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Opinions and analysis of Marketplace Lending, Online Lending, and Peer to Peer Lending.

Six Steps to Automated Selling on Lending Club Folio Secondary Market

Trading Delinquent Notes, Part 2: Needle in the Haystack

Selling Delinquent Notes on Lending Club Folio Secondary Market, Part 1: Loss Aversion


Despite your best efforts to avoid delinquencies, it is very likely that a few notes in your portfolio will become delinquent at one time or another. You may wonder what to do when notes becomes delinquent. This is the topic of this blog post. Once a note becomes delinquent, you stop receiving regular monthly payments from the note. At this point, there are only two options as a note holder:

  • Holding the note in portfolio, or
  • Selling the note on Lending Club Folio secondary market.

In this series of blog posts, we discuss how to price and sell delinquent notes on Lending Club Folio secondary market, review such listings on secondary market, gain insights and potentially develop guidelines for discounting such notes during listing for sale.

What to do with Delinquent Notes?

Hold Delinquent Notes in Your Portfolio

Once a note holder decides to continue holding the delinquent note in the portfolio, the best outcome is to wait for a borrower to restart the payments and the note becoming Current again. When Lending Club is unable to collect payments from borrowers, the note is charged off. Post charge off, sometime Lending Club is able to recover from borrower a small fraction of the charged off principal, historically about 7.72% net of recovery fees.

The major downside of continuing to hold delinquent note is the waiting time for final resolution that can stretch as long as six months. During this wait, the investment tied up in delinquent note doesn't generate any return. The net charge off also increases rapidly with time for delinquent notes as shown by Loan Status Migration Over 9 Months chart at Lending Club Loan Statistics. On top of that, Lending Club charges collection and recovery fees, 18% of collected payment and 35% of recovered charged off amount, to lenders as mentioned at What fees does Lending Club charge investors?.

For example, on delinquent notes with Late (31-120 days) status, the best loss scenario might be that you could lose 83.75%, that is 75% loss due to net charge off plus 8.75% loss due to fees (25% x 35% collection fee on any amount collected).

Loan Status Migration Over 9 Months

Sell Delinquent Notes on Lending Club Folio Secondary Market

The alternative to holding delinquent notes is selling such notes on Lending Club Folio secondary market, most certainly at a loss. The proceeds from such sale can then be used to buy other more promising notes from primary platform or secondary market. This option also reduces the time period of no returns when the investment is tied up in delinquent note. From end of year tax management perspective, lenders may find selling delinquent notes a useful strategy. By selling delinquent notes at loss in current year pulls forward capital losses to current year from potential charge offs that may occur in future years. Such capital losses can be used to adjust capital gains lenders may have from other investments. We are not tax professionals; please consult with your tax adviser for your specific tax situation.

Dataset

In this analysis, we use two different sets of listings of delinquent notes for sale on Lending Club Folio secondary market. One set of listings were captured evening of July 24th, 2016. The second set of listings were captured little over two years morning of June 22nd, 2014.

There may not necessarily be buyers who are willing to purchase most delinquent notes for discount considered reasonable by sellers. The discount offered by sellers of other delinquent notes from same/similar loans may have the most impact on the salability of the note. No reasonable buyer will purchase a note at a discount that is less than that for the notes from same/similar loans. To accommodate such constraint, we also filtered two set of listings for only one unique note with most discount/least markup from each delinquent loan. This eliminates the notes that had lower likelihood of selling because of availability of notes from same loan with higher discounts/lower markup.

In the end, four datasets were used for analysis:

  1. All 48,156 delinquent notes listed on July 24th 2016, typically referred as 2016 notes or all notes,
  2. All 9,515 delinquent notes listed on June 22nd 2014, typically referred as 2014 notes or all notes
  3. Unique notes with most discount/least markup from 8,941 delinquent loan listed on July 24th 2016, typically referred as 2016 loans or unique notes, and
  4. Unique notes with most discount/least markup from 2,681 delinquent loan listed on June 22nd 2014, typically referred as 2014 loans or unique notes.

Markup/Discount on Delinquent Notes

All delinquent notes

Chart 1 shows the distribution of markup/discount for delinquent notes (density plot) for ALL delinquent notes listed on July 24th 2016 on Lending Club Folio secondary market.

Majority of delinquent notes seems to be listed on secondary market close to par value. It appears most sellers tend to discount delinquent notes much less than even the net charge off rate, as indicated by Loan Status Migration Over 9 Months chart. In our experience, it is not surprising that majority of listings for delinquent notes expire without being purchased by a buyer.

Chart 2 shows the similar distribution of markup/discount for delinquent notes for ALL delinquent notes listed on June 22nd 2014. Despite the two years gap between the two listings, the Chart 2 is strikingly similar to Chart 1. Once again, in 2014 majority of sellers wanted to sell their delinquent notes near par value as they do in 2016.

The behavior of sellers on Lending Club Folio secondary market is no different than what has been mentioned in Behavioral Finance about loss aversion displayed by investors and their willingness to hold on to losers longer.

