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Lending Club FOLIOfn Secondary Market: Distribution of Available Attributes for Listed Notes

Lending Club Secondary Market: Profitability of Trade and Recovery Rate with Loan Status at Listing


This post is continuation of analysis we started to perform in previous post Lending Club Secondary Market: Loan Vintage and Loan Status at Listing on the dataset of over million records captured in 2014. We reviewed the availability of notes by vintage and by loan status at listing on Lending Club FOLIOfn secondary platform. We also introduced the topic of the migration of loan status since being listed.

In this post, we will continue reviewing the data associated with migration of loan status after notes were listed on secondary platform.

Completed Loans Since Being Listed

Our original dataset contains information on loans that have completed their journey, i.e. reached their final loan status of either Charged Off & Default or Fully Paid as well as loans that are still in one of the transitionary status of Current, In Grace Period, and Late. In the following analysis, we reduce our dataset to consider only those loans that have their status completed either as Charged Off or Fully Paid. Such reduced dataset will simplify our analysis to determine the profitability of trades on secondary market as well as identify the potential factors that may determine that profitability.

Our reduced dataset includes 115,583 notes belonging to 24,158 distinct loans listed and loan status completed on secondary platform in 2014. The table below shows the statistics on this reduced dataset and comparison with total dataset. The Notes per Loan and Ask Price to Principal Outstanding Ratio are listed as absolute values and not as % of total.


Table 1: Completed Notes Dataset Overview
Dataset Loan Count Notes Count Outstanding Principal Ask Price Notes per Loan Ask Price to Principal Outstanding Ratio
Reduced 24,158 115,583 $3,798,733 $3,409,404 4.8 89.8%
% of Total 11.7% 10.9% 9.7% 8.7% 5.1 99.8%

Fewer notes were listed on secondary platform for each loan that reached completion compared to all notes. Also, such notes were listed at higher discount, i.e. lower Ask Price to Principal Outstanding Ratio, compared to all notes.

Completed Loans Status at Listing

As mentioned above, the reduced dataset only contains loans that reached the final loan status of Charged Off & Default or Fully Paid. But, what was the original status of such completed loans when notes were listed on secondary platform?

The chart below shows the loan status of notes at listing and their completion status. The chart displays the distribution of notes count. The table below shows the same data as the chart. The table also lists the Odd Ratio of Fully Paid to Charged Off and contrasts with the Odd Ratio of Improved to Worsened loan status listed in previous blog post.

We incorporated the Loan Status at Listing with the Never Late flag in this analysis. This modification enables us to split notes with Current loan status at listing time in to two different groups. The first group of notes are those that were Current at listing time but were late in the past before being listed. The second group of notes are those that were Current at listing time and never have been late in the past. We labeled the first group as Current - Previously Late and the second group as Current - Never Late.

As you might expect, the odds of picking notes that are eventually fully paid are much lower than the odds of picking notes whose loan status improve for the notes with Late and In Grace Period (IGP) loan status at listing. It may indicate that purchasing Late and IGP notes and flipping them once loan status improves may be a better strategy than buying such notes and holding to maturity.

While the odd ratio for Current & Issued notes may indicate that someone has much better odds of picking notes that are fully paid, such conclusion may be flawed. Remember the reduced dataset only has notes that were listed on secondary market in 2014 and reached completion status in 2014 itself, less than a year time frame. This may mean that most of these notes were paid off very quickly. We will further explore this behavior in later posts as it may provide insight into the risk of prepayment on the profitability of trade in secondary market.


Chart 1: Lending Club Secondary Platform Listings: Loan Status of Notes at Listing and Completion Status
Chart 1: Lending Club Secondary Platform Listings: Loan Status of Notes at Listing and Completion Status

Table 2: Lending Club Secondary Market - Loan Status at Listing for Completed Loans
Loan Status at Listing Charged Off & Default Fully Paid Odd Ratio (Fully Paid/Charged Off) Odd Ratio (Improve/Worse)
Late (31–120 days) 98.41% 1.59% 0.02 0.08
Late (16–30 days) 75.64% 24.36% 0.32 0.72
In Grace Period 41.35% 58.65% 1.42 2.62
Current - Previously Late 16.60% 83.40% 5.02 2.50
Current - Never Late 5.97% 94.03% 15.75
Issued 3.27% 96.73% 29.58

Profitability of Trade

Till now, we have discussed in terms of quantity of notes and not in terms of monetary value. The profitability of trade is measured in dollar amount and not in quantity of notes that were fully paid. There are three types of participants on secondary market and profitability and expectations of each participant differs:

  1. Seller: Seller of a note on secondary market expects that he or she can get higher return by selling the note now rather than wait for note to reach the final loan completion status. The seller expects the present value of future payments will be less than the selling price. In an oversimplified view, the trade is profitable for seller when the future principal payments on the note are less than the selling price.

  2. Buyer: Buyer of a note on secondary market expects that he or she can get higher return by buying and holding the note till maturity. The buyer expects the present value of future payments to be more than the purchase price. The trade is profitable for buyer when the future principal payments on the note are more than the purchase price.

  3. Trader: Trader of a note on secondary market expects that he or she can sell the note for higher price than the price being paid for the note. Though the payments received after the purchase impact the profitability, trader is primarily concerned with ability to sell at higher price. Such traders are primarily focused on leveraging the inefficiencies in the system, for example, delay in reporting of payment received or notations in note payment history that are not captured in any of published attributes.

The notes that haven’t achieved the completion status create challenges in measuring the profitability of a trade for buyer and seller. In such situations, the expectation of future payments still exist that can influence the profitability of a trade for notes that haven’t completed yet. We need to exclude the notes that hasn’t reached completion to simplify our profitability analysis.

