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There has been a lot of news recently with regards to interest rates and loan performance on the Lending Club and Prosper platforms. While some may argue that these concerns are unfounded, investors are clearly taking an increased interest with the changes going on and the recent market volatility. In this post, I’ll address interest rate increases and then delve into vintage performance at both Prosper and Lending Club, which is the best gauge of performance.
Below are stories that received a lot of press, leading to additional speculation of poor loan performance:
- Santander recently sold nearly $1 billion of Lending Club loans to JP Morgan.
- Several articles were released stating that the Lending Club models had “misfired”. This report was addressed by Lending Club directly who stated that the chart in question was misinterpreted. The truth is that while some pockets of loans out-perform and some under-perform, general performance is in line with expectations.
- This past week, news broke that Moody’s may downgrade bonds sold by Citigroup which included loans originated by Prosper citing slower repayment and increased charge-offs.
- Today the Financial Times came out with this article discussing possible worrying signals from p2p lending platforms.
Increasing Interest Rates at Lending Club and Prosper
Increasing interest rates at Lending Club started back in December when the Fed increased interest rates by 0.25%. Lending Club responded immediately and raised interest rates by the same amount and subsequently increased rates again in late January. In Lending Club’s Q4 2015 earnings call CEO, Renaud Laplanche cited concerns in the global economy for increasing interest rates. The increase gives investors coverage if we experience an economic slowdown. As Renaud stated, one of the benefits of a marketplace model is pricing equilibrium. If there is any sign of degradation, they will act accordingly.
The increasing interest rates on Lending Club is a reversal of what we have seen since the beginning of 2014. The below chart taken from Lending Club’s statistics page shows the steady decline of interest rates across a majority of loan grades on the platform. Renaud stated several times throughout 2015 during earnings calls that investors were willing to accept lower yields given the confidence in past performance. The sentiment has now changed, but it’s important to understand the historical trend of interest rates over the last few years.
We reached out to Prosper for this article, who also announced increased interest rates this month. According to Prosper:
The recent move to increase risk-adjusted returns is a continuation of moves we began making in August of 2015. The move highlights our dedication to running a balanced marketplace that provides fair rates to borrowers and investors alike. Since 2013, the cumulative loss of our book has remained very stable (as indicated by the charts later in this post).
Lending Club Loss Curves
Below are Lending Club charge-offs by vintage for both 36 and 60 month loans taken from their earnings presentation. While it is still very early for the 2015 vintage loans, they appear to be tracking with other vintages that have experienced lower charge-offs.
In the case of 36 month loans, there is a clear difference from the worst vintage in 2009 compared to more recent vintages. If you’re interested in a more detailed look at performance by vintage you can view the cumulative charge off rates in spreadsheet format at additionalstatistics.lendingclub.com.
Prosper Loss Curves
Prosper’s loss curves paint a similar picture to that of Lending Club’s. It appears that all vintages are tracking on a similar course at this time with losses remaining far below the performance we saw from 2009 through 2012.
36M, All Ratings – Cumulative Chargeoffs (% of Originations) as of December 31, 2015
60M, All Ratings – Cumulative Chargeoffs (% of Originations) as of December 31, 2015
Independent Analysis from PeerIQ
Over the weekend PeerIQ released this excellent analysis on the potential Moody’s downgrade of Citi’s bonds noted at the beginning of this article. They have confirmed what we have shown above. Loss rates remain relatively steady with a mild increase in delinquencies in the second half 2015 loans compared to the previous year. Based on their analysis, concerns of some media pundits are overblown.
While we should be paying close attention to delinquencies, and it is certainly possible they will increase, we as investors are being compensated for that risk by the increasing interest rates being charged to borrowers. PeerIQ concludes that the level of delinquencies we are seeing are still at multi-decade lows according to Fed data.
Conclusion
From the data above, it appears as though there isn’t any meaningful deviation from the performance we’ve seen in recent years. While some investors may have seen some under performance in their portfolios, overall performance appears to be in line with expectations of each platform.
It’s important to remember that Lending Club and Prosper are continually monitoring performance and continue to improve underwriting. There will likely always be some pockets that out-perform or under-perform an indexed portfolio. The increased interest rates on each platform should give investors confidence in the platforms to react to uncertainty. Although there are not any red flags at this point, as an investor in this asset class it’s important to be prudent and monitor vintage performance and other economic data points such as unemployment closely.
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Good analysis Ryan. It’s also worth pointing out that both Prosper and Lending Club’s rate hikes are rather significant – in order to compensate for the higher risk aversion in the market. The rate increases (100bps+ in some segments) contribute directly to an investor’s return after losses.
Here’s a deeper look at where rates changed:
https://www.monjaco.com/blog/how-significant-is-lending-clubs-recent-rate-hike/
I have long been critical of peer to peer underwriting. They need to do more verification and more closely review the quality of income, Where loans default within one year of issuance fraud is a real possibility. Guarantors/co borrowers should be strongly encouraged. If a real recession hits defaults will increase.
