Gentlemen, we have officially voted someone off the island. I thought my WSO CDO update earlier this month would be the last one for the year, but then one of our borrowers went sideways and had to get the boot. Since a number of you were curious about how selling notes in the secondary market worked, I thought I'd write this up to show you.
The note in question was a $25 investment in a $5,000 loan with a 5-year term and an interest rate of 12.98%. It was issued November 30, 2010 and was given a C3 credit rating at the time. The borrower's credit score was in the 679-713 range at the time of issue; it has since declined. The purpose of the loan was debt consolidation.
The borrower had a decent payment history, but a couple things happened over the past three months that made me decide to dump the note. First, the borrower had a payment fail in October. It was made good within the grace period, so there was no late fee charged and I normally wouldn't make a big deal about it. Until it happened again in November. Again, the payment was made within the grace period. Then in December there was no payment. The borrower contacted Lending Club and set up a payment plan. Oops. Check please, I'm out.
So I listed the note for sale on the secondary market for $20 and it sold in less than 10 days. The borrower made a total of $6.16 in payments before I sold the note. There is a 1% transaction fee for the sale, so the net proceeds I received were $19.80. So we made a net profit of $.96 on the note (3.84%), but more importantly we transferred the risk of a note that I'm guessing will go sideways shortly.
This is what the FolioFN trading platform looks like. I sold three notes this month, and the one from the WSO CDO is titled Moving On:
You can also see from this screenshot that I had a listed note expire. Listings are good for 10 days. Once the listing expired I dropped the price a buck and the note sold.
The buyers of these notes think they're getting a good deal, and they very well could be. In fact I hope they are. The note from the WSO CDO will pay out $27.86 from now until maturity, so buying it for $20 represents a potential 40% return in four years. Assuming the borrower ever makes another payment.
Some of you might think I jumped the gun by selling the note before there was ever even a late payment penalty, and maybe you're right. But I'm not taking any chances when it comes to P2P lending. I think the concept is great, but it isn't worth doing for single-digit annual returns and to stay in the double digits requires pretty aggressive risk management. I'd rather make a small profit or take a small loss and redeploy the capital to a better risk than just sit around and hope for the best. Also, I know a few Lending Club investors who never bothered to set up a secondary trading account and the handful of charge-offs they got over the past couple years killed their NAR.
For those keeping track, the WSO CDO is now down to 9 notes.
If you have any questions, hit me with them in the comments.
Eddie, you seem pretty confident that the price you are getting in the secondary market favors you - in other words, there is some arbitrage going on. The people buying obviously can see the potential downside and you are obviously selling at a discount for a reason.
Since your portfolio is only 9 notes large and one is now gone, what if 3 more of these notes were to go sideways over the next 5 years and the others stayed current? What would your adjusted total returns be (approximately) if you took the same loss on 3 more discount sales? 4?
Just curious....I'm still not convinced of this P2P lending, and I feel like taking a portfolio of 10 notes may not have been enough to get a clear picture of what an average portfolio performs at (even if they employ your strategy of dumping any notes that go sideways).
My guess is that you took a bit more of a loss since you waited - you still ended up with a 3.86% annualized return on that note? What if they had missed a payment? You think you would have been able to sell it for $10?
Very interesting. When I first looked at this a few years ago there was no secondary market component. The after market is a definite upgrade.
I worry that the site is a natural filter for poor quality borrowers. I think diversifying is essential in this asset class.
I also wonder if the high interest rates that the market demands for low quality borrowers is a failed concept. I can't afford a 15% interest loan. How the hell is someone with bad credit and can't get a bank to lend to them going to afford it?
I agree with your decision, you have 2 things working against you; potential risk and inflation. Lending Club charges 1% on every transaction? Pretty steep.
Since this P2P thing is pretty new, theres obviously no basis for what I'm about to say but from the little I know it seems to me that these "debt consolidation" types missing a payment during christmas/holidays is and will be not that uncommon moving forward.
But that's just me.
@BCbanker, I think it's definitely a best next option for alot of the borrowers, e.g. people who've overloaded on CC debt during the boom years and are facing 20-29% (or higher) rates from CC companies. P2P is probably their best option to re-finance and consolidate debt. Obviously that means we're taking on the borrower's credit risk, but hopefully can mitigate through risk management.
@Patrick - there is a really good snapshot of all loans funded through LC, but is a snapshot in time vs time series tracking of performance. Would be great if LC could release all available data, but I figure thats a data dump too difficult / messy to release.
For my own curiosity, I had done a little slicing and dicing of the data LC provided to see what characteristics most likely led to default and non-current loans. I loosely defined non-performing loans as anything not current or fully paid off, e.g. all charged off, in grace, late, in payment plan, etc as non-performing loans.
