What does 9 month loss estimate REALLY mean?

[rj2]

https://forum.lendacademy.com/index.php?topic=4047.msg37250#msg37250">Quote"> from: Fred on August 18, 2016, 11:02:23 AM

[rawraw]

In my opinion, ANAR is for retail investors. If you're attempting to take expected credit losses and discount them back at the opportunity cost, then you aren't a typical retail customer.

In that case, you should just conduct a discounted cash flow to determine your adjusted account value. ANAR of course ignores the earnings from the 9 month period as well. Seems like you want to take a incomplete measure of value and make it as precise as possible without realizing the 9 month present value is more than just the expectation of losses subtracted from period 0 value.



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[Fred]

https://forum.lendacademy.com/index.php?topic=4047.msg37252#msg88888888Quote"> from: rj2 on August 18, 2016, 11:55:05 AM

[TravelingPennies]

The discount rate used should be the rate that makes you ambivalent between having the cash in hand, and having the note. It's certainly not going to be a small rate given that the expected future payment is highly speculative.

Arguably it should be higher than the account return. The expected return on G graded notes is about 12% so maybe the discount rate used for defaulted notes should be higher than that, since the expected payment is uncertain. You could also argue that the discount rate should be around 30%, similar to the interest rate on highly speculative notes.

In choosing the account return I was considering opportunity cost. But maybe you should instead base it on risk.

If your expected payment from recovery is $1 that you're likely to get in 3-4 months and you discount by 30%/year you would value that $1 as being worth about 90 cents.

[TravelingPennies]

https://forum.lendacademy.com/index.php?topic=4047.msg37256#msg88888888Quote"> from: rj2 on August 18, 2016, 03:13:22 PM

[TravelingPennies]

How do you figure? Consider the fractional payment on the late note to be a security you can buy, which it is. Your expectation is not full repayment, but you reasonably expect to get that fractional recovery amount, which you expect to collect on average in perhaps 4 months.

 Its value is its present value of future payments, the fractional recovery amount, discounted by the interest rate that applies to similarly risky investments over a similar time period.

That's going to be similar to the discount on the riskiest assets on the LC platform, since that's how risky this asset is it seems reasonable to assume a 30% discount rate owing to the high volatility.

You can't tell me that I should be using some super low rate to discount. These distressed assets aren't tbills!

[TravelingPennies]

I found a peer cube article on this topic, it suggests that late loans should be valued at under 2% of the remaining principle value:

https://www.peercube.com/blog/post/lending-club-secondary-market-profitability-of-trade-and-recovery-rate-with-loan-status-at-listing" class="bbc_link" target="_blank">https://www.peercube.com/blog/post/lending-club-secondary-market-profitability-of-trade-and-recovery-rate-with-loan-status-at-listing

Here's the relevant section:

"Objection 1: You are only accounting for the principal received since listing and not the total payments received since listing including interest received.

The present value of future payments since listing is the principal remaining at the time of the listing. This assumes the discount rate is same as the interest rate on the note. Any interest received in the future is just the adjustment for the time value of money on remaining principal. "

[bluto]

https://forum.lendacademy.com/index.php?topic=4047.msg37209#msg37209">Quote"> from: Fred93 on August 15, 2016, 01:43:44 PM