Author Topic: What's This "Best Note" Selection Business Anyway?  (Read 40747 times)

Fred

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Re: What's This "Best Note" Selection Business Anyway?
« Reply #45 on: January 24, 2014, 01:59:14 AM »
For those of you with a credit granting background, does LC see the FICO history when they run an inquiry or just the snapshot at that moment in time?

Most places that I have worked in only dealt with the latest FICO score.  Some took the 3 scores from different credit reporting agencies, and then took the average, min or max, of them.  However, I have never been a position where historical FICO scores were considered during underwriting.

On the other hand, historical (usually past 2 years) income and employment are often considered.

I have not been in a consumer finance underwriting role since 2007, so things might have changed since then.

Rob L

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Re: What's This "Best Note" Selection Business Anyway?
« Reply #46 on: January 28, 2014, 06:10:52 PM »
In the interest of continuity I'm repeating this post from another thread which was in response to Simon's blog article. It is very on topic here.
http://www.lendingmemo.com/redlining-florida-lending-club-prosper/
http://www.lendacademy.com/forum/index.php?topic=2000.0

Making loans to Florida is only a bad bet if LC has set the interest rate too low.
From the discussion in this thread it appears that, early on, the LC model did not weight # inquires heavily enough and lenders were under compensated. Over time it appears LC recognized this and updated their model. I wondered if the same had happened for the state of Florida parameter.

Using Interest Radar I found the following (only 36 month term loans included):

                   All Grade  Loans                                A,B Only Loans
Year   # Loans    Int Rate    FL Int Rate        # Loans    Int Rate    FL Int Rate
2009    4716        12.2%        12.2%             2543         10.3%       10.2%
2010    8466        11.1%        11.1%             5217           9.0%         9.0%
2011  14101        10.6%        10.5%            10301           8.9%         8.9%
2012  43470        12.6%        12.6%            27558         10.4%       10.4%
2013  97776        13.4%        13.6%            55971         10.6%       10.7%

Each year FL loans were between 6.7% and 7.3% of total originations.

It seems pretty clear that, unlike # inquires, LC has not learned from history and has not increased interest rates for Florida borrowers. Simon is right. By all appearances filtering by state works and Florida likely remains a bad bet.

Could be that the law (or the possibility of negative publicity) precludes consideration of such redlining or hot button factors by LC in their model. There's a story I read about one lender that used the number of vowels in the borrower's last name to filter for ethnicity. The word got out and there were very serious repercussions. If memory serves it cost them their business.

RaymondG

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Re: What's This "Best Note" Selection Business Anyway?
« Reply #47 on: January 28, 2014, 11:54:48 PM »
I just realized that I have a large amount of loans from CA, FL and NV. But the lose from these loans are average or better which might be because I use a little more restrict criteria to pick loans from these three states.

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Bohb Daishi

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Re: What's This "Best Note" Selection Business Anyway?
« Reply #48 on: January 29, 2014, 02:59:07 AM »
Could be that the law (or the possibility of negative publicity) precludes consideration of such redlining or hot button factors by LC in their model. There's a story I read about one lender that used the number of vowels in the borrower's last name to filter for ethnicity. The word got out and there were very serious repercussions. If memory serves it cost them their business.

Look at the bottom right of their home page where it says "Equal Housing Lender". That typically means they can't "discriminate" by illegal factors such as location.
There are three ways to make a living in this business: be first, be smarter, or cheat.

Rob L

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Re: What's This "Best Note" Selection Business Anyway?
« Reply #49 on: February 02, 2014, 06:32:31 PM »
A natural question to ask is "How accurate has LC's model been over the years".

For each loan in the browsenotes file LC provides its sub-grade which is defined by "interest rate" and "expected default rate" (both provided).
Terrific; all I have to do is go back to the LoanStats files, pull the expected default rates over the periods used (LC updates these along with interest rates periodically), and see how well LC did.

As I'm sure it's well known to folks that have been here much longer than I, LC doesn't record in LoanStats the expected default rate they provided at the time of loan issuance. See:

http://www.lendacademy.com/forum/index.php?topic=560.msg1916#msg1916

Very convenient. Looks like LC must not want folks going back to see how well their predictions held up.
The only way to have the required data is to have recorded and preserved one or more browsenotes files during each of the periods of sub grade use.
My browsenotes records only go back to 05/13. Not much help. Any old timers out there have the long record?

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Emmanuel

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Re: What's This "Best Note" Selection Business Anyway?
« Reply #50 on: February 03, 2014, 10:52:52 AM »
A natural question to ask is "How accurate has LC's model been over the years".

For each loan in the browsenotes file LC provides its sub-grade which is defined by "interest rate" and "expected default rate" (both provided).

I far as I know, default risk determines the grade, then grade + term determines the interest rate. Therefore to gauge LC's accuracy, one can simply check the correlation between sub-grades and default rates, see https://lendingrobot.com/data#default_sub.

As one can see, LC does a pretty good job with higher quality loans, not so much when the risks increases, which makes sense since there are more outliers.