Average non-performing loan rate in Lending Club: 6.4% (e.g. 6.4% of loans at time of data pull were in default, late, grace, etc. This was by # of loans, not $ of principal value or balance outstanding)
D, E, and F rated loans showed similar risk - non-performing loans were 10.3%, 9.9%, and 10.4% of loans issued. Assuming the sample is reliable, the lower rated F loans likely have better risk-adj return than slightly better rated loans.
Loans for education and small business have high risk. Education loans showed 16.7% non-performance, or 2.6 times more likely to be at risk. Small business loans were at 13.4%, double the portfolio average. Surprisingly, car loans had lowest non-performance at 3.8%, or almost half the portfolio average. Credit card and debt consolidation loans were slightly below average at 4.6% and 6.3%.
Size matters - interestingly enough, loans funded for smaller amounts were more likely to default. Loans under $4000 had non-performance rate of 7.3%, whereas loans funded at $5000+ were in line with portfolio average.
Mortgage is good - borrowers who had a mortgage had lower non-performance at 5.3% vs renters and home owners at 7.4% and 7.5%, respectively.
Debt burden - if loan amount was less than 15% of the borrowers reported income, non-performance rate was 5.4%, debt burden above 15% increased non-performance to 7.4%, Obviously those with debt burdens greater than 25% of their income have limited ability to repay.
Rich people = low risk- a bit of a no duh stat, but borrowers with incomes greater than 80K a year showed lower credit risk than those with low income.
Credit score - such an obvious metric. High credit score did result in low credit risk. Above 700 credit score reduces credit risk to 4.5%, or 30% less than portfolio average.
Some interesting stuff in the data, I might put a few more dollars into the club to see how well some of the metrics above pan out as credit risk predictors. See how a portfolio of F-rated loans for debt consolidation with funding requests over $5K by mortgage holders performs...
Nice post, can you tell me which article/data you got these deductions from?
Patrick,
That particular note actually went into the 30-120 days late category, which basically makes it unsaleable in the secondary market. It was only when the borrower agreed to a payment plan that it was listed as "current" again, and that's when I dumped it. It's not really an arbitrage move on my part as much as pure risk transference. Since I don't know the borrower and have no collateral, I think I have to be pretty quick on the draw - which is why I'll never let another note go 30-120 days late before selling it.
Obviously 10 notes isn't a sufficient representative sample. I put this particular portfolio together more for fun and to show everyone the mechanics of P2P investing. Of course more of the 10 (or the remaining 9, to be exact) could go sideways and we'd have to see what kind of money we could make selling them. For the record, the note I sold paid a net 3.84% because I owned it exactly one year and I made a 96-cent profit on a note I paid $25 for. Obviously I didn't invest in the note to make less than 4%, but by selling it I eliminated the chance of losing the remaining balance on the note.
As mentioned in another comment, Lending Club is really diligent with the numbers and my overall return for the year is 13.1% after selling a handful of notes for dodgy performance. I haven't yet taken a loss of more than $1.75 net on a note. Overall I'm really pleased with the performance of my Lending Club portfolio.
Now, had I done nothing and let the bad notes default, my annual percentage would probably be in the 7% range or so, and I wouldn't be nearly as happy with it.
@freeloader,
We should discuss some of the characteristics you've mined from the data. I might need to tweak my lending criteria. Nice work on the numbers.
https://www.lendingclub.com/info/statistics.action
There are some pre-made stats on the site. Download data enables you to see funded, in funding, and declined loans over the entire history, I believe.
Another tidbit to add, relevant to Ed's previous comment on late payments, the recovery rate of loans in the 30-120 days late bucket is only 53%. Pretty high VAR once a note reaches that territory...
Ed: I skimmed over a few of the previous posts on this , a few questions on this I didn't see answers to (I admit I could have easily missed): - How much time would you say you spend on this (per week, month, etc) - I see you started with 10 units @ $25/each in your personal account -- what was your step up process (if any)? - Did you end up buy through the secondary market? If so, how did that work out?
@Texas
I probably spend about a half hour a week buying new notes and adjusting the portfolio. I started with 10 units in this particular portfolio just to see how it all worked and get comfortable with the process. After that I started with a lump sum investment and I add to it each week with automatic deposits. I haven't purchased any notes through the secondary market, I've only sold them. I know there is a lot of hedge fund interest in P2P lending, and I wouldn't be surprised to see that they are the majority of the liquidity in the secondary market. It stands to reason: why go through the whole underwriting process (where a lot of notes get kicked back and you have to start the whole process over again) when you can buy a note that is already seasoned and know exactly what your rate of return will (should) be?
I agree with your last point... also - with you divesting the unit at profit of >3.5% on a loan that is incrementally likely to default, gets me to question - what can you do with a loan that is paying off quite well... i.e. is there strategy is selling sound loans on the secondary market? Do you receive a premium (simply due to the fact the borrower has proven their stability)? By moving transactions more quickly, I would begin to imagine you can significantly increase your total ROI over time
Certainly possible, and I've thought about trying it but just haven't invested the time. I see hundreds of notes listed at a premium on the secondary market, so people obviously do it.
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