Abuse of secondary market

SavingStream doesn't do it right, it does it wrong by not allowing premiums or discounts. This means that sellers have little reason to put things on the secondary market unless they just happen to want to get out of the loan. Something much more sensible is done at Ablrate where both prospective buyers and prospective sellers can offer their own rates to see if anyone is interested.

At Ablrate I'll list at prices that I doubt people will want, just because I can and if I do get the price, I'll be content enough to have sold at that price, without having given up too much of my potential profit. Any buyers who are interested will benefit from the chance to buy, rather than no chance at all which is what they would have if I had to give up all of the future income. I've also been content there to buy at a premium sometimes. Similar at Bondora where I've often sold at both premiums and discounts and bought at either as well.

A seller isn't usually likely to be making a double profit, a seller is giving up the whole future stream of interest payments of the loan. That can have very substantial value. You're asking mintos to force sellers to give you that whole future value for nothing. That may look like a good buy for you now, until you realise that you're giving up the chance to buy the loans because only buyers who want to exit will be willing to sell for no premium. And even they may decide it's just not worth taking that loss of interest and just hold to maturity.

No interest for loans while on the secondary market is another way of screwing things up. It penalises people for selling loans, further restricting the potential supply. The interest should at least be paid to the buyer where it may increase the yield they get each day until sale or next borrower repayment. Paying the current loan owner (the seller) also works fine and may produce yields that decrease over time and I think it's more logical to pay the current owner the interest for each day they own it. So what mintos is doing seems sensible.

Besides those supply issues, there's also the potential benefit form things like tax arbitrage. A buyer can sell at a price such that both buyer and seller make money if the seller is at a higher income tax rate than the buyer, because the buyer can transform their future flow of interest payments into a capital gain that may have no or lower tax rate.

There are some potential issues, of course:

1. Negative expected returns. This sort of pricing is pointless because only a buyer making a mistake would purchase. It's good that Mintos will block these. Any positive return at all can work to be an OK deal, just not negative or zero.

2. Returns below the market rate. This isn't such a concern so it's best dealt with using search filters and sorting, so buyers can eliminate from consideration loans with expected returns that just don't interest them. Sellers who find that they are offering at premiums that result in no sales may eventually tire of the activity once it's easy to just ignore them. And buyers then have the option of looking at the lower yields to see if there's anything there that interests them.

3. Flipping. Buying in a high demand primary market then reselling quickly for a profit. This can end up being in effect a tax by traders imposed on investors and it can produce far higher XIRR for the people doing it than normal loan interest rates, not just double returns. I think that platforms should very strongly discourage this and perhaps use tools like restricting the proportion of a portfolio that can be resold within a certain time, except occasionally to allow platform exits. Delays in selling can also reduce the reward for flipping by increasing the required capital. Flipping is by far my biggest concern when it comes to premiums because it can significantly harm both investors and the long term growth of the platform by getting it a bad name.

A possibly better way to do that is to have a yield figure that defaults to say current market yield minus two percent. This will by default end up filtering out most of the deals. It's not desirable to actually remove all those at lower rates than the market because diversification and the liquidity available on a secondary market both have value. Sometimes there can be so much loan supply that the secondary market supply doesn't matter but this is unlikely to always be true.

Consider say a five year loan piece worth €500 at 15% interest rate. Total interest over five years would be €198.95. To double that the selling price would need to be €897.90, a premium of 79.58% and projected buyer yield of about 8.5%. I doubt that the seller would find many buyers willing to pay a premium of around 80% to get 8.5% yield while accepting the early repayment and default risks. Double profit on a single loan is pretty words but not something that is likely to happen much. It could happen, a buyer might find 8.5% OK, particularly if loan rates on the primary market have dropped to below 8%.

At times at Bondora I've occasionally found myself selling loans at a projected yield of over 80% for the buyer. That's because Bondora has a 30% cap on the seller premium. The loans had pending payments and penalties that greatly pushed up the anticipated return for the buyer. In such cases I tend to either not sell or to sell only enough to diversify away part of my risk because I'm giving up too much potential income.