Should You Invest In Lending Club: A Statistical Analysis

Sep. 06, 2013 7:58 AM ETSPY, BND32 Comments
Emmanuel Marot profile picture
Emmanuel Marot
135 Followers

The stock market's performance since the beginning of 2013 is quite good, with the S&P 500 up by 13%, yet diversifying one's investment is always prudent. Benjamin Graham himself recommended to invest at least 25% in bonds, and a common advice is to put as much as 'roughly your age in bonds'.

Bonds are loans. Supposedly, they're less volatile than stocks and have lower returns. The Vanguard Total Bond Market (BND) gives a good overall estimation of bonds performance: in 2,273 days, from June 2007 to September 2013 (you'll see later why we choose those dates), the price went up from $73.84 to $79.19. The interests paid over that time are approximately 75 times 22 cents, or $16.5, which gives an annual return of ((79.19+16.5) / 73.84 ^ (365 / 2273) - 1 = 4.25%.

Over the same period, the S&P 500 (SPY) annual return is only (1653.08 / 1357.50) ^ (365 / 2273) - 1 = 3.22% (not taking dividends into account), mostly because of the market crash of 2008.

Yet bond returns are frustrating low, and an alternative has recently emerged: 'Peer to Peer lending'. P2P lending relies upon Internet as an intermediation platform, to lend (relatively) small amounts to numerous borrowers. Thanks to the law of large numbers, spreading the invested money over hundreds or thousands of borrowers significantly reduces the risk. Unless they're all correlated, as the Housing crash showed, but that's a different story...

One drawback of P2P lending compared to bonds is the lack of liquidity. There are a few secondary markets, but for the moment being they have the fluidity of a 16th century stock exchange. Investments are somewhat locked up for a few years, hopefully that is still short term compared to stocks investment horizon.

The most popular P2P lending platform is currently LendingClub, with over $2 billion of loans processed since inception in 2007. A fascinating aspect of LendingClub is their transparency: all the data is publicly available (at https://www.lendingclub.com/info/statistics.action), showing the history of all the loans, as well as their performance.

According to LendingClub, most of the investors returns are between 6% and 12%. Which is not bad, considering a) lending money around 2008 was probably riskier than usual, b) with enough diversification, the volatility is quite low. But those figures are somewhat opaque, and analyzing the full data gives us better perspective:

The comprehensive loans data is available from the site as 2 files, one for 2007-2011 and one for 2012-Present. When combined, the total data cover 177,078 loans, from June, 14th 2007 to September, 3rd, 2013.

For each loan that was issued, LendingClub show the amount funded by investors, and how much they got in return. But we cannot simply calculate the average return as SumReceived / SunFunded - 1, since most loans are still generating payments. Therefore we must exclude the ongoing loans. That leaves 34,541 loans that have been fully paid or defaulted, with an average return of 6.59%. Please note that's already higher than the BND ETF.

But there's another catch: loans may end prematurely when they default. By taking into account all the loans that have ended, we have a disproportionate share of recent, defaulted loans because all the recent loans that do not have defaulted are not counted in. One solution would be to approximate how much they will return, by factoring the average default rate, but that's too much assumption.

We're rather look back in the past and consider only the loans that are mature enough to be fully paid or have defaulted at one point. That means the 36-months loans issued before September 2010 and the 60-months loans issued before 2008, or only 14,118 loans. In that case, the return is slightly higher, at 6.71%.

It gets even better, when we study the distribution of loans returns, we have:

  • 10 percentile return: -27.79%
  • 20 percentile return: 4.89%
  • 30 percentile return: 10.15%
  • 40 percentile return: 12.37%
  • 50 percentile return: 14.37%
  • 60 percentile return: 16.75%
  • 70 percentile return: 18.56%
  • 90 percentile return: 23.58%

An unfortunate investors who would have picked the worst 1,412 loans (or 10%) would have lost 27.79%. But the median, i.e. picking up the better half of the loans, is an impressive 14.37%: more than 3 times the returns of the BND ETF...

In conclusion; yes, it's worth investing in LendingClub. But picking up the right loans to fund is key. And that will be the subject of a future post...

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am the co-founder of LendingRobot.com, a tool to automate investments in LendingClub.

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Emmanuel Marot profile picture
135 Followers
Emmanuel Marot graduated from leading French Business School ESCP with a major in Computational Finance and a MBA exchange from the University of Washington. He previously co-founded and managed three startups, all in the Internet field, and all with successful exits; the last one being a mobile search engine that served a billion queries in over 10 countries and was subsequently sold to Microsoft Corp. An ‘accidental quant’, Emmanuel now focuses on merging sound mathematical principles with his Internet data mining experience to create new stock market investment strategies.
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