Lending Club Borrower's Home Ownership and Loan Characteristics, Part II

Continuing the review of loan characteristics as a function of home ownership status of borrower from previous post ...

Interest Rate

The chart below shows the average interest rate of loans issued between 2007 and 2012 YTD as a function of borrower's home ownership status. Due to very small volume of loans issued to borrowers who claimed home ownership as Any or None, those loans are removed from this chart. The average interest rate is an arithmetic equal-weighted average and not loan amount-weighted average.

The average interest rate is slightly higher for borrowers who rent homes compared to their counterparts who carry mortgage on their homes. This pattern has been quite consistent year over year. The reason for the slightly higher average interest rate may be due to lower FICO scores and shorter credit history because borrowers who rent home are likely to be younger and with limited credit history.

Similarly, the average interest rate is slightly lower for borrowers who own homes compared to borrowers who carry mortgage, loans issued in 2009 being the exception. The reason may be due to long credit history and higher FICO scores because borrowers who outright own homes are likely to be older and with decent credit history.

Lending Club Borrower's Home Ownership and Average Interest Rate

To confirm the assumptions, I decided to chart the average credit age at the time of issue of loan with the home ownership status of borrowers as shown below. Sure enough, the average credit age of borrowers who have mortgage on their homes is significantly and consistently greater than their counterparts who rent home. For example, in 2012 YTD, the credit age for borrowers who have mortgage is 15.8 years versus 12.6 years for their counterparts who rent. But there is no such relation between the borrowers who outright own their homes and credit age.

Lending Club Borrower's Home Ownership and Average Credit Age

Next I decided to chart the composition of home ownership status for each FICO score range of borrowers. It's clear that the lower FICO range are dominated by borrowers who rent and higher FICO score range by borrowers who have mortgage. For example, 56.1% of borrowers with FICO score between 660 and 664 rent their homes while only 19.75% of borrowers with FICO score between 800 and 804 rent their homes.

Lending Club Borrower's Home Ownership and FICO Range

Both Credit Age and FICO Range appear to offer a reasonable explanation for average interest rate to be slightly higher for borrowers who are renters. It is also not surprising considering that FICO Range is a key component of calculations used by Lending Club in setting Interest Rate for a loan.

Loan Length

The chart below shows the percentage of 36 months and 60 months loans issued between 2010 and 2012 YTD to borrowers as a function of their home ownership status. Prior to 2010, Lending Club issued loans with 36 months term only thus the data prior to 2010 is excluded from this analysis.

The borrowers who carry mortgage on their home are more likely to request loans with longer terms compared to their counterparts who own outright or rent their homes. In 2012 YTD, 23.60% of borrowers with mortgage received loans of 60 months term. In comparison, only 13.4% of borrowers who rent home received loans of 60 months term. This pattern is very consistent since Lending Club started issuing loans with both 36 and 60 months term.

A likely reason could be the management of debt repayment load. The 60 months loan will have lower monthly payment compared to 36 months loan of the same amount and interest rate. Typically, mortgage holders already have high debt payment burden, i.e. high debt-to-income ratio; thus, they may prefer smaller monthly payments and longer term loans.

Lending Club Borrower's Home Ownership Status and Loan Length

The chart below shows the percentage of borrowers' home ownership status as a function of loan length. This chart shows the same data as the chart above, but shows the composition of borrowers who own, rent, or carry mortgage on their homes for 36 month and 60 month term loans. With this chart, it is much easier to point out that higher number of 36 month term loans are issued to borrowers who rent home and higher number of 60 month term loans are issued to borrowers who have mortgage on their home.

Lending Club Loan Length and Borrower's Home Ownership Status

The chart below shows the borrowers' home ownership status and average monthly loan payment for loans issued between 2010 and 2012 YTD. The average monthly payment for borrowers who have mortgage  is higher than for borrowers who rent their homes. This observation is not surprising considering the average loan amount for borrowers who have mortgage is much higher as observed in the previous post. However, it doesn't help in explaining the propensity of borrowers with mortgages to take out longer term loans at Lending Club.

Lending Club Borrower's Home Ownership and Average Monthly Loan Payment

The chart below shows the borrowers' home ownership status and their average debt-to-income ratio for loans issued between 2010 and 2012 YTD. There is no significant difference in average debt-to-income ratio of borrowers based on their home ownership status.

