LC Email: "The Next Generation Credit Model"

[SeanMCA]

I guess this is why they just hired Anuj Nayar to be their new PR expert. It looks the investor community needs more convincing about how great everything is.

[nonattender]

I guess this is why they just hired Anuj Nayar to be their new PR expert. It looks the investor community needs more convincing about how great everything is.

It'd be a great topic for Peter to cover on the blog - and ask some questions.  (Of a quant, not a PR guy.)

[rubicon]

They expect lower projected annualized net credit loss on F/G loans on 36 months compared to 60 months: 17.95% vs 16.99%. My guess is that the prepayment for 60 months F/G loans is high enough that the credit losses is actually lower (compared to 36 months). Hence perversely they are able to offer lower interest rate on 60 months F/G loans as you still get higher net projected return with a term premium of app. 1% (9.84% vs 8.89%). I guess lots of 60 month F/G loans refinance into 36 months D/E loans after 1 - 2 years.

But yes it does seem heavily data driven.

[AnilG]

Makes no sense. If the losses are lower, they shouldn't be F/G grade loans. The Credit Grades are supposed to be credit rating, on a risk-return continuum, of the loans being offered, 'A' lowest risk and 'G' highest risk. By claiming F/G/60 will have lower interest rate than F/G/36 because it has lower losses, the Credit Grade is no longer a rating for assessing risk and return of loans LC offers. Grades are turning into just a few "independent" buckets in which they distribute the loans with no relationship between them. Basically, they are undermining their own argument about selecting loans based on Credit Grade only. People using LC automated investing will be shafted.

Data-driven but knowledge-unaware, most probably performed by people who see data just as bunch of numbers and have no basic knowledge of credit modeling and aptitude for interpretation what data telling them.
 

They expect lower projected annualized net credit loss on F/G loans on 36 months compared to 60 months: 17.95% vs 16.99%. My guess is that the prepayment for 60 months F/G loans is high enough that the credit losses is actually lower (compared to 36 months). Hence perversely they are able to offer lower interest rate on 60 months F/G loans as you still get higher net projected return with a term premium of app. 1% (9.84% vs 8.89%). I guess lots of 60 month F/G loans refinance into 36 months D/E loans after 1 - 2 years.

But yes it does seem heavily data driven.

[Fred93]

Makes no sense.

Agreed. 

My guess is that the current model was data-fit (seems likely overfit) over some time interval, and then these estimates were produced by somebody else using some prognostication method (like maybe average over some different, shorter, historical interval).

[Data Junkie]

"We expect loan volume to shift toward higher quality grades (grades A and B) because some borrowers will qualify for lower interest rates under the new model..."

Kind of reminds me of another quote by Will Rogers:  "When the Oakies left Oklahoma and moved to California, it raised the I.Q. of both states."

[lascott]

Makes no sense. If the losses are lower, they shouldn't be F/G grade loans. The Credit Grades are supposed to be credit rating, on a risk-return continuum, of the loans being offered, 'A' lowest risk and 'G' highest risk. By claiming F/G/60 will have lower interest rate than F/G/36 because it has lower losses, the Credit Grade is no longer a rating for assessing risk and return of loans LC offers. Grades are turning into just a few "independent" buckets in which they distribute the loans with no relationship between them. Basically, they are undermining their own argument about selecting loans based on Credit Grade only. People using LC automated investing will be shafted.

Data-driven but knowledge-unaware, most probably performed by people who see data just as bunch of numbers and have no basic knowledge of credit modeling and aptitude for interpretation what data telling them.
 

They expect lower projected annualized net credit loss on F/G loans on 36 months compared to 60 months: 17.95% vs 16.99%. My guess is that the prepayment for 60 months F/G loans is high enough that the credit losses is actually lower (compared to 36 months). Hence perversely they are able to offer lower interest rate on 60 months F/G loans as you still get higher net projected return with a term premium of app. 1% (9.84% vs 8.89%). I guess lots of 60 month F/G loans refinance into 36 months D/E loans after 1 - 2 years.

But yes it does seem heavily data driven.

A college course I looked at recently being taken by a family member had the various types of 'premiums' that go into defining rates (eg. grade is a range of rates).  Maturity (time) Risk Premium is one of the parts of the formula. It seems they could have made two maturity of grades i.e. C36 and C60.   Perhaps they simplified it to make it easier to understand for the borrowers and investors.

