Free Updates

Exclusive content to your inbox for FREE!

What are the Default Rates with Lending Club and Prosper?

by Peter Renton on January 12, 2011

I have been doing a bit of digging around the loan data for both Lending Club and Prosper the last couple of days. Like most p2p investors I am concerned about default rates. Not just my own but default rates for all p2p investors. If p2p lending is going to make it as a mainstream investment alternative we need the majority of p2p investors to be successful. Defaults are a big factor in determining that success.

Take a look at the simple spreadsheet above. I looked at all the loans from July 1, 2009 through June 30, 2010. I would like to go back further but Prosper relaunched in July 2009. Lending Club relaunched with their new underwriting criteria in October 2008, so the above table really does compare apples to apples. Keep in mind, though the median age of a loan in this analysis is just 10 months old.

As you can see there have already been a few charge-offs and there are many more loans that are seriously late. To get my estimated default rate I simply added all the charged off loans with those that are more than 30 days late. This is a somewhat artificial way of estimating the final default rate because not all late borrowers will default. Plus there will be new defaults among those loans that are current right now. But my guess is that after 10 months, most of the scammers have already defaulted and the remaining defaults will be those people who experience true financial difficulties.

P2P Lending Default Rates by Credit Grade

The table above shows the estimated default rates (using my formula of charge-offs + 31-120 days late) spread across the different credit grades. If nothing else this tells me that both Prosper and Lending Club have done a good job in rating the borrowers, as it is somewhat of a linear scale from best credit to worst credit as far as default rates go. One point to keep in mind is that both Lending Club and Prosper skew towards higher rated loans. For example in Lending Club there are 1,803 A grade loans in the 7/1/09 – 6/30/10 time period and only 157 F grade and just 69 G grade loans. The median loan rating for Lending Club is B and for Prosper is C.

The Final Default Rate

Now, my estimated default rate calculation could be easily understating or overstating the actual final default rate on these loans. But I am quite certain of this. The final default rate will be more than what Lending Club claims as the sub 3% default rate in place right now. While this 3% number is technically true, because Lending Club is growing so fast most loans haven’t had much of a chance to default. To demonstrate this, I analyzed the older loans from that period, those that were issued between 7/1/09 and 12/31/09 (the first half of the period in the spreadsheets above). The median loan age in that period is over 15 months and actual defaults moved to 4.77% (up from 2.75% for the whole year) for Lending Club and 6.10% (up from 3.99%) for Prosper. If I had to guess I would say a final default rate will end in the high single digits but clearly the default rate of  3% Lending Club claims is an underestimate (Prosper makes no claims as to estimated default rates).

[Update: It has been pointed out to me that Lending Club claim an annualized default rate of 3% which corresponds with my findings. With a 3% annual default rate, the total defaults on the life of the loans will be around 10%. Also, there is much more data on the lendstats.com web site where you can slice and dice both Prosper and Lending Club data.]

Obviously you can reduce your default rate dramatically by choosing higher grade loans as well as conducting in depth research on the loans you are interested in. As I pointed out in my post last week three successful Lending Club investors have very low default rates by having strict criteria when deciding which loans to invest in. Their final default rate will likely be far lower than the averages suggested here.

While default rates for the average investor will be higher than 3%, I am also confident that we will not return to the 39% default rate that we saw on the loans (now mature) from Prosper’s first two years of existence. There is much stricter underwriting today than in the early days for both Prosper and Lending Club. A mid to high single digit default rate will still leave the average investor with a decent return on their p2p lending investment.

Later Defaults Have Less of an Impact

One last point to make about defaults. The longer a loan goes without defaulting the better off you will be. For example, if you have invested $25 in a loan that defaults after 18 months you will not lose your entire $25 investment. You will have received principal and interest payments for 13 or 14 months, so your total loss will only be around $13 – $15 depending on the interest rate. So this will have less of an impact on your net annualized return.