Lending Club Borrower's Home Ownership Status and Average Debt to Income Ratio

It appears that both monthly loan payment and debt-to-income ratio are not associated with the propensity toward longer term loans by borrowers who have mortgage.

Key Takeaways

• With the interdependence of Interest Rate with Borrower's FICO range, credit age and home ownership status, most lenders would be fine with only using one of these three parameters or may need to de-emphasize the weightings of all these parameters to not let them overly influence loan selection process.
• The Loan Length appears to be independent of Borrower's debt-to-income ratio, home ownership status, and monthly loan payment. It would be recommended for lenders consider all these parameters in loan selection process. 

Lending Club Borrower's Home Ownership and Loan Characteristics, Part I

In this post, I will review the home ownership status of borrowers and loans issued at Lending Club platform. Lending Club categorizes the home ownership status of borrowers as Rent, Mortgage, Own, None, and Any. While Rent, Mortgage and Own are self-descriptive, I am not so sure what None and Any categories represent and how they differ from each other. For the purpose of analysis, I combined the None and Any categories together.

Over the past year, I have come across multiple loan listings where a borrower indicated home ownership status of Own but had one or more mortgage accounts, loan description or Q&A mentioned having mortgage. I believe some borrowers may be confusing the Mortgage and Own categories.

Loan Volume

The chart below shows the percentage of loans issued in each application year to borrowers with each of the four categories of home ownership status: Any or None, Own, Mortgage, and Rent.

Lending Club Borrower's Home Ownership Status and Loan Volume

The combined category of Any or None accounted for less than 0.002% of loan issued in 2012 YTD and 0.004% in 2011. The highest percentage of loan issued to borrowers with home ownership status of Any or None was 1.90% in 2008. Between 2007 and 2012, only 102 loans were issued to borrowers with home ownership status of Any or None.

Majority of loans are issued to borrowers who declared either renting home (on average 50% from 2007 to 2012) or having mortgage on home (on average 42%). Lenders excluding any one of these two categories in their loan selection criteria are ignoring almost half of the loans available on Lending Club platform.

With the exception of 2012 YTD, the percentage of borrowers who rent home is declining while borrowers who has mortgage on their home is rising. Considering we went through a deep recession, primarily due to Real Estate bubble, the rise in borrowers who have mortgage on their homes is not surprising. The 2012 may be start of reversal in these trends.

Loan Amount Funded

The chart below shows the percentage of total loan amount funded in each application year to borrowers with different home ownership status.

Lending Club Borrower's Home Ownership Status and Total Loan Amount Funded

What is interesting about this chart is that the percentage of loan amount funded for borrowers who rent home is lower than the percentage of loan volume for such borrowers as shown in the previous chart. For example, in 2012 YTD, borrowers who rent home received 47% of total loans but only 42% of total loan amount. The trend is reverse for borrowers who have mortgage on their home. This observation seems to indicate that the borrowers who have mortgage seem to request higher loan amount than the borrowers who rent home. These observations are also confirmed by the chart below that shows the average loan amount funded for borrowers with different home ownership status.

Lending Club Borrower's Home Ownership Status and Average Loan Amount Funded

As the chart shows, in 2012 YTD, borrowers who have mortgage on their home borrowed almost $3,000 (~20%) more than their counterparts who rent home. This observation is perplexing as why a borrower who already have a mortgage (supposedly much larger than any other debt) would request loans for large amount. Only logical explanations I could come up with are that most borrowers don't consider mortgage same as other debt, they are more comfortable carrying additional debt, and they are likely to borrow for large value home improvement projects.

To confirm whether borrowers who have mortgage borrow large amount for home improvement purposes, I filtered the above chart to only include loans where borrower declared the loan purpose to be home improvement. The chart below is its result.

This chart indicates that in 2012 YTD the borrowers who carried mortgage borrowed on average $13,589 for home improvement loan purpose compared to $14,681 borrowed for all loan purposes. This would indicate that hypothesis of higher average loan amount due to home improvement projects is incorrect.

Lending Club Borrower's Home Ownership Status and Average Loan Amount for Home Improvement Loans

Key Takeaways

• Excluding any one of the home ownership status of mortgage or rent will reduce the loans available for lending by almost 50%.
• The borrowers who carry mortgage are likely to request larger loan amounts and such loans will not necessarily be for home improvement purpose.

