Author Topic: Does LC Suffer Fools Gladly?  (Read 10218 times)

Rob L

  • Hero Member
  • *****
  • Posts: 2108
    • View Profile
Does LC Suffer Fools Gladly?
« on: January 18, 2017, 06:43:10 PM »
From the most recent Loan Stats File for 2016 Q3 (policy 1 code loans only):



I'm reasonably sure LC makes most of its money from origination fees. My understanding of banks is that they are going with the sure thing A's. Maybe they drop to the B's; I dunno. Let's call the C's "no man's land" (or "many man's land"). Too risky for banks to put on their books but seen as reasonably conservative to individual investors and perhaps others. Finally there's the D, E, F and G "land of extreme risk" or as some would say "the land of the intellectually challenged". These extreme risk loans represent about 25% of LC's current originations. No small amount and I would guess almost exclusively retail investors fund them. LC has described retail lenders as "sticky money". It would be most unfortunate if they had the misconception that we are "dumb money". That said, I do not think LC has yet done enough to protect its "extreme risk" lenders. Many months have passed and our ship is still sinking. Additional actions are needed to "right the ship" or the "intellectually challenged" money funding 25% of LC's loans will dry up.

brother7

  • Full Member
  • ***
  • Posts: 130
  • Aloha!
    • View Profile
    • Email
Re: Does LC Suffer Fools Gladly?
« Reply #1 on: January 18, 2017, 07:22:24 PM »
I've experienced declining returns for several quarters which is why I'm looking into real estate crowdfunding now.

apc3161

  • Newbie
  • *
  • Posts: 43
    • View Profile
    • Email
Re: Does LC Suffer Fools Gladly?
« Reply #2 on: January 18, 2017, 08:17:34 PM »
From the most recent Loan Stats File for 2016 Q3 (policy 1 code loans only):



I'm reasonably sure LC makes most of its money from origination fees. My understanding of banks is that they are going with the sure thing A's. Maybe they drop to the B's; I dunno. Let's call the C's "no man's land" (or "many man's land"). Too risky for banks to put on their books but seen as reasonably conservative to individual investors and perhaps others. Finally there's the D, E, F and G "land of extreme risk" or as some would say "the land of the intellectually challenged". These extreme risk loans represent about 25% of LC's current originations. No small amount and I would guess almost exclusively retail investors fund them. LC has described retail lenders as "sticky money". It would be most unfortunate if they had the misconception that we are "dumb money". That said, I do not think LC has yet done enough to protect its "extreme risk" lenders. Many months have passed and our ship is still sinking. Additional actions are needed to "right the ship" or the "intellectually challenged" money funding 25% of LC's loans will dry up.

The only way to get their attention is to pull out your money as payments come in. Show them your money isn't "sticky" and you expect high returns given 1) the risk and 2)the bad tax status of these investments.

On a side note, they've been offering a lot of incentives to open an IRA with them. I would imagine that is because IRA money is a lot more "sticky", you can't just take it out whenever you want.

rawraw

  • Hero Member
  • *****
  • Posts: 2790
    • View Profile
Re: Does LC Suffer Fools Gladly?
« Reply #3 on: January 20, 2017, 05:05:45 AM »
These extreme risk loans represent about 25% of LC's current originations. No small amount and I would guess almost exclusively retail investors fund them. LC has described retail lenders as "sticky money". It would be most unfortunate if they had the misconception that we are "dumb money".
Back years ago, people on this forum would go into rages (yes, it was very emotionally charged) that there weren't enough E,F,G loans on the platform.  I contacted LC once and asked for their response.  On the phone, the gentleman told me that LC's originations were overwhelming in lower grades and that's why it was hard to get.  This was before LC loosened their standards.

Quote
do not think LC has yet done enough to protect its "extreme risk" lenders. Many months have passed and our ship is still sinking. Additional actions are needed to "right the ship" or the "intellectually challenged" money funding 25% of LC's loans will dry up.
If I was LC, I wouldn't want that money.   They could make way more low grade loans, if they wanted to. I'm pretty certain there's several reasons it has remained a small portion.  I'm still upset that my servicing fees subsidize the  intellectually challenged money, but I hope that will get corrected over time.

It isn't LC's job to protect us.  It is LC job to present us accurate information, collect payments, deal with legal issues, and set pricing relative to the risk and competition.  It is our job to set our risk tolerances and make our own decisions about whot o lend to.  If you want someone to protect you, go buy a bank stock that has been historically very safe.   
 
