A Guide to Investing on Lending Club with FOLIOfn

Today we have a guest post from Sarah V., who lives in Cambridge, Massachusetts. She is only able to invest in Lending Club through the Folio platform something she has been doing for about eight months. She manages her own investments, does her own taxes with paper and pencil, and has had an interest in investing since she was a kid. She is a regular contributor on the Lend Academy forum.

Much has been written about Lending Club – statistical analysis, strategies, and the like. But some of us are living out in the wilderness, in “trading only” states where you can invest via FOLIOfn but not the Lending Club retail platform. If you’re in one of those states, this blog post is for you! [Editor’s note: the purple states in the map below are the Folio-only states.]

States Open to Lending Club Investors

I’ll put it bluntly: the FOLIOfn interface is terrible. It’s slow, and it’s missing an enormous amount of features it really should have. But it’s not impossible to use and sometimes, if you’re savvy enough, you can even use its clunkiness to your advantage.

Buying notes on Folio

There are a few schools of thought on how to use the FOLIOfn platform to buy notes:

  • Sort by markup/discount, thus finding the best deals.
  • Sort by yield to maturity to get the best bang for your buck. (Note: this option has recently been removed, but will hopefully come back soon.)
  • Simulate the retail platform experience by purchasing newly-issued notes, which you can find by clicking both the “Now Current” and “Never Late” notes and sorting by Loan ID number or Note ID number (highest first).
  • If you have a higher appetite for risk and you’re a very hands-on investor, you can make a lot of money by buying and selling distressed notes, heavily discounted notes, and late or grace-period notes.

The problem comes in when you realize that almost every note on FOLIOfn is there because someone decided they didn’t like it. Usually there is a reason they didn’t want it, and often that reason means you don’t want it either. This results in a lot of lousy notes that you have to look through to find the good ones. Here are a few things to look out for on the “Loan Performance” page:

  • Notes that are in the midst of processing a payment: “Processing” notes that are heavily discounted are usually about to be late. Don’t buy those without knowing what you’re getting into. There’s also a chance that the payment will arrive right after you purchase the processing note, and the sale will be canceled.
  • Notes where the FICO has dropped precipitously: FOLIOfn uses an up/down/straight arrow system, but does not tell you if the FICO has dropped 5 points or 200 points unless you open the loan performance page and open the FICO chart. A large drop may be a sign that something is going to go wrong. Sometimes these notes turn out fine, but you should probably be paying a discounted price for these, if you are willing to buy them. On the other hand, you can sometimes get a deal on something with a very small FICO drop, because many investors skip over anything with a down arrow.
  • Notes that have worrying comments beneath the payment history: Comments beneath the payment history are usually a bad sign – either a payment has failed, or someone is declaring bankruptcy, or they are going on a payment plan. Again, don’t buy those unless you are getting a discount appropriate to the severity of the comment.

Selling notes on Folio

Now, let’s talk about the other side of things: selling notes. The trick to successful note-selling is to think like a buyer. Ask yourself: how would a buyer find this note? Try to look for it yourself and see if you can find it by any common methods (sort by high yield, low markup, etc.). If someone has to go through forty pages of notes to find yours, it’s probably not going to sell. Usually the only thing you can do to make it sell faster is to lower the price. That will make it go closer to the top of both the high-yield and low-markup sorting methods.

I find that higher-interest-rate notes sell a lot faster than low-interest-rate notes. If you are investing in conservative A and B grade notes, your investments will be extremely illiquid unless you are willing to lose money when you sell them. If you are selling D-E-F grade notes you could probably get most of your money out in a couple of weeks without losing anything.

An new alternative for Folio investors

Recently I have started using InterestRadar.com, which has a FOLIOfn search option on the Analysis page. I can’t recommend this enough for FOLIOfn investors – it’s a huge time-saver! It will allow you to try out complex, granular investing filters just like the retail platform. It also allows you to pick out real gems that would otherwise be near-impossible to find via the sorting on the FOLIOfn interface. One strategy I like that is much easier on Interest Radar is filtering for notes that have a proven payment history of two or three months, which weeds out all of the scammers who signed up for a loan and then immediately declared bankruptcy or ran off with the cash.

