Trading Delinquent Notes, Part 2: Needle in the Haystack

Posted by Anil Gupta | Monday September 5, 2016, 3:20 pm | Categories: Lending Club PeerCube

In our previous post Selling Delinquent Notes on Lending Club Folio Secondary Market, Part 1: Loss Aversion, we reviewed the Markup/Discount requested by sellers on delinquent notes. The analysis indicated that sellers have a tendency to primarily list delinquent notes for sale close to par value. Sellers were unwiling to take loss on their losers, i.e. loss aversion.

In this post, we will review how the delinquent notes performed after being listed on Lending Club Folio secondary market. In some ways, this analysis might be considered an extension to our blog post from 18 months ago Lending Club Secondary Market: Profitability of Trade and Recovery Rate with Loan Status at Listing.

Dataset

In this analysis, we use Folio listings of delinquent notes on June 22nd, 2014. The dataset contains 9,515 notes from 2,681 delinquent loans. We use historical loan listing captured June 23rd, 2014 and August 10th, 2016 in order to identify payments made before (pre) and after (post) listing of delinquent notes on secondary market and determine the post-listing performance of such notes.

There were a few discrepencies between Folio listings and 2014 historical loan data:

The loan status field of 2014 and 2016 historical loan data indicated ten notes from four delinquent loans being listed on Folio that did not meet the credit policy. This information was not available through Folio listings but only through historical loan data file. A buyer purchasing notes on Folio might not be aware of such listings that don't meet credit policy. We decided to include such listings in our analysis. By 2016, three such loans (nine notes) were charged off and one loan (one note) was fully paid. The folio listed 203 notes from 51 delinquent loans that were not listed in 2014 historical loan data file though listed in 2016 historical loan data file. Among them, 40 loans (161 notes) were listed on Folio as In Grace Period, 8 loans (29 notes) Late (16-30 days), and 3 loans (13 notes) Late (31-120 days). By 2016, 19 of these loans (76 notes) were charged off, 16 loans (78 notes) fully paid, 15 loans (47 notes) current, and 1 loan (2 notes) in grace period. It was a surprising finding for which we don't have reasonable explanation. We included these notes in our analysis when lack of data from 2014 historical loan data file didn't interefere, but excluded when lack of data impacted our ability to perform analysis.

We made certain assumptions in estimating post-listing performance as listed below. While these assumptions simplified our analysis, the post-listing performance in our analysis might be better than what may have been experienced by buyers of delinquent notes.

We only deducted collection recovery fees listed in historical loan data from total payments and applied 1% service charge on resulting payments to investors. We didn't account for various fees as listed in What fees does Lending Club charge investors? that may have been charged to investors. We only considered status of loans in June 2014 and in August 2016. Any changes in the status of loan between these two dates as well as after August 2016 were ignored. We considered two loans to be equivalent that may have made similar payments over different length of time, i.e. we ignored time value of the money. The gains/losses on notes post-listing are simply the difference between payment received post-listing and the ask price at the time of listing with no adjustment for time value of money.

Performance of Delinquent Notes

Loan Status Migration

Table 1 below shows the starting and ending loan status for delinquent loans listed on Folio June 22nd, 2014. As a delinquent loan can have multiple notes from same loan listed on Folio at the same time, Table 2 summarizes the data based on delinquent notes listed on Folio June 22nd, 2014. Table 1 can be viewed as a buyer purchasing one note from each loan listed on secondary market. Table 2 represents buyer purchasing all available notes on secondary market.

Table 1: Loan Status Migration for delinquent loans listed on Folio June 22nd, 2014

2016 Status 2014 Status Late (31-120 days) Late (16-30 days) In Grace Period Charged Off & Default 90.5% 74.4% 48.6% Fully Paid 6.6% 18.1% 35.5% Current 1.9% 5.2% 12.9% Late 1.0% 2.3% 2.9%

Table 2: Loan Status Migration for delinquent notes listed on Folio June 22nd, 2014

2016 Status 2014 Status Late (31-120 days) Late (16-30 days) In Grace Period Charged Off & Default 93.0% 78.6% 55.8% Fully Paid 4.0% 12.7% 29.2% Current 1.8% 5.3% 11.7% Late 1.2% 3.5% 3.4%

93% of Late (31-120 days) notes listed on Folio June 22nd, 2014 were charged off by August 10th 2016. Only 4% of Late (31-120 days) notes have been fully paid. In other words, for every note that has been fully paid, 24 other notes were charged off.

Typically, on primary platform, most lenders experience high quantity of fully paid and current notes and small quantity of charge offs and defaults. On secondary market, the situation flips. Buyers of delinquent notes experience high quantity of charge offs and fewer fully paid notes. The key question is do the gains offset losses from purhcasing delinquent notes on secondary market. In following sections, we attempt to answer this question at high level.

