Let’s start off by looking at data for all existing loans at Lending Club. Specifically, the plots below are based on loan data downloaded on April 1, 2011 from Lending Club’s website. I will leave it to future posts to describe how I clean up and process the loan data that I download.
For our purposes, we can split existing loans by their status: Current, In Grace Period, Late (16-30 days), Late (31-120 days), Default, Charged Off, and Fully Paid. Most of these categories are self-explanatory. “In Grace Period” means that the latest loan payment was not made on time, but the borrower is still within the grace period for payment. Loans enter “Default” before being “Charged Off.” There is a very, very small chance that loans in default return to current status, but the overwhelming majority will be charged off. “Charged Off” means that no further payments will occur, and the lender must consider any principal invested to be a total loss (minus, of course, any payments already received.)
I use past loan data to estimate the probability that a loan will transition between status categories. For example, their might be a 95% chance that a current loan remains current in the next month. These probabilities let me predict the rate of return for any given loan in Lending Club’s database of existing loans. Charged off or Fully Paid loans, of course, require no prediction because I can determine the total payments made on those loans. More on loan probabilities in later posts.
April 2011: All Loans
This first plot estimates the percentage gain if one randomly chose a selection of loans from all the loans in Lending Club’s history. The y-axis (Density) represents the number of loans, as a percentage of the total number of loans. The x-axis (Percentage Gain), represents the estimated percentage gain or loss for each loan. N is the total number of loans analyzed (23,007).
If you invested in every loan, the probability model estimates that you would have a median return of 5.12%. The long tail on the left represents the small percentage of loans that eventually default. Depending on the number of payments made before a particular loan defaults, one may lose 0% to 100% of their principal.
April 2011: Late Loans
Now let’s zoom in on the various late loans. As one might expect, the model estimates increasing losses as a loan moves from Grace Period all the way to Default and Charged Off. Take, for example, the Grace Period loans, which represent loans that, as of April 2011 data, are between 1 and 15 days late on payment. The probability model estimates that these loans have a median percentage loss of approximately 20% (the peak of the curve). This is because some of these loans will make additional payments, but overall, the probability model suggests that these loans will, on average, eventually default: thus, the total return is a negative percentage. Of those loans that are currently registered as Default, the total return is approximately -75%, on average. So, not surprisingly, we expect loans in Default to be much worse investments than loans currently in Grace Period.
April 2011: Finished Loans
Finally, let’s look at loans that are “finished.” That is, loans that have a status of either “Charged Off” (bad) or “Fully Paid” (good). We have 4,588 loans with that status. The left side of the density curve represents the fact that a small percentage of these loans default, and thus the investor would lose some percentage of his total principal (anywhere from 0% to 100% loss). On the right side, we see the influence of paid off loans. The double peak on the right likely represents the following scenario: some loans are paid off quickly, so the investor gets back her principal, but not much interest. Then a second peak occurs, representing the larger median gains from loans that are not paid off extremely early.
Note that no probability model is used in this last graph, because we do not have to estimate future payments. The loans are finished, either charged off or fully paid.
The median percentage gain if you had invested in every loan that is now charged off or fully paid? 6.68%. Not too bad, and if you exercised some discretion in loan selection, you might even too better.