Update: Distressed P2P Investing Experiment

Programming note: I’m contemplating making this into a monthly feature. Please, express your approval or hatred of that idea in the comments.

Sometime back, I embarked on an experiment that involved investing in Lending Club notes on the secondary market. My idea was to buy “distressed” P2P loans at a discount that was higher than the default rate.

The really dumb, simple math goes like this:

If you can buy loans that are late (in the grace period or whatever) for $0.65 cents on the dollar (35% discount), but the default rate is only 25%…you will make money…like more money than the 6.5% returns I’ve been getting with my more traditional P2P experiment buying primary loans when they’re originated.

Why would people sell loans at a steeper discount than the failure rate? Lots of reasons I guess. But mainly I figure it’s unsophisticated investors who want to GTFO of the P2P lending space because they’re disappointed in the total returns they’re seeing.

Or they need the money or whatever. That is the cost of liquidity.

It’s not unreasonable to expect an arbitrage opportunity exists. It’s just a question of whether or not a schlub retail investor like myself can actually exploit it.

I do not know the answer yet, but if it is in the affirmative…it’s not easy.

Anyway, this is what’s going on with my junk P2P investing experiment.

Distressed notes purchased


Total amount invested


Outstanding principal remaining


Adjusted value of principal remaining


Payments received


—-Principal received


—-Interest received


—-Late fees received


Actual losses (charged off)

$10.36 (4 loans…$77.45 in original principal)

Principal in default

$244.74 (9 loans…$69.24 invested)

Principal 31-120 days late

$386.20 (19 loans…$155.67 invested)

Principal 16-30 days late

$32.70 (2 loans…$21.69 invested)

Principal in grace period

$0.00 (0 loans)

Principal issued and current

$177.99 (9 loans…$101.96 invested)

There are several different ways to look at this.

One way is to have complete and total faith in the robot overloads and accept Lending Club’s algorithmic adjustment to the principal outstanding.

According to the robots, the value of my distressed loans (after adjusting for default probabilities is $0.36 on the dollar ($305.29 out of $841.62).

Since I’ve received $40.51 in payments from these crappy loans, the theoretical value of this “distressed portfolio” is $345.80 (adjusted principal remaining plus payments received) which represents a loss of $13.12 on the $358.92 invested (3.7%).

That’s a bummer, but a pretty good improvement over last month which had me at a loss of 15%.

There’s another way to look at it though.

9 of these loans are now issued and current. That’s where my payments have come from and that is pretty sweet. I only paid $101.96 for those 9 loans, but they have outstanding principal of $177.99. If they end up not being bad loans and get paid back in full I will have made $76.03 in principal alone…never mind the interest I’ll get.

Of the $841.62 outstanding, how much will go into default and how much will end up being okay? If it’s just the $305.29 that the robots are projecting, that will be sad but not the end of the world. The interest I get when the loans start paying should make up for the $13 of losses.

I have no idea what is going to happen but this is pretty fun for a finance nerd like myself. I do have some commentary though:

Pay Attention to the Loan Number

So Lending club divides their “loans” up into a bunch of “notes”. Technically you’re buying the notes, which are just broken up little bits of the loans.

Well on the secondary market, notes from the same loan might be available for sale. If you are not careful you might buy notes from the same loan a bunch of times. This screws up the math behind the distressed debt investing theory.

If you buy 100 notes in the “grace period” for an average of $0.65 on the dollar, figuring they have a 25% failure rate, you should come out ahead. But the trick to that 25% failure rate assumes the outcome of all 100 notes is independent of the others. If 50 of those notes are from the same loan, you aren’t really properly diversified, and  your averages are going to get all screwed up.

This is how I jumped from 1 note in default last month to 9 this month. Those 9 notes only represent 3 different loans.

I wasn’t really paying very close attention to this when I started, so I expect it to just be a very expensive lesson. The fact that I’m only 4% under water (according to the robots) after that big of a mistake makes me think I might be able to actually make good money at this.

Of course those default notes also violated my rules for P2P investing, because I was impatient with the secondary market.

By 1) sticking to my rules and 2) spreading my investments out among different LOANS (as opposed to just NOTES), I think I might get this ship turned around after all.

Well, what do you think about my crack-pot, half-baked, waste-of-time experiment?

Shout! Shout anonymously on the internet! Comments are encouraged.

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