I intend to keep a watch on this portfolio of loans from 2009-10. I will report back on the defaults (both actual and my estimated calculation) on a monthly basis to see how they are going. My goal here is to report the facts as they are. I believe that p2p lending is a great investment, but there is a risk of defaults. It is best if investors come in fully informed as to those risks and not be disappointed a year or two into their investment.

{ 30 comments… read them below or add one }

Dan B January 12, 2011 at 3:16 pm

Let us first & foremost understand that all these numbers are PER ANNUM.
So…………the average interest rate on a 36 month loan right now is 11% (LC statistics page). Subtracting the service charge of 0.7% & we get 10.3%. Based on the research in this post, what would the estimated return be for the average investor after the 1st year?? Would it be 9.6% or something close to it………….as is claimed?
No? Perhaps 8% or 7% then ?
No, it’d be lower MUCH lower than that wouldn’t it??

Reply

Peter Renton January 12, 2011 at 4:57 pm

Dan, These numbers are not “per annum”. If you believe they are per annum, that assumes that a loan is just as likely to default in year 3 as it is in year 1, which I believe is unlikely. From research I have done as well as speaking with another long time LC investor defaults mainly happen from month 9-18 on three year loans and then taper off with very few defaults in the last year.

But getting to your point as to the actual return, let’s take a simple example to illustrate it. Let’s say you have 100 loans at $25 each for a total portfolio of $2,500 with a 10% interest rate on all loans. After 12 months let’s say 3 loans have defaulted (based on the 2.75% default rate after 10 months). Now, for simplicity’s sake we’ll assume that on average these loans defaulted after six months, so you received six months of interest and principal payments and then nothing more for those five loans. Assuming a simple interest calculation each of those loans was paying $2.50/year in interest and $8.33/year in principal repayments.

So, if three loans default after six months of payments, you will have received 3 * (2.50 + 8.33)/2 or $16.25 before they defaulted. So your loan portfolio at the end of year 1 will be $2,500 – $75 + $16.25 = $2,441.25. You have received $242.50 in interest for your remaining 97 good loans, which brings your balance (excluding principal repayments) to $2,683.75 which is a 7.35% return on your original investment. Not the 10% expected but not lower than 7% as you suggested.

I realize I have simplified these numbers but I have merely done that as an illustration. If you have five defaults after six months then your return drops to 5.6% for the year. In the above example, if you add another three defaults in year 2 at the 18 month mark, for these three loans you have received half your principal and received $3.75 per loan in interest before default. By my calculations you will have a portfolio worth $2,876.24 or a total return of 15.05% after two years.

Now, if my math is correct (and I acknowledge this is not the NAR formula Lending Club uses – I tried to simplify it) then having a 6% default rate over two years will not result in a terrible real world return. Am I wrong? Any math genius want to chime in?

Reply

Dan B January 12, 2011 at 5:14 pm

Are you sure?……….. Because LC states “The overall annualized default rate since our inception in 2007 has been below 3%”. Does annualized default rate not mean per annum? If not then what do you think it means?

Reply

Peter Renton January 12, 2011 at 5:21 pm

Hmmm. Well I think I stand corrected. I will have to do some more digging around in Excel to run some numbers on a 3% annual default rate. Be good to get some real life examples to illustrate the impact of that default rate on returns. Thanks for the clarification.

Reply

David January 12, 2011 at 6:06 pm

Some guy named Ken has already crunched out these numbers in a lot more detail then this. He has set up a data website at lendstats.com

Just click on “all loans” for the Lending Club side. He calculates that about 10 percent of all loans issued in 2009 are either defaulted or over 31 days late. A few common sense loan filters he has immediately reduces this rate to about 5 percent, or an annualized default rate of 2.5 percent for that subset of loans.

He also has calculated the total “real world” return on all Lending Club loans issued to date as about 3.46 percent. Again, a few basic filters immediately increases this number to between 7 and 10 percent.

Reply

Dan B January 12, 2011 at 8:19 pm

There’s plenty of anecdotal information. For example, Kim Berg***** posted less than a month ago on LC Facebook his results after about a year. He had around 1000 notes of $25-100 each & had suffered 70 defaults already & had another 40 late. You can read the rest of the details there.

