We’ve seen a rise in default rates across asset classes, whether you’re talking about P2P lending, stocks, or bonds. The bulk of it is attributed to the Energy and Materials sectors. Specifically, oil prices have undergone a massive fall in pricing due to a supply issue, which led many energy projects to halt / cancel exploration and drilling projects and consequently laid off many employees. From Lending Alpha’s point of view, the loans we invest into are materially affected by a borrower’s main source of income: their jobs.
That is why our loan selections models since late 2015 have been enhanced avoid lending to borrowers from zip codes that are heavily exposed to the Energy and Materials sectors. We have performed the necessary research to identify these geographic locations and applied exclusion filters across the board in order to avoid impacted borrowers who may have lost their jobs or are at risk of losing their jobs soon. Effectively, this is one of among many of the risk management strategies we employ in our models, and are transparent and seamless to our investor clients. We actively improve everyone’s returns using proprietary techniques not available anywhere else, in addition to traditional methods.
Here’s a look at some macro-economic data. We reference the HY (high yield corporate bonds) indices to represent the health of corporations by sectors (those who employ the potential borrowers in Lending Club’s platform).
It’s clear that the Energy sector is attributed to a disproportionate amount of the recent defaults within the HY index.
When these two sectors are combined and compared against all other sectors from a global perspective. It’s clear see where the recent market risks in terms of default rates.
The number of jobs for Oil & Gas extraction industry peaked in 2014 and began declining in 2015.
The number of jobs for the Coal mining industry peaked in 2012 and started to decline in 2014.
Today Lending Club disclosed an interest rate change. Compared to the previous rates, it’s a relatively large adjustment to the risky grades. This is to address the higher-than-average default rates we’ve seen in the D and E grade loans. It’s refreshing to see that Lending Club is adjusting the rates according to default rate changes so quickly to balance risks. Here’s how the new interest rates stack against the previous ones:
- Reduce erroneous loan usage
- Reduce fraud – likely more documentation are required for this type of loans
- Allows Lending Club and investors to tap deeper into higher risk population
Lending Club opened 14 new states to retail investors in 2015, which made the platform available to over 92 million Americans (+29% of the U.S. population). The biggest states were Texas and Michigan. This was in the works since the company went IPO in late 2014, which made it easier to open up new states for investors in its platform.
When we rank all the newly eligible states by population, it’s clear that Lending Club pushed for making their platform available to the everyone. The remaining states that are not yet eligible are (in order of population rank): Pennsylvania, Ohio, North Carolina, Maryland, New Mexico, North Dakota, and Alaska.
To sum it up, Lending Club now has 43 eligible investor states, covering over 276 million people (86% of the U.S. population), up from 201 million people a year ago.
Lending Club increased interest rates just days after the Fed raised the Fed Funds rate by 0.25%, being one of the first in the industry to do so. However, an environment with interest rate hikes is foreign to P2P investors and many of us have questions on its implications. Here are our thoughts from a few angles:
Loan Interest Rates
We expect interest rates to rise inline with, and promptly after, future Fed rate hikes. Since Lending Club also adjust interest rates periodically based on market conditions and model changes, they will likely piggy back a Fed rate hike to make the net changes. However, do not expect the rate adjustment to benefit every grade level by the same amount. For example, our most recent Fed rate hike and Lending Club rate adjustment had a weighted interest rate change of 0.25% across all of its loan grades, but the changes were mostly in the mid- and high-risk grades. Lending Alpha’s strategies are expected to see a +0.23% to +0.46% interest rate increase for the latest adjustments, which a good thing:
Higher interest rates mean a higher cost of financing for new borrowers. We don’t expect interest rates to move up quickly, and any move will be gradual (+0.5% to +1% per year). The net impact to the borrower due to financing cost should be minimal due and would imply that it’s a small contributor to any increases in default rates.
Investor returns should increase due to the higher interest rates, especially those employing strategies that optimizes for rate changes over time (like Lending Alpha’s strategies). We could see default rates stabilizing in the near future, supported by an improving employment environment.
Lending Club Corporation
Lending Club generates the bulk of their revenue from loan originations and higher interest rates is negative to their business as cost of borrowing increases with the interest rates. Lending Club will continue to create new consumer loan products such as Direct Pay Loan to reach new population segments to continue growing their (personal loan) business.
