Lesson 3: Lending Club Returns – The Relationship Between Ratings & Returns

In this video we will discuss Lending Club returns, and the relationship between peer to peer loan ratings and returns.  This video assumes that you have opened an account with Lending Club If you haven’t, please click on the link below to open an account.

This is video 3 of a 6 video p2p Lending Series.  Click here for the other free videos.

Open a Peer 2 Peer Lending Account and get started with as little as $25

Open a Peer 2 Peer Lending Account and get started with as little as $25

Lending Club rates loans by the probability in their opinion the loan will default. Loans are rated from A to G with A being safest. Within each letter grade is a 1 to 5 ranking, with 1 being the safest. As you can see below, a G1 rated loans pays a much higher interest rate than an A1 rated loans to compensate for the higher risk of non-payment.

However, its not the interest rate that matters but your Lending Club returns after defaults are taken into consideration.

Lending Club Returns Including Defaults

Lending Club Rating Lending Club Returns Loans Issued Between 2010 – 2012
A1 – A5 5.0%
B1 – B5 7.0%
C1 – C5 7.3%
D1 – D5 8.2%
E1 – E5 9.0%
F1 – F5 8.8%
G1 – G5 9.0%

The performance numbers are from an independent site called LendStats that tracks the Lending Club returns (using a slightly different and more accurate) methodology than the company.

What stands out? The numerical interest rate on the loan has little to do with Lending Club returns! G Rated loans which have an interest rate of 24% or more, have averaged a return of 9%

Lending Club returns on all loan categories ranged between 5 and 9%. Not Bad. However, the three lowest letter ratings had the best return, averaging 8.8% or better.

 

Should you buy loans that have F and G ratings because they have the highest return?

My answer is no. The Lending Club return data is for 2010 – late 2012. While the economy was not great during this period, there was not a recession going on. My concern is that during a recession the defaults on the worse rated loans would increase more than those with better ratings. F and G loans might have a much lower return than the other credit categories if the economy goes south.

I would also avoid A rated loans. As you cannot earn more than the interest being charged on the loan, the relatively low interest rates on these loans make them unattractive.

I would focus on buying B, C, D, and E Rated loans. The first time you invest. Perhaps, stick primarily with the more the safer B loans. As you become more comfortable, perhaps build a portfolio evenly divided between B, C, D and E loans

The next video in the series discusses tool that you can use from Lending Club that save time and help you achieve proper diversification.

This lesson is part of our Free Guide to Investing in Peer to Peer Loans.  To continue to the next lesson go here.

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