Balancing Your Portfolio by Loan Term – 36/60 Month

Posted June 7, 2012

Buying Only 60 Month Notes? Consider This…

I suspect many P2P investors indiscriminately invest in 36 or 60 month loans. I know when I started out I took whatever showed up in the loan search results (literally) and didn’t pay much attention to loan term. Most people know that 60 month loans pay a higher interest rate. The higher interest rate is to reflect the additional time you have to put your money at risk. I took this understanding and then started to focus pretty much exclusively on 60 month notes to get higher return rates. As of today about 76% of my portfolio is 60 month notes. This fact and the fact that 95% percent of my late or defaulted notes are 60 month prompted me to take a very close look at 60 month loans.

Within a loan grade, take 60 month E for instance, E1 will have the highest markup and it will decrease until E5. This pattern persists for all loan grades except for A. You actually receive no additional interest for buying 60 month A grade notes. I went to Lending Club’s website and browsed all 60 month notes. I then recorded all of the interest rates for the loans and the spread (this is not available on the export). I put this into a chart and actually saw something very interesting…

As the risk of loan increases for 60 month loans the spread decreases compared to 36 month loans. So in essence the best “bang for your buck” 60 month loans are B1, C1, D1, E1, F1 and G1 in that exact order. If you see the spike for D1 there was actually no spread on the currently listings. There was only one D1 on the system (Member Loan ID 1333671). Not sure why this was.

As you can clearly see the reward decreases as the risk increased with 60 month loans. I’m not an investment professional but I would think this spread should be relatively static. I’m curious to hear your thoughts.

I’m still not 100% why all of my underperforming notes seem to be 60 month notes. Granted 76% percent of my portfolio is 60 month, I would still except more of the notes to be 36 month considering the monthly payment on 5 year loans will be less. Going forward my new core strategy will be to be 50/50 36 and 60 month notes. Right now my allocation is off by about 24% so it will take some time to rebalance.

Curious What Your Allocation Is?

There are two ways to do this. 1.) Nickel Steamroller has just added this to the portfolio analyzer. 2.) You can also find this information in lending club under your portfolio break down:

Data Source

	SPREAD	60 IRATE	36 IRATE
A5	0	8.9	8.9
B2	4.12	10.74	6.62
B3	4.14	12.12	7.98
B4	5.21	13.11	7.9
B5	4.77	13.67	8.9
C1	4.23	13.99	9.76
C2	3.91	14.65	10.74
C3	3.19	15.31	12.12
C4	2.7	15.81	13.11
C5	2.62	16.29	13.67
D1	0	17.27	17.27
D2	4	17.99	13.99
D3	3.6	18.25	14.65
D4	3.24	18.55	15.31
D5	3.41	19.22	15.81
E1	3.7	19.99	16.29
E2	3.23	20.5	17.27
E3	3	20.99	17.99
E4	3.23	21.48	18.25
E5	3.42	21.97	18.55
F1	3.23	22.45	19.22
F2	2.79	22.78	19.99
F3	2.63	23.13	20.5
F4	2.27	23.26	20.99
F5	1.85	23.33	21.48
G1	2.23	24.2	21.97
G2	1.88	24.33	22.45
G3	1.74	24.52	22.78

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http://www.wallstreetoasis.com/blog/16325 Eddie Braverman

Michael,

I’m responding to the post from your latest thread. As I disclosed in those comments, I’m running a 90/10 split in favor of 36-month notes. This is not by accident.

First, I primarily invest in notes of $5,000 or less, so on the lower range of available notes. When you think about it, would you really feel comfortable lending $2,500 to someone if they told you if would take 5 years to pay off? I know I wouldn’t. Either because their income is too low or they’re overleveraged (poor DTI). So I made a conscious decision to only invest in 36-month notes if at all possible. As you can see I do have some 60s in there, but believe me when I tell you I had a compelling reason to buy those notes (great story on the app, somehow made me really comfortable, high credit score, whatever).

You asked me to break down my defaults by loan term, and I have to tell you that after nearly 2 years of P2P lending I haven’t had a default yet. I attribute that to my willingness to sell errant notes in the aftermarket at the first sign of trouble.