LC will suffer the same market forces that every originator suffers. They will have to sell junk if their customers want junk. It is up to you to make sure their sales of junk do not put the platform at risk and that you never buy the junk.  The first point is why I do not like their secret loan programs we cannot see.
« Last Edit: January 20, 2017, 05:17:07 AM by rawraw »

Rob L

  • Hero Member
  • *****
  • Posts: 2108
    • View Profile
Re: Does LC Suffer Fools Gladly?
« Reply #4 on: January 20, 2017, 10:58:28 AM »
do not think LC has yet done enough to protect its "extreme risk" lenders. Many months have passed and our ship is still sinking. Additional actions are needed to "right the ship" or the "intellectually challenged" money funding 25% of LC's loans will dry up.

If I was LC, I wouldn't want that money.   They could make way more low grade loans, if they wanted to. I'm pretty certain there's several reasons it has remained a small portion.  I'm still upset that my servicing fees subsidize the  intellectually challenged money, but I hope that will get corrected over time.

I don't understand the "subsidizing fees" comment. How does that work? Do you mean collections of high risk loans is much more expensive than low risk, but the service fee is 1% across the board?

It isn't LC's job to protect us.  It is LC job to present us accurate information, collect payments, deal with legal issues, and set pricing relative to the risk and competition.  It is our job to set our risk tolerances and make our own decisions about whot o lend to.  If you want someone to protect you, go buy a bank stock that has been historically very safe.

It is in LC's own best interest to protect us. Prosper 1.0 (before my time) did what you suggest and it didn't work out very well. However I respect the projections LC made in its most recent 8-k which are dismal regarding the projected risk rewards of higher risk loans.

As for the bank stock comment, do you not remember what happened to all of them in the great recession? Most lost at least 75% of their market cap. There were no "very safe" bank stocks.

LC will suffer the same market forces that every originator suffers. They will have to sell junk if their customers want junk. It is up to you to make sure their sales of junk do not put the platform at risk and that you never buy the junk.  The first point is why I do not like their secret loan programs we cannot see.

Yeah, and it sure looks like the high risk loans are junk now. I've bought my last one.


rawraw

  • Hero Member
  • *****
  • Posts: 2790
    • View Profile
Re: Does LC Suffer Fools Gladly?
« Reply #5 on: January 20, 2017, 06:28:26 PM »
Yes, the cost to service consumer credit is not the same across the credit spectrum.  But LC charges a flat fee, which gives some of the lower grade notes higher returns than they should have.

Are your investments so short term that you have to sell when they decline?  If not, then it is easy enough to pick safe bank stocks.  Just because your LC portfolio isn't marked to market in a crisis doesn't make it safer.  I promise you a portfolio of LC loans would have been selling at similar discounts.

I think buying the last one is the wrong conclusion. I almost started a thread on this but stopped.  Instead of chasing returns, decide the rules that govern your LC investment.  And just stick by them

Rob L

  • Hero Member
  • *****
  • Posts: 2108
    • View Profile
Re: Does LC Suffer Fools Gladly?
« Reply #6 on: January 21, 2017, 12:58:24 AM »
Are your investments so short term that you have to sell when they decline?  If not, then it is easy enough to pick safe bank stocks.  Just because your LC portfolio isn't marked to market in a crisis doesn't make it safer.  I promise you a portfolio of LC loans would have been selling at similar discounts.

I think buying the last one is the wrong conclusion. I almost started a thread on this but stopped.  Instead of chasing returns, decide the rules that govern your LC investment.  And just stick by them

"In the long run we are all dead". I recently sold a bank stock (FHN, previously FTEN) that I'd held for about 25 years. It saw a high of over 40 in the housing bubble and a low of around 4 in the crash that followed. It had gone through similar gyrations around the tech stock bubble / bust and 9/11. The recent 25% surge in bank stock prices from the so-called Trump effect provided a nice selling opportunity at about 20; still 50% below its peak, but several multiples of its acquisition cost in the early 90's. At my age, it had simply become time to take those chips off the table and Keynes would probably have agreed. Meanwhile, please don't talk about those safe bank stocks; 90% drops aren't for the faint of heart. And if I had the misfortune of having bought FHN in 2006 and needed the money now, 11 years later, I'd have a 50% loss. Just saying ...

