Monday, March 18, 2013

Lending Club Loans - Principal Paid Back and Defaults

In this post, I will analyze the defaults based on principal paid back by the borrowers before default. For earlier posts in the series, please refer to Lending Club Loans - Defaults with Loan AgeLending Club Loans - Months of Payment before Default, and Lending Club Loans - Principal Paid Back and Months of Payment.

Loan Length

The chart below shows the percentage of loans defaulted as a function of principal paid back for 36 and 60 months loans. Similar to previous methodologies, the curve for 60 month loan is exaggerated, i.e. higher defaults at lower principal paid back because all of 60 month loans are less than 3 years old.


One interesting observation from this chart is that 2.7% of 36 month loans that default pay back less than 0.04% of principal, i.e. borrower only makes one or two payments on the loan. A few other interesting observations for 36 month defaulted loans are:
  • About 44% of defaulted loans pay back less than 20% of principal.
  • About 80% of defaulted loans pay back less than 50% of principal.
  • About 95% of defaulted loans pay back less than 80% of principal.
Put another way, we can expect 50% of our defaulted loans to pay back less than 24% of principal. This causes a double whammy for peer to peer lenders who are using a non-retirement account for lending. The interest earned is taxed at higher ordinary income tax rate while the principal lost to default is deducted from capital gains that are taxed at much lower rate. The monthly repayments during the first year consist mostly of interest resulting in lender paying higher percentage of interest income in taxes while lower percentage of principal loss to offset the capital gains if borrower defaults within a year.

Credit Grade

The chart below shows the percentage of loans defaulted as a function of principal paid back for various credit grades. There are no surprises here.
  • The defaults with principal paid back for loans with credit grades E, F, and G behave very similar to each other. The similar trend is also seen for  loans with credit grades B, C, and D. This may suggest that better returns to be have by investing in the loans with higher interest rate within each group.
  • As expected the defaults of higher quality loans, i.e. credit grade A loans, tend to pay back larger portion of original principal. The open question is whether the lower interest payments for such loans cover the principal loss.


Key Takeaways

Overall, I am disappointed that principal paid back didn't prove to be as effective of methodology as months of payment in determining when loan defaults peak. It appears sometime simpler measurements are much more effective in describing the trends. Also, none of the methodologies discussed able to explain the defaults of 60 month loans without observing such loans to maturity.

2 comments:

  1. Interesting information, thank you for posting!
    I noticed that graph 2 combines 36 and 60 month loans. With 34 months of data for 60 month notes available, is it possible to compare, for instance, the last 30 months of data for 60 month loans with the corresponding past 30 months of 36 month loans to examine the changes in the shapes of those curves over that time frame?
    That may shed more light on trends between the two maturities.

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  2. Your analysis abilities definitely trump my Excel pivot table work, but I found that about 80% of loans default within the first 20% of their payments (so 48 months for 60s, and 28/29 for 36s. Thanks for supporting my findings as I use my work extensively (as in automated evaluation of each individual loan) to pick loans which I sort by highest probability of return. Helps to have accurate data when doing that! :-)

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