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Buying Lending Club Notes on the Secondary Market

Written by Nickel - 16 Comments

Earlier this week I began experimenting with the Lending Club note trading platform. I’ve been investing with Lending Club for about 14 months now, and have almost exclusively invested in new loans. Sure, I’ve sold a few sketchy loans, but I still hadn’t bought a note on the secondary market.

I finally decided to take the plunge after: (1) several commenters shared their positive experiences, and (2) I had a hard time finding enough suitable notes through the ‘normal’ investing channel.

What is the note trading platform?

Instead of trying to describe the note trading platform myself, I’ll let Lending Club describe it themselves:

The Note Trading Platform is an electronic marketplace where individuals and organizations can buy and sell Notes that correspond to consumer loans issued through the Lending Club website… The Note Trading Platform is operated by FOLIOfn.

You can access the trading platform from the “Trading Account” link in your Lending Club account. Be forewarned: You have to apply for an account and wait for it to be activated before you can use it.

Why use the note trading platform?

There are several reasons you might want to use the Lending Club note trading platform, including accessibility, speed of investments, risk reduction, and discounts.

Increased accessibility

Probably the biggest reason to buy notes on the secondary market is that not everyone is eligible to invest directly via Lending Club. In fact, you can only use Lending Club if you live in one of 26 select states. Residents of the other 24 states (and DC) are out of luck.

As for the note trading platform, nearly everyone can participate. In fact, only residents of the District of Columbia, Kansas, Maryland, Ohio, Oregon, Texas, and Vermont are ineligible.

Put your money to work quickly

Another big reason to use the note trading platform is that you can use it to put your money to work much more quickly than via direct investments. While new loans can take 10-12 days to fund, you can buy a note on the secondary market and the transaction will settle within 24 hours.

Risk reduction

Of my two notes that have been charged off, neither borrower ever made a single payment. By investing on the secondary market, you can screen these individuals out by only investing in notes that have received at least one (or a few) payment(s).

While an established payment record doesn’t guarantee that a borrower won’t eventually turn into a deadbeat, it does get rid of the outright scammers.

Buying notes at a discount

Finally, it’s possible to pick up decent notes at a slight discount. And yes, this applies to decent looking notes, not just stinkers. Sure, the discounts will be smaller on better notes, but I’ve been able to find plenty of promising notes at a 0.2% to 0.5% discount – not much, but I’ll take it.

How to select notes

So… Now that I’ve convinced you to give it a try, how do you go about selecting notes to buy? I’m still rather new to the game, but I’m always happy to share my strategies.

Unfortunately, FOLIOfn only has rudimentary filtering capabilities. You can filter based on interest rates, payment status, and the number of payments remaining. My primary considerations here are status and number of payments remaining.

I set the status to “Never Late” and the number of payments remaining to “35” – this latter setting guarantees that there’s been at least one payment made. At this point I have a huge number of loans to choose from, so I sort them based on their “Markup/Discount” with the largest discounts at the top.

Another major consideration at this point is the borrower’s credit score change. There’s a column for this in the resulting data table, with an arrow pointing up (increase), down (decrease), or across (no change). From here, I simply look for notes that have had no change or an increase in the borrower’s credit score, and I click to load each of them in a new tab.

Now the fun begins… I simply flip through the tabs and click the “Original Listing” link to load the original loan application. I then quickly check the loan against my loan selection criteria and close tabs that don’t meet my expectations. I then hop back to the list of loans, check off those that I want to buy, and submit my order.

The first time I did this, I managed to identify and order twelve promising loans rather quickly. If you place your order before 2:30 Eastern, your trades will settle that day. Otherwise, they will settle at the end of the next business day.

The downside of the note trading platform

The primary downside of the Lending Club note trading platform is that the interface kind of sucks. As I noted above, the filtering is rather limited, and I was also frustrated by the order submission process.

Instead of being able to add notes to a shopping cart of some sort and continue clicking through the available notes (you can only view up to 60 at a time), you have to submit your order before changing pages. No big deal, right? Wrong, as you can’t easily pick back up where you left off.

Instead, you get dumped back out to the main screen where you have to re-filter, re-sort, and then find your place back in the long list of available notes. Not a deal killer, but their design is definitely lacking.

