LendingClub Responds To Concerns About Investment Return

LendingClub requested an opportunity to clarify the Net Annualized Return measure and overall Lending Club performance discussed in my updated analysis based on historical return data. I’m just going to go ahead and share it in its entirety. The following is provided by from Renaud Laplanche (CEO) and Rob Garcia (Sr Director of Product Strategy).

Is Average Net Annualized Return Meaningful?
The first question raised was whether or not the aggregate 9.64% net annualized return is representative of a track record that is long enough to be meaningful, considering that it includes many loans issued recently. This is a valid question, and we believe the answer is positive: the average age of the Lending Club portfolio is around 12 months and, considering that it takes 4 months for a loan to default, a 12-month average age is really reflective of an 8-month track record. In a 3-year unsecured loans portfolio, defaults typically occur faster in the first 6 to 8 months, after which they start to level off. See for example data provided by our friends at ZOPA, who service a portfolio with characteristics similar to the Lending Club portfolio.

While Lending Club does not have as much history as ZOPA does, we have seen similar default behavior in the first 6 to 8 months of a loan portfolio’s life. We therefore believe that the current 12-month portfolio is a meaningful proxy to gauge overall annual performance, and that performance improves over time as defaults level off (see the Net Annualized Return performance curve over a 3 year period below). The credit policy improvements outlined below makes the displayed performance even more meaningful.

Is Performance of 2007 Vintage an Indicator of Overall Lending Club Performance?
The second part of the original analysis focuses on past performance, looking specifically at 2007 and 2008 originations. While it makes sense to review older vintages in general, pre-2009 vintages are not the most indicative of future performance in the case of Lending Club, as the current credit policy has been established in December 2008.

Loans issued in 2007 and early 2008 underperformed, which led us to adopt a more stringent credit policy and higher interest rates in November and December 2008. A performance snapshot of loans issued in 2009 (after the tighter credit policy came into effect, but excluding loans recently issued in 2010) show an average return over 10%:

Focusing on loans issued in the first quarter of 2009, which are just over one-year old, the net annualized return is roughly 8%. Based on the default cycle observed above, that performance is likely to improve in Year 2 and Year 3.

As always, past performance is no guarantee of future results. While it seems adequate to look at the older vintages as an indicator of future performance, only recent vintages with current underwriting criteria are comparable to the loans currently being issued, and therefore more relevant to evaluate Lending Club Notes as an investment opportunity.

Thanks for the opportunity to let us shed some light on how to understand net annualized returns at Lending Club.

Kind regards,
The Lending Club team

I haven’t had a chance to create my own formal response, but my overall impression remains the same… I would not count on 9.6% annualized returns over a 3-year term. But hey, if I get even 6% that would be great. I do hope for both LendingClub and investors that the returns do end up high enough to sustain the business model.

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Comments

  1. So many words, but none to the point. Reads like yet another marketing gimmick. All they need to do is very simple, that is to be open. Reveal the formula and data set that was fed into it to obtain this result. No single word is needed. We customers will decide how feasible it is in our particular investment circumstances. Until you do that your number will remain just a writing on the wall without any credibility in it. Now it is even worse for their image not to be open. Today many feel like their number was cooked and further word games and reluctance to reveal the truth will only appear as proof of that and drive customers away.

  2. @Vlad, the formula is shown on their website if you delve into the performance sections. There’s a pretty long explanation of it.

    The fact is that the formula takes into account all incoming cashflows, and so it still takes into account very recent cashflows from loans that have very little time to default. They admit this above, but argue that a 12-month average loan history is enough. The question is, do you agree?

  3. I’ve actually been pretty impressed with Lending Club’s transparency. The info they put out is far more than I would have expected. What I’d love to see them publish is statistical information about the loans that have defaulted. It’d be great to be able to do a comparison of most of the stats they let you browse notes by vs default rate. Things like length of employment vs default rate or months since last delinquency vs default rate would all be interesting things to know.

  4. Kevin,

    I would argue that you shouldn’t invest through them if they’re not transparent and that they need to provide even more data. I’m sure the people ultimately deciding on lending money at BAC and Citi have access to much better aggregate historic data than LC provides us.

    We should have access to as much information as possible, w/o jeopardizing some minimal level of privacy. In the LT it won’t work any other way. If it’s impossible to know accurately who is going to default, then you have to assume that everyone is going to default and therefore not lend at all.

    This is the real hurdle to LT success of P2P lending; can they provide enough data to lenders to allow people who do their research to be adequately profitable? If they can, then lenders will lend at lower rates than banks (lower over-head and some ppl will lend too low relative to risk/return) and the medium will grow. Prosper has failed miserably at this btw and seems to be on life support right now b/c of that failure.

  5. Daniel Terry says:

    Thanks Jonathan for posting all of this.

    I’m continually impressed by their transparency. For my own investment in LC, I’ve decided to use the default rates from older loans (2007-8) to calculate returns (~5% APY after fees and defaults for my A-weighted portfolio) and assume that this is likely an underestimate. That 5% is still better than most options out there when risk is taken into account. I think it is entirely possible that their analysis will end up being correct and that the average return will be >7% in the long run.

    I think it is also worth mentioning that all of these yield calculations assume that you reinvest all payments the moment you get them. This investment is somewhat unique in that you get most of the principle back very quickly, so if you let the cash sit, you’ll get a pretty low rate of return (~2.5% vs ~5% for the above).

  6. Didn’t change my mind but I did appreciate them trying to answer.

  7. GreeceGrease says:

    I’ve been investing with Lending Club for over 2 years now, and to be honest, they are the most transparent financial institution I have ever known. All the loan data is available to download from their site so you can run your own numbers, and all their collections activity shows to all investors of a loan (including every single detail on what they are doing to get a late loan back on track). If I don’t get what I need, I call them or send them messages via email and twitter and they’re very responsive.

    So far, I’ve had my share of defaults, but I’m still around 8%. Even if I get double the defaults I have had to far, I’ll be around 4-5%… try that at your favorite bank!

    Lending Club is offering an opportunity to invest in a very different product that only big fat bankers made money on. If you don’t see that as a chance to get some investing action you either have no money to invest, or don’t understand how banking works.

  8. Very interesting. Maybe someone will come up with the idea to create an LC default derivative — and sell CDS you can use to hedge your loans.

  9. GreeceGrease,

    I’m not sure that the correct benchmark for LendingClub returns is a savings account. The risk is much greater here. How about comparing to a high-yield corporate bond mutual fund? The Vanguard fund (VWEHX) has delivered an average return of 8.77% per annum since inception. If you’re only getting 5-6% with Lending club, I would think that such a fund is a better investment.
    However, for the first $2500, it may make sense if you’re getting a $250 bonus. That adds approx 3% per year to the returns. Even then, you’re barely breaking even when compared to the mutual fund.

  10. Phoenix says:

    Just curious, are you investors writing off your defaults on your tax returns? If not, you should.

  11. LendingClub states in their net annual return describtion: “However, there are other methods for evaluating the historical or potential investment return on fixed-income securities that you could choose to use instead, and you may want to consider such methods as well.”
    But this isn’t possible as the statistical data provided by LendingClub doesn’t provide the necessary information to calculate the net return: the month in which the loans defaulted and went late.
    The performance and default figures of LendingClub on their statistics page uses therefore an other information source then they provide to the lenders.
    Providing only this partial statistical data is in my opinion therefore an attempt to convey the impression of being transparent without being transparent at all.
    Greetings, nic

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