You asked me how I identify a potential problem note and then you pointed out that you’re using Excel. There is a much better way to do it. From your LC account page, click on My Notes At-A-Glance and then click on Issued and Current. That will take you to the first page of your Issued and Current notes. Now click on Payment Due Date. That’s going to arrange the notes by most recent payment. Any problem notes will be right at the top.

Click on the status of the first note on the list (which should be Current unless you have one in the grace period). This is going to pull up the payment history for that note. What you want to see at the top of the list is the word Processing under status. That means the payment was made and is waiting to post to the account.

If a payment was missed, you will see that under status and you’ll see notes at the bottom of the page. The first will probably give the date of the missed payment and the status Payment Failed. Then you’ll probably see that they’ve attempted to contact the borrower to straighten it out. You might see a borrower response (that’s a good sign), or you might not.

Usually, if it’s the first time a borrower has missed a payment I’ll chalk it up to some kind of bank error and give the borrower a couple days to get the payment in. If he doesn’t contact LC, however, I list the note for sale immediately. If it’s the second time a borrower has missed a payment, even if he cleared it up right away the first time, I sell the note immediately. I have no time for people who miss their payments.

Here’s a recent example. I invested $25 in note 727547 in May 2011. The borrower missed the March 2012 payment but cleared it up within 6 days. No harm, no foul. But then he missed his June 2012 payment. No can do. At that point I’d received $10.32 in payments ($7.15 principal, $3.17 interest). I listed the note for sale at $18 and it sold within 2 hours. It still had a Current status. After the $.18 commission FolioFN charges, I netted $17.82. So my net profit on the note was $3.14 ($17.82 – $14.68). Since it was an even 12 months that I owned the note, it’s easy to annualize the return. I made 12.56% on a note that was originally slated to pay 14.54%, but most important I protected my remaining principal and was able to re-allocate it to a better performing note. As a former stockbroker, I can tell you that return OF principal is far more important that return ON principal.

This is already too long, so if you have any other questions fire away. And yes, my notes number in the hundreds.
- http://www.nickelsteamroller.com/ Michael
  
  Awesome information Eddie. Do you think it would be work while to add this to the portfolio analyzer? I just looked and I have quite a few in grace right now. I am going to see how they do at par, they most likely won’t sell but some of them have about 8 months of payment history. I’m going to start monitoring my notes and seeing. What might be cool is if I add a service where you can upload your portfolio and then I monitor notes for one that meet the late criteria that you have outlined. If they miss the payment I could send a text message to let you know to sell.
  - http://www.wallstreetoasis.com/blog/16325 Eddie Braverman
    
    If you have a bunch In Grace Period you should probably just take the hit and sell them for a loss. Better to recoup some of your investment than none at all.
  - http://www.facebook.com/profile.php?id=705083114 Charles Vanderhoff
    
    The text message feature for missed payments would be awesome, Michael.
- Chris Fennimore
  
  Great post, Eddie. I haven’t really tested the waters with selling potentially problem notes. Just curious what your thought process is in determining what you sell that note for? Is it usually just selling at par. Do you have a hard time finding takers considering it has already had shown a few troubling signs?
  - http://profile.yahoo.com/AQPQR4F62SFLL3NYHUFF2XB2TE Tony
    
    I have been on the other side, with poor results. I bought about a dozen notes which had previously missed payments, but started paying again. Nearly all of those notes eventually went late again, and several went into default. As an experiment, it was an interesting bet with small money. I don’t know any other way that I could have tested that theory. But as an investment, I got maybe 25% of my capital back, and the rest was simply lost. I can pull exact numbers, if that would be enlightening.
    - http://www.wallstreetoasis.com/blog/16325 Eddie Braverman
      
      That’s exactly my point, Tony. If someone even misses one payment, they’re on the razor’s edge with me. The second time they’re late and they’re gone. As ugly as it sounds, deadbeats are deadbeats and there’s no good reason to miss a payment (at least if you owe ME money, lol).
http://www.wallstreetoasis.com/blog/16325 Eddie Braverman

Michael and Chris,

The key thing to selling a note is it’s status. When a note buyer goes to the FolioFN platform to buy notes, he’s going to have his own criteria. In order to get your note in front of the maximum number of potential buyers, you need to make sure the note you’re selling meets the strictest of criteria. The strictest is obviously Current – Never Late. A note that is in the grace period for the first time still meets this criteria, by the way.

