Lending Club Loans Issued Since 2010 - Principal Paid Back and Months of Payment

This post is the last in the series of posts discussing when default of loans start to peak (Part 1, part 2, part 3, and part 4).

Months of Payment

The chart below shows the percentage of 36 month and 60 month loans defaulted as a function of months of payment for loans issued since 2010. By reviewing both 36 month and 60 month loans issued in same time frame, we may be able to better compare such loans. While the default patterns are very similar for first 10 months of payment, the rate of defaults increases rapidly for 60 month loans after 10 months of payment. 50% of defaults for both 36 month and 60 month loans occurred within 8 months or so, the 80% of defaults for 60 month loans occurred within 13 months compared to 15 months for 36 month loans.

Principal Paid Back

Similar chart for Principal paid back is shown below. It is clear from the chart that while 50% of loans of both maturities defaulted within 8 months, the 60 month loans paid back (9%) only half of principal compared to the principal paid back by 36 month loans (18%). Can the 60 month loans that continue to make payment make up for this extra loss in principal with longer repayment duration and/or higher interest rate?

Another interesting observation from above chart is the increasing difference in principal paid back between loans of 36 month and 60 month maturities. For example, the 20% of defaulted 60 month loans paid back 4% of principal little more than half of 7% principal paid back by 20% of defaulted 36 month loans. In comparison, the 80% of defaulted 60 month loans paid back 16% of principal less than half of 37% principal paid back by 80% of defaulted 36 month loans.

The chart below shows the scatter plot of Principal paid back and Months of payment for 36 month and 60 month loans issued since 2010. A second order polynomial trend line is shown on the chart separately for 36 month and 60 month loans. As the principal portion in monthly repayments for 60 month loans is much smaller than that for similar 36 month loans, the increasing difference between principal paid back with months of payment is understandable.

Key Takeaways

• In the end, the months of payment is much more straightforward method to determine when defaults peak.
• For 36 month loans, 50% of defaults are expected to occur within 10 months of payment, and 80% of defaults within 20 months. 
• The default trend for both 36 month and 60 month loans is very similar for first 8 months of payment.

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 Age, Lending 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.

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.