Post Listing Profitability

Table 3 below shows the gains and losses for delinquent notes listed on Folio secondary market June 22nd, 2014. The NA row represents the notes for which we didn't have pre-listing payment data as highlighted during discussion earlier of discrepencies in hitstorical data. 90% of Late (31-120 days) notes resulted in losses. When we compare Table 2 and 3, we find a bright spot. While 7% of delinquent notes were not charged off, 9% of delinquent notes produced gains post-listing. Even though some notes were charged off after listing, a few made payments that exceeded the listing (Ask/Purchase) price. A buyer purchasing all listed delinquent notes can expect to get results similar to Table 3. Instead, can the buyer improve the Gain/Loss by purchasing only one note from each loan listed on secondary market?

The Table 4 below shows the gains and losses for delinquent loans listed on Folio when only one note with lowest markup/most discount from each listed delinquent loan is considered.

Table 3: Post-listing Performance of Delinquent Notes

2014 Status Late (31-120 days) Late (16-30 days) In Grace Period Loss 90.6% 84.2% 65.6% Gain 9.0% 13.9% 27.6% NA 0.2% 1.9% 6.8%

Table 4: Post-listing Performance of Delinquent Loans

2014 Status Late (31-120 days) Late (16-30 days) In Grace Period Loss 80.7% 76.7% 56.7% Gain 19.1% 21.2% 38.7% NA 0.2% 2.1% 4.7%

The number of Late (31-120 days) notes on which post-listing payments exceeded listing price doubled, 19.1% notes producing gains versus 9.0% when multiple notes may have been purchased from the same loan. This is one reason we encourage our readers, specifically PeerCube subscribers, to only purchase one note from each listed loan on Lending Club Folio secondary market. Automated Folio purchase system at PeerCube is also restricted to purchasing only one note with the most discount/least markup from each listed loan that meets user's criteria.

Post Listing Returns

Chart 1 shows the Box Plot of post listing performance of all delinquent notes listed on Lending Club Folio secondary market June 22nd, 2014. As highlighted in previous section, majority of delinquent notes if purchased at listing price result in losses for the buyer. In fact, for delinquent notes late by 31+ days, notes with positive return will be considered outlier akin to finding needle in the haystack. But all is not lost. Reliable identification of needle among delinquent notes can net buyers handsome returns as shown in Table 5.

Chart 1: Post Listing Performance of All Delinquent Notes Listed June 22nd, 2014 on Lending Club Secondary Market

Table 5: Post-Listing Return Distribution of Delinquent Notes with positive Gains

Status Post Listing Performance Minimum 1st Q Median Average 3rd Q Maximum Late (31-120 days) 0.14% 9.82% 19.97% 42.32% 38.24% 1,330.54% Late (16-30 days) 0.02% 6.73% 12.86% 23.74% 33.92% 155.17% In Grace Period 0.02% 6.50% 12.76% 16.83% 23.18% 91.94%

Chart 2 shows the box plot for return distribution when only one note with most discount/least markup is selected from each delinquent loan listed on Folio. It appears that purchasing delinquent notes with most discount indiscriminately may not be a profitable strategy.

Chart 2: Post Listing Performance of Delinquent Loans Listed June 22nd, 2014 on Lending Club Secondary Market

Further Analysis

As we move forward with our analysis, we will only consider one note with most discount/least markup from each delinquent loan listed June 22nd, 2014 on Lending Club Folio secondary market. It should be quite obvious that notes with higher discount from a loan will be more profitable than notes with smaller discount from the same loan. As Chart 3 shows there can be multiple notes from same delinquent loan listed at the same time on Lending Club Folio secondary market. By eliminating listings of multiple notes from same loan will minimize the outsize influence of loans with high number of notes listed at the same time.

Chart 3: Distribution of Notes from Loans listed June 22nd, 2014 on Lending Club Folio Secondary Market

Key Findings

On secondary market, purchasers of delinquent notes experiences big losses on majority of these notes and abnormally high returns on very few notes.

Indiscriminately purchasing delinquent notes with lowest markup may not be a profitable strategy for buyers on secondary market.

Reliable identification of profitable delinquent notes can net abnormal returns though it may not be easy to find such notes.

The low overall post listing returns on delinquent notes are not encouraging for sellers to be able to sell delinquent notes without offering significant discount.

In future blog posts, we will explore post listing performance, profitability, and loan status migration with different secondary market atttributes including Markup/Discount. In the mean time, we leave you the chart of post listing performance with listed discount as a teaser.

Related Posts

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

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

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