So when a buyer filters the available notes to exclude those which have been late in the past and are not current at the moment, the system is presenting to the buyer the theoretically “best” notes available. At that point most buyers will then filter the notes for rate of return. Here’s where strategic pricing comes in. Obviously the lower you price your note, the better return to the buyer and the higher up the list your note will appear.

My pricing strategy is pretty simple: I take the amount I paid for the note (always $25 in my case) and subtract the amount I’ve been paid in principal and interest. This is going to be my minimum price. So if I paid $25 for a note and I’ve received $10 in payments, I’m looking to sell that note for $15 or more. I’m really not so concerned about my own rate of return at this point; my primary concern is just not losing anything on the note.

I then look at the amount of the remaining payments and the remaining duration of the note. Let’s say the note in my above example went sideways at the one year mark and it’s a three year note. The remaining payments equal $23 and there’s 24 months left on the note. I’m probably gonna price that note at $18 or $18.50. The reason being, a buyer is going to pick it up for that price and make $5 on an $18 investment in two years, or a 28% total return. That’s pretty appealing to an investor (#1) and it’s going to place that note pretty high on the list of available notes by return (#2). When the note sells for $18 (for example), I’ve made $3 (minus the 18-cent commission) on a $25 note in a year. 12% is nothing to write home about, but it’s better than the total loss of the remaining $15 I had tied up in the note.

And you’ll be surprised how quickly the notes sell if you price them right. The last one I listed was sold in two hours. There are a lot of hedge funds buying into P2P lending with big money these days, and their top priority is getting the money invested. That means they don’t want to go through the process of finding new loans, analyzing the credit-worthiness of the borrower, waiting for the loan to get fully subscribed, and then possibly having the loan not issue for some reason or another (which happens quite a lot in my experience).

It’s much easier for them to go to FolioFN where every note listed has already been issued and is already performing in some capacity. Us early investors have done all the legwork for them. They simply download the notes that meet their fund’s criteria to an Excel spreadsheet (fund analysts salivate at the mere mention of Excel) and buy a whole bunch of notes at one time. They’re not even particularly concerned about the individual performance of a note because the law of large numbers is in their favor and they already have an expected default rate baked into their secret sauce.

I can’t say for certain, obviously, but I’m betting that all the notes I’ve sold over the past six months have gone to hedgies. Simply because of how fast they sold. These guys are literally camping out on FolioFN and picking off the choicest notes.

This is why I would really love the ability to track what happens to the notes I’ve sold AFTER I’ve sold them. I’d love to know if I’m pulling the trigger too quickly.

Anyway, that’s my strategy in a nutshell.
- Chris Fennimore
  
  Thanks Eddie, this makes a ton of sense and is really helpful! I’m going to start employing this strategy.
http://www.flexcredit.co.uk/ 12 month loan

A loan term has many benefits, although it may appear to be costly because of the greater per month amount. However, a short phrase term guarantees you that you’ll be free from this problem before or at the time of pension and preserve countless numbers. Consider having your mortgage updated to a short phrase term.
Frucifer

I have a question for the author, but I can’t find a general contact link anywhere on the site, so here it is:

I read a post by someone saying that they invested in their own loan at one point. Is this legal? It seems ripe for abuse. In order to make some free money, all you have to do is the following:
1. Get a loan through LendingClub
2. Immediately fail to make your payments and go into grace period.
3. LendingStats reports an 84% recovery rate for grace period notes, so in theory you should be able to buy some fraction of your loan for 84 cents on the dollar through FOLIO
4. Pay up your loan before any fees attach and continue to make all the payments.

You lose a certain percentage in origination and servicing fees, but as long as it’s less than 16 percent, you’re making a profit without ever impacting your credit score. What do you think?
- 123
  
  You’d also have to pay taxes on the borrowing side. Between that, loan fees, & the risks associated with fraud/timing/creditscores… I like the way you think, but too risky IMO.