Lending Club Borrower's Credit Age and Loan Defaults

In this post, I continue the analysis of borrower's earliest credit line and relationship with loan status. As Lending Club doesn't publish the age of borrower, in this analysis I use the year of earliest credit line, termed credit age, as proxy for borrower's age. I am particularly interested in finding out whether:

• The finding from past consumer finance research of older borrowers being higher credit risk holds true for peer-to-peer lending platforms, and
• The borrowers with recent earliest credit line are higher credit risk, as asserted by White Coat Investor in his blog post Peer to Peer Lending Club Update.

Personally, I believe that Lending Club borrowers with earliest credit line several decades old likely to be much higher credit risk. Such borrowers in need for loan with high interest rate are likely to be not very savvy in managing their finances.

Earliest Credit Line and Loan Status

The chart below shows the loan status as a function of the year of earliest credit line. The loans issued to borrowers who started their credit in early 70's or earlier seem to have higher charged off, defaults and late payments. With 40+ years of credit history, these borrowers are likely to be in their late 50's and early 60's.

It may appear from the chart that loans issued to young borrowers who started their credit history in 2007 and later seem to have lower charged off and later payments. Considering that the fully paid loans are also lower for such borrowers, I believe most of these loans were recently issued. Even though I didn't find any explicit statement, I believe Lending Club doesn't issue loans to borrowers who have less than three years of credit history.

The chart below shows the charged off and default loan status as a function of the year of earliest credit line by loan application year 2008 through 2010. The loans issued to borrowers that started their credit history in 1970's or earlier appear to have consistently higher charged off and default status. There is no such pattern for borrowers with recently established credit history.

Credit Age and Loan Status

The chart below shows the loan status as a function of credit age. The pattern of loans issued to borrowers with longest credit history (40+ years) with higher charged off and default loan status, observed in first chart appears to hold. Also, loans issued to borrowers with credit history less than four year old appears to have higher charged off and default loan status.

The chart below shows the charged off and default status as a function of credit for application year 2008 through 2010. While borrowers with long credit history continue to show higher tendency to have loans charged off and defaults, there is no such consistent pattern for borrowers with short credit history.

Key Takeaways

• The borrowers with long credit history (40+ years) tend to have more loans charged off or defaulted. Risk averse lenders may benefit by avoiding older borrowers.
• There is no consistent patterns of charged off and defaults with younger borrowers. Lenders may consider taking a cautious approach toward borrowers who have less than four years of credit history.

Lending Club Loan Borrower's Earliest Credit Line and Loan Volume

After returning from vacation, I have started to analyze Lending Club historical loan data again and have improved PeerCube further. I am pleased to see PeerCube user base growing another 20% in my absence. Peter was kind enough to set up a section for PeerCube on Lend Academy forum. I'd like to encourage you to use the forum to suggest enhancements, request new features, and report any issues on PeerCube.

In a few posts, I will analyze a correlation between borrower's earliest credit line and credit risk. The past consumer finance research indicates that age of the borrower is significantly related to credit risk. As Lending Club doesn't publish the age of the borrowers, I have been using Earliest Credit Line as a proxy for age in my loan selection at Lending Club.

I am particularly interested in finding out whether the year of earliest credit line moves with loan application year as that would indicate a particular age group of borrowers more likely to use peer to peer lending for their credit needs.  My impression is that most people start their credit in late teens and typically get into credit problems in late 20's or early 30's if they don't manage money properly. I expect that most borrowers on Lending Club to have their earliest credit line opened 10 to 15 years ago.

The chart below shows the loan volume as a function of the year of earliest credit line. The surprising pattern is that the borrowers with first credit line established in year 2000 appears to have most loans issued, year after year. The breadth of years when first credit line was established for which most loans were issued seem to be narrowing with application year.

I wanted to see whether the distribution of loans by borrowers' earliest credit line is changing year over year. The chart below shows the distribution of loans by borrowers' earliest credit line for each application year. The percentage distribution for each application year appears to track closely. While the previous chart indicates that borrowers who established credit line in 2000 have the biggest share of loans, this chart indicates that the percentage of loans issued to borrowers with earliest credit line established in 2000 is rising with each application year and shifted from 1999 and 1996 in earlier application years.