My NAR went from around 12.5% to 9.4% after suffering 4 defaults at the 14 month mark. Those 4 defaults out of 500+ notes put my default percentage at under 1% per annum. So you still think that even a 3% default rate won’t put you under 7%………..or do you want to take another crack at that??

Reply

Peter Renton January 12, 2011 at 8:59 pm

@David, Thanks for that. I should have included the info from lendstats.com in my research. I just included an update to the post with a link to them. I will do a follow up article on this data some time in the next couple of weeks.

@Dan, Without seeing all the numbers for your portfolio I can’t really comment. I don’t doubt your NAR went down that much but what about your real world results? That is what I want to focus on because everything else is just noise. Did you ever do the XIRR() calculation for your LC account?

Reply

Dan B January 13, 2011 at 1:09 am

The question here should have nothing to do with my numbers. I provided them because you asked for some real numbers. I put in a good amount of work to keep my default numbers down. Not only do I use very strict screening but I now look over my portfolio DAILY to get rid of notes before they go into “grace” period. I am not your “average” p2p investor. Matt over at Steadfastfinances is not your average p2p investor. Your post concerns itself with the average investor & that individual is going to suffer the default rates that are being mentioned here & elsewhere. I believe that the whole point of your post was to examine the accuracy of the default numbers being claimed & to project (when possible) future default numbers………….was it not? So what is your conclusion? Is the AVERAGE investor going to do a real world 9.6%? Or is he going to do a real world 4% or less?? That’s the bottom line question is it not? And the answer is going to be a helluva lot closer to the 4% number than the other number. Or would you care to wager otherwise??

But since you asked……….my real world returns after 14 months are 9% annualized without results from my “trading” & 10.4% with trading.

Reply

Wiseclerk January 13, 2011 at 10:24 am

Hi Dan,

good article.

Here are some older articles where I analysed lending Club’s default rates
http://www.wiseclerk.com/group-news/services/lendingclub-lending-club-default-rates-higher-then-initially-expected/
http://www.wiseclerk.com/group-news/services/lendingclub-annualized-default-rate/

I gave up on comparing Prosper’s defualt rates with their public statements on expected defaults long ago. The Prosper statements had many footnotes defining the sample taken. Fred’s blog kept track regulary of the bad performance.

Reply

Peter Renton January 13, 2011 at 10:50 am

The average investor is not going to get the 9.6% claimed in my opinion. If I had to wager I would guess the real world return will fall into the 6-7% range for the average investor. If it falls much below that then I can’t see p2p lending making it as a viable long term investment alternative. I hope and expect that the sub-4% number you think is likely will not happen for the average investor.

Reply

Peter Renton January 13, 2011 at 12:18 pm

@Wiseclerk, Thanks for your comment (by the way, I write the articles, not Dan). and the links. I wasn’t aware of these posts from your blog but this is great stuff.

Reply

Wiseclerk January 13, 2011 at 3:59 pm

@Peter

sry for mixing up your name with the first commentor’s

Reply

Mike January 14, 2011 at 4:09 pm

I knew LC’s real world default rates were higher than their touted 3%. My gut feeling for default rates over the entire life of a loan will approach 20-30% for those in Grades D and below.

Question for Dan B: How do you know which notes to get rid of if you are doing this before they go into their grace period? Isn’t that like saying I’ll start taking medicine for a cold the day before I get sick? I too, try to keep track of grace period notes, and will try to sell them on the trading platform before they go into late status. One of the things about LC that bothers me is that they don’t have a category for grace period notes, like they do for currents, lates and defaults. You have to search through all of your notes to see which ones have entered the grace period. It would be nice if someone from LC chimed in here, but they know that their presentation of default rates doesn’t represent what their average investor experiences. They use the formula that puts them in the best light possible.

Reply

David January 15, 2011 at 1:12 am

@Mike

I’m not Dan, but it’s simple to find grace period notes, just click on “Notes” up top, then order the notes by “payment due date.” All grace notes and late notes will be at the top.

