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

Posted by Anil Gupta | Thursday March 5, 2015, 10:16 am | Categories: Lending Club

In last few post, we reviewed different attributes available for the notes at the time of being listed on secondary market. In this post, we will review a trading strategy from the perspective of a buyer on secondary market.

Previously, I had heard from a few P2P lenders that they were trading notes on secondary market by buying and selling heavily discounted notes. But the strategy crystallized for me during my travel late last year in Asia Pacific. I met a hedge fund manager who was purchasing heavily discounted debt internationally. I also met with a friend working in debt collection industry who explained the economics of paying pennies for each dollar of debt. Can a similar strategy work on the P2P Lending secondary market?

Though, termed Penny Notes Strategy, there are several variations to this strategy:

Purchase the lowest priced notes, Purchase the heavily discounted notes, and Purchase notes with highest YTM (yield to maturity).

Ask Price

First, we start with exploration of the dataset for distribution of Ask Price, the attribute that helps in identifying the lowest priced notes.

The Ask Price in dataset ranges from $0.01 to $10,960.09. The 80% of notes listed on secondary market have ask price of $30 and less. As we are interested in lowest priced notes, we only consider notes priced at $11 and less, which account for approximately 10% of notes listed on secondary market.

The chart below shows the distribution of notes with ask price and loan status at listing for notes priced at $12 or less. The average outstanding principal is also shown with axis on right side.

Chart 1: Lending Club Secondary Platform Listings: Distribution of Notes with Ask Price and Loan Status at Listing

The peaks at ask price that are whole number ($1, $2, $ 3, and so on) indicate that more notes are listed with asking price rounded to nearest dollar. Lot more notes are listed at $5 and $10 ask price. Lower the asking price more likely the notes belong to loans that are late by 31+ days, though there are a few notes that belong to current loans. The average outstanding principal for notes priced at less than a dollar appears to very small indicating majority of these notes belong to loans on which borrowers have paid off most of the original amount borrowed, i.e. older vintage or repaid ahead of schedule. The wide spread of average outstanding principal for notes priced at between $1 and $6 suggests that such notes may offer the profitable trading opportunities.

Profitability of Trade with Loan Status

In this analysis, there are several assumptions made for estimating the profitability of trade after notes being listed on secondary market.

There is no data available for interest received on notes before being listed on secondary market. Although the total interest received on a loan is available, the unavailability of interest received before notes being listed prevents determining the actual interest received after notes being listed. We used an approximation for interest received after note being listed estimated based on number of payments remaining, the months between loan issued date and the note listing date, and outstanding principal at listing.

We assume that Late Fee and Recoveries are received after notes are sold on secondary market. Although the recoveries are most likely received at the end of the completion of loans, we can’t say the same for the late fees. We reviewed a sample of notes for the timing of receiving late fees. We estimate that the impact of assuming late fees being received at the end on profitability of trade is minimal.

The chart below shows distribution of notes with ask price and profitability of trade for low priced notes. The notes are grouped by ask price in $1 buckets (bin). The total ask price of all notes in dataset with ask price bin is also displayed with scale on right axis.

Chart 2: Lending Club Secondary Platform Listings: Distribution of Notes with Ask Price and Profitability of Trade

Almost 45% of notes priced at less than $3.00 result in gains after being listed. As expected, the lower the Ask Price, the higher percentage of notes profitable. One of the challenges of implementing low price strategy is availability of inventory to deploy sufficient capital. Even if all the notes priced at less than $3.00 were to be purchased, only $15,413 could have been deployed in this sample dataset of notes listed in 2014.

The chart below shows running total of gain/loss after notes being listed with increasing ask price (gray line). The running total of gain/loss is also shown with loan status at listing with scale on right axis (colored lines). The chart is annotated with the ask prices when running total of gains are maximized and when the break-even is achieved. The ask price at maximum gain and at break-even are also reproduced in the table below. The table also shows the potential portfolio size based on the analyzed dataset.

Chart 3: Lending Club Secondary Platform Listings: Gain/Loss after Listing by Loan Status at Listing with Ask Price

Table 1: Ask Price and Portfolio Size with Loan Status Loan Status Maximum Gain Break-even Ask Price Portfolio Size % Gain Ask Price Portfolio Size Current $4.06 $8,513 42.9% $5.77 $30,632 In Grace Period $2.75 $362 188.4% $5.99 $2,930 Late (16–30 days) $1.99 $77 324.7% $3.78 $616 Late (31–120 days) $1.87 $1,854 43.4% $2.17 $5,328 Without Loan Status $1.89 $3,185 118.6% $2.99 $15,414

In aggregate without considering the loan status at listing, the maximum gains and break-even is achieved at ask price of $1.89 and $2.99 respectively. Buyers on secondary market could implement a strategy to purchase all notes at or below these ask prices without considering the loan status of such notes.

Based on the projected portfolio size listed in table above, it appears that low priced notes with loan status of Current and Late (31–120 days) are the only ones with enough volume on the secondary market.

Key Takeaways