Q4 2017: An update from our CIO
A core strength of LendingClub’s marketplace model is the ability to incorporate data insights quickly in order to responsibly adapt for the benefit of borrowers and investors. We share insights on loan performance regularly to give investors a sense of what we are observing on the platform.
During the fourth quarter of 2017, we continued to see credit performance across the industry and on the platform return to long-term averages. We see sizeable opportunities for investors in consumer credit, supported by strong borrower profiles on the platform and solid economic fundamentals.
Observations on platform performance
This quarter we continued to see a similar trend as we have for the past two years: credit performance across the industry and on the platform is returning to long-term averages. This dynamic is a result of the 2008 financial crisis. From 2009 to 2014, credit supply was tight, so consumer loans experienced better-than-average loss rates. Since then, credit supply has increased, and the industry has seen a return to long-term average delinquency rates and higher losses in higher risk populations.
Throughout 2016 and 2017 and while seeing this trend, LendingClub took substantial and repeated action to reduce risk; our efforts continue today as part of our continuous credit enhancement process. As a result of cumulative actions taken, our loss forecast for newly originated loans remains unchanged in aggregate compared to last quarter. During the quarter, delinquency levels remained largely stable across lower risk grades, with slight increases concentrated in higher risk grades. We believe this is partially due to the temporary impact of hurricanes as well as seasonality. Industry-wide, delinquencies typically trend higher in the fourth quarter each year as consumers spend more heavily during the holiday season. (Delinquency seasonality generally reverts in the spring during tax refund season.)
While each investor’s portfolio is unique, and returns will be based on the performance of the individual Notes or whole loans selected for investment, projected investor returns for the overall platform remain largely unchanged from those shared in our November update. Projected returns continue to range from approximately 4% to 8% (see below for details).
Q4 2017 update
See below for an update on some of the many factors1 that influence returns on the LendingClub platform:
U.S. economic growth remains slow but steady, with annual GDP growth rate increasing to 2.6% in the fourth quarter of 2017. A primary driver of GDP growth since the financial crisis has been a historically low unemployment rate, which is down to 4.1% from its peak of 10% in 2009.
Recent vintage performance continues to come in broadly in line with our expectations. We are also seeing slightly stronger borrower profiles on the platform, which we attribute to the release of the latest credit model (see more details below). We also expect borrowers to benefit from the recent tax cuts passed by Congress; it’s estimated that a family of four should save about $1,800 while a single person without kids should save approximately $1,650.2
The overall interest rate environment is starting to shift from historic lows. Noting sustained economic expansion, a strengthened labor market and a low inflation, the Federal Reserve raised the federal funds rate to a range of 1.25-1.50% in December. Three additional hikes are expected in 2018. On the LendingClub platform, interest rates are increasing for certain subgrades in grades D and E.
Last quarter, we reported that hurricanes Harvey (August 2017) and Irma (September 2017) were likely to have a near-term impact on delinquency rates. As expected, we observed an increase in delinquency rates in the fourth quarter in hurricane affected zip codes. Given the effect on near-term performance, in November we offered investors a more detailed view of delinquencies by reporting loan data both with and without the impact of hurricanes. With delinquencies rates in hurricane affected areas already trending back toward historical norms, we expect to see continued stabilization in the first quarter of 2018, and a limited long-term impact on returns for the vast majority of investors.
In summary, while we see a return to long-term delinquency levels as consumers take advantage of increased credit supply, we also see that economic fundamentals remain solid and support consumer health. We believe LendingClub provides both attractive access to credit for consumers as well as attractive risk-adjusted return opportunities for investors as compared to bond market alternatives with similar duration, volatility and yield compositions.
We continuously and proactively adjust credit models on behalf of both borrowers and investors. In addition to the many actions taken in 2016 and 2017, over the past several months, we have implemented a series of notable enhancements to the platform aimed at making smarter credit decisions and optimizing risk/return for investors.
Continued to innovate with the latest credit model
Our approach to risk management is a continuous, proactive process that runs against a constantly shifting set of conditions. We test and monitor borrower results and, when necessary, adjust using a disciplined, deliberate and data-driven approach. Periodically we introduce new credit models to incorporate new insights, new data sources and new analytical tools. In September 2017, we rolled out the fifth-generation credit model and revamped the criteria for underwriting and pricing loans facilitated on our platform in order to bring even more predictive power to credit decisioning. The most comprehensive upgrade of the credit model to date, the model incorporates dozens of new proprietary borrower attributes that are predictive in assessing risk, and includes more data points per borrower than ever before. Although loan vintages are still too new to make conclusions, early indications are positive. As always, we are vigilant in monitoring credit and will take action accordingly to protect investor returns.
Protecting consumers from taking on excess debt
Observing the trend sparked by increased credit supply overall, we’ve begun to test a feature where borrowers can utilize their LendingClub loan to directly pay off existing creditors. In addition, we continue to enhance our ability to reduce loan stacking risk and are deploying new data sources this month to more powerfully mitigate risk. (Loan stacking can occur when an applicant attempts to take out two or more loans across lenders in quick succession, during the brief period before the loan is reflected in credit bureau data and when loan originators may not be able to detect the full risk profile of a borrower.) By leveraging new data sources, we can identify and decline populations that are significantly riskier within each grade.
Alternative underwriting data
LendingClub has a long tradition of innovating beyond traditional FICO-based underwriting. This quarter, we began layering additional alternative data into the underwriting process as part of ongoing optimization of the credit model. Incorporating more predictive alternative data sources that paint a more detailed picture of a borrower’s financial history and behavior enable us to swap out riskier populations and swap in less risky ones. We believe that this capability will reduce risk across all grades while keeping loan volume stable.