I also calculated the Credit Age in years, the number of days between the earliest credit line date and application date. The chart below shows the loan volume as a function of credit age. The chart is not that different from the first one above. Even though no additional insights I gained from this chart, I expect the credit age to be handy when I analyze loan defaults.

In the next post, I will analyze loan defaults with respect to earliest credit line and credit age.

Lending Club Loan Selection using PeerCube's BLE Risk Index

One lesson I learnt from Peter's review of PeerCube and subsequent discussions is that I need to share how PeerCube can be used effectively during loan selection at Lending Club. In this post, I would like to provide some basic examples of strategies with BLE Risk Index.

As a refresher, BLE Risk Index of 1.0 is considered average risk. The lower the number, the lower the risk and the higher the number, the higher the risk.

Strategy #1: Loans with BLE Index below a specified value

The easiest way to use the BLE Risk Index during loan selection process might be to select loans on the basis of BLE Risk Index below a specified value. Very conservative lenders may consider selecting loans with BLE Risk Index below 0.90, while moderately conservative lenders may select loans with BLE Risk Index below 1.10.

PeerCube makes this strategy easier by listing loans with lowest BLE Risk Index under menu Lending Club -> Loan Review -> Low BLE Risk Loans. As the screen capture shows below, most available loans with BLE Risk Index below 0.90 are likely to be Grade A and B loans with Interest Rate as high as 12.12%. The moderately conservative lender can pick loans up to Grade D with interest rate as high as 19.72% while keeping the BLE Risk Index below 1.10.

Selecting loans solely on the basis of BLE Risk Index is the quickest way to make lending decisions. But in my opinion, this strategy may not be appropriate for most lenders because it puts too much faith on the current applicability of methodology used in a 1940 research and PeerCube's ability to implement the methodology correctly after 70 years.

At present, both concerns are valid ones and can't be ignored before adopting this strategy. The additional questions may arise about the "right" BLE Risk Index number for a lender and foregoing additional returns possible by increasing the threshold value, as previously discussed as part of BLE Index Caveats.

Strategy #2: Loans with lowest BLE Index in Each Credit Grade

This strategy is slight variation of previous strategy. Instead of relying on absolute specific value of BLE Risk Index, it relies on the relative risk as represented by BLE Risk Index.

One way to use relative risk is choosing loans with the lowest BLE Risk Index within a Credit Grade. This strategy will enable lenders to capture higher interest rate offered by higher credit grade while minimizing the BLE Risk Index within that credit grade.

We plan to utilize similar strategy in our new account with Lending Club. Our lending strategy with new account will be to:

1. Invest in total seven loans per week.
2. Invest in loans from all credit grade per week.
3. Invest in one loan per day.
4. Invest in loan with the lowest BLE Risk Index in each credit grade.
5. Not review loan details or any other quantitative and qualitative criteria.

PeerCube makes implementing this strategy a breeze by listing loans with the lowest BLE Risk Index for each Credit Grade under menu Lending Club -> Loan Review -> Low BLE Risk Loans. The concerns with this strategy are very similar to the concerns with the previous strategy. By not considering a fixed value of BLE Risk Index, the strategy minimizes the impact of errors in BLE Risk Index calculations as such errors will manifest for all loans.

Strategy #3: BLE Index as additional criteria with Filtered Loan Results

I believe this strategy is the most prudent among the three strategies discussed in this post. With this strategy, a lender considers BLE Risk Index as a data point for review after filtering available loans based on other loan and borrower parameters.

The advantage with this strategy is similar to the second strategy discussed above. Instead of linking BLE Risk Index with Credit Grade, as in the second strategy, this strategy links the BLE Risk Index with a lender's filtering criteria. A lender can choose to include either BLE Risk Index below a specified value or relative value of BLE Risk Index among loans available after filtering.

PeerCube now lists BLE Risk Index alongside the major loan and borrower parameters for filtered loan as shown below. This change facilitates easier consideration of BLE Risk Index.

Personally, I use BLE Risk Index with Founders' Filter in my current portfolio. I consider filtered loans with BLE Risk Index below 0.90 first and then loans with index below 1.10. I typically minimize investing in filtered loans with index above 1.10.