Rob L

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Re: What's This "Best Note" Selection Business Anyway?
« Reply #51 on: February 03, 2014, 02:43:43 PM »
I far as I know, default risk determines the grade, then grade + term determines the interest rate.
Therefore to gauge LC's accuracy, one can simply check the correlation between sub-grades and default rates, see https://lendingrobot.com/data#default_sub.

Yes that should do it. One could even make similar charts by vintage if so inclined. We could see if LC is getting any better at it over time.
It would also be interesting to have a similar graph of FICO range at application vs. default rate for comparison.

dontvote

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Re: What's This "Best Note" Selection Business Anyway?
« Reply #52 on: February 04, 2014, 05:16:39 PM »
The best indication that their credit model is working accurately is a sameness between captured returns across the grades. b-g should basically give you the same return if you buy all the notes offered. This is the fully diversified naive portfolio that shows how well they are pricing risk to give an after default economic return for the platform. I think they've been doing a pretty darn good job. B-G are basically giving you about the same.
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Beekaycee

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Re: What's This "Best Note" Selection Business Anyway?
« Reply #53 on: February 04, 2014, 09:12:52 PM »
The best indication that their credit model is working accurately is a sameness between captured returns across the grades. b-g should basically give you the same return if you buy all the notes offered. This is the fully diversified naive portfolio that shows how well they are pricing risk to give an after default economic return for the platform. I think they've been doing a pretty darn good job. B-G are basically giving you about the same.

With tax filing season top of mind it struck me that for those individuals with a taxable Lending Club account equal returns across the grades may give substantially unequal results after taxes.

We are fully taxed on the interest, but limited to $3000 capital losses per year from your defaults (unless you have other capital gains to offset). Any losses you can't deduct roll forward, but meanwhile the defaults keep coming in, too.

Bottom line, the high risk grades throw off big interest yields, but also have large defaults that you may not get to deduct anytime soon.



Beekaycee

Rob L

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Re: What's This "Best Note" Selection Business Anyway?
« Reply #54 on: February 04, 2014, 09:58:27 PM »
The best indication that their credit model is working accurately is a sameness between captured returns across the grades. b-g should basically give you the same return if you buy all the notes offered. This is the fully diversified naive portfolio that shows how well they are pricing risk to give an after default economic return for the platform. I think they've been doing a pretty darn good job. B-G are basically giving you about the same.

I must be reading this paragraph from the LC "How We Set Rates" paragraph incorrectly:

Lending Clubís interest rates take into account credit risk and market conditions. The final interest rate for each loan grade is the result of the following equation:
Lending Club Base Rate + Adjustment for Risk & Volatility
The Adjustment for Risk & Volatility is designed to cover expected losses and provide higher risk-adjusted returns for each loan grade increment from A1 to G5.

Seems clear to me that says lenders should expect a higher return for riskier loans, not the same risk adjusted return across the board. That returns have been flat, as you correctly describe, says LC has done a lousy job of accomplishing their stated goal (from a lender's point of view).



dontvote

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Re: What's This "Best Note" Selection Business Anyway?
« Reply #55 on: February 05, 2014, 11:56:33 AM »
What I'm calling the 'economic return' is the return net of defaults. That means that you will have a higher rate of defaults on higher interest rate loans. So yes investors get higher rates on riskier loans with higher default rates. If the system works well, your rate of return will be the same after all is said and done, irregardless of the loan grade you invest in.

this is describing the same principal that evens asset class returns. higher return assets get bid up until all returns from risky money are basically equivalent. It doesn't always work cleanly, but it is a basic market force that contributes to asset class prices.

in the p2p space we saw this early when people took a look at the 14% average returns from higher yield notes and said anyone investing in higher grade notes earning 11% after defaults was leaving money on the table.
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Rob L

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Re: What's This "Best Note" Selection Business Anyway?
« Reply #56 on: February 05, 2014, 04:01:23 PM »
What I'm calling the 'economic return' is the return net of defaults. That means that you will have a higher rate of defaults on higher interest rate loans. So yes investors get higher rates on riskier loans with higher default rates.

Clearly true.

Quote
If the system works well, your rate of return will be the same after all is said and done, irregardless of the loan grade you invest in.

I just can't see that being correct for a number of reasons.

What you are saying is that the feeding time frenzy for the riskier notes by individual and institutional investors alike is a fool's errand. Just buy a fully diversified portfolio of B notes and fugetaboutit. No doubt everyone caught up in this frenzied buying believes they are getting the "best notes".

For the sake of agreement lets say LC successfully assigns interest rates so that the lender has no economic incentive to invest in riskier notes. Why would anyone do so? They hope they get lucky?

Consider loan grade diversification risk. If you want to build a fully diversified portfolio of A or B notes it's pretty easy. But as the grades become more risky the variance of returns of portfolios not containing every loan of that grade increases. If you have 100 A notes you are far more certain your portfolio returns will be near the average of all A notes than portfolio of 100 F notes being near the average of all F notes. It wasn't that long ago that LC had to stop claiming that no investor with 800+ notes had ever lost money. Someone did; and I'll bet that person wasn't holding A's and B's. I don't know the answer but it would be interesting to know over all fully matured F loans the required number of notes in your all F grade portfolio needed to have 95% confidence of being within 5% of the average of all F note returns.

