A participation sale often hinges on its estimated yield. Price, servicing spread and prepayment speed are the obvious inputs. But two subtler factors often make a participation’s yield diverge from its underlying loans:
- Accrued interest: participations are often bought after loans close, sometimes months later, so the seller is owed accrued interest.
- Delay days: borrowers pay the originator on the payment date, but the originator distributes to participants later.
Mishandling either leads to wrong yields. Delay days usually have the bigger effect.
How delay days hit yield
Delay days extend average life with no extra interest; participants wait longer but earn nothing for the wait. The impact grows with the length of the delay and shrinks as weighted-average life (WAL) grows. For very short loans, the yield hit is large. Even for a 2-year loan, roughly an auto loan’s average life, delay days can cut expected yield by 14–24 bps.
The better way to calculate expected yield
A method that conforms to NCUA guidance is to run an IRR using the actual purchase and cash-flow dates, the price including accrued interest, and projected cash flows. Participation analytics packages do this, as does Excel’s XIRR function. Better still, convert the result to a semi-annual bond-equivalent yield for an apples-to-apples comparison with other fixed-income benchmarks.
Better technology, better yield
Informed buyers price in delay days, so longer delays cost the seller through a lower price. The faster a seller can complete and remit monthly payments, the smaller the impact. Buyers facing sellers who can’t shorten delays should pay less upfront.