Another minor issue was that, of the twelve notes that I selected, I only ended up getting ten of them. The other two simply disappeared from my order, and the money was credited back to my account.

Confused, I pinged Rob Garcia of Lending Club. His response was that, if there are payments coming in while a purchase is in progress, the transaction might get cancelled “so the purchase is not mispriced.”

My interpretation of Rob’s explanation is this:

The interest that has been accrued but not yet paid goes to the buyer. If a payment comes in before the sale is completed, the accrued interest plus the principal portion of that note would end up in the seller’s account, thereby reducing its value. Because this has an adverse impact on the buyer, the transaction gets scrubbed and you get your money back.

It seems like it would be easy enough for FOLIOfn to protect against this possibility, but I guess this is just how things work — at least for now.

What do you think?

For those of you who have tried out the note trading platform, I’d love to hear your thoughts. Any tips or tricks for navigating the interface a bit more efficiently? What about tips for finding those “diamond in the rough” notes? Anything else to add?

Published on August 6th, 2010 - 16 Comments
Filed under: Saving & Investing

About the author: Nickel is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

16 Responses to “Buying Lending Club Notes on the Secondary Market”

1
Kevin Richards Says:
August 6th, 2010 at 10:41 am
I am contemplating investing with lending club. I am not too sure if the earnings from this investment will be considered 1099 or not. Any idea?
2
Nickel Says:
August 6th, 2010 at 11:09 am
Kevin: Yes and no. It’s investment income so it’s taxable, but… They only report it (1099-OID) if the earnings on an individual note exceeds $10 during that year. Since most people buy lots of relatively small notes, the earnings on each note is typically quite low, so you may not get any 1099s. On the other hand, if you have multiple large notes, you will get potentially get multiple 1099s, one for each note that generates more than $10 income.
3
LCInvestor Says:
August 6th, 2010 at 12:07 pm
Good overview. Filtering for 60 month notes is a little trickier, but as long as you pay attention to the payments remaining column and filter for say 59 or 58 months this shouldn’t be a problem. I agree on the whole payment processing fiasco. They shouldn’t allow any notes to display for purchase that have payments in process. This is a waste of a lender’s time and is very frustrating. FolioFN told me it can’t be done currently, but how hard can it be to implement? Filter out the payment in progress notes so we can buy only viable notes and I can overlook the faulty interface at FolioFN for the time being. Any word on an interface-lift?
4
CPA Says:
August 6th, 2010 at 1:16 pm
The earnings ARE taxable and should be included when you prepare your taxes, whether or not you get a 1099. If you get audited (and I know the odds of that are slim, but still, people DO get audited), the IRS will ding you for not including the income – then, not only will you owe the taxes on it, but you will also owe interest & penalties on the amount you should have paid in the first place.

Happy Investing
5
Suwannee Refugee Says:
August 6th, 2010 at 1:25 pm
I’ve been doing this for a while. I like it because I can choose loans with a shorter time span. My money is then not tied up that long. Its a pretty easy process.
6
Nickel Says:
August 6th, 2010 at 1:38 pm
CPA: Yes, I didn’t mean to imply otherwise. One thing to be careful about is that you don’t double pay. Your unreported earnings are total interest earned during the year minus anything that comes on a 1099. So you should report the 1099 amounts plus anything that was unreported.
7
James Says:
August 6th, 2010 at 1:52 pm
Does anyone know about a way for people to invest who live in Texas? I used to live in NY then moved down to Texas and no longer can invest but really REALLY want to! Please if anyone from the “banned” states know a way, please email me or post it here! Thank you soo much!
8
David Says:
August 8th, 2010 at 5:42 pm
I know Nickel does not have a mortgage but for those people who have mortgages like myself, I think it is better to pay off your mortgage because you get a guaranteed return rate of 5 percent or more.