Maybe my argument above is badly flawed, but it seems to me that if real returns after charge offs do not increase with risk (not just keep pace with it) then they are a bad bet.
However we see from the link below it's the bet LC investors have been making. So much money chasing yield ...

https://www.lendingrobot.com/data#by_sub
« Last Edit: February 05, 2014, 10:34:57 PM by Rob L »

dontvote

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Re: What's This "Best Note" Selection Business Anyway?
« Reply #57 on: February 05, 2014, 06:04:38 PM »
What I'm calling the 'economic return' is the return net of defaults. That means that you will have a higher rate of defaults on higher interest rate loans. So yes investors get higher rates on riskier loans with higher default rates.

Clearly true.

Quote
If the system works well, your rate of return will be the same after all is said and done, irregardless of the loan grade you invest in.

I just can't see that being correct for a number of reasons.

What you are saying is that the feeding time frenzy for the riskier notes by individual and institutional investors alike is a fool's errand. Just buy a fully diversified portfolio of B notes and fugetaboutit. No doubt everyone caught up in this frenzied buying believes they are getting the "best notes".

For the sake of agreement lets say LC successfully assigns interest rates so that the lender has no economic incentive to invest in riskier notes. Why would anyone do so? They hope they get lucky?

Consider loan grade diversification risk. If you want to build a fully diversified portfolio of A or B notes it's pretty easy. But as the grades become more risky the variance of returns of portfolios not containing every loan of that grade increases. If you have 100 A notes you are far more certain your portfolio returns will be near the average of all A notes than portfolio of 100 F notes being near the average of all F notes. It wasn't that long ago that LC had to stop claiming that no investor with 800+ notes had ever lost money. Someone did; and I'll bet that person wasn't holding A's and B's. I don't know the answer but it would be interesting to know over all fully matured F loans the required number of notes in your all F grade portfolio needed to have 95% confidence of being within 5% of the average of all F note returns.

Maybe my argument above is badly flawed, but it seems to me that if real returns after charge offs do not increase with risk (not just keep pace with it) then they are a bad bet.
However we see from the link below it's the bet LC investors have been making. So much money chasing yield ...

https://www.lendingrobot.com/data#return_sub

what I'm saying is true in aggregate - you have to invest in every loan to have equivalent return across grades

if you feel that you can pick loans within the range better than 'all loans' your 'skill' will have more impact among higher yielding loans.

I will tell you without asking anyone else that people who are picking loans think they are going to beat the averages. people who pick people who are picking loans think the same.
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Bohb Daishi

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Re: What's This "Best Note" Selection Business Anyway?
« Reply #58 on: February 06, 2014, 02:04:56 AM »
what I'm saying is true in aggregate - you have to invest in every loan to have equivalent return across grades

if you feel that you can pick loans within the range better than 'all loans' your 'skill' will have more impact among higher yielding loans.

I will tell you without asking anyone else that people who are picking loans think they are going to beat the averages. people who pick people who are picking loans think the same.

Even in aggregate, the risk/reward should never be the same across all loan grades. If you made the same amount of money investing in G5 notes as you would investing in A1, then everyone would put their money in A1 because they would prefer to not deal with defaults. The higher return is the compensation you receive for putting up with higher default rates. Some people want zero defaults, so they put all their money in low-risk grades. Likewise, some people aren't bothered by having defaults, so they put money in higher risk notes.
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dontvote

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Re: What's This "Best Note" Selection Business Anyway?
« Reply #59 on: February 07, 2014, 02:30:45 PM »
what I'm saying is true in aggregate - you have to invest in every loan to have equivalent return across grades

if you feel that you can pick loans within the range better than 'all loans' your 'skill' will have more impact among higher yielding loans.

I will tell you without asking anyone else that people who are picking loans think they are going to beat the averages. people who pick people who are picking loans think the same.

Even in aggregate, the risk/reward should never be the same across all loan grades. If you made the same amount of money investing in G5 notes as you would investing in A1, then everyone would put their money in A1 because they would prefer to not deal with defaults. The higher return is the compensation you receive for putting up with higher default rates. Some people want zero defaults, so they put all their money in low-risk grades. Likewise, some people aren't bothered by having defaults, so they put money in higher risk notes.

you're right, there is a volatility of return which is higher in the riskier notes that will give them some additional risk premia but that should be really small since we're looking at all loans in aggregate. while G loans may have a standard deviation of default rates that changes across time and that deviation will be larger than that of grade b loans I don't see why it would be a large amt.  Additionally, since a bad economy will ostensibly affect riskier notes more that should add to their return requirement (all else being equal).   I was trying to simplify to say we'll know if the models are working well if we see aggregate returns at *about* the same level. And we do outside of the lowest risk notes.
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