Updated pricing and return forecast
We continuously refine our methodology and recalibrate interest rates based on shifts in risk across the portfolio. This quarter, interest rates are increasing for certain subgrades in grades D and E.
Loss forecasts are remaining stable in aggregate for the platform relative to last quarter. (Some individual grades have slightly higher forecasted losses while others have slightly lower forecasted losses.) Projected investor returns are substantially similar to last quarter (20 basis points higher in aggregate across grades), with the exception of 60-month grade D loans where projected returns are about 100 basis points higher. Please see the summary table below.
Platform Summary and Projections as of February 20, 2018
Our agile process of continuous credit model enhancements and quarterly loss forecasting helps us anticipate and adapt to risks or changes faster on behalf of borrowers and investors alike.
As always, we will continue to keep our investors apprised of changes on the platform. Please feel free to reach out to firstname.lastname@example.org with any questions. We look forward to continuing to serve you as an investor for years to come.
Some of the statements above are “forward-looking statements.” The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “outlook,” “plan,” “predict,” “project,” “will,” “would” and similar expressions may identify forward-looking statements, although not all forward-looking statements contain these identifying words. Actual performance of the overall platform has differed from projected performance in the past, and could differ in the future. Factors that could cause actual results to differ materially from those contemplated by these forward statements include: increases to unemployment rates, particularly if such increases are concentrated in populations with a greater propensity to take loans facilitated by our platform; changes to consumer credit behaviors; stagnation or reduction in the growth of the nation’s gross domestic product or uncertainties created by political changes associated with a change in presidential administrations, the Company’s ability to continue to attract and retain new and existing retail and institutional investors; competition; and demand for the types of loans facilitated by the Company and those factors set forth in the section titled “Risk Factors” in the Annual Report on Form 10-K, filed with the SEC. LendingClub may not actually achieve the plans, intentions or expectations disclosed in forward-looking statements, and you should not place undue reliance on forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in forward-looking statements. LendingClub does not assume any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
1Investor returns are also impacted by other factors, such as prepayment rates, the size and diversity of a portfolio, the exposure to any single Note or loan, borrower or group of Notes, loans, or borrowers, as well as other externalities and macroeconomic conditions.
2Analysis by Ernst & Young. Family of four assumes: married filing jointly with 2 children, taking a standard deduction (no mortgage deduction). Single person assumes: single, no children, taking a standard deduction (no mortgage deduction). Analysis only considers federal taxes (not state).
3“Average Interest Rate” is the hypothetical loan grade and term mix used to calculate weighted average interest rate was generated by applying the fifth generation credit model to certain applications received November 20, 2017 through December 31, 2017. This hypothetical mix is for illustrative purposes only and is not a guarantee or indication of future inventory distribution. This analysis uses elements of backtesting. Backtesting is hypothetical and is provided for information purposes only. Backtested data has inherent limitations, including that historical borrower populations are not necessarily indicative of future borrower populations.
4“Projected Charge-Off Rate” also known as Expected Charge-Off Rate, is LendingClub’s projection of the aggregate dollar amount of loan principal charged-off, net of any amounts recovered and accounting for the impact of amounts prepaid, as an annualized percentage of the aggregate dollar amount of loan principal for all loans issued under the Prime Program after February 20, 2018. Projected Charge-Off Rate is not a promise of future results and may not accurately reflect actual charge-off or prepayment rates. Actual charge-off and prepayment rates experienced by any individual portfolio may be impacted by, among other things, the size and diversity of the portfolio, the exposure to any single loan, borrower or group of loans or borrowers, as well as macroeconomic conditions.
5“Projected Return” is a measure of the estimated annualized return rate on invested principal (meaning for all funds then invested in Notes or loans) using an internal rate of return (IRR) methodology using a monthly term. Monthly cash flow projections are calculated as follows: the scheduled principal and interest payments based on the Interest Rate, minus the amount of such principal and interest payments lost due to the Expected Charge-Off Rate, minus Expected Fees. Monthly IRR figures are annualized by multiplying the monthly IRR figure by 12. Projected Returns are calculated based on grade and maturity mix described in the “Average Interest Rate” disclaimer above. Projected Return is not a promise of future results and may not accurately reflect actual returns. Actual returns experienced by any individual portfolio may be impacted by, among other things, the size and diversity of the portfolio, the exposure to any single Note or loan, borrower or group of Notes, loans or borrowers, as well as macroeconomic conditions. Individual results may vary and projections are subject to change. The information presented is not intended to be investment advice, guidance, or a guarantee of the performance of any Note or loan. Notes are offered by prospectus filed with the SEC and investors should review the risks and uncertainties described in the prospectus prior to investing. Actual results may vary.
“Interest Rate” is equal to the weighted average stated borrower interest rate for the loan grade or mix of loan grades (whichever is applicable) using the grade and maturity mix described in the “Average Interest Rate” disclaimer.
“Expected Charge-Off Rate” is defined above as “Projected Charge-Off Rate.”
“Expected Fees” for loan purchasers means the aggregate estimated impact of LendingClub’s then-applicable: servicing fee (1%), collection fee (18%), recovery fee (18%), and an administrative fee (0.10%), each as of the date above.
“Expected Fees” for Note investors means the estimated impact of all applicable fees as well as the impact of interest not earned during the administrative holding period in the first month (2 business days). Applicable fees are LendingClub’s service fee and collections fee (if applicable). LendingClub charges an investor service fee of 1% of the amount of any borrower payments received by the payment due date or during applicable grace periods. The service fee is not an annual fee and may therefore reduce annual investor returns by more or less than 1%. We estimate the collection fee based on expected charge-off rates and the expected number of late payments that will be collected on past due loans with a given grade and term. For more detail on LendingClub fees for Note investors, please click here. Individual results may vary and projections can change. Past performance is no guarantee of future results.