With stocks and bonds, loans you have to pay capital gains tax, dividend taxes on your investments which diminishes your return rate by 20 percent or more. I think lending club also takes a bite out of your return rate. Better to get rid of all debt before investing
9
paulie Says:
September 6th, 2010 at 10:05 pm
Some things I’ve learned about LCTP.
1. Default listing is for 15 notes per page. 30 and 60 notes page are available. With my screening I’m usally down to less than 120 notes to look at.
2. This is riskier, but I don’t look for discounted notes. I look for high ‘yield to maturity’ by clicking on the ‘yield to maturity button until its in the descending listing. These start somewhere around th 18% level and go down. Like I say this is riskier, but I look for 14.5% or better yield to maturity. Anything I want to look at is usually in the first 30 notes.
3. Then I look back at the ‘credit score change’ column and look for no change or the green up arrow.
4. Then I look at the original listing and finsh my screening for notes I want.
I welcome any critique or suggestions on how to improve these ideas
10
Chris Says:
October 19th, 2010 at 4:11 pm
The issue with the notes being listed for purchase and ultimately not getting them (as reported by Nickle and LCInvestor) is significant. In fact, I had noticed this for several months now where I would purchase a note and have it just “disappear” from my account the next day. It just so happens that today I was scanning for notes and saw the same note I purchased _yesterday_ listed again. I quickly checked my account and sure enough, it was gone! I actually re-purchased the same note on two different days because it was removed from my account without notice or warning. Does anyone know of anyway to avoid this or any official word from LC about how to prevent it? Seems grossly unfair and non-transparent to me. Warning bells go off in my head when this sort of thing is seen. I don’t believe its legal to arbitrarily void a securities purchase that has been listed for sale, especially to just re-list it again!
11
Nickel Says:
October 20th, 2010 at 8:51 am
Chris: The reason that it happens is that the pricing information (% discount, etc) includes the interest earned but not yet paid. If you buy a note and the interest payment hits before the trade settles, the interest gets paid to the seller. Thus, you would end up getting less than you bargained for. Hence, the canceled transaction. As I understand it, the loan doesn’t really get re-listed, it just goes back on the market with a slightly lower value, and the % markup/discount changes to reflect this.

While this is somewhat annoying, I would imagine that many investors would be upset if they got less than they bargained for, so the cancellation save other types of headaches.

Probably the best way to avoid this problem is to avoid buying notes with a payment due right around the time you are buying.
12
Chris Says:
October 20th, 2010 at 10:39 am
Although this reason makes sense, there are some issues with it. There is no documentation of this policy ANYWHERE I could find. Furthermore, if this is concern of LC, they should block these types of transactions in the first place (or delay them from listing until the payment completes). This does go against the “buyer-beware” mantra that is normal in all other trading activities. In fact, as a buyer, if a I see a note that is discounted 27%, I am likely not going to be worried about it actually being 26% because the payment went to the previous owner before it settled to me.

Lastly, I think the lack of response by LC when I contacted them speaks the loudest. What are they hiding if this is the real reason? Shouldn’t that be a disclaimer or at least listed in a FAQ page? Even my contact by email and phone has resulted in only a “we are aware of the isssue” response (in reference to be stating notes disappear from my account).

Although understandable why they would void a transaction, the fact no notice to the buyer is generated, its listed in the first place (only to GUARANTEE that the first buyer will lose that note until the payment settles), and their lack of documentation still leads me to feel something else may be going on.

To be clear where I am coming from, on the 8-11 times this has happened to me over the past couple months, I have lost “good” notes discounted anywhere from 20-80%. Three weeks ago I lost 3 notes at about 80% discounts. If put in this context, it seems shady they would just suddenly leave my account without notice. I’ve also had a lost opportunity cost where funds are tied up waiting on these notes to settle preventing me from purchasing other notes, only to have the original notes disappear.

Thanks for the good feedback on this. Its ashame I have to rely on great sites like yours instead of being able to deal with LC. Although my use of FolioFn may be at an extreme, it seems very wrong to me that I have to check a note LISTED FOR SALE for the payment pending and not buy it because I know I’ll lose it anyway. Would this work in any other marketplace?
13
Jck Says:
January 9th, 2011 at 5:39 pm
I’m new to this and trying to do my taxes.
14
Jck Says:
January 9th, 2011 at 5:42 pm
Iâ€™m new to this and trying to do my taxes. How do i do the taxes for notes sold on the secondary market?
15
Richard Says:
May 9th, 2011 at 5:56 pm
Can someone show the formula on how FolioFN calculates the Yield to Maturity from LC notes?

It seems my math never matches what the platform displays. I want to know if the platform is doing it correctly.
16
Jeff Says:
November 16th, 2011 at 12:39 am
JCK – you should hire a CPA to do your taxes especially when investing.

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