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Credit Variables Explained: Credit Grades on LendingClub and Prosper

By Angela Ceresnie
September 23, 2013

This week, we are taking a deep dive into Credit Grade on both LendingClub and Prosper.  Credit Grade is the letter (A-G or AA-HR) that is assigned to a borrower and corresponds with the interest rate that is charged for the loan.

 

 

These rates are set based on the originator’s underwriting assessment for the individual borrower.  The higher the expected risk of default, the higher the interest rate is set in order to offset this risk.  The assessment of the credit grade decision includes FICO, loan term (shorter term is considered better), proprietary models, and the loan amount requested by the borrower.

 

We wondered how the Prosper and LendingClub credit grades differ from one another, and wanted to answer the following questions:

 

  • What is the current distribution of these credit grades on newly issued loans?
  • Are the interest rates similar within the same credit grade on LendingClub and Prosper?
  • How do the borrowers within each credit grade compare across the platforms based on their FICO range?

 

Given that both platforms have changed underwriting criteria in the past year, we only looked at loans issued in 2013.

 

Distribution of Credit Grade on 2013 Issued Loans

LendingClub’s booked loans in 2013 are skewed toward the lower risk credit grades with 45% in A and B grades, and 12% in the higher risk bands of E, F & G.  Prosper, on the other hand is distributed somewhat evenly throughout the credit grades with 15%-20% issued in each grade and 30% in the higher risk bands of E and HR.

 

creditgrade1

This distribution explains the large number of B-rated loans we’ve seen on LendingClub, and why a similar trend doesn’t seem to exist on Prosper.  However, to truly understand the impact of this distribution with regards to the notes available, we need to know how comparable credit grades are priced on each platform.

 

Average Interest Rate by Credit Grade

Both Prosper and LendingClub use letters for their credit grade system, and the range is similar:

 

  • Prosper uses A-E for the first 5 credit grades, and after that, they list loans as “high risk” or HR.
  • LendingClub uses A-G for their grades.
  • We will compare Prosper’s HR with LendingClub’s F&G in our analysis.

 

As expected, the credit grades rank the same, but Prosper’s average interest rate is higher in each group.  For credit grade A, it is 4% higher – that difference increases as the credit grade increases.

creditgrade2

Risk Profile by Credit Grade (FICO)

Within each credit grade, LendingClub’s FICO distribution actually trends lower than that of Prosper.

 

% of 2013 issued loans with FICO < 700 at time of origination:

 A & B GradesC & D GradesE & F / G / HR Grades
Prosper15%53%73%
LendingClub43%76%86%

 

  • For the mid-Grades of C and D, we do see an increasing percentage of Prosper’s loans being issued to borrowers with FICO < 660, which LendingClub does not have.
  • For the higher risk-Grades of E, and F&G/HR, Prosper’s proportion of loans issued to FICO < 660 is significant at 30%, whereas LendingClub does not approve borrowers with FICO < 660.

 

The graphs below show the distribution of FICO score by credit grade:

creditgrade3 creditgrade4 creditgrade5 creditgrade6 creditgrade7 creditgrade8

What does this all mean?

Given that both LendingClub and Prosper have made major changes to their underwriting in the past year, looking at default rates/performance relative to these credit grades and their respective interest rates is not possible yet.  This analysis illustrates the importance of an independent risk assessment in any Online Lending portfolio.  Investors seeking to deploy capital with optimal returns in this market need to understand the underlying credit profile of the loans in which they are investing relative to the interest rates that are assigned by the originator.  If a strategy is developed using unbiased credit bureau variables and select application attributes, default rates can be predicted with accuracy regardless of the originator’s approach to assigning a credit grade.

 

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