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Rejected Loans on LendingClub

By David Snitkof
November 25, 2013

In the Online Lending community, we spend a lot of time discussing the quality of loans, including credit history, repayment behavior, interest rates, default rates, and ROI.  Less often explored are the characteristics of a much larger population, the applicants who are declined by the origination platforms.  What if LendingClub is just not that into you?

LendingClub has long maintained that they are able to achieve a high quality of loans and solid returns for lenders by maintaining stringent underwriting criteria and accepting only approximately 10% of applicants.  Fortunately for us, LendingClub publishes data on rejected loan applications, which allows us to examine how this population differs from those who are approved.

lc-apprv-decl-bymonth

Applicants by FICO

In previous blog posts, we have explored the nature of FICO and credit scores in general.  Now, let’s take a look at how declined LendingClub applicants stack up against those who are ultimately approved for a loan.

As we can see in the chart below, LendingClub is declining a massive population of low-FICO applicants.  We also see that nearly 75,000 applicants had a missing FICO, which means that the TransUnion credit bureau was either unable to match the applicant to a verified consumer record or that the bureau did not have enough data to calculate a FICO score.

lc-apprv-decl-byfico

 

Clearly, there is a very significant appetite for credit in the marketplace, particularly among those with missing or low FICO scores.

 

Geographic Distribution of Declines

Aside from following general state-level restrictions on P2P lending, the geographic distribution of declines does not differ greatly from that of LendingClub approvals, as detailed in an earlier post.

lc-declines-geo

In Conclusion

The early Online Lending exchanges have been able to grow and earn the confidence of investors by maintaining consistently high credit quality among the loans allowed on their platforms.  This strategy has clearly paid off, but questions do remain.  The fact that the declined population is so vastly larger than the approved is cause for discussion, and it is an open question as to whether or not it would be possible to somehow underwrite these loans in a way that they are priced effectively for their risk.

At a time when investors are itching for more borrower volume, there is likely significant capital out there willing to invest in a riskier but higher-yielding block of loans.  However, doing so would require a greater level of predictive analytics to parse the good risks from the bad as well as a very finely tuned system for investment execution and portfolio management.

 

 

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  • Alex Aspiotis

    I had as much as 30K invested in LC but you don’t have to a lot of experience to understand why lending to the 90% of rejected applicants is so hard. A quick comparison of returns for the safest, middling and riskiest grades shows:
    grade | interest rate | return
    A | 7.7% | 5.9%
    D | 17.8% | 9.5%
    G | 24.3% | 9.6%

    Most of LC is refinancing existing debt and for these types of notes the historical data, as well as common sense, shows that on average, you can’t expect significantly more than 10% return. While it is true you may be able to get higher returns by beating the market at predicting defaults (analyzing the data to find trends by loan type, income, age, FICO etc.) it’s hard for me to imagine that there is a huge untapped market of potential borrowers that can afford to borrow at interest rates significantly over 10%. To a large extent, the higher the interest rate a given individual can sustain, the lower the chance they will need to borrow in the first place.

    To the extent LC is efficient at screening applicants, loans to the 90% of rejected applicants would have higher default rates on average than the 10% of accepted applicants. These new “Class H” and higher notes would have to charge ever higher interest rates but would almost certainly yield less than 9% due to increased defaults. At 9% return, alternative investments like stocks are more attractive due to potential upside.

    An exception could possibly be made for “business loans” because such borrowers have potential upside in the form of higher profits. But when it comes to business loans I feel that LC does a poor job in helping investors get the information they need to make sound decisions. And in any case, I think lenders investing in businesses would rather have the option to take an ownership stake in the company – thus adding some upside potential. Obviously this is not something that LC currently provides.