This is a question that comes up frequently and is a concern of many investors. If you haven’t already I would recommend looking at Lending Club’s page on income verification which talks in detail about their processes:
https://www.lendingclub.com/public/income-verification.action
Near the end of the page, Lending Club states: “Historically, Lending Club loans that have passed income verification perform similarly to loans that were not income verified; they have higher or very similar charge-off rates to non-income verified loans.”
I agree with you on the loans that default withing a year of issuance. I am currently invested in over seven hundred loans with Prosper. Withing the current year I have seen an increase in defaults on loans issued this year. My criteria for choosing loans are quite strict. My ROI has gone from 11% to 9.7% within the last 9 months. It appears that the verification process is slacking off and their collection process has not being very thorough. So as of October 2016 I have effectively stopped investing in Prosper and moving my funds over to stocks as it frees up.
Ryan,
I looked at the raw data on LC’s website by vintage and noticed that things are getting worse for the 2015 tranche (I aggregated the year together). Specifically, charge off rates for the most risky (E, F, and G) seem to be substantially higher compared to prior years. This is most noticeable in the 3 year loans, but also holds true for 5 year.
The least risky (A&B) seem to be performing better than prior years, while mid risk (C&D) seem mostly in line.
When I’ve went to purchase new loans on LC’s website, I notice a much smaller available inventory of low risk loans and its easier to get the high risk ones than it used to be.
Put together, it seems like people have figured this risk shift out and have shifted their investing habits.
My question – The data for 2016 is too new, but was wondering if you have any insights into if last year’s trend will continue (in which case avoid the risky ones) or things will get better.
Hi Zack, your findings echo what we have heard from Lending Club as well. They have since increased interest rates multiple times and also cut some credit policy out of their underwriting altogether in riskier loan grades. This should help compensate for some of the higher defaults we saw in pockets in 2015. We won’t know how these newer vintages have performed just yet, but it is great to see that Lending Club took action where they saw some issues. I suspect we will see better performance with everything else being equal with the adjustments made, but we will see what happens.
FYI Lending Club has a losing business model for many reasons.
1. They invested heavily in borrower loans instead of just being satisfied with revenue from service fees because they wanted to be bigger then the industry allows and now they not only cannot even cover their overhead but are experiencing massive losses from those loans. Truth is loans are not a good investment and if not for billions in government subsidies major banks would be doomed and credit card companies survive by the ridiculous interest they charge plus the fact the interest is not amortize like installment loans so they are able to actually bring in revenue to offset defaults which they expect over 70% of borrowers will eventually get over their head and default.
2. Lending club charges all fees to the investors and none to borrowers. Even the origination fees come out of the total amount borrowed instead of being additional to the amount loaned so investors take a hit right upfront and the borrower isnt actually paying a fee if the fee is deducted from the loaned money. In addition investors pay a fee for early payoffs while lending club pushes borrowers to refinance their current lending club loan so each time the borrower does the investor pays the penalty plus other investors cover the new loans origination fee so why would a borrower decline a refinance offer. Lastly investors pay collection fees while the borrowers are not being charged any late fees to offset the collection costs. All in all its not much of an investment if you are paying someone to lend your money and they are taking from you the small return you could have earned by refinancing all your loans without your knowledge.
3. As far as I have seen lending club should never have left the starting gate and clearly was doomed to fail at least when they started investing in the loans themselves. Take your payments and run like hell because investors will soon get tired of financing the continuation of this scam and nobody is gonna buy up a company with such a losing business model that made deadly investment decisions and thats what they are waiting for because nobody is focused on business development at all.
Michael, I am responding because you make some pretty bold and misleading claims here. Let me address your three points:
1. Banking has traditionally been an extremely profitable business. The government had to bail out some large banks during the financial crisis because they made some bad decisions but you will find most of that money has been repaid with little or no loss to taxpayers. Look at the income statement of any large bank today and you will see a strong bottom line.
2. This is a mischaracterization as to how the lending model works. The investor pays a service fee and the borrower pays an origination fee. For example, a borrower who takes out a $10,000 loan will receive around $9,500 (assuming a 5% origination fee) but will pay back interest on the full $10,000. The investor will earn interest based on the full loan amount.
3. The average investor at both Lending Club and Prosper has received a positive return every year since 2009. Prosper is now profitable and Lending Club is getting closer to that. They are not scams and I disagree with your assertion that they have “losing business models”.
Hi Zack,
I’d like to see an update on these charts: Here are a few links to some interesting data from the LC site:
https://www.lendingclub.com/info/statistics-performance.action
https://www.lendingclub.com/info/demand-and-credit-profile.action
Regards,
Reggie R