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Lending Club Announces Launch of Next Generation Credit Model

Lending Club outlines what's new in their fifth generation credit model in an email to investors.

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Today, Lending Club announced a new credit model in an email to investors. According to the email, this is the most advanced and predictive credit model ever used on the Lending Club platform. This is Lending Club’s fifth generation model that began to go in effect on September 8, 2017 and will roll out to all borrowers in the coming days. While Lending Club historically has made improvements to their credit models, the new model caught our eye for a few reasons.

The company outlines that the model further leverages machine learning along with the 10 years of data on 1.5 million borrowers they have accumulated. The new model is 24% better at differentiating the likelihood of a borrower charging off compared to the fourth generation model. It also includes more data points, and uses new custom attributes that Lending Club states are predictive in assessing risk. Lending Club provided the two below examples for these custom attributes:

  • Instead of using aggregates, the new model uses very granular views of credit data which discern individual borrower actions vs. a simple aggregate (e.g. a borrower’s credit card balance per credit card vs. his total credit card balance).
  • The model makes more extensive use of trended data, which provides insight into a borrower’s credit behavior over time rather than a snapshot into a borrower’s credit behavior at a point in time. Dozens of new custom variables like these improve the model’s predictive power and are proprietary to Lending Club.

It also appears that Lending Club is continuing to tighten their credit criteria for higher risk borrowers with a shift to higher quality loans:

We expect loan volume to shift toward higher quality grades (grades A and B) because some borrowers will qualify for lower interest rates under the new model, and other higher-risk borrowers, who may have received an offer previously, will be screened out.

Lending Club has made a lot of changes to both credit criteria and interest rates over the last couple of years. We shared the trend of increasing interest rates in a blog post earlier this year. Following poor loan performance that started late 2015, the company began increasing interest rates. They also publicly announced that they identified pockets of loans that were underperforming last year. Lending Club is now tightening credit even more with the reduction of higher-risk borrowers.

LendingClub also noted that they are seeing lower delinquency rates across grades and terms in the existing loan portfolio than in the second and third quarters of 2016. This is good news for investors.

In a blog post, Lending Club provided updated projected returns based on the changes. Returns range from 4-9% and expected charge-offs platform wide have decreased from 6.2% to 6.0%.

Conclusion

One of the main advantages that Lending Club has over their competitors is the amount of data that their 10 year history provides. It appears they have taken a closer look at their underwriting models which now is leveraging machine learning even more. We’ll have to wait and see whether these recent changes provide a meaningful increase in returns for investors. It will also be interesting to see how the platform mix changes and how originations are affected in the coming quarters.

Lending Club and Prosper Interest Rates, Loss Curves and Loan Performance

With recent interest rate changes and economic uncertainty, we look at the latest Lending Club and Prosper loss curves.

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LendingClub_Prosper_Loan_Performance

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:

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Lending Club Raises Interest Rates for New Borrowers

Reacting to the Fed's 0.25% interest rate increase last week Lending Club raises their rates by an average of 0.25%.

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Lending Club Raises Interest Rates

How rising interest rates would affect marketplace lenders has been a question that many people have been asking for a long time. Demand for loans, credit performance and supply of capital to the platforms are all things that may be affected as interest rates increase. Today, we found out how the leader in marketplace lending is going to react. Lending Club announced in this press release today an average interest rate increase of 0.25% for all new loans going forward.

Last week, the Fed raised rates 0.25% for the first time in nearly a decade. Now this was a very minor move, but it is important symbolically as it gives us a window into how marketplace lenders will respond to interest rate increases. Renaud Laplanche, CEO of Lending Club, has regularly gone on the record to state that Lending Club is not interest rate sensitive at all.

This suggested that Lending Club’s marketplace continues to operate in an equilibrium. As short term credit interest rates increase, Lending Club will charge their borrowers more, thus passing on higher yields to the investor. And that is precisely what they are showing by this move today. [Read more…]

Harmoney Celebrates One Year in Business and NZ$100 Million in Loan Volume

New Zealand's first P2P lending platform has a great first year in business achieving their goal of deploying their $100 million of committed lending capital.

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Harmoney New Zealand

You could fit the entire population of New Zealand (4.5 million people) in the New York City boroughs of Queens and Brooklyn. It is not a big country and certainly not where you would expect to find one of the emerging world leaders in marketplace lending. But Harmoney, celebrating their first year in business, is quickly becoming a force to be reckoned with.

I caught up with the Harmoney team this week to discuss their one-year anniversary and get an update on how they are doing. When I covered their launch 12 months ago I said they were the first platform I had ever seen launch with $100 million in lending capital before making a loan.