Chart 1: Distribution of Markup/Discount for All Delinquent Notes available on July 24th, 2016

Chart 1: Distribution of Markup/Discount for All Delinquent Notes available on July 24th, 2016

Chart 2: Distribution of Markup/Discount for All Delinquent Notes available on June 22nd, 2014

Chart 2: Distribution of Markup/Discount for All Delinquent Notes available on June 22nd, 2014

Unique delinquent notes with most discount/least markup

Table 1 and Chart 3 show the Markup/Discount offered by sellers in 2016 of delinquent notes on Folio secondary market when only the note with lowest markup (most discount) was considered.

Removing the duplicate notes with higher markup/lower discount from dataset seems to have produced a more pronounced second peak for In Grace Period and Late (31-120 days) loans. Those two distinct peaks may indicate potentially two different groups of delinquent loans or sellers of such loans. It may also be indicative of fewer sellers choosing to list their delinquent notes at deep discounts.

For Late (31-120 days) loans, the bigger peak at higher discount (about -80%) compared to smaller peak at lower discount (about 0%) seems to indicate more Late (31-120 days) loans being listed for sale at higher discounts.

The First Quartile Markup/Discount displayed in Table 1 seems to be much closer to the net charge off rate indicated by Loan Status Migration Over 9 Months chart. Less than 25% of delinquent loans (less than 8% of delinquent notes) listed on secondary market may be worthy of any purchase consideration.

Table 1: Markup/Discount for unique delinquent loans listed on Folio secondary market on July 24th, 2016
Status Loan Count Minimum 1st Q Average Median 3rd Q Maximum
Late (31-120 days) 5,325 -90.6% -79.6% -53.2% -65.1% -25.0% 17.0%
Late (16-30 days) 1,452 -83.0% -52.3% -32.5% -31.0% -9.2% 12.7%
In Grace Period 2,164 -70.1% -23.0% -13.0% -10.1% -2.1% 11.8%
Chart 3: Distribution of Markup/Discount for Unique Delinquent Notes available on July 24th, 2016

Chart 3: Distribution of Markup/Discount for Unique Delinquent Notes available on July 24th, 2016

Table 2: Markup/Discount for unique delinquent loans listed on Folio secondary market on June 22nd, 2014
Status Loan Count Minimum 1st Q Average Median 3rd Q Maximum
Late (31-120 days) 1,433 -94.0% -75.3% -46.3% -50.7% -12.8% 16.7%
Late (16-30 days) 387 -66.6% -40.1% -22.6% -22.3% -4.9% 14.1%
In Grace Period 861 -42.2% -16.1% -9.5% -6.2% -1.1% 17.1%
Chart 4: Distribution of Markup/Discount for Unique Delinquent Notes available on June 22nd, 2014

Chart 4: Distribution of Markup/Discount for Unique Delinquent Notes available on June 22nd, 2014

Table 2 and Chart 4 show the Markup/Discount offered in 2014 by sellers of delinquent notes on Folio secondary market when only the note with lowest markup (most discount) was considered.

In last two years, there has been significant growth in volume of notes listed on secondary market primarily due to automation such as automated selling on Folio offered by PeerCube. While on average, discounts offered on delinquent notes have marginally improved, still discounts are nowhere close to expectations based on Loan Status Migration Over 9 Months chart.

PeerCube users can use table FOLIOfn Pricing by Loan Status for latest markup/discount range offered by sellers on delinquent loans. The table is updated every time PeerCube updates the listings on secondary market.

Key Findings

In summary, sellers of delinquent notes exhibit loss aversion. Only a small fraction (< 8% of notes, < 25% of loans) of delinquent notes listed on secondary market may be worthy of purchase consideration.

The seller of delinquent notes can not expect to transfer all risk to buyers of such notes by selling notes at net charge off rate. They will need to offer incentives to buyers in the form of higher discounts. While pricing a delinquent note for sale, note holder needs to consider:

  • Expected Charge Off based on similar notes, for example, similar to Loan Status Migration over 9 months.
  • 18% service fee on future payments on delinquent notes,
  • 35% collection fee on any future recoveries from collection on delinquent notes,
  • 1% transaction fee for selling note on Folio secondary market,
  • The opportunity cost of holding a delinquent note to charge off versus selling on secondary market, i.e. potential return on reinvesting the sale proceeds into new more promising notes.

In the end, the sellers of delinquent notes should expect to share some of the risk born by potential buyers.

PeerCube users have access to a few tools such as Delinquency Risk with Loan Age based on past performance of their loan filter, Delinquency, Default, and Loss Rate for their portfolio, and Detailed Folio Pricing to better estimate the discount they may offer on delinquent notes on secondary market.

In future blog posts, we will further explore these datasets including profiling of delinquent notes and pre and post performance of delinquent notes listed on secondary market.

Lending Club Secondary Market: Loan Vintage and Loan Status at Listing

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

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

Lending Club FOLIOfn Secondary Market: Penny Note Strategy based on Lowest Ask Price

Reading Referrals

Flash Boys: A Wall Street Revolt

Liar's Poker

The Big Short: Inside the Doomsday Machine

Comments: (1)

Vik J | Wednesday August 31, 2016, 10:35 am

Wow thank you for pointing out the collection fees that I was not aware of. Seems the collection fee is reduced, at least temporarily, from 35% to 18% of amt recovered or 30% of any legal fees, if any. 

Honestly think these fees alone negate most arguments for investing in delinquent notes. The always late borrower is a terrible investment when LC takes 18% of every payment past 15 days past due. 

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