Also, Lending Club doesn’t claim a 3% default rate for the life of loans, they claim a 3% *annualized* default rate, and they are correct. According to lendstats.com, about 10 percent of D-rated notes are currently defaulted or past 31 days late, and the lifetime default rate may very well end up past 20%. There is not enough data to say for certain as very few loans have gone to full term so far (the average age of Lending Club loans is only 10 months).

As far as chastising Lending Club for not publicizing the least appealing statistical analyses of their loan data, I don’t think that’s a reasonable expectation for an expanding company that is trying to increase their investor base. They are in the business of marketing their product, not driving customers away. They already make all the loan data public, it’s up to you to make calculations for yourself (or go to the site of someone who has). I don’t expect Coca Cola to publicize adverse health effects of high-fructose corn syrup or large intakes of caffeine, even though such research papers are readily available, and I don’t think that would be a reasonable expectation to make of them.

@Peter

regarding

>I would guess the real world return will fall into the 6-7% range for the average investor. If it falls much below that then I can’t see p2p lending making it as a viable long term investment alternative. I hope and expect that the sub-4% number you think is likely will not happen for the average investor. I hope and expect that the sub-4% number you think is likely will not happen for the average investor.

If Ken’s calculation of 3.46% overall ROI for Lending Club loans is correct (and I have no reason to doubt that it is), then it seems to be a reasonable expectation that the “average” Lending Club investor would also experience similar returns. He has the overall Prosper ROI at -4.34%, and it is fairly well known fact that the majority of Prosper investors lost money through their investment.

As for such low returns “dooming” p2p lending, I don’t think this is necessarily correct. Something like 90% of forex traders lose money trading, but forex brokerages do a brisk business. If Lending Club manages to eke out real returns a tiny bit higher, perhaps on the order of 4 or 5%, I think it’s possible that the allure of higher returns will be sufficient to lure enough investors to make the company profitable.

Reply

Peter Renton January 15, 2011 at 10:15 am

David, Thanks for your comment. One point about the lendstats data. The 3.46% takes into account all loans issued since they started issuing loans in July 2007. But we know that the defaults rates were very high for the first year and since they tightened their underwriting standards defaults on LC are way down. So, I think if lendstats.com showed a total ROI since LC relaunched in Oct 2008, I think you would find it is several percentage points higher than 3.46%.

Prosper’s returns is a case in point. Since their relaunch in July 2009, lendstats calculated the ROI at 9.19%, a full 13.5% higher than the total return of -4.34%. Now, I think Prosper had a lot more room for improvement than Lending Club. I am going to try and convince Ken to add a similar ROI number for Lending Club.

Who knows what return Lending Club and Prosper need to ensure their long term success. We are in a historically low interest rate environment right now, so 4 or 5% sounds decent. But when you can get FDIC insured CD’s for 5%, which might happen in a couple of years then returns will have to be in the 8-10% range I believe to make it p2p lending a viable alternative.

Thanks again for your comments.

Reply

Dan B January 15, 2011 at 1:59 pm

@Mike……….Sorry Mike, that’s something that I’m not interested in divulging.

Reply

Mike January 15, 2011 at 2:03 pm

David, thank you for the tip on viewing notes in the grace period.
Peter, I disagree that a 4-5% return is decent. It appears that way when you compare them to CD’s or online bank rates, but a more accurate comparison would be to junk bonds, where there is a risk of default. From my perspective, I feel a 9-10% return is justified when the model is based on loaning money to people you’ve never met and who may declare bankruptcy at any time.

Reply

Mike January 15, 2011 at 2:05 pm

@ Dan B….is that because you have ‘inside’ information on borrowers?

Reply

Dan B January 15, 2011 at 2:06 pm

@David………….But the difference is that the target investor for “forex” & the target investor for p2p are 2 very very different individuals. In fact you probably couldn’t find 2 more different ones. Everyone knows that forex trading is extremely high risk. P2p companies are, on the other hand, touting these investments as “safe” alternative in this low interest rate environment. The expectations level is quite different, I’m afraid.