As for LC my goal has always been and remains a 6% return. More is great, less is disappointing, and much less is unacceptable. To my thinking participation in LC requires acceptance of the fact that there is a small but very real possibility I may lose everything. Could be fraud; could be a computer hack; could be LC bankruptcy; could be ... This has always constrained the amount I was willing to invest. Along the way, and with the profits I made, the amount I had invested in LC exceeded the amount I was willing to lose. Kinda ignored that a bit until the events of this past May sharply reminded me of this reality. I took the action I thought appropriate, reduced my exposure, and I'm glad I did. Finally, a little over a week ago, LC submitted a forward looking estimate of returns in a SEC 8-k. I learned of it after starting this thread; quite a coincidence. The new data told me that projected returns for 36 month B grade loans is expected to be 5.79% and the much riskier E grade loans are expected to return only 1.04% more (6.83%). That looks to me like a ton more risk and not so much more return. For that reason, I have bought my last E grade note (C, D, F and G as well). My conclusion is based on newly available data from LC and that seems as good a reason as any.

rawraw

  • Hero Member
  • *****
  • Posts: 2790
    • View Profile
Re: Does LC Suffer Fools Gladly?
« Reply #7 on: January 21, 2017, 03:45:19 AM »
I'm not so sure FHN is a good example.  A good rule of thumb is that any bank with C&D loans >20% is not a safe bank stock (I doubt they had this much for the tech crash etc).  Unfortunately it seems like all the real estate fintech guys are jumping into C&D lending. I sure hope it isn't a train wreck.

I'm not suggesting that large swings in stocks are easily ignored.   But just like we  don't check our LC's mark-to-market daily, we do not have to check our stocks either.  If you are worried about not taking a loss in a financial crisis, LC loans are probably not where you should be either.  But the point still remains that if you want someone else to make those decisions, I guess you can buy a LC fund or another financial.

Where does 6% come from?  But I agree with your conclusion about lower grade notes. I don't see much incentive to invest in them.
 
LC is subject to the market, which is highly competitive for consumer loans.  Especially  lately.    When a company's ability to live comes from originations and they don't hold the paper, they tend not to be incentivized to miss out on volumes.   Where as another type of lender could choose not to grow or even shrink slightly and earn money off of existing loans, LC is reliant on origination fees so they have to move with the market or give up a lot of profit.  Anil used to bring this up in the past, but I think it is essential to understanding how the dynamic will work over time. 
   

jheizer

  • Sr. Member
  • ****
  • Posts: 480
    • View Profile
    • LC Tools
Re: Does LC Suffer Fools Gladly?
« Reply #8 on: January 21, 2017, 09:39:48 AM »
The part I find really interesting with all this is that on Jan 10 I decided I needed to sit down and make a decision.  Start pulling out or start investing again.  After not reinvesting for 2.5 months I had a decent amount sitting there.  I decided to set up an extremely strict filter targeting only B and C loans.  It's grabbing about 80% B 10 C so far.  I've decided to not reenable my folio buyer.  I just want to say good buy to all 2015 and 2016 even if they look good.  Hopefully this semi gut reaction works out.
Replacement to P2P Quant's Percentile Tool http://lc.geekminute.com

SLCPaladin

  • Full Member
  • ***
  • Posts: 202
    • View Profile
Re: Does LC Suffer Fools Gladly?
« Reply #9 on: January 21, 2017, 05:19:18 PM »
Quote

As for LC my goal has always been and remains a 6% return. More is great, less is disappointing, and much less is unacceptable. To my thinking participation in LC requires acceptance of the fact that there is a small but very real possibility I may lose everything. Could be fraud; could be a computer hack; could be LC bankruptcy; could be ... This has always constrained the amount I was willing to invest. Along the way, and with the profits I made, the amount I had invested in LC exceeded the amount I was willing to lose. Kinda ignored that a bit until the events of this past May sharply reminded me of this reality. I took the action I thought appropriate, reduced my exposure, and I'm glad I did. Finally, a little over a week ago, LC submitted a forward looking estimate of returns in a SEC 8-k. I learned of it after starting this thread; quite a coincidence. The new data told me that projected returns for 36 month B grade loans is expected to be 5.79% and the much riskier E grade loans are expected to return only 1.04% more (6.83%). That looks to me like a ton more risk and not so much more return. For that reason, I have bought my last E grade note (C, D, F and G as well). My conclusion is based on newly available data from LC and that seems as good a reason as any.

Rob L, your thought process is strikingly similar to the random musings that flow through my brain. I am very much aligned with this way of thinking. For almost a year now I've been reinvesting only in A and B grade notes. Occasionally I'll buy a C grade note, but I don't buy anything down. For me, it's all a matter of rates. From my vantage point, the interest rates being charged on those notes is insufficient to compensate for the risk.