At that time they said they would deploy that entire $100 million in their first year. True, to their word, CEO Neil Roberts shared that they crossed that milestone two weeks ago. Here are some of the highlights from Harmoney’s first year in business:

  • $1 billion in loan inquiries
  • $100 million in approved loans
  • 7,200 loans issued ($14K average size)
  • 10,000 retail investors, 3,000 logging in several times a day
  • 100,000 accounts created on their website

Harmoney was the first platform to be granted a P2P lending license by the New Zealand regulator, the Financial Markets Authority (FMA). The FMA has since granted two more licenses but Harmoney is the only company operating today. They have also recently been granted an Australian Credit License and will be launching operations there shortly.

Strong Interest from Retail Investors

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An Updated Look at the Risks of Marketplace Lending

This financial advisor thinks the risks of marketplace lending have changed over the years in part due to lower interest rates offered by the platforms.

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[Editor’s note: This is a guest post from Matt Shibata, a Portfolio Manager at Morling Financial Advisors, where he provides investment advice and allocates to variety of asset classes, including marketplace lending. He also writes on investment topics at his blog ThoughtfulFinance.com.]

Several years ago, I wrote a two-part guest post about marketplace lending as an investment asset class. It has been truly amazing to watch the industry’s growth and see how widely marketplace lending is now accepted as a bona fide asset class. The industry’s maturation has mitigated many risks, but I also believe that the rapid growth and increasing competition has increased other risks.

The primary risks today, in my opinion, stem from the decline in lending rates. Although rates were declining in 2013 (when I first invested in and wrote about marketplace loans), rates were much higher then. Today, rates have already come down significantly and continue to decline. Lower projected returns translate to a narrower margin of safety. Many, if not all, of the below risks have existed for quite some time and have been widely expected at some point, but they warrant more caution now due to today’s lower and still-declining rates.

Loan Refinancing

One factor that has been driving down returns has been loan refinancings, which represent a conflict of interest between investors and the platforms. Investors would generally prefer to hold performing loans to maturity in order to maximize returns, whereas the platforms are incentivized to originate as many loans as possible in order to maximize revenue. These are not mutually exclusive interests, but the platforms have been actively soliciting existing borrowers to refinance their loans at lower rates for the past several years. This is not inherently wrong (it’s great for borrowers), but investors should realize that a conflict of interest exists and that their loans are callable at any time (which is detrimental during a period of declining rates, since reinvestment returns will be lower). Orchard Platform recently posted a good summary of this issue here.

Loan Quality Questions

As more platforms go public, the pressure to grow continues to increase. Growing loan volume needs to be carefully weighed against maintaining loan quality. My observation is that both the pressure to grow and the huge demand for loans has led to a loosening of underwriting standards. We are seeing explicit examples, such as “high yield” offerings and euphemistically named “near prime” loans. But several sources have also confirmed that at least some platforms are now accepting less borrower documentation than they have in the past. My hope is that the technology used in place of traditional underwriting methods is robust enough to make up for the weaker verification processes. Only time will tell.

Questionable Practices in the Corners of Business Lending

The 2015 LendIt conference in New York (highly recommended!) was a great showcase of the industry and I met a ton of interesting people and learned about many marketplace lending platforms that focus on business lending. However, a few of the business lending platforms and funds were extremely aggressive. I am not trying to be moralistic, but it was honesty difficult to tell whether some of the platforms were helping or exploiting borrowers. A more economic concern is that several claimed that their high-degree of collateralization mitigated a lot of risk, but further questioning about recovery rates called many of these claims into question. This certainly does not apply to the entire business lending segment, but I would encourage investors to research any platform and/or manager that they are considering.

Investor Risk Analysis

The platforms’ risk models appear much more robust, but my guess is that many individual investors rely on some of the public commentary that compares the credit risks of marketplace lending with the credit risks of credit cards. This is an imperfect analog, at best, since revolving consumer credit (like credit cards) is fundamentally different from non-revolving personal loans (like marketplace lending) on many levels. For instance, a troubled credit card customer has an incentive to continue paying their monthly bill so that they can continue to use the card. A marketplace lending borrower does not have that incentive. This is not a prediction that marketplace loan loss rates will exceed credit card loss rates in the next economic downturn (although they may), but I would encourage investors to consider possible losses carefully.

