Lending Club Numbers Revisited

  In 2008 I did a post on expected returns from using the Peer to Peer loan service Lending Club. It's been just over a year now, so what better time to take a look at the results? (Thanks mike for the comment on my other post).
  I'll come out and state right now, it's not as rosy as my initial assessment led me to believe(O RLY?). Much as the initial Propser investors took a beating, so have my first LC investments. I made the post when LC was still getting started, and there was a lack of historical data at that time, so I used the historical data for traditional loans that LC had on their website. Also, I wasn't as savvy about how to invest in loans at that time. Now you can take the historical data that they post on the LC website and do calcs with actual results. Interestingly enough, LC quite period last year provides a clear demarcation between my old and new loan strategies. But enough chat, here is a screen shot of my portfolio of "Old Notes".
 

Click to enlarge the image if you can't read it. It shows that of my 225 original loans, 10 are charged off, 16 are in default, and If you count those 1-4 months late as defaults, then that is 38 loans total in default. That makes almost 17% defaults. That's not terrible, but keep in mind that this is only after 1 year. These are three year loans, so most have about 2 years left to be fully paid. Also not that good either, since my original calcs show give a annual rate of return of around -1%.

  So how am I actually doing? If you look at the interest earned versus the defaulted amount, it's a net gain for me, but not by much. About $1029 defaulted, compared to $1,133 in interest payments gives me a prophet so far of $104 You can slice that value a number of ways, but since the payment/default process is still on going, and I don't want to delve into statistics tonight, I'll just leave it at that. The reason I have a profit vice the loss my original calcs showed is due to the assumptions made(ie, the loan defaults at origination, and all loans are of equal value). My actual portfolio is not homogeneous, and, of course, not all loans default right away.
  What this really means to me is that I'm not being adequatly compensated for risk(ie the interest rates on high risk borrowers is too low). Lending Club's interest rate model assigns an interest rate based on a number of risk factors, but I suspect that the for the D,E,F,G category notes that interest rate is too low. It's a tough choice, because if LC sets the rate too high, poor credit loanee's will not even apply. Plus I don't want to gouge people, I want to help them out of those high interest credit cards or bills. Some of it is also my fault for not being careful how I invested in the those old notes.
  So what can a person who wants to invest in do to mitigate the risks? First, only invest the minimum amount in any particular loan. This allows for greater loan diversity, and minimizes the chance that one loan going bad sinks your whole portfolio. I actually have a loan like that in my old notes. Thankfully the borrower has proved to be trustworthy so far, but I will never again go out on a limb for a single borrower, no matter how good there profile looks. The fact is, you can't really know the borrowers situation, or even if you do, it could change during the 3 years of the loan.
  Second, weight your portfolio toward the A,B, and C categories. You don't have to limit yourself soley to them, but the compensation isn't there for a large portfolio of low grade loans. Here is a snap shot of my current "new" note portfolio.

Most of the loans are about 3 months old, so there is not much of a history yet. This newer portfolio is definatly more risk averse, but by following the two principles outlined above I think my overall yield will be much better.

Comments

[Mike]

Thanks for updating your info. I had a gut feeling that LC's risk/reward setup didn't reward borrowers enough, especially for the lower grade loans. I recently had one loan go late because the person declared bankruptcy. Your advice is spot on: keep all loans to $25, and stick to the top tiers unless you can handle significant default rates. These are all unsecured loans to people you do not know, so loaner beware.