a view of LC's deteriorating investor returns

[Fred93]

I don't remember where I got this chart. ...

Google Image Search suggests this:
http://libertystreeteconomics.newyorkfed.org/2016/11/just-released-subprime-auto-debt-grows-despite-rising-delinquencies.html

Woohoo.  Ye old image search proves its worth.  Yes, that was the article.

[DLIFVOIP]

I am not disagreeing with anyone and think most who have posted have valid points.

However, to me it is very clear why returns have declined.  I have said it before and will say it again.

The lowering of the interest rates has done the most damage.  We as investors were forced to either accept lower returns and maintain our risk appetite (meaning we use filters to choose which loans to invest in and the return was the return) or in order to try and maintain returns we increased our risk appetite and invested in loans that would not have met our previous filters in order to chase the interest rate higher.

[apc3161]

The correct strategy should have been this: You have your filters (with their known returns), and you stick with them. If lending standards got worse and/or interest rates were lowered, this would have resulted in a lot of unused cash in your account. This cash should have then been withdrawn and put in stocks, bonds, real estate etc. If/once your filters started to find matches again, you can bring that cash back into LC.

[Emmanuel]

The correct strategy should have been this: You have your filters (with their known returns), and you stick with them. If lending standards got worse and/or interest rates were lowered, this would have resulted in a lot of unused cash in your account.

Indeed. If your algorithms says 'don't go out when it rains', you stay dry, whatever the weather outside. At least LC still provides investors with enough information so they can judge if the interest rate they decided for a given loan makes it worth the risk.

[DLIFVOIP]

The correct strategy should have been this: You have your filters (with their known returns), and you stick with them. If lending standards got worse and/or interest rates were lowered, this would have resulted in a lot of unused cash in your account. This cash should have then been withdrawn and put in stocks, bonds, real estate etc. If/once your filters started to find matches again, you can bring that cash back into LC.

You are exactly correct.  I do not choose loans to invest in based on the interest rate, I base my investment on credit criteria. 

[SLCPaladin]

I am not disagreeing with anyone and think most who have posted have valid points.

However, to me it is very clear why returns have declined.  I have said it before and will say it again.

The lowering of the interest rates has done the most damage.  We as investors were forced to either accept lower returns and maintain our risk appetite (meaning we use filters to choose which loans to invest in and the return was the return) or in order to try and maintain returns we increased our risk appetite and invested in loans that would not have met our previous filters in order to chase the interest rate higher.

I completely agree. This was my biggest complaint about LC's underwriting. They lowered interest rates too far, and too fast. I think they should be raising interest rates now. It should be pretty easy to see interest rate's impact on borrower demand for loans, but interest rate impact on lender returns (e.g., ANAR) take much longer to discern, and an error is only apparent with much hindsight (as we are seeing now). I'd rather LC err on the side of having higher borrower rates to ensure that lenders have a cushion for any downturn that might be coming.

[Fred93]

I am not disagreeing with anyone and think most who have posted have valid points.

However, to me it is very clear why returns have declined.  I have said it before and will say it again.

The lowering of the interest rates has done the most damage.

It is true that reduction in interest rates in the 2014/5 time frame reduced our returns.  However, performance of loans also substantially decreased, and I disagree with your "most damage" characterization.  I've published vintage delinquency curves in another thread, where you can clearly see that performance of loans in 2015 and 2016 is much worse than prior years.

We as investors were forced to either accept lower returns and maintain our risk appetite (meaning we use filters to choose which loans to invest in and the return was the return) or in order to try and maintain returns we increased our risk appetite and invested in loans that would not have met our previous filters in order to chase the interest rate higher.

Well I certainly did NOT increase my risk appetite.  I did not "chase the interest rate higher".  I accepted that I would receive a lower return when rates dropped, and I quantified that via back testing.  (My own back testing ... which used current rates, not like the NSR back testing which uses the rates that were in effect when the old loans issued.)  However, during 2016 my portfolio (like everyone else's) performed much more poorly than previous experience or backtest results suggested.  The reason is that loans of these vintages performed more poorly than expected.