Hopefully, these examples will help readers come up with more creative and appropriate strategies leveraging PeerCube platform. Please share through comments how you are using BLE Risk Index in your selection process for Lending Club loans.

Note: I am currently on vacation. For next three weeks, posts and responses to comments will be infrequent.

PeerCube Update - Comprehensive Details for Lending Club Loans

Last week, Peter wrote an excellent review of PeerCube on his blog. The number of PeerCube users has greatly increased since his coverage including interest from individual and institutional investors. The major focus of users has been on PeerCube Loan Filter and Peer Filters. Users are becoming more comfortable with sharing and using Peer Filters which have been used almost 250 times. Three users, excluding myself, have shared their filters with the broader community. I also posted half-a-dozen curated peer filters.

Peer Insights functionality continues to be under-utilized. Originally, I saw peer insights features to be natural extension of crowdfunding nature of peer-to-peer lending. But as Peter suggested, quick churning of loans may be preventing users from rating and discussing loans. Any suggestions for increasing traction of peer insights are most welcome.

New Features on PeerCube

In last couple of weeks, I also learnt that I need to frequently update users on changes and improvements made to PeerCube and discuss ways to use PeerCube effectively. I have been quietly rolling out new functionalities and changes almost every week or two on PeerCube. Going forward, I will start writing blog posts to introduce new features and usage.

Peter already introduced Bad Loan Experience (BLE) Risk Index that is now integrated on PeerCube. For past few weeks, I have been discussing on this blog the BLE Index according to various loan parameters (Loan Purpose, Loan Length, Interest Rate, Loan Amount, Credit Grade, Borrower's Location, and FICO Scores). In future posts, I plan to discuss more about the foundation underlying BLE Risk Index and how lenders can use it more effectively during loan selection process.

In this post, I would like to introduce another change on PeerCube that I rolled out this week. Now the loan detail page on PeerCube includes comprehensive details about the loan and borrower. Except for the Q&A, almost all other available information is included on PeerCube loan detail page.

I am not aware of any place online including Lending Club's own loan detail page where as much information about a loan is available as on PeerCube's loan detail page.

Frequently Updated Funding Progress

Upon user's request, PeerCube does not display most 100% funded loans anymore. PeerCube has taken further steps in displaying more up-to-date funding progress. During business hours, funding progress is updated every four hours that results in reducing further the chances that a user will encounter fully funded loans during loan selection using PeerCube.

Expanded Loan Request Summary

The Loan Request Summary is significantly expanded with Initial List Status, Review Status, and various dates such as when Lending Club reviewed the application, pulled the credit report and borrower acceptance of the loan terms. The changes are highlighted below.

Comprehensive Borrower Details

The Borrower Details section now includes lot more information about borrower's employment and items from borrower's credit report. The changes are highlighted below.

Thank You

Overall I am very impressed with the progress PeerCube has made in last two months since introduction. I thank users of PeerCube who continue to engage with me and give suggestions and feedback. I have been enjoying all interactions and they stimulate ideas.

Thank you to all users of PeerCube and thank you for following this blog. I'm looking forward to coming up with many more ideas. Stay tuned...

Lending Club Loans - Borrowers' FICO Score and Bad-Loan Experience Index

After reviewing the defaults as a function of the borrowers' FICO score in the previous post, I decide to review FICO range according to bad-loan experience (BLE) index. Please refer to my first post on BLE Index for background information.

The table below shows the BLE Index according to borrowers' FICO score range. The range of BLE Index from 0.23 for FICO score 790-794 to 1.84 for FICO score 660-664 is not considerably wide. It appears that changes in FICO score is not significantly related to credit risk. The borrowers with FICO score below 709 appear to be greater credit risk.

Are you interested in Retirement Planning and Investment Annuities? Learn more from the published works of Moshe Milevsky

The table below shows the BLE Index according to FICO score range for loans issued each year from 2007 to 2012. Except for loans issued in 2012, the pattern of borrowers with FICO score below 709 being greater credit risk is pretty consistent. For loans issued in 2012, even the borrowers with better FICO score have BLE Index greater than 1.10. In my opinion, this observation shows that borrowers with better FICO score are more likely to default during the first year of the loan.

