Loan Issued Date
There is no doubt that loan transactions at Lending Club have skyrocketed, almost doubled between 2010 and 2011, as the chart below shows. The bars indicate the number of loans issued in Quarter and straight line across year indicate total number of loans issued in the year. The total number of loans issued to date in 2012 are 11,656 (a digit clipped in the image). High number of loans are positive for the continued viability of Lending Club platform. It also reduces the risk for lenders losing their investment because of Lending Club as a middleman going out of business.
Default Rate and Loan-at-Risk Rate
Too many recently issued loans (44,913 loans since 2010) and not enough aged loans (6,529 loans prior to 2010) in historical loan database create a challenge in calculating default rate. As the recent loans haven't aged enough, currently these loans most likely will have much fewer charged off, defaults, in grace period, late and performing payment plans (bad outcome). The high percentage (87.3%) of recent loans in analysis will underestimate the loan population default rate.
As the chart below shows, the average annual default rate, if only counting Charged Off and Default status is 8.74%, much higher than the 3.64% calculated in my previous post Lending Club Data and Default Rate for the whole population of loans. The average annual default, using my definition for default rate, is 10.29% much higher than the 5.85% calculated in my previous post. Going forward, lets call the average default rate calculated using my definition as Loan-at-risk Rate to better differentiate from the other default rate. For aged loans, those issued in 2009 and earlier, the default rate is much higher than average and most likely the true representation of default risk on performance of loans to maturity.
The bars for each status have their own independent scale for % of total loans (Y-axis). The bars for all status for a particular year (vertically) add up to 100%. The straight horizontal line across the bars show the annualized average for last six years. The shaded band shows +/- 1 standard deviation from average.
One way to interpret this data is that, for example, on average you can expect to have 8.73% of loans in Charged Off and Default status with the uncertainty that this percentage could be as low as 1.35% and as high as 16.11%. Another way to interpret is that, for example, on average the probability of a loan to be Charged Off and Default is 8.73%.
The probability of a loan in Charged Off and Default status rise as age of the loan increases. Both on annual and quarterly basis, the age of loan is found to have very significant effect (p < 0.0001) on probability of loan with Charged Off and Default status. For mathematically minded,
Probability of Loan with Charged Off and Default status (%) = 0.0103481 * Quarters since Loan Issued - 0.0127628
Key Takeaways
The analysis of loan status with respect to loan issued date suggests three takeaways from my perspective. Please feel free to share your insights in comments.
- The Lending Club loans have higher default rate, i.e. higher risk on annualized basis than most of the "popular" opinion. The wisdom of the crowd doesn't necessarily overcomes the advantage of extensive background information available to commercial banks.
- In order to assess the real performance of your loan portfolio on Lending Club, only consider seasoned loans.
- In addition to diversification across lots of loans, selling loans on the secondary market before maturity is a potential way to reduce the impact of loan default risk on portfolio.
Brady at Lucrative Lending recently discussed investing in P2P lending while in debt. He has great advice, check it out. Personally I believe you should only be a P2P lender once you have built a solid financial foundation. Considering the evolving state of P2P lending, you should consider investing in P2P lending only a small fraction of your funds allocated to Junk Bond or high risk assets.
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Interesting analysis Anil. But what is unclear to me is how you arrive at an annual default rate of over 10% or even over 8.74% when the TOTAL default percentage of completed three year loans from 2007 and 2008 is only 17.93% and 15.81% respectively. What am I missing?
ReplyDeleteThere are two points in your analysis that you failed to mention that have should have a huge bearing on investor thinking when analyzing loan history at Lending Club:
1. Borrowers with loans issued in 2007 and 2008 went through the worst financial crisis in 75 years. To think that loans issued in 2011 or 2012 would have a similar result seems to be a stretch.
2. You are also assuming that Lending Club's underwriting model is unchanging. This is simply not true. In October 2008 they went through a major change when they came out of their quiet period (increasing minimum FICO score from 640 to 660) and since then they are continually improving their model.