If you decide to use the filters on Interest Radar, try making several of them that don’t overlap – otherwise you will have to look through the same notes more than once. I have an “ideal notes” filter for the best of the best, which rarely turns up anything (but if it does, I want it badly!) and a “second best” filter for notes which meet my standards but aren’t quite as good as the other filter. This way if I have a limited amount of money to spend, I know I will see the best notes first.

One last tip: your returns in a buy-and-hold strategy will probably be a little lower than the same strategy on the retail platform. You will often pay a small premium on the best notes, or you will buy them a couple of months old, after the highest interest payments were already paid. If you buy the highest-grade A notes, you may well end up with a mere 1-2% annual return, which could be easily wiped out with a few defaults and taxes (if you’re not investing within an IRA). You don’t have to go for the riskiest notes, but you should probably avoid single-digit interest rates if you are investing solely on FOLIOfn.

Have you got any other tips or cautions for FOLIOfn investors? Let’s hear about them in the comments!

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Drew Withers
Jan. 11, 2013 10:51 am

For those interested, http://www.prosper-stats.com has a similar feature that is still in beta for browsing folio notes using the same filters you use for Prosper loan filtering. Unfortunately there is no option to filter out notes you already own, so you have to search the original listing for your username in the list of lenders to make sure you don’t double up on the same loan.

Jan. 11, 2013 12:31 pm

So, on “In Processing” notes, which you say may or may not “about to be late” – can you provide more color on that, with respect to how that works on both the buy and sell side?

Jan. 11, 2013 12:54 pm
Reply to  Peerlend

There’s been a lot of talk on the forums about the specifics of that – notes SHOULD be in processing for four business days. E.g., every note with a payment date of January 7th should be marked “completed” by the end of today. They don’t get marked down to “grace period” until the next business day. So if payment was supposed to be completed today, but it didn’t complete, it will continue showing “processing” all weekend. The seller may notice that it didn’t pay today and discount it over the weekend in hopes someone will pick it up without realizing what’s going on. The buyer is privy to the exact same information as the seller, but they may not be paying as close attention to the dates.

This can get more complicated with holidays and weekends and the like, so unless you are really on top of things, I usually suggest skipping the “processing” notes altogether.

Of course you might still want to buy these notes at sufficiently deep discounts, but it’s important to know when you may be buying something in grace period and not getting an amazing deal on a never-late, high-quality note.

Jan. 11, 2013 1:16 pm

Thanks. So, if I understand you correctly, the mechanics work such that if an “in processing” note happens to complete its payment, beyond the usual 4 day ACH window, that the sale is cancelled and the seller retains the note. But that if payment ultimately does NOT complete, the transaction is honored and the buyer winds up with a note that is now >1 days past due?

So, the behavior you’re seeing in the market is such that sellers monitor their “In Processing” notes for not flipping to “Completed” within 4 business days – knowing that the loans will not update to a status of >1 dpd until, say, business day six – and put these loans up for sale on Folio during this brief window? (With the implicit mechanism that – if the payment does happen to complete [*any idea what determines 4 vs 6 day completion*?], their sale of the note will be voided – but that if the loan flips to a late state, they’ve sold it, and it’s now the problem of the buyer.)

And you’re saying that there’s no information asymmetry and/or misclassification of note state because during this 2 day window both selling and buying party can measure “days in processing” (by looking at the payment date) and determine that the note is, essentially, in a “limbo” period where it could – and usually does – flip to being late. Is that correct?

Jan. 11, 2013 1:26 pm
Reply to  Peerlend

That’s exactly right.

I’m not sure if this is behavior exhibited 100% of the time – it’s possible a payment occasionally takes one extra day to complete, for example – but this is what I’ve observed.

