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What are these Policy Code 2 Loans at Lending Club?

by Peter Renton on November 21, 2013

I first noticed these loans back in July when I did a download of the entire Lending Club loan history. There was a new column added to the download file called policy_code. And some recent loans had been added that had a policy_code value of 2, whereas previous loans had a value of 1.

I had been told some changes were coming where different kinds of loans were going to be made available and this looked like it. When you look at these Policy Code 2 loans in the downloadable CSV file you will notice they are different. In fact there are several differences between these loans and the regular loans. For Policy Code 2 loans:

  1. All of the credit data fields are blank.
  2. They are all F and G grade loans with interest rates ranging from 23.5% to 26.06%.
  3. They are all 36-month loans.
  4. Average loan size is around $8,500, well below the roughly $14,000 average of all loans.
  5. Maximum loan size is $15,000.

These Policy Code 2 loans have been growing rapidly in volume. The first one was issued on July 12, 2013 and each month has seen a significant increase:

MonthPolicy Code 2 Total Loan VolumePercent
July$2.7 million$173.5 million1.6%
August$10.3 million$190.3 million5.4%
September$15.4 million$203.4 million7.6%
October$18.3 million$223.1 million8.2%

When I chatted with Scott Sanborn, the Chief Operating Officer at Lending Club, about these new loans he was able to answer many of my questions and clarify exactly what is going on. So here is the rundown on Policy Code 2 loans:

  • These are loans made to borrowers that do not meet Lending Club’s current credit policy standards.
  • The FICO scores on these borrowers are typically 640-659, below the 660 threshold on Policy Code 1 loans.
  • These loans are made available to select institutional investors who have a great deal of experience with consumer loans in this credit spectrum and with Lending Club.
  • They are only available as whole loans at this time.
  • Lending Club believes that Policy 2 loans could grow to a total of 15% of the total volume over the next 12 months.

Basically, Sanborn said that these are loans to creditworthy borrowers that Lending Club believes should be made. But they want to be completely sure these loans will perform as expected before deciding whether to make them available to everyone. So, a small number of institutional investors are taking the leap by investing in these loans without a track record and knowing full well they do not meet Lending Club’s existing credit policy.

Given that these seem to be riskier loans I wondered why they were listed as grades F and G and not, say, grade H. When I asked Sanborn that question this is what he said:

These are grades F and G because our models tell us that they should perform in the same way.  However they are riskier in that we have not served this population before, and we need to be deliberate about making the jump from a spreadsheet to real life.

Given the appetite there is for the high yield segment of the market I imagine there will be large demand among retail investors if and when these loans are made available. I, for one, am hoping they perform as expected and are made available to everyone at some point.

{ 17 comments… read them below or add one }

RawRaw November 21, 2013 at 9:43 am

Perform as expected? Are they going to wait for an economic shock to make that call or just the base line?

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Peter Renton November 21, 2013 at 10:44 am

Every loan vintage has an expected loss curve and they will be mapping these loans against this curve. They wouldn’t say how long but most credit risk experts say should have a good idea with 10-12 months. So, by the end of next year they should be able to make the call as to whether these loans are meeting expectations.

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Simon Cunningham November 21, 2013 at 10:36 am

This explains why LC recently told me they lowered the FICO minimum to 640, even though 660 is still listed on the site.

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Peter Renton November 21, 2013 at 10:45 am

Well it still is 660 for investors like you and me…so I can see why they still list 660 on their site.

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writing2reality November 21, 2013 at 11:31 pm

This seems to me to be Lending Club looking to broaden the funnel in which they bring in potential borrowers (obviously) but the interesting part is how much of the month over month growth in August and September was attributable to these PC2 loans. I’ve done a modified month over month increase after stripping away the PC2 loans.

Adjusted August growth: (190.3-10.3) – (173.5-2.7) / (173.5-2.7) = 180-170.8/170.8 = 5.4% which compares to the 9.7% reflected in the gross numbers

Adjusted September growth: (203.4-15.4) – (190.3-10.3) / (190.3-10.3) = 188-180/180 = 4.4% which compares to the 6.7% reflected in the gross numbers

As can be seen above, the comparison in growth was showed it was significantly slower than the readily recognized figures for the end of this past summer. Short of you noticing the PC2 loans, one would have been under the presumption that their growth this summer was just a part of the normal controlled growth pattern they’ve been exhibiting all along, not expanding into additional markets.

As an investor, I like to look at comparisons year over year like the same-store sales at McDonald’s, as an example. Just something to ponder I suppose and perhaps something to add in the details of your monthly summaries, Peter.

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Peter Renton November 22, 2013 at 6:43 am

I wouldn’t read too much into this. If LC had not issued these Policy Code 2 loans I feel certain that they would have had the exact same growth numbers and same topline numbers. Their growth is limited by the work their underwriters can do and these policy code 2 loans would be just as much work as regular loans, maybe even a little more.

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writing2reality November 22, 2013 at 8:28 am

That is a fair statement Peter, and you’re correct, we shouldn’t read too much into things.

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Chris November 22, 2013 at 5:02 pm

Good investigative blogging Peter. Very informative. Thank you sir!

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Peter Renton November 22, 2013 at 5:40 pm

Thanks Chris. Good to hear from you.

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Charlie November 22, 2013 at 8:38 pm

This is interesting because this is essentially creating 2nd class of loans. Not sure how I feel about this.

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Dan B November 23, 2013 at 3:46 am

The only surprising thing about this move is that it is surprising to anyone. I said so 3 years ago that sooner or later they’d have to lower standards or lower rates…………..regardless of what LC said about never lowering standards. With the ever increasing demand for high yielding notes the decision was pretty much made for them

Besides, how long could it have been before that tight band between 660-720 or so could no longer provide enough borrowers interested in borrowing at the high interest rates offered? It was only a matter of time. Btw, I’m not saying this is a good or bad thing. It is what it is. My only question is whether LC will continue to insist that these are all “Prime” Consumer notes. Also, I wouldn’t be even a bit surprised if there is a policy code 3 in the works……………though I’d doubt they’d call it that, especially after they read this. :)

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Peter Renton November 23, 2013 at 7:05 am

My thinking is that these will remain available only to the select few until after the IPO. That way they can keep referring to their borrowers as prime consumers. If a reporter ever quizzes Renaud about these loans he can truthfully say that this is just a pilot program and that Lending Club is totally focused on prime consumers.

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Dan B November 23, 2013 at 3:54 pm

Sure, that would make sense……………& like I said, I’m not saying any of this is a bad thing.

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Wendy November 25, 2013 at 9:01 am

Very interesting Peter! Happy Thanksgiving to you and the family.

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Peter Renton November 25, 2013 at 10:55 am

Thanks Wendy. Same to you.

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Simon Cunningham January 22, 2014 at 9:57 pm

Peter, I see NSR is listing both policy 2 and something called policy code 99s. Any idea what these might be?

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Peter Renton January 23, 2014 at 6:44 am

Yes Simon, when I first saw Policy Code 99s I pinged Scott Sanborn on them. These are small tests that Lending Club is running – a slight tweak of their underwriting model that they want to track. There are not many of them so I have never bothered in doing a separate post about them.

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