Average Returns by Loan Grade at Lending Club

Lending Club P2P Investment Returns by Credit Grade

A couple of days ago Lending Club added this new page to their site that included the graph above. I found this extremely interesting. For years they have told us the average returns of the different loan grades on their statistics page but this is the first time they have provided a range of returns within each grade.

Here is the fine print that explains the top 50% and bottom 50% numbers in the above graph:

3 – Top 50% and Bottom 50% are dollar-weighted averages of individual loan performances for each grade calculated from either the best performing half or the worst performing half, respectively, of all issued loans in each grade as of May 25, 2011. In practice, if a portfolio of Notes was created from the worst performing half of all issued loans in a specific grade, the return would be roughly equivalent to the Bottom 50% of that specific grade as depicted in the chart above. Conversely, if a portfolio of Notes was created from the best performing half of all issued loans in a specific grade, the return would be roughly equivalent to the Top 50% of that specific grade as reported in the chart above.

Obviously the top 50% of loans in all loan grades would include no defaults whatsoever, and the bottom 50% would include all the defaults. As you would expect the average return for the top 50% of loans within each credit grade increases as the interest rate gets higher. But as you can see for the bottom 50% of loans there is no opposite trend. I would have expected bottom half of the G loans to perform badly, I am actually surprised they managed a positive return, but what is fascinating is that E rated loans have the best performance when taking the bottom 50% of loans.

What this chart tells me is that investing in A rated loans is not a recipe for safe returns. Sure there is far less deviation in returns for A rated loans but both C and E rated loans perform better even when taking the bottom 50% of all loans. I may tweak my selection criteria after seeing this chart and load up on more E-rated loans and lessen my exposure to D-rated loans. Based on these numbers any way you slice it E-rated loans are a better bet than D-rated loans.

As always I am interested to hear your thoughts.

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Brian B
Brian B
Jun. 9, 2011 2:13 pm

There are 2 ways to explain the D bottom 50% number.

1. Just random luck. Each E loan is expected to be more likely to default than each D loan. However over a given sample size, these default rates can’t be predicted exactly and have room for fluctuation. It looks like significantly more D loans have defaulted than predicted. This could just be due to a bunch of D’s being unlucky and losing jobs or something uncontrollable.

2. Lending Club is placing some people in the wrong categories. Some less qualified people are getting D rates that they don’t deserve and should actually be in the higher risk E/F categories.

Peter – since you plan on buying more E’s and fewer D’s, you think that #2 is a likely reason?

(btw, if you don’t think #2 is likely, then you are in #1 territory and you are following the same logical path whereby a roulette wheel comes up red 3 times in a row and you bet on red since you think its more likely)

Brian B
Brian B
Jun. 9, 2011 4:06 pm

My first instinct was that the bottom 50% stats for D/E were just due to luck, but the more I think about it – I don’t think so anymore.

-This chart is based on tens/hundreds of thousands of loans. sample size is too big for the numbers to be skewed by a few outliers as was my initial instinct.

Looking at those 2 dots, I am convinced that Lending Club either now or in the past has made significant errors in assessing risk at the D/E level. Impossible to tell just based on this graph whether D is too low, E is too high or both, but there’s no way the points should line up as they do.

(based on your 5.2/4.1 vs 10.6/12 numbers, it certainly looks like they tweeked something during the past year and have been giving people D ratings that should have been E/F)

The main question for us investors is this: Has Lending Club recognized this error, found its source, and corrected it? If it hasn’t already, will it be able to and when? (ie, have they found out why they are getting more D-loan defaults than they expected or fewer E loan defaults than expected, and have they adjusted their loan rating criteria based on this for new loans?)

->If they have adjusted their loan rating criteria, then any action shifting one’s portfolio makeup based on this graph is moot as the future loan ratings aren’t directly comparable to the past anymore. (and might even be bad if LC overcorrects on any actions they take)

->If they haven’t adjusted their loan rating criteria, then I completely agree that E is a far better place to be putting your money than D.

