Monday, March 04, 2013

Lending Club Loans - Principal Paid Back and Months of Payment

In the last post, I analyzed the defaults based on number of monthly payments made by borrower before default. In next post, I will analyze the defaults using another methodology of principal paid back before default. In this post, I will review the relationship between principal paid back and months of payment.

Principal Paid Back

While months of payments methodology provides us a time frame when most defaults occur, it doesn't provide a decent comparison for loans in different maturity cycle and loans of different maturity length. My expectation is that the principal paid back will serve as an appropriate proxy for matching the loans at the same point in maturity cycle. For example, a 3 year loan at 10% interest rate would take about 20 months (55% of maturity length) to pay off 50% of principal while same loan with 5 year term would take about 34 months (56% of maturity length) to pay off 50% of principal. In this analysis, I assume that defaults for these two loans should behave similarly when each has paid off same percentage of principal.

Principal Paid Back is one of my favorite data point in evaluating a lending strategy as it is a good method to gage the risk tolerance of a lender. It quickly communicates on average what percentage of principal is going to be recovered from defaulted loans. Combined with the return from fully paid loans, it also communicates how many loans a lender needs to recover principal lost from defaulted loans and just break-even.


For example, the screen capture above from PeerCube shows historical performance of loans issued between 2007 and 2009 for a specific lending strategy that only includes borrowers who own their home. On average, each defaulted loan paid back only about 42% of principal. To break-even, this strategy need to recover 58% of lost principal from other loans in the portfolio. With, on average, only 14% return (ROI to be discussed in future blog post) from fully paid loans, a lender need at least 4 loans to be fully paid to just break-even. If a lender invested in all loans meeting this criteria between 2007 and 2009, 55% of loans contributed 0% to return and only 45% loans contributed to achieving 7.32% ROI from this strategy.

Months of Payment

The chart below shows the Principal Paid Back as a function of Months of Payment for both 36 and 60 month loans. Actually axis are swapped as certain observations listed below are easier to see this way. [Edits 03/16/2013: As requested by Andrew in comments below, updated the chart to include linear trend lines and screen capture of trend model description.]



The 36 month loans and 60 month loans clearly have two different paths on  the chart. It is clear that the principal payback schedule is different for 36 month and 60 month loans. The scatter plot for 60 month loans shows most data points in the region below 30 months of payment and left of 50% principal paid back. This is primarily due to 60 month loans issued only since second quarter of 2010. The solid color at 100% principal paid back mark for loans with both terms is due to loans that are fully paid either on schedule or ahead of schedule.

The chart below shows the Principal Paid Back as a function of Months of Payment for loans with various credit grade.


This chart is very similar to the previous chart. From density of different colors, it can be observed that the 60 month loans are primarily carry credit grade E, F, and G. Also, it appears that majority of 60 month loans that are paid off early carried credit grade A, B, and C.

Key Takeaways

  • The Principal Paid Back would be a good data point to gage the risk tolerance of a lender and variance in return of a lending strategy over the loan maturity cycle.
  • Reviewing the loans that have paid back less than 50% of principal may offer better comparison between 36 and 60 month loans.

8 comments:

  1. Thank you for posting these charts! It will be very interesting to continue to compare and contrast the 36/60mo issues as the data becomes generated.

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    1. Thanks for the encouragement, Andrew. I will continue to analyze historical loan data as much as possible.

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  2. I have some questions about the first chart showing 36 and 60 month loans.

    Basically I would expect to see loans that are ahead of the default payment schedule appear below the trend line, and loans that have fallen behind the default payment schedule appear above the trend line.

    Since the earliest 60 month loans are now hitting the 36 month mark, it seems there should be no red stars above the 36 month line. And the 60 month loans that have paid off early should be indicated by a red bar whose highest data point would appear at the 36 month mark? (The vertical red and blue bars at 100% should show some overlap from the 36 month point down.)

    Also, to make sure I'm understanding the chart correctly, is it showing that the earliest 36 month note paid off was at month 26?

    Thanks.

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    1. Lets start with your last statement first. No, the chart doesn't show that earliest 36 month loans was paid off in "actual" month 26.

      The Months of Payment measurement on the chart is a pseudo-measure instead of actual number of months payment was made. Historical data doesn't provide when loan was paid off so I am using this pseudo-measure months of payment as a proxy. It is important to understand how it is calculated.

      Months of payments = Total dollar amount paid back / Monthly payment

      Lets look at an example of a fully paid 60 month loan. I believe the example will also address you second question about there shouldn't be any orange/red star above 36 month mark. I picked a fully paid 60 month loan with Loan ID 638114 for $18,000 loan amount with monthly payment of $440.80.

      This loan on the chart will show up at intersection of 100% principal paid back and 51.5 months of payment. Actually, this loan was issued 12/31/2010 so it couldn't possibly be paid off after making 51 months of monthly payment. On this loan, borrower made total payments of $22,700.28 that includes all of original principal and interest till the 'actual' month the last payment was made.

      Months of Payment = $22,700.28 / $440.80 = 51.49 months.

      Anytime a loan is fully paid off it should show up at 100% principal paid back vertical line and higher than number of months takes to pay off 100% principal horizontal line. In this case,

      Months of Payment to pay off 100% principal = $18,000 / $440.80 = 40.83 months.

      Now lets get to your first statement. Loans that are ahead of schedule on payment should show up near top right area while the loans that are behind schedule should show up in bottom left area.

      Hopefully, this clarifies the confusion, you may have, what I believe between 'actual' months of payment and 'pseudo' months of payment used on these charts.

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  3. This comment has been removed by the author.

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    1. Edited:

      For image 2/3, would you mind using the data to show lines of best fit for the 36 and 60 month scatter plots? Perhaps also an equation that describes each line? If it's not too much work, I'd appreciate it.

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    2. Andrew, I updated the second chart in the post to include linear trend line and a screen capture describing the trend model. Thanks. Anil

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