Conclusion

As “peer-to-peer lending” matures towards “marketplace lending,” the high returns of early-adopters are now trending down towards market-driven ones. I believe marketplace lending will provide positive returns for quite some time, but the margin of safety is narrowing and its relative value to other investable markets has diminished as well. My hope is that all parties protect the integrity of the asset class, to ensure its long-term viability. Of course, hope is not a prudent investment strategy, which is why I am writing this and encourage all marketplace lending investors to recognize and weigh the risks along with the opportunity.

Full Disclosure: I advise clients on private investment vehicles dedicated to the marketplace lending asset class, as well as personally own loans on both the Lending Club and Prosper platform. I am also a client of NSR Invest.

A Visit With Prosper

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Prosper New Officce Reception

This week saw my first face-to-face meeting with Prosper management in several months and there was a lot to talk about. So, on Tuesday morning I sat down with several of their senior managers for an in depth conversation.

This meeting was my first in their shiny new offices (pictured above); Prosper has moved across town to the SoMa (south of Market St) district of San Francisco. While their previous offices were in a beautiful historic building I like the new space better. It has a more modern feel that is more fitting to a cutting edge company like Prosper.

When I last met with the Prosper executive team they were 20 days into their new jobs and president, Aaron Vermut, was yet to come on board. They talked about hitting the ground running with their 100-day plan and righting the Prosper ship that had been struggling for several months. Now, we are more than 200 days into their tenure and they reported everything on their 100-day plan has been accomplished and they are ahead of schedule on many items.

They provided a list of some of their recent accomplishments:

  1. Switch to FICO from Scorex (more on that later)
  2. New borrower funnel to increase conversions
  3. Sustained growth in new loan volume
  4. New API for investors
  5. Simplified data download for investors
  6. New internal accounting system
  7. New and less expensive office space
  8. Settlement of the class action lawsuit

Prosper now has 77 full time employees in their San Francisco office. They also have retained an outsourcing firm that provides them with 24 independent contractors (full and part time) in a Texas call center dedicated to supporting the borrower funnel in the gathering of documentation, a very time consuming and labor intensive process. This call center provides a similar service for companies like American Express and Sallie Mae.

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New Fund Invests in Small Business Loans

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Those of us that have been following the p2p lending industry for a while will recognize the name IOU Central. Back in February 2008 they became the first p2p lending company to launch in Canada. In late 2008 they opened an office in Atlanta to service the US market.

But their foray into p2p lending didn’t last very long. After dealing with similar regulatory issues that plagued the start of Lending Club and Prosper, founder Phil Marleau decided to pivot into an opportunity that he thought would be more lucrative: small business loans.

Not only did IOU Central switch from consumer to business loans they also decided not to pursue the p2p lending model, preferring instead to pursue a direct lending model. In December 2009 they had issued their first business loan. To give you an idea of their growth and volume, in 2012 they issued $11.5 million in new loans and in just the first quarter of 2013 that number was $8.7 million.

These are not loans made to high-risk startups – these are all established businesses looking for credit. The most common type of business is a doctor or dentist office. The average age of the businesses obtaining a loan is around 12 years and the owners all have good personal credit. The average loan size is $39,000 and most borrowers choose a 12-month loan duration (there is also a 6-month option).

The Direct Lending Income Fund Launched in October 2012

Now, to the investing side of the equation. Brendan Ross of Ross Asset Advisors launched the Direct Lending Income Fund in October 2012. This fund purchases small business loans issued by IOU Central.

Many of you may remember Brendan Ross from my interview with him last year. He was the first registered investment advisor to invest in LC Advisors and he has also invested his clients’ money in funds that invest in Prosper. He has been very bullish on p2p lending from the beginning. So why has he started a fund dedicated to small business loans? When I asked him that very question he sent me a detailed reply.

I’ve been an investor in P2P since Lending Club first created institutional vehicles in March of 2011. I’ve since put personal and client money into almost every fund that has grown up in this space. I reached the point where I couldn’t responsibly own more P2P consumer loans, but I wanted more private debt.

I knew that web-based underwriters could succeed wherever banks were failing to meet demand, and I knew in my gut that loans to local, established businesses were what was next. Starting in March 2012, almost exactly a year after I put money into consumer loans, I began doing serious research into the existing web-based underwriters whose focus was local, established businesses.

Although the Fund has a mandate to be multi-platform, I chose to start with IOU Central because they are a public company, their management team is strong and supportive of what I am doing, and they have been loaning money since Q4 2009 with excellent results.

I started the Direct Lending Income Fund because I wanted to put personal and family money to work in the business loans asset class. I lined up friends to join me during the first six months, when the Fund would be less proven. Now the results speak for themselves, and I’m typically running a 30-60 day waiting list for new investors.