Jun. 9, 2011 6:33 pm

They always had this information here: https://www.lendingclub.com/info/statistics.action the bottom left, although not sure what the difference is, as I see the numbers are different.

Jun. 9, 2011 6:46 pm

Oh I see that these averages are ffom May 25th, interesting that thay changed so much in a few days…

Dan B
Dan B
Jun. 9, 2011 11:20 pm

I’ve decided to stay out of this whole default numbers discussion this time. It’s all just so way over my head 🙂

Couldn’t help looking a few paragraphs below the chart though & skimmed through the “Who Invests in Lending Club” writeup. Noticed the total number of investors listed at 26,000. Does that number sound low to anyone else?

Larry V
Larry V
Jun. 10, 2011 9:34 am

10k per investor? After the LC-funded stuff gets pulled out, it may be right? BTW, hi everyone. Started investing on LC a month ago. Thanks to Peter, Ken L at lendstats.com, and all the active commentors. I hope to be one myself, lets see if my first loan gets its first payment (due tomorrow!).

Brian B
Brian B
Jun. 10, 2011 11:04 am

Larry – don’t panic when you don’t get paid tomorrow. When the scheduled date hits, the payment goes from “scheduled” to “processing”. It then sits there for 4-6 days normally before it is actually received. It takes several days to process, and the number of days also varies due to weekends and holidays.

Steve S
Steve S
Jun. 10, 2011 1:44 pm

Peter and Brian as someone who has been in the subprime lending business for 25 years, I have always felt that Lending Club underestimates the long term default rates on the D, E and F loans. For all loans but especially subprime, defaults are not evenly spread over the course of the loan. The longer the loan is outstanding the higher the chance of default. With Lending Clubs very high growth rate, they simply do no have enough experience to accurately estimate default rates. I assume that they are projecting based on models from other loan platforms. But as Proper demonstrated the internet attracts a higher defaulting customer than brick and mortar certainly for the subprime. So I would be very skeptical of the actual yield being as high as are projected in this chart.

Dan B
Dan B
Jun. 10, 2011 10:44 pm

The simple truth is there is very little personal downside in underestimating risk/defaults. Therefore I’d like to propose that Lending Club install a pillory outside their new headquarters. Given their history, Prosper should install 2 or 3 outside theirs, just to be safe.

When unacceptable/ridiculous levels of defaults occur, these p2p companies (who after all pride themselves on transparency), will immediately notify us lenders, thereby affording us the option of swinging by their offices & expressing our, shall we say, displeasure to the people who signed off on those loans. If the offenders wish to avoid the ridicule & punishment of the stocks then they may pay restitution to the lenders in question out of their own pocket.

Now that I think about it I believe a pillory should be placed outside every major bank & subprime lending company & the punishments should be retroactive to before the financial crisis. Considering that next year is an election year I think that this idea can gain a lot of traction with the masses.
Steve S………..So you worked in subprime lending for 25 years huh? I’ll probably be needing an address for you as well 🙂

Dan B
Dan B
Jun. 13, 2011 3:51 pm

Sure I’d agree that there’s going to be consequences in the case of p2p. But remember that just the threat of punishment is often more dissuasive than the punishment itself. Placing a pillory outside the doors of the office will be a daily reminder of the consequences of failure. 🙂

As for cruel & unusual punishment I’m sure that I could round up a boat load of people at prospers.org who would support my proposal & would in fact contend that they were defiled in every way imaginable during Prosper 1.0……………& that this punishment wouldn’t even compare to what they went through.

Dan B
Dan B
Jun. 14, 2011 10:41 am

Right on, I’m all for that. I want accountability! When you screw up you pay………..one way or another. Don’t want public humiliation? Then don’t make ridiculous self serving recommendations. Or pay restitution in lieu of the public humiliation………….your choice.

All I have to say is that when this proposal becomes part of the Tea Party platform, you’ll know where it came from.