Key Takeaways

• No surprises that borrowers with lower FICO score are greater credit risk.
• The lenders who purchase notes on secondary market may be better of purchasing notes that have aged at least a year.

Lending Club Loans - Borrowers' FICO Score and Defaults

In this post, I will review the borrower's FICO score and its relationship with defaults. At the end of September, Lending Club started reporting the FICO scores in narrow and uniform width bands. For this analysis, I decided to switch historical loan data file to a new one from Oct 14th to be more granular with FICO range. There is general perception that borrowers with lower FICO score are at greater credit risk and more likely to default on their loans. I wanted to find out if this perception is true in peer-to-peer lending segment also.

Loan Volume

As the chart below shows the majority of loans are issued to borrowers that have FICO score below 730. Less than 100 loans are issued to borrowers with FICO score above 825.

Looking for some instant cash back on computer products? Check out Newegg’s Rebate Center.

The chart below shows the loan volume with FICO score for each application year, from 2007 to 2012. The loan applications from borrowers with FICO score 830 and higher were started to be listed on Lending Club in 2012.

The two observations stand out from this chart. First, more and more borrowers with lower FICO scores are applying for loan on Lending Club platform. The strict lending practices by traditional lending channels in the last few years may have resulted in borrowers with lower FICO score to look for alternative lending platforms such as peer-to-peer lending for loans. Second, the increasing smoothness of the FICO curve with time might be due to higher loan volume and Lending Club becoming more granular with borrower's FICO score since about 2010.

Loan Status

The chart below shows the loan status with borrowers' FICO score range for all loans issued since 2007. As expected, there is a clear trend of greater percentage of loans with charged off, default, and late status for borrowers with lower FICO score. Similarly, fewer borrowers with lower FICO score are likely to fully pay their loans.

The chart below shows the loan status of charged off or default with borrowers' FICO score range for application year 2008 through 2011. The pattern of defaults with FICO range each year are very similar to aggregate results shown in the earlier chart. The default rate on loans issued to borrowers with FICO score of 670 and less can be considered exceptionally higher than what normally seen for other borrowers on Lending Club platform.

Key Takeaway

• There were no surprises in expectations of borrowers with lower FICO scores attracted to alternative lending platform such as Lending Club and higher defaults and late loans for borrowers with lower FICO scores.

Lending Club Borrowers' Location and Bad-Loan Experience Index

After reviewing the Lending Club borrowers' state of residence for default rate in my previous post, I was very curious to see how states stack up with respect to bad-loan experience (BLE) index.

As a refresher, the smaller the BLE index the better the parameter is in reducing the credit risk. The green color represents the parameters that have BLE index less than 0.90. The pink color represents the parameters that have BLE index greater than 1.10. For more information on BLE index, please refer to my first post on BLE index, Lending Club Loan Purpose: Default Rate and Bad-Loan Experience Index.

The table below shows the calculated BLE Index according to borrowers' state of residence. There were not many surprises with the states that showed up with highest BLE Index and that also had the highest default rate as discussed in the last post. The BLE index variation from Rhode Island (0.45) to Nevada (1.92) is not considerably wide. It appears that States are not that significantly related to credit risk. From this analysis, it appears Nevada is the only state of some concern.

The table below shows BLE index for each year from 2007 to 2012. The rows are arranged in the same order as the above table for easy comparison. Except Nevada, Florida, and California, none of the other states has BLE index consistently greater than 1.00.

Key Takeaway

• The analysis of borrowers' state based on BLE index doesn't provide any conclusive answers about impact of borrowers' location on credit risk.
• The risk-averse lenders may want to consider excluding borrowers based in Nevada, Florida, and California, the states that consistently show up with BLE index greater than 1.10.

Lending Club Borrower's Location and Defaults

Previously, I analyzed parameters that were specific to loans: Credit Grade, Loan Length, Interest Rate, Loan Amount, and Loan Purpose. Now, I plan to review parameters that are specific to borrowers such as their location of residence, FICO range, income, etc.

In this post, I review the states where borrowers' live and find potential trends and patterns. There is general perception online by Lending Club lenders that California borrowers have higher defaults. I wanted to find out the validity of such views. Personally, in my personal P2P lending, I do not take into consideration the state of residence of borrower. Similarly, the Founders' Filter at PeerCube doesn't exclude loans based on the borrower's state of residence.