Premiums Added to k* for Different Types of Debt

ShortTerm Treasury: only IP for ShortTerm inflation
LongTerm Treasury: IP for LongTerm inflation, MRP

ShortTerm corporate: ShortTerm IP, DRP, LP
LongTerm corporate: IP, DRP, MRP, LP

k = k* + IP + DRP + LP + MRP.

k   = Required rate of return on a debt security.
k*   = Real risk-free rate.
IP   = Inflation premium.
DRP   = Default risk premium.
LP   = Liquidity premium.
MRP   = Maturity risk premium.

Related page with short defns: The Five Components Of Interest Rates
http://www.investopedia.com/exam-guide/cfa-level-1/quantitative-methods/time-value-money-interest-rates.asp

[Rob L]

+1 on all of the above. "Makes no sense".
If you were LC would you not be embarrassed by this?

[SLCPaladin]

Is this LC's version of a partially inverted yield curve? It does make intuitive sense that interest rates should be higher on notes with longer maturity. The fact that this is not the case is perplexing.

[Rob L]

Is this LC's version of a partially inverted yield curve? It does make intuitive sense that interest rates should be higher on notes with longer maturity. The fact that this is not the case is perplexing.

Okay inverted yield curve; now I'm worried a recession may be just around the corner. 
Oh wait; these aren't treasury bonds; never mind.

[nonattender]

Is this LC's version of a partially inverted yield curve? It does make intuitive sense that interest rates should be higher on notes with longer maturity. The fact that this is not the case is perplexing.

That part of it could perhaps be explained by factoring prepayment rates into the pricing model.  No way to know for sure, until they talk - or until a few years from now.  (Probably best to talk.)  I nominate Anil as Chief Inquisitor - with the power to torture quants into telling the Truth - as Peter seems to be too busy writing for the Huffington Post, lately...

[JohnnyP]

I do not think 36 and 60 month loans follow the same credit model. For example, a 60 month E3 will have fewer deliquencies the first year than a 36 month E3. This is because they tighten the requirements for 60 month loans.

[bdbrooks]

I think you guys fail to understand the full scope of things. The reason for normal yield curves has to do with increasing uncertainty about inflation, economy, etc. as dates get farther out. 3 years vs 5 years really isn't much of a difference. Especially when you are only considering F/G borrowers paying ~30% apr (who cares if inflation goes from up half a percent).

The driving factor is credit loss, and here you have to switch perspectives from an investor to a borrower. If you are a borrower in the F/G grades you typically need the money more desperately and have far fewer alternatives. These borrowers are like travelers walking on the edge of a cliff. 60 month loans means smaller AND MORE MANAGEABLE payments for borrowers. It is like increasing the walkway for that traveler from 24 inches to the dropoff up to 36 inches to the dropoff. I have worked in unsecured consumer credit, and manageable payments is necessity on the lenders part. Yes there will still be people that have no intent on paying, but most people would like to pay. Though once they feel like they can't live and pay, they will stop paying: ACH Revoked, cease and desist, account issue (aka they closed their account or issued a stop payment). Maybe the lower interest rate is meant to encourage those risky borrowers to take the option that will be more manageable for them.

This concept is also what infuriates me about LC collection process, but that is too long of story.

[SeanMCA]

Now that I think about it, someone I know just refi'd their student loan to an online student lender. They were given two choices from the lender, a long term loan and a short term loan. The long term loan had a lower interest rate (maybe 75-100 bps if I recall). The loan amount was the same and there were no prepayment penalties. I told them to take the longer one and pay according to the shorter one's schedule. He had to call up the lender in advance to make sure there wasn't a catch and there wasn't. 

[rawraw]

Now that I think about it, someone I know just refi'd their student loan to an online student lender. They were given two choices from the lender, a long term loan and a short term loan. The long term loan had a lower interest rate (maybe 75-100 bps if I recall). The loan amount was the same and there were no prepayment penalties. I told them to take the longer one and pay according to the shorter one's schedule. He had to call up the lender in advance to make sure there wasn't a catch and there wasn't.

That's is really strange. I'm trying to understand what economic incentive could prompt that. Perhaps they had too few loans for a securitization and used the rare to have enough supply to deliver to the pool. Only thing I can come up with