While I agree it is difficult to do analysis on a moving target when the major portion of the loans are less than a year old, to make an assumption on the completed loans exhibiting the same behavior as these new loans may not be valid.
Having said all that it is always good to look at different analysis. I think your research is interesting and something for investors to consider.
Peter, thanks for the interesting point you raised. The 8.73% average is for all 6 years. (17.93 + 15.81 + 10.92 + 5.99 + 1.71 + 0.01) / 6 = 8.73% Averaging over the year takes out the volume effect that is so pronounced if I take the Charged-off and default divided by total loans since 2007 (population default rate).
DeleteIf I exclude 2007 and 2008, average is 4.66%. Three year loans issued in 2009 have started to complete in 2012. The default rate for those 2009 loans already at 10.92% and expected to rise by year end. Even if I discount 20 - 25% (just a wild discount number) for the influence of 2008 financial crisis on 2009 loans, I will be closer to 8% default on 2009 loans.
Fair point about change in underwriting model. In this particular analysis, I only used two factors - Status of Loan and Loan Issued Date. I should have clarified that analysis assumes other factors to be constant. I will look into impact of Credit Score on default rate when I start analyzing credit score and loan quality. I will make a note to detect for underwriting model changes.
I am only working with data file with one snapshot in time. It will be more interesting and beneficial to do time-series analysis to see how and when status of loans changes and what influences this change. BTW, do you know anyway for me to get access to older data files? Thanks. Anil
Very interesting article. What I would be interested in going forward is default rates of certain kinds of loan. Almost no one goes on Lending Club and selects loans randomly, so while the big pictures is helpful I like to think that by filtering I am hopefully lowering my own default rate below that 8.7%. However, only time will tell.
ReplyDeleteThe key question for me and I think most investors is, which specific loans have the highest risk of default so they can be avoided going forward.
My goal is same, I would like to identify factors that influence the default rate of loans so that I can use them to filter out available loans for investing.
DeleteHmm ... you believe that you can beat the return and default risk of a portfolio of randomly selected loans! We will see :-) It is one of my objective to identify whether it is worth spending time to review and pick loans versus randomly picking loans.
Dan B........Quite a few people can beat the returns of a portfolio of randomly selected loans. Been doing it for over 2 1/2 yrs. now & I can think of a couple of bloggers who have been documenting their results for 3+ years who have done so as well. And I'm not talking about guys who own 32 loans & have gotten lucky. I'm talking about people like blogger Investor Junkie who has over 400 loans & has always beaten the average. MattSF who runs the blog steadfastfinances has always beaten the averages by a wide margin even though he's no longer reinvesting in LC. And these are just off the top of my head.
DeleteDan B.......I think most of the confusion among the different commentators or popular opinion as you put it, stems from the fact that Lending Club going back to 2009 has periodically put out the figure of 3% or under 3% as a default number. Some commentators have mistakenly interpreted that as a default number for the life of the loan when in fact it's CLEARLY specified as an annual number..........as in 3% per annum. So, 3% per annum comes out to around 9% for the life of a 3 yr. loan.
ReplyDeleteSo if you compare that expected 9% number to your own example of 2009 loans maturing now, the difference doesn't appear that dramatic to me.
Can you share a link or document that points out that 3% default rate is annual default rate? My best guess is that 3% default rate put out by LC is actually total amount of loan principal written off as charged-off and default divided by total outstanding loan principal at the end of a period.
DeleteDan B...........Sure can & it's quite easy to find. It's in the Q&A section & in answer to the question, What is the default rate ? It says right in the first sentence: "The overall annualized default rate since our inception in 2007 has been below 3%". Now whether this is accurate or not may be another matter, but that's what it says. Here's the link........
Deletehttp://www.lendingclub.com/kb/index.php?View=entry&EntryID=81
Dan B.........Gee, I would have thought that a simple thank you would have been appropriate here.
ReplyDelete