thanks. seems like i have been overthinking it a bit and should just assume original risk is priced in and i should feel good purchasing a note at no markup or a discount, particularly if the credit rating has stayed neutral or gone up.
There's an effect that you need to understand, which Rob L was trying to explain with those curves.
As the remaining fraction of the loan (which is what you are buying) gets shorter, you need more and more "discount" to get the same return as if you had bought the original note. The reason for this is that LC takes a fee of 1% of each note payment. Another way to think of this is that it is 1% of all the money you're going to get from the borrower. Part of each payment is principal simply being returned to you, and part of each payment is interest. So strangely, part of LC's fee is 1% of your own money being returned to you. If loans are all full term, ie say 36 months, then this always works out the same, because at a given interest rate and term, the ratio between total interest and principal paid over the life of the loan is a constant from loan to loan. However, when you buy a short "tail" of a loan in the secondary market, something different happens. The fraction of payments which is principal is higher, and the fraction which is interest is lower. That means that the fee you pay is a higher fraction of the interest you receive (which is of course the source of your return). Therefore the NET income (interest minus fees) is lower.
To counter this effect, you need a steeper discount on notes with a smaller number of payments remaining.
This is true at all risk levels. This is why LC calculates a YTM. Theoretically, you can see this effect by looking at YTM. Notes with smaller numbers of payments remaining require a larger discount to get a reasonable YTM.
However, none of us have ever been able to duplicate LC's YTM calculation. Therefore, IMHO, I think it is wrong, and I calculate my own. Your mileage may vary.
As for your original question of why notes are listed with negative YTM ... The answer is simple. People are stupid. People list notes at all sorts of crazy prices. Most people can't do the math, so they list notes at a price they figure is high to see if any sucker's buy, and then over time they lower the price to see what happens then, rinse, repeat. ALMOST ALL NOTES LISTED are listed at stupidly high prices, because if they were listed at reasonable prices, I would have bought them already. What looks to the naive user as a big inventory is actually a big pile of irrationally priced notes that are not really indicative of any sort of market pricing.
The rule you suggested in your original message is appropriate. That's what I do.