I think the trigger for me was when I realized that institutional capital was shunning most notes lower than B. Also, I have a taxable account and the tax implications of higher-than-expected defaults in my lower grade notes were basically negating any hope of outperformance to be had at the riskier end of the credit spectrum.

SLCPaladin

  • Full Member
  • ***
  • Posts: 202
    • View Profile
Re: Does LC Suffer Fools Gladly?
« Reply #10 on: January 21, 2017, 05:28:37 PM »
Quote
LC is subject to the market, which is highly competitive for consumer loans.  Especially  lately.    When a company's ability to live comes from originations and they don't hold the paper, they tend not to be incentivized to miss out on volumes.   Where as another type of lender could choose not to grow or even shrink slightly and earn money off of existing loans, LC is reliant on origination fees so they have to move with the market or give up a lot of profit.  Anil used to bring this up in the past, but I think it is essential to understanding how the dynamic will work over time.

The consumer loan market may be highly competitive for consumers, but the market for retail investors to participate in the economic gain of this asset class is not diverse. We essentially have two options: Prosper and LC. Accredited investors have more options, as do international investors in the UK and Western Europe. So while it is true that LC is subject to the market, they are the market for retail investors. There are asymmetries of information and power with this unequal power dynamic. The caveat emptor approach and "take it or leave it" approach may be good advice, but I don't think it fully acknowledges the asymmetry of power inherent in the relationship. In any case, LC and Prosper also risk destroying their creation if they don't get the underwriting right.

Rob L

  • Hero Member
  • *****
  • Posts: 2108
    • View Profile
Re: Does LC Suffer Fools Gladly?
« Reply #11 on: January 21, 2017, 08:54:09 PM »
I'm not so sure FHN is a good example.  A good rule of thumb is that any bank with C&D loans >20% is not a safe bank stock (I doubt they had this much for the tech crash etc).  Unfortunately it seems like all the real estate fintech guys are jumping into C&D lending. I sure hope it isn't a train wreck.

Where does 6% come from?  But I agree with your conclusion about lower grade notes. I don't see much incentive to invest in them.

I gotta admit I was totally unaware of C&D Loans>20% implies unsafe bank stock thesis. FHN imploded most recently because it ventured into national mortgage lending during the housing boom. Afterward, Fannie and Freddie crammed their stupidly underwritten mortgage loans back down FHN's throat a little at a time so as not to bankrupt the company over the past 7 or 8 years. Anyway, if you have an example of a safe bank stock or two over the span of circa 1992 to date I'd really like to know. I'd seriously consider investing.

6% is simply the number I settled on in 2013 when I started with LC (scout's honor). The larger question in my mind now is whether or not this possible over the next 3 or more years. I'm becoming increasingly concerned with the long-term viability of LC. I  may come to regret switching to B grade loans rather than discontinuing all reinvestments. Maybe not.  I'll keep a close eye on corporate earnings and the stock price as the best indicators of the company's long-term prospects. If interest rates continue to rise I expect to see more and more attractive alternatives for my investment dollars. ZIRP has been a real bummer for us savers ya know.

Rob L

  • Hero Member
  • *****
  • Posts: 2108
    • View Profile
Re: Does LC Suffer Fools Gladly?
« Reply #12 on: January 21, 2017, 09:29:23 PM »
In any case, LC and Prosper also risk destroying their creation if they don't get the underwriting right.

Couldn't agree more. LC's underwriting is broken right now (don't know about Prosper). If LC doesn't increase returns for high-risk loans (C and higher) eventually no one will buy them. Seriously. Who, with the knowledge of LC's returns projections in the recent 8-k (above), is gonna go there? On the other hand, maybe LC simply can't raise interest rates for these loans and sell them. Borrowers could find a better deal elsewhere. Bummer.

The coincidental timing of the start of this thread before LC's release of the 8-k is kinda spooky (maybe the 8-k was submitted prior to the thread but I was not aware of it until lascott started another thread with a link to the 8-k). Anyway, LC told me in that 8-k that investing in higher risk loans was IMHO foolish; not only today but also projected going forward. Okay, I get it.

rawraw

  • Hero Member
  • *****
  • Posts: 2790
    • View Profile
Re: Does LC Suffer Fools Gladly?
« Reply #13 on: January 22, 2017, 05:18:55 AM »
Quote
LC is subject to the market, which is highly competitive for consumer loans.  Especially  lately.    When a company's ability to live comes from originations and they don't hold the paper, they tend not to be incentivized to miss out on volumes.   Where as another type of lender could choose not to grow or even shrink slightly and earn money off of existing loans, LC is reliant on origination fees so they have to move with the market or give up a lot of profit.  Anil used to bring this up in the past, but I think it is essential to understanding how the dynamic will work over time.