The results that Brendan is talking about here are annual returns in the low to mid teens. This is what caught my attention when I first started looking at his fund.

IOU Central is not a P2P Lender

There has to be a catch, right? Unfortunately, IOU Central is not available as an investment for the general public. At this time it is only available through Brendan’s Direct Lending Income Fund and the minimum investment is $100,000.

So why am I writing about this if it is not about p2p lending? Because I believe it is a great investment that offers a predictable, high yield. This year I am expanding my focus beyond true p2p lending to other areas of direct investment. Most of the readers here are investors looking for opportunities for yield in this prolonged low yield environment.

What are the Risks?

Like any investment there are risks. In fact there are 18 pages in the fund’s Private Placement Memorandum going into great detail about all the risks involved. For example, we could have another financial crisis that could send default rates up dramatically or IOU Central could go bankrupt which could cause loss of principal, just to name a couple of the risks.

IOU Central has gone to great lengths to ensure investor’s money is as safe as possible. They file a UCC against the assets of the business for every single loan they make. Also, they obtain personal guarantees from the owners of the business. So, in effect these are secured business loans.

I Have Invested $100,000 in This Fund

This fund is not for everyone. For starters, it is only open to accredited investors. And if you are not a qualified client (see definition here) then you pay slightly higher fees.

I researched the Direct Lending Income Fund extensively including a long sit down with Brendan Ross going through the IOU Central platform and looking at the loan history. I decided to make a $100,000 investment in this fund.

To Find Out More

If you are an accredited investor and want to find out more you can fill out the contact page on the Direct Lending Income Fund site and Brendan will get back with you.

I only share investment ideas with you that I believe in and that I have invested in myself. This post is not a paid endorsement; I am sharing it with you because I have made this investment and believe it is a good opportunity. But please read my disclosure below.

Disclosure: I am by no means suggesting that you should make an investment in this fund. I want to make it very clear that this article is not investment advice. You should always check with a financial professional before making any investment decisions.

What Will Happen To Returns When Interest Rates Rise?

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In a few months it will be five years since the Federal Reserve lowered interest rates to zero. I don’t think anyone could have predicted rates would be this low for so long. While the stock market has been hitting new highs recently the rates for fixed income investments have remained at historic lows. People looking for income producing investments have had few options.

It is against this backdrop that p2p lending has come of age. It is relatively easy to sell investors on the idea of 8-10% returns when there are so few options for returns like this elsewhere. But what happens when interest rates rise and FDIC-insured investments are returning 5% or more? It makes little sense to invest in an unsecured loan that is paying 6% when you can get an equivalent return with no risk.

What will happen to the interest rates for p2p lending in a higher interest rate environment? While I don’t have the definitive answer (no one does) I can provide my own theory.

Borrowers have shown a capacity to continue borrowing in any economic cycle. There will still be demand, of that I am confident. But interest rates will have to change. Right now the lowest interest rate available at Lending Club is 6.03%, at Prosper the lowest rate is 6.04%. And herein lies the problem. The expected return to investors for these loans (after expected losses and service charges) is going to be between 4% and 5%.

That is not a bad return today but when FDIC-insured investments return 5% it starts to look unattractive. So rates will have to go up in order to attract investors. If the Federal Funds Rate goes to 5% again I think we will see borrower interest rates begin at around 8% to ensure a return to investors of 6% to 6.5%.

Will this mean the most creditworthy borrowers will look elsewhere? Possibly. But keep in mind other borrowing options will also be more expensive.

So, I believe that the impact of higher interest rates will not be that dramatic for p2p investors. We might see a slight increase of the average risk profile for the most creditworthy borrowers but apart from that I don’t foresee any major changes.

What do you think will happen if interest rates begin to rise? As always I am interested to hear your comments.

Taking Stock of the Recent Changes at Prosper

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It has been nearly three months now since the new executive team took over at Prosper and the changes keep coming. We all know about the new look they launched two weeks ago but there have been plenty of other recent changes as well. Here is a quick summary of some of the major changes that have been made as well as some that are coming very soon.

Maximum loan size is now $35,000

Until this month the maximum loan size was $25,000. Now, for grades AA, A and B the maximum loan size has been increased to $35,000. For C-grade loans the maximum is $25,000, D is $15,000 while both E & HR grade loans have stayed at $4,000. This is not a surprising change. Lending Club made this same increase over two years ago and the higher dollar loans have been performing well. The one thing that you should keep in mind if you have any saved searches where the loan amount is one of your criteria you may want to consider adjusting those searches to adapt to these new maximums.