With the reduced dataset of completed notes, we can look at trades where possibility of any further payments doesn’t exist. All trades, in a sense, are final.

Principal Recovery since Listing and Loan Status at Listing

The table below shows the Outstanding Principal at the time of note listing and Principal Received since Listing. Percentage of Outstanding Principal paid before and after fees since listing is also displayed in the table.

In aggregate, only 53.23% of outstanding principal at the listing of note on secondary market was paid back to the lender. Notes with Current & Issued loan status at listing paid back 90.88% of outstanding principal while notes with Late (31–120 days) loan status paid back only 1.30% of outstanding principal. The paid back outstanding principal can also be considered as principal recovery rate. The recovery rate provides a good benchmark for maximum markup/discount at which point the trade provides no loss or profit to both parties excluding any impact of fees.

For example, in aggregate, a trade for a note with loans status of Late (31–120 days) at 1.30% of outstanding principal provides neither profit nor loss (at the money in Options terminology) to both buyer and seller.

Impact of Transaction and Servicing Fees

On secondary market, only seller is charged 1% transaction fee and buyer pays no transaction fee. Once note has been sold on secondary market, buyer pays 1% servicing fee on the payments received. To account for these fees, we need to reduce the principal received since listing by 1%.

For example, in aggregate for all notes, the principal received since listing will be $2,021,862 * (1 - 0.01) = $2,001,643.38 while outstanding principal resulting in net recovery rate of 52.69% compared to recover rate before fees of 53.23%.

To keep our analysis simple, we ignore the impact of fees on the profitability of trade.


Table 3: Lending Club Secondary Market - Principal Payment since Listing and Recovery Rate
Loan Status at Listing Outstanding Principal at Listing Principal Received since Listing % Outstanding Principal (Recovery Rate) Ask Price % Outstanding Principal (Ask Rate)
Late (31–120 days) $1,462,619 $18,934 1.30% $1,014,236 69.34%
Late (16–30 days) $104,675 $24,215 23.13% $84,671 80.89%
In Grace Period $137,396 $75,743 55.13% $123,463 89.86%
Current - Previously Late $337,004 $269,642 80.01% $346,507 102.82%
Current - Never Late $1,674,351 $1,555,017 92.87% $1,754,537 104.79%
Issued $81,715 $78,312 95.84% $85,030 104.06%
Total $3,797,760 $2,021,862 53.24% $3,408,444 89.75%

It is clear from the comparison of principal recovery rate with ask price to principal outstanding ratio (Ask Rate) that the sellers have unrealistic expectations. Thus, it wouldn’t be surprising to see most of the notes listing on secondary platform expire without any transaction taking place.

A few may have objections on these findings:

  • Objection 1: You are only accounting for the principal received since listing and not the total payments received since listing including interest received.

The present value of future payments since listing is the principal remaining at the time of the listing. This assumes the discount rate is same as the interest rate on the note. Any interest received in the future is just the adjustment for the time value of money on remaining principal. Please refer to Investopedia Complete Guide to Corporate Finance, Section 3.2.2 Discounted Cash Flow Valuation - Annuities and the Future Value and Present Value of Multiple Cash Flows for more information.

  • Objection 2: Your findings seems to indicate that buyer should never pay a premium on secondary market even for notes with Current - Never Late loan status. Shouldn’t Current - Never Late notes be valued higher as such notes have a track record of consistent payment history?

Recall that the reduced dataset only has notes that were listed on secondary market in 2014 and reached completion status in 2014 itself, less than a year time frame. This restriction on notes reaching completion status introduces negative sampling bias. It excludes the notes that may be continuing to repay after 2014 (potentially positive samples). The notes that were current at listing were either paid off quickly or charged off quickly. The completions in short time frame for issued and current loans are not positive scenarios and are reflected in the aggregate principal received since listing for such loans.

Key Takeaways

  • Purchasing Late and IGP notes on secondary market and then flipping them once loan status improves may be a more effective strategy than buying such notes and holding to maturity.
  • In aggregate, the principal recovery rate after listing was 53.24%, ranging from 1.30% for notes with Late (31–120 days) loan status to 95.84% for notes with Issued loan status at listing.
  • Presently the price demanded by sellers for notes listed on secondary market may be unrealistic in light of much lower principal recovery rate achieved for notes after being listed.

Comments: (5)

Puneet | Friday February 20, 2015, 4:09 am

Anil,

Don't you think on balance, buying on secondary doesn't make sense at all. Even if I buy both lates and Grace period at seller's prices, I will never be able to recover it by selling in Current - Previously late. Think I will lose on both counts - Principal I can sell and Price Aggregate at which I can sell my Current-Previously loans against what I paid for both lates and Grace period. Would be great to have your thoughts. 

Anil Gupta | Friday February 20, 2015, 11:14 am

Puneet,
Buying on secondary market makes sense for lenders who do not want to fight for loans and then wait for loans to be issued on primary platform. Selling makes sense for lenders who do not want to hold suspect loans in their portfolio, a downside protection when market becomes bad.
You might be ignoring that some of Lates and IGP loans will improve their loan status and start repaying. Such loans will pay off handsomely and may overcome losses from others.

 

 

Ping Chan | Tuesday June 9, 2015, 7:23 am

What is your source to calculate the recovery rate? Is this based on your own portfolio?

Anil Gupta | Tuesday June 9, 2015, 3:26 pm

@Ping,

The recovery rate is based on payments and recoveries made on loans since being listed on secondary market.

Bob Haya | Wednesday April 27, 2016, 11:41 pm
Newbie here: Is there a way to automate this process so that it automatically tweaks the capital gains return on investment to be as high as possible and what would you guess would be that automated system's Annualized Roi?

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