Back in early August, I got a wild hair and decided I wanted to play around in Lending Club’s secondary marketplace. My idea was to buy “distressed” notes at a discount. If my discount is bigger than the failure rate, I should make money.
I was excited and impatient to try out my idea so I just bought a bunch of discounted loans pretty indiscriminately.
As you can imagine, this hasn’t turned out so well. Although I haven’t exactly gotten my face ripped off…yet. Here’s the latest update for my “distressed” portfolio.
Anyway, I’ve gotten a lot more discriminating about the notes I purchase now. I’m letting my rules for investing in new “primary” notes guide my selection of discounted notes I buy on the secondary market. Unfortunately, the interface doesn’t have the same set of filters, so I have to go through them one by one, which is really tedious.
I had originally set aside $1,000 for the distressed P2P debt experiment, but that may get cut down as I just don’t have the time to dig through all these junky notes.
I decided to put this post together to explain my process for secondary loan shopping, and to give an example of a loan I bought last night.
Primary Loan Filters That Are and Aren’t Available To Me in the Secondary Market
The secondary loan marketplace isn’t actually run by Lending Club…it’s run by “FolioInvesting” which IDK if they’re part of Lending Club or what, but the point is that the interface is pretty different from the one you use to shop for primary notes.
For example, I can’t filter for loan purpose, # of delinquencies in the last 2 years or verified income, which are key metrics in my loan selection process. So the only way I can make sure to meet these criteria is by opening up the loan prospectus for every note and checking. Ugh. Of course my other filters, like job title, loan amount:revolving credit balance, etc. have to manually checked in the primary market, so it’s not that much different.
I can filter for interest rate though, which effectively lets me keep within the E or better (max 22% interest rate) grade range. So that’s nice.
Secondary Loan Filters
Since these loans have already been issued, there are some metrics that don’t exist with primary notes. I’ve developed a kind of secondary set of rules to keep the number of loans I have to sift through down.
For now I’m focusing on loans that are in the grace period. You can get steeper discounts for loans that are 16-30 and 31-120 days late, but obviously the risk is a lot greater too. A lot of the ones offered at the discounts I’m looking for are about to turn 16-30 anyway and some of them actually do before the trade settles (which takes several days for some reason).
Credit Score Change
This I find pretty interesting. Lending Club is constantly checking in on borrowers’ credit scores (I assume a “soft” credit check?), and they keep track of it and let you know if it has moved up or down. Obviously with loans where someone’s credit score recently went down, you would expect a higher default rate, but how much higher? IDK…I don’t want to mess with it.
I only look at notes where the credit score has been flat or has increased recently.
Why anyone would pay above par value for a P2P note is completely beyond me, but some are definitely priced that way. Weird.
Anyway, I’ve found that you can get a decent, but not overwhelming number of grace period loans if you set the minimum discount to 30%. This makes sense, since according to Lending Club’s most recent data, about 31% of loans in the grace period end up charged off 9 months later:
I’d prefer more of a margin of safety here (like get a 40% discount for grace period loans) but if you get too greedy with the minimum discount you won’t have any loans to pick from.
I honestly do believe that my criteria probably make for a better loan pool than the overall average. If that’s true, I should be okay buying grace period loans for 30-35% discounts, but I guess time is going to tell eh?
A few thoughts on this chart before we move on to my recent example:
- These data are markedly WORSE since I first started researching this in August. I don’t remember exactly, but it was more like 25%, 50%, 70% and 90% for “grace”, 16-30, 31-120 and “default” respectively. A lot of the complaints I’ve heard about P2P lending is that the default rates are way higher than the algorithms have been projecting. This anecdotally supports that. Also having sifted through a lot of garbage loans lately, I can’t say I’m surprised, which is why I think I might be onto something with my criteria.
- Am I the only one that finds it extremely weird, and a little funny that the charge-off rate is lower for loans in default than loans that are 31-120 days late? It wasn’t like that back in August. WTF is that all about?
Anatomy of a Secondary Note
Okay, as promised, I ran my filter criteria last night and found 26 notes in the grace period for sale that were offered with
- a 30% or higher discount,
- a neutral to positive credit score move and
- a 22% or lower initial interest rate.
Of those, only one met my primary loan criteria, so that’s what I bought. Here it is, Note ID: 117249426 which back in 2016 was originally a $25 chunk of Loan ID: 72624466.
I paid $9.02 for this little diamond in the rough, even though there is $13.68 in principal and interest still outstanding (that is a purchase price of $0.66 on the dollar or a 34% discount).
If the borrower gets his or her shit together and ends up paying it back according to the original payment schedule, I should get $15.21 over the next 17 payments, which works out to a 69% “yield to maturity”.
Of course it’s also possible this Womens department associate [sic] from Sarasota is going to skip out on this unsecured loan and I will lose 100% of my $9.02
We’ll find out I guess.
What do you think? Was this a good note to buy? Am I crazy for spending over an hour just to find a single $9 investment? Think Lending Club’s robots are wrong about the charge off rates?
Let’s hear it in the comment section folks!