No More 1-Year Loans

The 1-year loans at Prosper have always been just a small part of their business. But many investors liked them because it provided a quicker repayment of cash. Unfortunately, they are no longer available. When I asked why they said it was really a borrower demand issue. When the origination fee can only be amortized over 12 payments the APR gets pretty high and there just wasn’t enough take-up in it to make 1-year loans worthwhile.

Washington is Back Plus Two New Investor States

When Prosper introduced their bankruptcy remote vehicle on February 1st investors from the state of Washington were locked out and could not invest in new notes due to state regulatory issues. That changed a couple of weeks ago and they are now back in the fold and able to invest again. Also, as a result of the new legal structure Prosper is now approved for investors in Michigan and West Virginia.

Borrower Interest Rates Have Been Adjusted

This change is not unusual, both Prosper and Lending Club regularly adjust their interest rates. At Prosper rates now start at 6.04% for a AA-rated 3-year loan which is lower than the rate of 7.49% that was being charged 12 months ago. The drops are more dramatic for the lower grade loans. An E-rated 3-year loan is now 26.39% down from 29.58% 12 months ago. Interestingly, repeat borrowers no longer enjoy a discounted loan rate, which probably explains why there are fewer of those kinds of loans these days.

[Update: Someone from Prosper called me today to explain that my assumptions here are not completely accurate. You see, Prosper now has multiple interest rates within each loan grade whereas before they had just one. AA-rated 3-year loans can now range from 6.04% to 8.49% whereas before they were all 7.49%. For 3-year E-grade loans the range is now 26.39% – 30.06%, so rates have not in fact uniformly gone down as I suggested above.]

A Whole Loan Program is Coming 

Astute investors will have noticed a new field on the loan summary page called Initial Status. This has been added in preparation for a whole loan program that is launching at Prosper soon. This program will be run in a similar fashion to Lending Club’s where a random portion of loans will be held back from the main platform for a short period and large investors will be given the opportunity to invest in the entire loan. A test of this program was run last week and it will be implemented some time in the coming weeks.

Prosper is Moving to a New Location

Pretty much since their founding in 2006 Prosper has occupied the top floor of a beautiful historic building in the heart of downtown San Francisco. Last year they expanded to another floor in that building. But starting next month they will be at a new location at 2nd and Mission, just a few hundred yards away. The new space is larger and is a better deal financially.

They mentioned a few other changes as well. They have hired a new Chief Financial Officer, as well as an ex-FICO analyst and many others as well. There are also signs of a bit more public outreach than before. In the blog post by the new president, Aaron Vermut, published a couple of weeks ago there were many comments that were in fact responded to by the president himself. That was the first time a Prosper executive had engaged in public discussion since founder Chris Larsen left over a year ago.

I have been assured there are more changes in store as well. I realize not all these changes are great news for retail investors but I believe these are all necessary for Prosper to grow and to be able to compete with the industry goliath, Lending Club.

What do you think?

This Financial Advisor is Very Bullish About P2P Lending

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Brendan Ross is one of the few financial advisors who gets p2p lending. He is the principal of Ross Asset Advisors based in Los Angeles and I chatted with him recently about his practice and his p2p lending investments. An edited transcript of the interview is below.

SLN: Tell me a bit about your practice. How are you different from other financial advisors?

Brendan Ross: Five years ago I looked a lot like my peers. I used a combination of index funds and a buy and hold strategy to get the maximum return for my clients. Then came the financial crisis and that changed. Now, my clients are looking for a “Sleep Well at Night” portfolio where they don’t have to worry about their portfolio dropping 50% over the course of a year. But they still want a portfolio that grows – they certainly don’t want to have the same amount of money in 10 years time as they do today. Which is really where we have been in the stock market. The S&P 500 is not back yet to the levels that were reached in early 2000. Now, with the huge government debt that we have, it concerns me that over the next 10 years we will continue to move sideways. So the stock market isn’t attractive and the bond market is yielding just 2% to 3%. That means you are getting very little there for all the interest rate risk you are taking by buying bonds.

SLN: So where are you investing your clients money?

BR: I like municipal closed end funds – these funds are yielding 6% tax-free and I like p2p lending.

SLN: Why p2p lending?

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About Lend Academy

Lend Academy has been bringing you all the news and information about peer to peer lending since 2010. Founded by Peter Renton, Lend Academy not only has the most active news site, but also the largest online forum and the first and most popular podcast in the industry.

The Lend Academy team loves peer to peer lending and our staff have all invested their own personal money in one or more of the platforms. Lend Academy Media is part of Cardinal Rose Group which also owns LendIt, the leading industry conference, and has a majority interest in NSR Invest.

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