Lending Club has opened up 5 new states in the past few weeks to allow more investors to participate in its platform. This is good news for people in the states of Texas, Arizona, Arkansas, Iowa, and Oklahoma. These 5 states have a combined 42.2M in population, which opens up the investors demand for LendingClub loans. We suspect LC would only do this when they can expand their loan originations business and/or when retail/institutional investing slows down.
+34.1M population reach
+8.1M population reach
Lending Club changed their interest rates again effective 5/13/2015. Here’s how it compares against the last change from February 2015:
Compared to the February 2015 interest rate changes, the May 2015 changes seem to focus on the extreme ends of the risk spectrum (A1-A4 and E2-G5). Here are some highlights:
- There were no changes to interest rates for A5-E1, as most of the adjustments last time (February 2015) were focused in that range.
- The A1 sub grade was adjusted down -0.61%, or 1/10th of the raw interest rate. There may be a goal to move the A1 sub-grade loans closer to the U.S. Prime rate + 1% after LendingClub’s investor fee (3.25% + 1.00% + 0.67% = 4.92%). A1 rates currently stands at 5.32%.
- For the high yield seekers who favored E and F grade loans, the rates were cut across the board by up to 1%
- However, at the extreme end of the grade scale, F5-G5 loans saw an increase in interest rates. Previously, F5 vs. G5 loans only had a 0.49% interest rate spread. Now, we see a 3.21% spread.
Finally, how does this impact the typical investor return on an annual basis? Nothing significant…a loss of 0.01%/year.
The latest SEC 8K filing reports that LendingClub is soon to move out of its current San Francisco, CA office space in Stevenson St. and in to a new building across the street on Market St. We suspect this is to accommodate the increasing size of their team as previously mentioned in an earlier post on the 90 job openings a few months ago.
LendingClub make use of the 10 year lease to occupy 112,000 sq. ft of space over 8 floors in a newer, larger building. They would be spending $4 million and $6 million for fiscal years 2016 and 2017, respectively. The lease will be between $7-9 million per year thereafter expiring in 2025.
LendingClub continues to ink partnerships with community banks to expand its origination business, which currently make up over 90% of their revenues. In this three-way partnership between LendingClub, Citi Community Capital, and Varadero Capital, they look to generate $150 million in personal loans.
Key Players and Roles
LendingClub – Provides the originations and servicing responsibilities for loans. In return, they take a cut off the origination and investor fees.
Citi Community Capital – Offers loans through its community bank branches to low and moderate income families using LendingClub’s platform.
Varadero Capital – Provides the 100% of the capital to invest into the loans through the LendingClub platform. This would be a $150 million commitment.
Win-Win for All – Lending Club continues to expand its lending business through partnerships with lending institutions since LendingClub’s technology platform is markedly more efficient than a traditional bank. There likely is some origination fee sharing between the two. Varadero Capital would be on the side of the equation by providing the capital for lending as an investor and benefiting from the relatively high returns.
Partnership Expansion – Over time, once the $150 million in loans are fulfilled and business executes as expected, it would be reasonable to expect the trio to expand its business to increase the loan amounts and offer new types of loans(Small business, student, or medical).
LendingClub is on a hiring spree and currently has 90 job openings across various departments. Among the departments hiring, the top areas are in: Technology & Engineering, Finance & Accounting, and Risk Management.
- Recent Default Rates Influenced by Two Sectors
- Interest Rate Change: +1% for Risky Grades
- Direct Pay Loans
- 2015 – A Big Year for Eligible Investor States
- Lending Club Raises Interest Rates by 0.25%
- New Investor States: Texas, Arizona, Arkansas, Iowa, and Oklahoma
- Interest Rate Changes – Sub-grade Analysis
- LendingClub Moving Office Across the Street
- LC Partnership with Citi and Varadero Capital
- Now Hiring: 90 Job Openings at LendingClub
- LendingClub (LC) Q414 and FY14 Earnings Results
- LendingClub Reports First Earnings Results Tomorrow
- LendingClub New IRA Account Promotion
- How the Partnership with BancAlliance Helps LendingClub
- Lending Club Partners with Alliance Partners
- Lending Club’s Investor Returns Squeeze
- Lending Club Interest Rate Changes
- LendingClub Analyst Coverage – Credit Suisse
- LendingClub Analyst Coverage and Price Targets
- Learn More About P2P Lending