In fact, I tightened my filters several times during 2016.  My risk appetite was constant, but I perceived that the LC grades had shifted, so I changed my filters, based on back testing of more recent loan performance, to shift me toward the higher quality grades.  It wasn't enough.  Loans from 2016 have performed much more poorly than the back test results predicted.  That's my experience.

My position is that LC changed the underwriting, producing a lower quality product.

[DLIFVOIP]

I am not disagreeing with anyone and think most who have posted have valid points.

However, to me it is very clear why returns have declined.  I have said it before and will say it again.

The lowering of the interest rates has done the most damage.

It is true that reduction in interest rates in the 2014/5 time frame reduced our returns.  However, performance of loans also substantially decreased, and I disagree with your "most damage" characterization.  I've published vintage delinquency curves in another thread, where you can clearly see that performance of loans in 2015 and 2016 is much worse than prior years.

We as investors were forced to either accept lower returns and maintain our risk appetite (meaning we use filters to choose which loans to invest in and the return was the return) or in order to try and maintain returns we increased our risk appetite and invested in loans that would not have met our previous filters in order to chase the interest rate higher.

Well I certainly did NOT increase my risk appetite.  I did not "chase the interest rate higher".  I accepted that I would receive a lower return when rates dropped, and I quantified that via back testing.  (My own back testing ... which used current rates, not like the NSR back testing which uses the rates that were in effect when the old loans issued.)  However, during 2016 my portfolio (like everyone else's) performed much more poorly than previous experience or backtest results suggested.  The reason is that loans of these vintages performed more poorly than expected.

In fact, I tightened my filters several times during 2016.  My risk appetite was constant, but I perceived that the LC grades had shifted, so I changed my filters, based on back testing of more recent loan performance, to shift me toward the higher quality grades.  It wasn't enough.  Loans from 2016 have performed much more poorly than the back test results predicted.  That's my experience.

My position is that LC changed the underwriting, producing a lower quality product.

Out of curiosity, was your vintage testing performed on performance meaning based on net return or was it based on quantity of loans (meaning you completely ignored interest rates and looked at percentage of default/charge off as a percentage of the population)?

[storm]

I completely agree. This was my biggest complaint about LC's underwriting. They lowered interest rates too far, and too fast. I think they should be raising interest rates now. It should be pretty easy to see interest rate's impact on borrower demand for loans, but interest rate impact on lender returns (e.g., ANAR) take much longer to discern, and an error is only apparent with much hindsight (as we are seeing now). I'd rather LC err on the side of having higher borrower rates to ensure that lenders have a cushion for any downturn that might be coming.

There is another active thread on here about the rising trend of prepayments, so obviously borrowers are finding loans with better rates.  LC needs to go back to the whatever they were doing prior to the last 2 years to filter out the deadbeats.  If nothing else, create new credit grades with really high interest and filter the sub-prime borrowers there.

[Fred93]

Out of curiosity, was your vintage testing performed on performance meaning based on net return or was it based on quantity of loans (meaning you completely ignored interest rates and looked at percentage of default/charge off as a percentage of the population)?

Outputs of the back test are WAIR, and IRR, from which one can impute the annual credit loss. 

My risk appetite has always been to keep IRR > 2 x credit loss.  The idea behind this is that this allows a recession or credit crisis, such as the last one, to roughly triple the loss rate, and I'd still break even.  Over time, I've adjusted my filters to make my back test results meet my risk criteria.  As loan quality has degraded, my filters look more and more conservative.

In the past, I was able to achieve this 2x objective with IRR > 10% .  And ... Actual results matched back test results.

Using recent times for the back test (ie 2015) I can achieve about 7.5% IRR in back test, but my portfolio is now doing substantially worse.  (Back test numbers change a bit every month of course, as I download the new loan data files every month)

IRR for the month...
10/2016  6.3%
11/2016  5.41%
12/2016  7.65%
01/2017  3.88%

There is a lot of complexity hidden in dozens of choices one makes about how to do these back test calculations.  I earlier pointed out that NSR uses the old interest rates, whereas I use the new interest rates for each grade, because I am interested in how a given filter  will perform on loans I select NOW.  I'm using the back test process to choose a filter.  For my filters, the increase in interest rates from 2015 to present has been 0.64%, so you might expect actual loans from 2015 to do a bit worse than today's back test result.  On the other hand, during 2015 my filter was a bit different, and the back test results then, using the actual rates LC applied to those loans, told me to expect > 9%, which hasn't happened by a long shot.  In recent times,  my experience is that loans have performed worse than the back test told me to expect.

