Wednesday, February 27, 2013

Lending Club Loans - Months of Payment before Default

In the last post, I reviewed the defaults based on loan issued date. As I mentioned in the previous post, due to point in time snapshot of historical loan data that Lending Club provides, it is difficult to determine exactly when a loan actually was charged off or defaulted.

Months of Payment

In this post, I will review the defaults using a different methodology. Before a loan is charged off or defaulted, borrowers stops making monthly payments on the loan. Based on the total payments made by borrower, we can determine approximately the number of months or number of times monthly payments were made before loan was charged off.

The months of payment will always be smaller than when actually loans was charged off as Lending Club can take significant time to write off a loan once payment stops. Also, as there is no information about partial payments and any late fees in historical loan data file, this analysis assumes that all payments were made toward monthly payments.

Loan Length

The chart below shows the percentage of defaulted loans as a function of number of monthly payments made for 36 month and 60 month loan terms.


At first glance, someone may make following observations:
  • The 60 month loans default quicker than 36 month loans.
  • Most 60 month loans default within first 24 months.
  • Both 36 and 60 month loans have similar default trend within first six months after loan issued date.
Such conclusion may not be correct. While 36 month loans of at least three vintage issued years have reached full maturity, none of the 60 month loans have gone through complete maturity cycle. The 60 month loans were first issued in early 2010. This is the main reason why the curve for 60 month loans gives the impression that most defaults happen within first two years.

Following observations can be made for default behavior of 36 month loans:
  • About 20% of all defaulted loans make five or less monthly payments.
  • About 50% of all defaulted loans make ten or less monthly payments.
  • About 80% of all defaulted loans make twenty or less monthly payments.
Put another way, we can expect half of our default loans to occur before a borrower makes ten complete monthly payments. Assuming Lending Club takes on average four months (120 days) after payments stop to charge off loan, we can expect half of our defaults to occur by 14th month after issue date.

Credit Grade

The chart below shows the percentage of defaulted loans as a function of number of monthly payments made for different Credit Grades.


There doesn't appear to be any significant difference in default trend for loans with different credit grade. The separation of curves for Grade E, F, and G from rest of the pack at 15 months of payment and higher may suggest that greater number of such loans are defaulting earlier. Majority of E, F, and G grade loans are of 60 month term. As mentioned earlier none of the 60 month loans have reached full maturity yet. The separation in curve is most likely result of incomplete defaults data for 60 month loans to maturity.

Key Takeaways

  • We can expect half of our default loans to occur before a borrower makes ten monthly payments, i.e. by 14th month after loan issue date.
  • It is too early to compare default trend of 60 month loans with that of 36 month loans.
  • There is no significant difference in default trend for loans with different credit grade.



7 comments:

  1. Excellent information! This confirms my recollection that I posted in our discussions on Lend Academy.
    I wonder then if a portfolio of loans have an average age of 10 months and have an estimated loss of x%, then as a rough estimate would the eventual total loss on that portfolio approximately be equal to 2x%?

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    1. Andrew, at high level your rough estimate will be correct with some caveats. The 10 months is number of months a borrower made monthly payment, so actual loan age by the time LC charges off may be 14 or even 16 months. Also, your loan portfolio will need to mimic typical LC loans (all LC loans). As the early defaults can be deadly for overall return, the lender should focus on loans that default later in maturity cycle to reduce impact from default.

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    2. My apologies, I meant to imply with estimated loss at 10 months as jumping to the conclusion of treating a late loan at that time as charged off (technically untrue, but forcing the absolute worst case).

      Great insight, I had not thought of one of those caveats. Realistically though, wouldn't a "well-diversified portfolio" mimic the data presented to a high degree?

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    3. Andrew, a well-diversified portfolio of loans meeting certain selection criteria will be biased. A large portfolio of randomly selected loans most likely will mimic the results better.

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    4. I agree it would be biased. It was more for the sake of discussion. I wonder to what degree the bias selection criteria would have. I suppose that's impossible to know for certain but it's fun to think about.

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  2. Andrew, remember assuming equal note size, you lose less for late defaults.

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