What are the Default Rates with Lending Club and Prosper?

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.

Peter Renton is the chairman and co-founder of LendIt Fintech, the world’s first and largest digital media and events company focused on fintech.

LendIt Fintech conducts three conferences a year for the leading fintech markets of the USA, Europe, and Latin America. LendIt also provides cutting-edge content all year long via audio, video, and written channels.

Peter has been writing about fintech since 2010 and he is the author and creator of the Fintech One-on-One Podcast, the first and longest-running fintech interview series.

Peter has been interviewed by the Wall Street Journal, Bloomberg, The New York Times, CNBC, CNN, Fortune, NPR, Fox Business News, the Financial Times, and dozens of other publications.

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Dan B
Dan B
Jan. 12, 2011 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??

Dan B
Dan B
Jan. 12, 2011 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?

David
David
Jan. 12, 2011 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.

Dan B
Dan B
Jan. 12, 2011 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??

Dan B
Dan B
Jan. 13, 2011 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.

Wiseclerk
Jan. 13, 2011 10:24 am

Hi Dan,

good article.

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

Wiseclerk
Jan. 13, 2011 3:59 pm

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

Mike
Mike
Jan. 14, 2011 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.

David
David
Jan. 15, 2011 1:12 am

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.

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.

Dan B
Dan B
Jan. 15, 2011 1:59 pm

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

Mike
Mike
Jan. 15, 2011 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.

Mike
Mike
Jan. 15, 2011 2:05 pm

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

Dan B
Dan B
Jan. 15, 2011 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.

Dan B
Dan B
Jan. 15, 2011 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.

David
David
Jan. 16, 2011 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:

https://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.

Dan B
Dan B
Jan. 16, 2011 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………..?

Andy
Andy
Mar. 6, 2011 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.

Ingrid
Ingrid
Apr. 4, 2011 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!!!

Daniel B
Daniel B
Jun. 3, 2011 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!

Daniel B
Daniel B
Jun. 3, 2011 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!

Joe R
Joe R
Jul. 5, 2016 4:29 pm

I would like to know if there is data for defaults per category?
example: of all debt consolidation loans 50% default, of all business loans 30% default…etc. Maybe even per category per grade?
Thanks