There's a lot of noise in monthly numbers.  I expect that the low January number is low mostly because of noise, and not an indication of the latest trend, but we'll have to wait and see.  I hope to see the IRRs level off.

Aside: LC's Broad Based Credit fund, which is essentially filterless, ie "broad based", is now earning 0%.  They have fallen more than I have.

[rawraw]

My position is that LC changed the underwriting, producing a lower quality product.

In terms of underwriting, what do you mean by this term?  If you mean the selection of grade based on credit metrics, it seems like this is an empirical question (since LC discloses the data and the grade assigned).  However, you always seem to crunch numbers, so I'm assuming you would have tested this hypothesis already.  I wouldn't be surprised that the definition of a given credit grade has changed over time.   Given that I haven't seen you mention testing it, are you suggesting something LC does that we can't observe has changed?=

[Rob L]

Just checked my account balance and I'm up $7 for the month of February (0.008%). Better than the alternative.
All the effects of halving my portfolio size should be in the rear view mirror by now, but my adjustment amount in dollars is roughly the same as it was before I sold. Yeah, it's that bad ...

[lascott]

My position is that LC changed the underwriting, producing a lower quality product.

In terms of underwriting, what do you mean by this term?  If you mean the selection of grade based on credit metrics, it seems like this is an empirical question (since LC discloses the data and the grade assigned).  However, you always seem to crunch numbers, so I'm assuming you would have tested this hypothesis already.  I wouldn't be surprised that the definition of a given credit grade has changed over time.   Given that I haven't seen you mention testing it, are you suggesting something LC does that we can't observe has changed?=

I was called a couple weeks back to ask about withdrawals I was making. In the conversation, I was told Lending Club was tightening their criteria such as DTI from 40 to 35. (To rawraw's point I think we could see this in the loan data file ... ie. max DTI month to month). Indicating that even tho the economy is doing well, people are using that to spend more ... on credit. That was the only example they divulged.

[Rob L]

It's easy to be a Monday morning quarterback but the reasons could just be this simple. At the end of 2014 consumer loan charge offs were at an all time historic low. Beginning around that time LC embarked on a series of interest rate reductions. In hindsight dramatically lowering rates just when chargeoffs were at historic lows was a really really bad idea (at least for lenders). It was an easy thing to do as it increased LC's originations at the expense of OPM (ours). Fast forward over the next couple of years and chargeoffs began to rise back to more normal levels while interest rates were ratcheted down. This double whammy is what we are living through now. Presently LC has increased interest rates but charge offs are still on the rise (possibly just back to more normal levels) and we investors are still behind the curve so to speak.

[newstreet]

It's easy to be a Monday morning quarterback but the reasons could just be this simple. At the end of 2014 consumer loan charge offs were at an all time historic low. Beginning around that time LC embarked on a series of interest rate reductions. In hindsight dramatically lowering rates just when chargeoffs were at historic lows was a really really bad idea (at least for lenders). It was an easy thing to do as it increased LC's originations at the expense of OPM (ours). Fast forward over the next couple of years and chargeoffs began to rise back to more normal levels while interest rates were ratcheted down. This double whammy is what we are living through now. Presently LC has increased interest rates but charge offs are still on the rise (possibly just back to more normal levels) and we investors are still behind the curve so to speak.

Well--investors in the notes are behind the curve...LC has effectively proven that they don't know credit (have you see the Colchis and LC partners annual returns--YIKES!!!!!). The math speaks for itself. But.....they are showing they know how to churn and burn as well as the brokerage industry in order to drive fees. As long as institutions are desperate for yield-(they have mandated FI allocations)-LC will churn for fees and keep loosening credit standards.