Reply

Dan B January 15, 2011 at 2:08 pm

@Mike…………….not at all. It’s because I’ve put in the work to figure it out & I’m still using it for my purposes. But there are others who have figured it out as well.

Reply

David January 16, 2011 at 1:50 pm

@Dan

>Everyone knows that forex trading is extremely high risk. P2p companies are, on the other hand, touting these investments as “safe” alternative in this low interest rate environment. The expectations level is quite different, I’m afraid.

I was about to disagree with you that p2p companies tout their investments as low-risk, but then I did a quick search on Google and found:

http://blog.lendingclub.com/2007/08/31/why-lending-club-is-better-than-a-savings-account/

Wow, that’s pretty damn unrepresentative of the risks involved, possibly borderline false advertising, and probably a large part of what led the SEC to clamp down on the p2p industry and force them to become registered securities issuers.

At the same time though, now that p2p lending is SEC-regulated, there is a clear delineation between what marketing is and what an investment prospectus is. Regardless of what is spouted by company marketing teams, the Lending Club prospectus is actually extremely accurate and honest about the risks involved in the purchase of their securities (I haven’t read Prosper’s prospectus, but I’m assuming it is similarly honest).

As far as Forex and Lending Club serving different types of investors, I agree that they utilize different marketing techniques and probably serve a different social subset of individuals, but ultimately speaking all non-insured investments serve the same purpose: to maximize return upon the assumption of a certain number of risks.

Regarding dubious advertising, I don’t mean to sound brutal, but regardless of a company’s unrepresentative and misleading marketing (as long as they are not flat-out lying or cooking their books), it’s incumbent on the investor to fully research an investment they are making before putting their money into it. I would never invest in something without fully reading the investment prospectus as well as performing a good deal of initial exploratory research. Lending Club is doing nothing illegal, and depending on the level of libertarianism in your thinking you could even say they are doing nothing immoral.

Reply

Dan B January 16, 2011 at 9:04 pm

@David………I agree. I believe that as time goes by though the enforcement & the regulations as to what can & can’t be claimed by p2p companies will get tougher & tougher specifically because of the marketing of p2p as some sort of a safe “interest generating” option not just for investors but also for SAVERS. It’s implicitly understood that investors expose themselves to risks involving the potential loss of their investment. However “savers” don’t expect to face those same risks & I don’t think that the regulatory agencies &/or the general public will not look favorable at companies that are marketing a product to “savers” that involve these high levels of “not clearly” delineated risks.

Here we are having this semi-deep discussion about potential issues with p2p, but I think that it’s important not to lose sight that your “average” CD depositor isn’t about to come here or anywhere else & engage in some sort of dialog or some sort of learning curve if they’re looking at an alternative to low interest CDs. They’re just gonna look at that 10.1% or 9.6% advertised return & that’ll be about the extent of their research before they sign on the dotted line, so to speak. And that specter of a large number of disgruntled investors when they don’t get anything near those numbers is the main stumbling block if p2p is to become anything but a tiny niche investment. I don’t know, perhaps p2p will evolve into something that’ll have some sort of minimum guaranteed return………..?

Reply

Peter Renton January 17, 2011 at 12:29 pm

Thanks for all the comments over the weekend gentlemen. Here are a couple of additional thoughts:

@Mike – When I said that a 4-5% return (I mean real world return) is decent I meant it as a reflection of the interest rate environment of today. Personally, I would not be satisfied with that return on my p2p lending investments because I think the average investor should be better rewarded for taking on the additional risk of p2p lending.

@David, Most of the promotional stuff I have seen from Lending Club compares the investments to the bond and stock market, targeting at investors not savers. The blog post you refer to should have come with a risk disclaimer (which several people picked up in the comments). What is needed is for an unsophisticated investor to come in, pick one of the automated plans and generate a nice 7-8% return or something like that. The jury is still out on whether that will happen.

@Dan, It is interesting you mention guaranteed return. One of the UK p2p lending sites Ratesetter has a fund setup to cover defaults (paid for by borrowers) to try and eliminate the downside of defaults. They only launched three months ago, so we have no idea how this will play out but they are tackling the problem head on.