Jan. 11, 2013 4:02 pm
Reply to  SarahV

Is there any indication anywhere which would alert buyers to the existence of this “limbo” period and/or necessity to measure days in processing to insure against buying lemons?

Or is it purely “learn by being burned”? (Is that how you learned of this particular issue?)

Jan. 11, 2013 5:33 pm
Reply to  Peerlend

I just learned by watching what happened to notes when payments came in. On days when I needed just one or two more dollars to come in before I could buy a new loan, I’d be waiting for the cash to come in and then notice that one loan didn’t pay today when all the other ones of the same date did. Then the next day that same loan would be in grace period. And then when buying, if you’re sorting by markup/discount with “never late” checked, the most discounted notes always have the same number of days since payment, and it’s always right around 30 days. Those are the “about to be late” notes.

Jan. 11, 2013 6:18 pm
Reply to  SarahV

Nice. So, you check “NEVER LATE”, and look for notes with around 30 days since last payment – and that’s how you find notes that are, in reality, “LATE”.

Sounds totally fair! 🙂 Thanks for posting.

Jan. 11, 2013 3:13 pm

I also made a post on this as I’m a serial buyer >2000 notes in the past year. I’ll remove the ones Sarah already mentioned and some of these might be a little dated since I wrote this a while ago

*Although the FAQ says that the cutoff time on the same day 11am PST for settling the notes. Based on my experience the cutoff time is more like 7am PST if not earlier.

Due to the lack of adequate filters, you will need to wade through scores of bad notes. I will detail the ones to avoid unless they are severely discounted:

*Notes where Days Since Payment is “—” or over 27 days. There is a flaw in the system where if the payment arrives before settlement, the note goes back to the seller. So if the payment fails or the borrower decides to stop paying, guess who ends up with the note? YOU DO. Do not get tricked into this HEADS the seller wins and TAILS you eat a bad loan scenario.

*Anything where payment received is today and it is between 1-3pm PST. That is when most ACH payments are starting to trickle in. The payment has come in but the note information does not get updated properly. This usually results in the note suddenly looking cheap. What will happen is you will get refunded your money and note returns to the seller. You end up with money that didn’t do anything for a day.

*Notes under $5 in remaining principal. I fell for this one a couple times because the notes were slightly discounted and it was a certainty that the borrower would pay. But remember when the principal they owe is reduced, the amount of interest does as well. No matter what, Lending Club will take their 0.01. At $5 and under, almost all the interest accrued for the month will go to Lending Club.

Always go into the loan for details. There are current notes that have COLLECTION LOG for missed payments. And there are current notes where the borrower is habitually in grace period.

Speed matters. This is first come first serve so the best priced loans don’t last more than 15 seconds. I’ve seen perfectly good notes drop for 30+% discount twice already in the past 2 weeks. So training the eye to do quick due diligence and make a snap decision is needed.

Jan. 12, 2013 11:33 am
Reply to  MichaelS

“*Notes where Days Since Payment is “—” or over 27 days. There is a flaw in the system where if the payment arrives before settlement, the note goes back to the seller. So if the payment fails or the borrower decides to stop paying, guess who ends up with the note? YOU DO. Do not get tricked into this HEADS the seller wins and TAILS you eat a bad loan scenario.”

That’s not a flaw, that’s the way it should work. The note is owned by the seller until settlement. If new information comes in prior to settlement, it is appropriate to reprice the note. The buyer needs to decide if the note is priced fairly assuming the note will go to grace period. If the buyer decides yes, then they reap the reward if a payment does come in – after the settlement date.