The consumer loan market may be highly competitive for consumers, but the market for retail investors to participate in the economic gain of this asset class is not diverse. We essentially have two options: Prosper and LC. Accredited investors have more options, as do international investors in the UK and Western Europe. So while it is true that LC is subject to the market, they are the market for retail investors. There are asymmetries of information and power with this unequal power dynamic. The caveat emptor approach and "take it or leave it" approach may be good advice, but I don't think it fully acknowledges the asymmetry of power inherent in the relationship. In any case, LC and Prosper also risk destroying their creation if they don't get the underwriting right.

I think there are two dynamics that need to be separated.   There is the market in which retail operates and the market in which LC operates. At the end of the day, LC's underwriting is still competing with everyone who we don't have access to.  Credit markets will tighten in times of stress or perceived stress and loosen when things are good.  It's just the dynamic that occurs over time.  Whether LC sells to retail or Buffet, they are subject to these competitive forces.

And then there is our  market for retail consumer loans.  I'm not advising a take it or leave it approach.   Rather I'm suggesting we should understand what is LC responsibility and what is our responsibility.  No one on this earth can predict defaults or what is going to blow up.  These models will never be right.  Sometimes they will be more right and sometimes they will be less right.   Seems to me LC was less right on some of these low grade borrowers.  But there are ways to minimize the impact of stress.  Can the borrower pay?  How much wiggle room do they have?  How stable is their job?  These are very basic things us as retail investors can focus on regardless on what LC is selling.  The only thing that is different here, is that LC could not sell us junk but sell our next door neighbor junk.  Even though we aren't buying, it does impact the platform risk for us.   Hence why I don't like secret loan programs.


And I still do not understand how "underwriting is broken." Is this statement due to fact that the economy is perceived to be doing OK but the defaults are rising?  I found this paper you can look at from a bank june 2016.  Look at the curves -- you'll see something similar to LC



http://www.valuewalk.com/2016/06/consumer-nonperforming-loans-soar/

Quote
What are the takeaways from this? Well, UBS concludes that the US consumer credit market is going through a period of change; a change in market structure. The Fed’s easy money policies have resulted in too much money chasing too few high-quality lenders.

At the same time, the market has opened up as the ‘democratization of credit’, (more lower quality borrowers gaining access to unsecured credit) has gained traction. Lenders have been leaning on credit scores alone to determine creditworthiness, the last cycle and recent literature underscore several pitfalls related to excess dependence on credit scoring models, including gaming of the system, which is bound to lead to higher default rates and NPLs.
« Last Edit: January 22, 2017, 05:21:47 AM by rawraw »

nonattender

  • Hero Member
  • *****
  • Posts: 719
  • I am not here.
    • View Profile
Re: Does LC Suffer Fools Gladly?
« Reply #14 on: January 22, 2017, 06:57:25 AM »
The only thing that is different here, is that LC could not sell us junk but sell our next door neighbor junk.  Even though we aren't buying, it does impact the platform risk for us.   Hence why I don't like secret loan programs.

A little color on this (for those reading along at home who may be slightly confused by rawraw's references to "secret loan programs"):

LC services borrowers with <660 FICO scores in at least one program and does small business lending in at least one other program - retail investors on the platform are not able to purchase fractional note interests in these loans nor are they able to buy whole loans, nor is it at all clear which funds do actually have access to purchase these loans or how much of any of these programs LC self-funds.

The volumes involved are not transparent in LC filings, though it did come out during the May 2016 "unpleasantness" that LC had (effectively) 'guaranteed' a certain minimum performance threshold (through "credit support agreements") to at least some of the funds who purchase loans originating via those 'secret' programs.  Rawraw is referring to the opacity of these programs and what (unknown) risks that LC may be taking onto it balance sheet (and, therefore, a cumulative risk passed on to investors in any LC-serviced asset, as "platform risk") through these undisclosed arrangements (including any inducements or CSA's or the like granted during the "drought") or through LC's own self-funded "testing" (which I believe it has started to break out, in recent filings - I will remember to look, next time) of any non-standard loan programs.

It's the unquantifiability of the potential risk - and I am sure rawraw will correct me if I'm misrepresenting his views - that concerns him.

I believe this is a valid "known unknown" regarding LendingClub that truly exists, but I am completely unable to assign any magnitude.

(Which I believe is his point...)
A little nonsense now and then is relished by the wisest men.