes on the secondary market as a way to mitigate losses from defaults. I made this change for at least two reasons. First, it is labor intensive to identify, list, price, and track defaulting notes, and it essentially makes investing in prime consumer notes through Lending Club an active (not passive) investment activity. Further on this point, there is nothing more frustrating than listing a very late note at a deep discount, having it come current, and then having that now current note sell for a fraction of its value.
Second, forcing myself to spend twenty or thirty minutes every other day or so focusing on all of my defaulting notes was having an adverse effect on my perception of prime consumer note investing. Instead of dwelling on the negative, I would prefer instead to focus on the positive by watching my account value grow and calculating my RoR.
I know it sounds simple, but if I enjoy something, I will continue to do it. In contrast, if I dread logging into Lending Club because I make myself wade through all of my defaulting notes every other day, I am likely to delay, defer, and neglect my Lending Club investing activity.
2. I credit what success I am having with investing in Lending Club prime consumer notes to my development of a good filter. If you don’t have a good filter that is effective in screening out those notes most likely to default, I would strongly encourage you to develop, borrow, or buy one. I used the CSV data file published by Lending Club to develop mine, and credit it for my high NAR and relatively low default rate.
3. Similarly, to get the best notes, I am logging four times each day, to get a shot at notes as soon as they are listed. It is amazing to see a $35,000 loan get fully funded in less than one minute. If the big money is that confident in that loan (because they have a good filter, and that loan meets the statistically-supported criteria of that filter), I want to get my $25 of action as well. To do that, I have to be there to buy as soon as they are listed.
4. While I am certainly not a tax expert or an economist, I have found that the post-tax, post-inflation RoR is one helpful way to conceptualize Lending Club prime consumer notes as a perpetual INCOME STREAM investment. For example, assuming that you can earn a 13% Lending Club NAR, are in the 28% income tax bracket, and have 3.5% inflation, you could realize a 5.86% RoR (post-tax, post-inflation) perpetual INCOME STREAM:
13% LC NAR – 28% Income Tax – 3.5% Inflation = 5.86% Perpetual INCOME STREAM
[Editor’s note: a 13% real world return is an aggressive goal and may only be achievable long term to the very top investors.]
In this example, a Lending Club prime consumer notes portfolio could throw off 5.86% of usable income, after taxes are paid, after 3.5% of the interest is re-invested to grow the account to adjust for inflation. And because the account would be growing to keep up with inflation, no loss of purchasing power would occur (which is a common risk when investing in debt). Finally, since the principal is not getting touched (but is in fact being grown to keep up with inflation), this portfolio becomes a perpetual source of income.
In summary, I still find great value in investing in Lending Club prime consumer notes. It is still my highest yielding semi-passive investment, in addition to having very low volatility and very high diversification ($25 notes per loan spread out over hundreds/thousands of loans).
Thanks to Peter for letting me post again. If it pleases Peter and the group, I will be back in October 2014 with another update. Until then, please share your comments below or if you have a specific question you can email me directly at email@example.com. Thank you.