Jan. 12, 2013 2:09 pm
Reply to  flyp52

This is true, so far as it goes – but it assumes that all buyers know the esoteric and non-explicit “rules” that apply specially to “NEVER LATE” yet “In Processing” notes, which Sarah and others happen to have learned – and been kind enough to share…

These – having different (non-transparent) risk characteristic than “NEVER LATE” / “LATE” – are desperately in need their own “state” to reflect their actual character…

I dare say it’s disingenuous to continue to allow these to be marked NEVER LATE – or, alternately, to continue to allow these to be sold while in this “questionable” state.

Larry Ventura
Larry Ventura
Jan. 11, 2013 4:42 pm

Nice write up Sarah

Henry Miller
Henry Miller
Jan. 12, 2013 9:20 am

I am currently buying notes for resale on Folio. My model is to arbitrage the gap between states with a primary market and states that are only secondary Folio market. I buy D to G, hold for 3 months to get some high interest payments, and sell at about a 1% market to cover transaction fees. I expect about 1/3 of profits will cover for the infrequent loan going bad within 3 months. Net yield about 10%. Not serious money but it will pay for a few meals out a week; better than the bank savings account interest rates – which guarantee a loss after inflation is factored in. The note buyer pays a tiny premium for being in the prohibited states; but still has good prospects. Ultra low interest rates penalize prudent savers; Folio, clunky as it is, offers buyers one small escape from low interest rates.

Matthew Allen
Jan. 12, 2013 10:43 pm

I also live in a state (MI) that only allows me to participate through the note trading platform. I personally like it better than the retail platform. If you’re careful, you can score some notes at great bargain prices. I disagree that expected return rates should be a percent or two lower as compared to the retail platform. I’m two and a half months in now with a current NAR of 21.97%.

I did learn a thing or two from this post. Thanks Sarah!

Peter – where did you get that states graphic, the same one as in your book. Is it yours? I would love to use it for a post on my blog soon when I write about my Foliofn strategy.

Jim Burke
Jim Burke
May. 23, 2013 9:56 am

Peter, Your map lists Maine as a state that has access to LC’s fresh loan platform. That was probably the case in January of 2013, but it isn’t now. I live in Maine, and last week LC denied me access for that reason. I can have foliofn access if I want it.

James Wood
James Wood
Apr. 2, 2014 11:09 am

“If you have a higher appetite for risk and you’re a very hands-on investor, you can make a lot of money by buying and selling distressed notes, heavily discounted notes, and late or grace-period notes.”

I would like more information on this strategy. Many people will attempt to dump non-preforming loans, sometimes below what I *estimate the loan to be worth. However, I have questions regarding how to value distressed loans and what happens if one of them goes to collections and then actually starts paying off. Basically, I am trying to figure out how much these loans should be discounted to 1) break even and 2) profit from given the increased risk.

The one thing I am certain of, is that the discount should be a function of time; every day the borrow doesn’t pay increases the chances that they never will. Is there more granular data on default rates than what Lending Club publishes?

Lets say a loan is 65 days late, the principal is $20 and I bought it for say $5 (75% discount). What happens if the borrower starts paying again? Specifically, what amount does the collection agency take or does the late fees go to the borrower?

A simple model is that if one bought four of these loans and 1 in 4 paid ($20) that would be a break even point. . . but that isn’t the case if there are collection fees that reduce the investors take.

Another thought is that if a distressed loan starts paying again, it isn’t actually worth the same as a current loan that never defaulted as the risk of it defaulting again is higher. So the resale value is lower if even in a “win” situation (distressed to paying again).

There are analytic tools to test models for the retail side of Lending Club but I don’t know how to test and model things for the secondary market. Suggestions?

Long Tail
Long Tail
Apr. 20, 2014 1:55 pm
Reply to  James Wood

P2P sites still need lots of work. I would like to see a default transtion matrix by loan stautus, vintage, etc. I would create it myself if the data was more conveniently available in Excel or CSV. In the age of big data, this should not be too difficult to produce by the P2P platforms.

As regards collection fees eating into your recovery, it might be 30-35% of oustanding principal depending on the efforts spent by LendingClub to collect. Check out the FAQ sections on fees for more details.