Borrower's State of Residence and Loan Volume

As the chart below shows, since 2007, more than 40% of all loans were issued to borrowers residing in California, New York, Florida, and Texas. Less than 100 loans combined have been issued to borrowers residing in Mississippi, Tennessee, Indiana, Idaho, Nebraska, Iowa and Maine.

For further analysis, I decided to combine states in Others  group that accounted for less than 200 loans issued each. In addition to states listed above with less than 100 loans, this group also includes Delaware, Montana, Alaska, Wyoming, South Dakota, and Vermont.

The chart below shows the distribution of states as a function of loan application date. The state composition appears to be more or less same for past several years. Considering California, New York, Florida and Texas being most populous states, the trend of most borrowers from these states is not surprising.

Loan Status

The chart below shows the loan status for borrowers from different states for all loans issued since 2007. One observation right away stands out is that borrowers residing in California don't have exceptionally high default rate. Borrowers residing in Nevada, Utah, Florida, Missouri, and Maryland have higher default rate than borrowers residing in California. Borrowers from Alabama, Arkansas, Washington DC, New Mexico, Rhode Island and Kansas appear to have lowest default rate.

Even after excluding loans from years 2007 through 2009 (charts not shown), there was no evidence that borrowers from California have exceptionally higher default rate.

Key Takeaway

• There is no evidence from above default rate analysis that borrowers from California have greater tendency to default compared to other borrowers.
• The perception of higher defaults for California borrowers may be due to significantly large number of loans issued to borrowers from California (12,607) thus large number of loans in defaults (4.12% * 12,607 = 520) but not necessarily due to higher default rate.

Lending Club Loan Amount and Credit Grade: Bad-Loan Experience Index

This post is continuation of last two posts discussing bad loan experience (BLE) index according to Loan Purpose, Loan Length and Interest Rate. In this post, I will review the two loan parameters that I had previously analyzed using default rate: Loan Amount and Credit Grade.

As a refresher, the green color represents loan parameters that has BLE index less than 0.90 and light red color represents loan parameters that has BLE index greater than 1.10. The smaller the BLE index, the better the loan parameter is in reducing the credit risk.

BLE Index for Loan Amount

The first table below shows the calculated BLE index according to loan amount. The second table shows BLE index according to loan amount for years 2007 through 2012. While reviewing the table, we need to keep in mind that loans for amount greater than $25,000 were only started to be issued in 2011.

It appears from BLE index that loan amount on its own may not be so much relevant in reducing credit risk.  This observation is consistent with the findings of 1940 study in NBER publication. That study also found that the amount of loan is not shown to be significantly related to bad-loan experience. Logically, it makes sense because the borrowers' capacity to make payments on borrowed amount (loan amount in connection with income, debt to income ratio, and revolving credit balance) is more likely to be influential on credit risk instead of loan amount.

---

---

BLE Index for Credit Grade

I consider credit grade to be a composite parameter developed by Lending Club to rate loans based on the methodology described at Interest Rate and How We Set Them. I expect bad-loan experience to show not only the relationship of credit grade with risk but also effectiveness of Lending Club methodology in assigning credit grade. Now, as the BLE index in the first table below shows, Lending Club does one fine job with credit grade. The smaller the BLE index, the better the credit grade. Also, the second table shows that by 2010 the bad-loan experience is rising with the credit grade. It appears Lending Club has done great job adjusting credit grade with credit risk over the years.

BLE Index for Credit Sub Grade

The two tables below show the BLE index according to the credit sub grade. It is clear that while Lending Club has done good job assigning Credit Grade with credit risk, some more work need to be done to do the same at credit sub grade level.

In general, the Credit Grade A and B appear to have lowest BLE index, i.e. better credit risk profile.

Key Takeaways

• The BLE index according to loan amount, on its own, is not a good indicator of credit risk. I expect to get better results when loan amount is analyzed in connection with borrowers' income, debt to income ratio and revolving credit balance (to be analyzed in future posts).
• Lending Club has done good job assigning credit grade according to credit risk; however, more work is required at credit sub grade level.
• Loans with credit grade A and B have lower risk profile according to BLE index. As discussed in previous post, for other credit grades, lender should consider advantage of eliminating X% of bad loans versus disadvantage of eliminating Y% of good loans.