Transplant Athlete
Tuesday, December 21, 2010
  The Underbelly Of Lending Club...FOLIOfn

I promised not to write about Lending Club, but I've been harping on my dad to start an account and he lives in New Jersey and he can only buy notes on the trading platform. So this post will be some quick observations about the trading platform.

I JUST signed up for an account to see how it worked, so I don't have a lot of time on it yet. My first impression, there are far fewer filters available, so few that it's shocking. You can search by interest rate, Loan status (never late, current, late 16-30, late 31 - 120) and the number of payments remaining. As of today there are over 9000 loans for sale on the trading platform. Sellers set their own price and buyers can only buy at that fixed price (a bid/offer system might be better). Lending Club/FOLIOfn gives very little guidance to sellers (basically, if your note doesn't sell lower the price). This apparently results in some seriously insane pricing.

Before I go into how insane the pricing is, I wanted to say what I thought would be normal pricing. In most cases, I would expect a CURRENT loan to sell for the Principal + Accrued Interest (P+I) or Par Value. It looks like FOLIOfn recommends this as well.

If the Loan is late, I would expect it to be discounted to account for the possibility of it defaulting. If the loan has already been charged off, meaning Lending Club has exhausted all attempts at getting the money back and Lending Club has declared it a COMPLETE LOSS, I wouldn't expect those loans to sell at all. If on the other hand, the loan has never been late, I would expect it to sell at slightly higher premium to the P+I to account for it being more of a sure thing.

As an example, If I initially lend $25 for a 3 year term at an F2 grade with an interest rate of 18.67% and the borrower has made 4 payments, The outstanding principal would be $23.96 and the accrued interest would depend on when the last payment was received, but for the sake of this example let's say it's $0.33. The borrower has only made 4 payments, so this note still has a risk of default. If I were looking to purchase this note from someone else, it would need to have a Yield To Maturity (YTM) that reflected this risk (which would be pretty close to the initial interest rate of 18.67%). Obviously, the closer you are to maturity the lower the risk drops and the interest rate can drop accordingly. So, given this same loan where the borrower has faithfully made 30 of the 36 payments, I don't know what I would price it at (yet*), but it would be less than the 18.67%. Does that make sense?

Now, looking at the loans for sale, why is a similar loan (18.67%, 3 year term, 9 of 36 payments made) with $40 outstanding principal selling for $10,000. That's insane. The next 15 loans have outstanding principal between $15 and $20 and are listed at $1,000. That would be like me putting my $450K house on the market for $26 Million. Of course this is America and I'm free to put my house up for sale for $26 million, but who is going to buy it?

So, if we are serious about searching for loans on FOLIOfn, we need to look for serious sellers and that means looking at the YTM. There are simply too many loans to parse through, so I'm going to use the Never late and Now current filter that gets it down to 6500 loans.
I'm going to use the 24 payments remaining filter to get the number down to 650 loans. 340 of these loans have negative YTM (meaning if the buyer holds the note to maturity, they lose money). Another 220 loans have YTM below 7.7% (which may be appropriate if it's an A grade loan and/or it has very few payments remaining). That might only leave 10% or 20% that are worth taking a look at.

It just occurred to me that in some of these cases, the sellers are probably looking to capture the outstanding principal AND ALL the remaining interest. Given my F2 loan example above, the remaining payments total $36.06. It looks like these sellers are pricing their loans at that remaining payments figure or greater. Which doesn't make sense, The buyer assumes all the risk AND loses money on the deal.

So, why is the pricing so out of whack with reality? Well, there are probably a lot of unsophisticated sellers out there who don't know how to price their loans. There might be some who are sophisticated and hoping someone is stupid enough to buy the loan. When you attempt to sell a loan, Lending Club recommends the P+I and if you click on that it automatically fills it into the asking price box. The listing is active for 1 month. Maybe they should shorten the time frame to 2 weeks instead. That way people putting these ridiculous selling prices on their notes have to enter them more frequently. Maybe they need to attach a listing fee of something like 0.1% of the listed value whenever the listing price is x% higher than the par value. Then, someone listing a $25 loan at $10,000 would be charged $10, but someone listing that same $25 loan near par wouldn't pay anything extra.

I wonder if sellers are putting these crazy numbers to inflate the value of their portfolio (my portfolio is not worth $40 it's worth $10,000) or maybe there is a bit of money laundering going on...Who knows. All I know is that digging through all that crap lowers the utility for me.
Filters I'd like to see added:
Yield To Maturity (high and low range) I'd like to be able to search between 0% and say 25% (or 30%). Anything below 0% means you cannot make money on the note, you are paying more than you will receive in P&I. I don't need to see the loans with a YTM of 10,000% or even 50%. Yes, there is always the chance you could get lucky in this space, but let's be serious here, this is an unsecured loan.
In the absence of more filters, the ability to download the data in CSV format would help.


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I would certainly agree with you here. However, if you look at the matter of fact from Lending Club's perspective business model;

1) They're in the business to originate as many $$ as possible and make more $.

They only true reason they setup the trading platform arrangement with Foliofn is because they wanted a liquidity selling point to the investors. Otherwise, they likely wouldn't have as much investor interest.

3) They're only interested in updating the primary market for now (sadly) because they don't generate money by selling your notes (in fact it adds to their cost of doing business).

I do hope once they reach profitability (expected in early 2012) they will hire a larger staff and be able to focus slightly more on this aspect of their operations.

Good luck for now!
The FOLIOfn filters today look pretty much as you describe them. I did speak with someone from LendingTree at the start of April 2011 and they said they are working, or will be working, on the trading platform to make it more useful for buying large numbers of loans.

@Zachary, I believe they make 1% off the seller so LendingTree is interested in seeing notes change hands.
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