Thursday, June 07, 2012

Lending Club Loan Credit Grade - Is There Demand for High Interest Loans?

Loan Credit Grade

The way Lending Club calculates loan credit grade and interest rate has been constantly evolving for past five years. Lending Club provides detailed information on method for setting the Interest Rate and Loan Grade for each loan. It appears from my analysis, Lending Club continues to tweak interest rates and underlying dependencies especially for lower quality loans. Before I review the relationship of Loan Grade with Interest Rate, let's look at Loan Grade with Loan Issued Date and Loan Listing Date.

Loan Volume

As the chart below shows, more than 50% of loans issued every year are categorized as top two best grades; Credit Grade A and B. The volume of loans of all credit grades has been growing at spectacular rate, year over year. However, only 1,301 and 377 loans were issued with Credit Grade F and G respectively in past five years. It is difficult to build a diversified portfolio (800+ loans) solely from grade F and G grade loans that carry high interest rates due to low volume of such loans.


Default Rate

As the chart below shows, the number of loans with charged-off and default status increases with the credit grade, from A to G, for loans issued each year. The trend is similar to the ones shown in my previous post Lending Club Loan Interest Rate and Return - Do Defaults Matter?.  While the default rate and interest rate bin relationship was much more consistent, that is not the case with loan credit grade. The relationship with loan credit grade is only consistent for better quality loans, those with credit grade A to D.


Days between Loan Listing and Issued Date

A reader 'Learner' commented on Peter's blog post Every P2P Loan is Getting Funded at Lending Club:
"The more creditworthy the loan, the longer it will take to fund."
As I was preparing to analyze the data for Loan Credit Grade with respect to the Number of Days between Loan Listing and Issued Date, I became curious to find out if the above quote holds true for loans with different Credit Grade. Do higher quality Grade A and B loans take longer to be issued after listing? I don't have the date when funding for a loan completed so I can't directly analyze the days it takes a loan to be fully funded. However, days between loan listing and issued date for a loan offers a close proxy.

The chart below shows the number of loans of a specific grade issued as a function of number of days between listing and issued date for the loans. The Lower quartile line represents the number of days from listing to issue (timeline) for 25% of loans, the Median line represents timeline for 50% of loans, and Upper quartile line represents timeline for 75% of the loans.

Days to Issue Loans Credit Grade
Percentage of Loans Issued A Grade B Grade C Grade D Grade E Grade F Grade G Grade
Lower Quartile (25 percentile)
4
6
7
6
7
7
6
Median (50 percentile)
12
14
15
13
15
13
12
Upper Quartile (75 percentile)
21
22
23
21
23
20
18

As the chart below shows, I couldn't find a trend that indicates loans with Grade A and B take longer to be issued than loans with other grades. In fact, 25% (Lower Quartile) of Grade A loans were issued within four days of listing, the shortest timeline among all loan credit grades. It is more surprising that the lower quality loans, supposedly Grade E, F, and G, in spite of very low volume are not issued any faster than higher quality loans. It leads me to suspect that either demand for low quality loans is not high enough or Lending Club takes too long after being funded to issue low quality loans. Update July 6, 2012: The quartiles in the chart and associated findings are incorrect. I made error in interpreting how Tableau calculated the quartiles.


The chart below shows the percentage of loans of each grade that have Charged Off and Default status as a function of number of days between listing and issued date of loans. In general, the default rate is higher for loans as the days from listing to issue loans increases. The exceptions are the loans issued within two days of listing and lower quality loan grades. I suspect these exceptions have more to do with fewer number of loans and data points for loans issued within two days of listings and in lower quality loan grades.


Key Takeaways

  • To build a high return diversified portfolio, investment need to be made in all or most lower quality loans listed on Lending Club platform at much higher risk.
  • There is no evidence from above analysis that better quality loans take longer to be issued.
  • The lower quality loans, in spite of higher interest rates and small volume, are either not in much demand or take too long to be issued by Lending Club after being fully funded. Update July 6, 2012: This takeaway may not be correct due to error in interpreting how Tableau calculates quartiles.

Leigh Drogen at Surfview Capital recently published an interesting article Complete Lending Disruption. He writes "Lending is about to be taken out of the hands of the banks, and put into the hands of the average person." I couldn't agree more. Worth a quick read.


Recommended Book: Your Money or Your Life: 9 Steps to Transforming Your Relationship with Money and Achieving Financial Independence is a classic book that should be read first by everyone interested in personal finance.


3 comments:

  1. Anil,

    Good analysis, and I'm glad you used data to back up your statement. Can you inform me how you gathered this data?

    -Learner

    ReplyDelete
    Replies
    1. Learner,

      Thank you for the comment. The data was downloaded from Lending Club statistics page at https://www.lendingclub.com/info/download-data.action.

      Thanks.

      Anil

      Delete
  2. Thanks for the quick reply. :D

    ReplyDelete