Reply

Andy March 6, 2011 at 10:18 pm

I’ve been an investor since 2008 with lendingclub. I have around 400 loans @ $50 each. About 10% of those are As, 30% Bs, 60% Cs, 7% Ds, 2% Es, 1% Fs. I am averaging around 7-8%. I screen every single loan and NEVER choose a loan where a borrower has previously defaulted. I’ve noticed that right around the 12-18month mark a whole bunch of loans go sour. In fact, I was down to 6% return at one point. From experience, the default rate at 36 months is much much higher than the under 3% NAR that they report. The one thing that surprised me is that it really doesn’t take many bad loans to kill your NAR.

Reply

Peter Renton March 7, 2011 at 11:46 am

Hi Andy, Thanks for your comments and providing the details of the your experience with Lending Club. My NAR has bounced around as well, it was down to 4% at one stage due to some mistake I made when I started out. I am now much more careful, but at 19 months in I have several late loans that will probably default here before too long. So I will take another hit. My NAR has been as high as 10%, as low as 4% and is currently right at 8%. But it will drop again I expect in the next 2-3 months. The NAR calculation is somewhat misleading I think, it doesn’t necessarily reflect real world returns. This is why I recommend everyone calculate their own returns: http://www.sociallending.net/investing-lending/what-is-your-actual-return-with-p2p-lending/

Reply

Ingrid April 4, 2011 at 5:59 pm

Can’t really back my info up with an analysis, but here is my personal experience: 3 years ago I invested $1000 in prosper loans, mostly in $50 chunks, there were 3 for 100. Now, almost at the end of the 3 year term 4 loans are in default for a total of $184.62 , don’t know if prosper even tried to collect. I collected a total of 945.53, which means I would have been better off with the money under my mattress.
Prosper,on the other hand, presumably got its share, how much I can’t say, since they don’t disclose this in any obvious way.
How likely am I to recommend or repeat this experience ?
NOT!!!

Reply

Peter Renton April 5, 2011 at 10:28 am

@Ingrid, Thanks for your comment. To be honest with roughly a 5% loss you came out better than average for the early Prosper investors. Prosper made many mistakes in their first three years but I think you will find that the new Prosper is completely different. I opened my Prosper account six months ago and have yet to have a default and I am investing in high risk loans. My annualized return right now is a ridiculous 21%.

So, I understand you not wanting to jump back in, I would probably think the same if I was you. But when Prosper reopened after their quiet period their focus was on risk management. And they have done a great job of reducing defaults despite having many high interest loans on the platform.

Reply

Daniel B June 3, 2011 at 12:50 am

8. What about the fees at the different P2P lenders, apart from the interest rate? Is one better than the other(s)?

Thanks!

Reply

Daniel B June 3, 2011 at 1:00 am

Sorry about all the afterthoughts:

9. It occurred to me that I would need a five-year repayment program. Would that be feasible? Would it affect my interest rate or which site I should go to?

10. Are there pre-payment penalties? (I would try to payoff the obligation ahead of schedule.)

Thanks!

Reply

Peter Renton June 4, 2011 at 2:34 pm

@Daniel,

8. The fees vary depending on your credit grade. For AA on Prosper you pay a closing fee of 0.5%, A & B it is 3% and C-HR it is 4.5%. On Lending Club (for five year loans) it is 3% for A and 5% for B-G. So, if you score the AA listing on Prosper you will save a great deal otherwise it will be about the same.
9. Five year loans are popular on both platforms but you will pay a higher interest rate. It is will 2.5% – 3% more. Both sites will hit you with a similar higher percentage for this.
10. No, there are no prepayment penalties on either site.

If you want more information about how to minimize your interest rate, Lending Club provides some good details here:
http://www.lendingclub.com/public/how-we-set-interest-rates.action

Good luck.

Reply

Leave a Comment

Notify me of followup comments via e-mail. You can also subscribe without commenting.

{ 2 trackbacks }

Previous post:

Next post:

Real Time Analytics