Today marks the completion of my eight month study: The Liquidity Project. Every week, from May 2013 through January 2014, I gradually discounted my taxable Lending Club account until it was completely sold off. The resulting data paints an extremely interesting picture of the secondary economy that exists in this backsection of the Lending Club website.
The Problem: P2P Lenders Have Struggled to Liquidate Their Accounts
Peer to peer lending has often been celebrated for its liquidity. Not only are its returns more stable than the swings that often characterize the stock market, and not only are the returns incredibly lucrative in the face of more traditional investor yields, but the secondary markets on Lending Club and Prosper have contained an avenue for people to sell off their investment if they ever need the cash. As a result, many proponents of this asset class, myself included, have proclaimed that peer to peer loans contain good liquidity. We feel that if someone needs to exit this asset class without taking too big of a hit, they can do so.
The problem inherent in this claim is that little proof exists to support it. Also, the wider investor community’s experience has often been quite variable and unconsolidated. In short, there has been a lack of hard data to help investors correctly price the notes they are trying to sell. As a result, investors seeking to exit peer to peer lending have often struggled in how to begin liquidating their accounts.
The Solution: An Eight Month Study on Foliofn Liquidity
The Liquidity Project (as initially outlined in this post) is a first-attempt at establishing a baseline for account liquidation. By gingerly lowering an entire portfolio’s price on Foliofn (the secondary market for Lending Club loans), each individual note’s markup became solely dependent upon its quality and characteristics alone. As a result, particular markup/discount thresholds could be identified so as to help future investors quickly liquidate an entire portfolio while still earning a respectable markup.
Methodology: Create a Sell-Calendar, Record Note Sales, and Analyze
My first Lending Club account was chosen to be liquidated for this project, an account containing 35 active notes worth around $1,000.
Starting the 29th of May, I listed all these notes for sale at the maximum possible markup (+50%). Following a selling calendar, I lowered the markup on these notes every three days until the account was liquidated.
- From a 50% markup to 20%, the premium dropped 2.5% every three days until July 4.
- From a 20% markup to 10%, the premium dropped 1% every three days until August 3.
- From a 10% markup to 6%, the premium dropped by 0.5% every three days until Aug 27.
- From a 6% markup until every note was sold, the premium dropped by 0.25% every three days.
The project ran eight months, with the final note selling January 29, 2014. The portfolio’s markup/discount had adjusted 50 different times. Since Lending Club auto-renews the Foliofn listing whenever its price is updated, every note remained for sale on the platform for months at a time, from late May until every was sold.
Note: Originally I had 40 notes in this project, but five went late or were paid off, so only 35 were used. Also, my original intention was to sell a comparable number of Prosper notes the same way, comparing the liquidity of one platform against the other. Despite identifying these notes and opening their sale on Prosper’s Foliofn section, I gave up this goal when I realized how Prosper’s site frustratingly does not renew listed notes when they are repriced. Having to dig through my entire Prosper investment for specific notes (no portfolios) every 7 days was too tedious. As a result, this study became only focused on Lending Club.
Four Major Insights into the Lending Club Foliofn Secondary Market
As a reminder, all of these sold notes contained a Current status. The markup/discount was calculated from each note’s outstanding principal.
Insight #1 – Notes with ‘Current’ status sell from an 11% markup to a 4% discount
Even though the project started in late May, two months went by without a sale. But in July a number of low-grade notes were the first to sell, earning a surprising 11% premium. The project continued until late January, when the last sub-par notes were sold at a -3.75% discount.
Insight #2: Notes with higher interest rates sell at higher premiums
The above graphic demonstrates how the notes with higher interest rates were in greater demand, and earned a higher premium on Foliofn. This can be seen more easily in a breakdown of average markup by loan grade:
E, F, and G-grade notes earned an incredibly high markup, the Fs and Gs selling with a 11% markup to their outstanding principal. B-D grade notes earned far less than this. It deserves mentioning that there were more D grade notes (16 D vs 9 E-G), so their markup may be more accurate of the market as a whole.
Surprisingly, the entire portfolio was sold at a 3.66% markup. After 1% in fees, this account was liquidated while earning a 2.66% premium. While no seller should ever take eight months to liquidate his portfolio, this 2.66% result does propose a best-case scenario and baseline for future investors (including the Sacramento Method below).
Insight #3: Notes with healthier FICOs sell at higher premiums
This result was my favorite of the bunch. I would even go so far as to say that the beautiful curve of this chart makes the entire eight-month project worth the time. I am not sure what the implications are of knowing that sell price is so deeply tied to how a borrower’s FICO has changed. Perhaps it just further encourages us to improve our initial loan selection criteria so as to imbue our overall account with as many quality borrowers as possible.
Insight #4: Notes with more outstanding principal may fetch a higher premium
This seems the loosest insight, but purchasers of notes on the Lending Club Foliofn secondary market seem eager to find notes with a greater percentage of outstanding principal.
Further Research is Needed
While this project seemed to use decent methodology, it could be improved upon. First and foremost, the number of notes in this experiment (35) were too few, though I am pleased that this data contains good correlations despite this weakness. However, a similar study with hundreds of notes would give far clearer results. Secondly, additional statistical factors could be interesting to look at, like number of missed payments, loan term, and note size. A larger liquidated portfolio that contains a mix of sizes and terms would be ideal. Thirdly, this project did not include A-grade notes. Finally, it would be really interesting to do something similar with notes that have gone late. I was able to do that with a single note during this project. A single D-grade Late note with a FICO drop of -175 sold at a 49% discount.
How to Quickly Liquidate Your Account? The Sacramento Method
Most people who are trying to liquidate their account are attempting to do it in the quickest manner while also earning as much premium on their healthy notes as possible. As a result, I would like to theorize a five-day liquidation method based on this project’s results: the Sacramento Method.
Named after its five sell points (a zipcode in Sacramento, CA is 94204), this method prices notes at five efficient markup/discount points so as to liquidate an account in less than a week while still garnering a respectable premium.
- Day 1: Price notes with a 9% markup over outstanding principal
- Day 2: Offer a 4% markup
- Day 3: Offer a 2% markup
- Day 4: Price notes without a markup/discount
- Day 5: Offer a 4% discount
If I would have used this model, I would have drastically lowered my sell time while still earning a 2.7% markup on my portfolio. Minus fees, this method could theoretically have liquidated my entire account and earned me a net 1.7% premium in just 5 days. Of course, there is no guarantee that Foliofn performs the same way today as it did back then, but it is possible.
The reason I feel confident in the Sacramento Method is for the way it first makes space for high-markup notes, spends three days cutting the common markup arena more gradually (4/2/0), and finishes by catching discountable notes. This method seems more effective for accounts containing a medium to high degree of risk, since this is what it was built around (project’s avg. interest rate is 17.2%). It will probably be less effective for people who have low-risk portfolios containing many A-grade notes.
Disclaimer: This Method is Conjecture
It is worth repeating that this entire project, its data, and its method was based on a small sample size (35 notes), and as such, its overall quality is speculative. Foliofn is a turbulent environment that requires a far more rigorous project than this one before any real conclusions can be made. Furthermore, even if this project had a decent sample size (800 notes or more), no method or theory is a guaranteed way of liquidating your account at an overall premium.
However, I am willing to posit the Sacramento Method as a preliminary standardized approach to account liquidation, and I am eager for more rigorous studies in the future to prove it wrong or uphold its conclusion.
Download the Liquidity Project Data
The Liquidity Project (results).CSV (right-click & Save As…)
[image credit: Kyle May “DIY Fake Ice Cubes” CC-BY 2.0]