Peer Loan Advisor
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Lending Club Investing Tips
One of the first questions many of our members ask is: How should I use your ratings to improve my Lending Club investing returns? There is no simple answer to the question, but it begins with using our ratings as a tool, along with your goals, risk tolerance, knowledge and experience. Below is an exchange I had with one of our members and I think it will be very valuable to others. Please feel free to contact me for further explanation or clarification.
Cody Smith, Founder
Member: Hello! I found your service yesterday after researching P2P investing services; I liked what I found with your research and signed up (which I guess makes me a “one day wonder”, so to speak…). In trying to implement your research, I ran across three different questions that I need your help with:
1) “Ratings” on the Quick Tips page: I found the following paragraph: Loans are rated on a scale of 0 to 100. We recommend focusing on loans in the 90th percentile based on rating. The scores listed below represent approximately the 90th percentile for each loan grade based on past loans. The score shown should be applied to the lowest subgrade, with one point added for each subgrade above the lowest.
Grade A - 70
Grade B - 63
Grace C - 58
Grade D - 53
Grade E - 51 (new loans no longer available)
Could you please “dumb this down” for us folks that don’t have advanced degrees? Do I read this as a grade B loan with a 63 rating is a 90 percentile loan, and that anything above 63 is an even better rated grade B loan? I really got lost when you state that “The score shown should be applied to the lowest subgrade, with one point added for each subgrade above the lowest.” Could you expand on that a little bit?
2) Implementation: I have your updated list in front of me, but I need some ideas on how to more easily use the information. The only way that I can come up with to see the underlying loans is to cut and paste each loan number over to Lending Club, but that seems to take forever… Has anyone has come up with another way to be able to more easily see the loans? Of course, the ideal way would be to be able to click on a loan on your site and it come up, but that may not be possible, considering each investor has their own account. On a small account, cutting and pasting might be doable, but for a larger account, that would be time consuming. I am just hoping there is an easier way…
I realize this is a lot to ask, but I am really impressed with the work you have done to come up with an algorithm to reduce write offs in P2P investments. I am anxious to put your work into practice, and I just need your help in order to better understand the process. Thanks in advance for helping me with these questions.
Cody: Thank you for the feedback. Here are answers to your questions. Let us know if you need any additional clarification.
1) This is a good question and we just updated the site to make this more clear. The higher the rating the better. While we did not include subgrade in the ratings table, we suggest that you consider it when you make your selections. Essentially, a grade B1 loan is slightly less risky than a grade B2 loan. Therefore, you may want to see a slightly higher rating. The difference of one subgrade is small, but the difference between a grade B1 loan and a B5 loan is significant enough that you probably want to see a higher rating for the B5 loan.
2) There are two ways to approach using our ratings. Some investors look at the loans listed on LendingClub, find the ones they are interested in, and then check our ratings to help make final decisions. Other investors just take the top rated loans from our list and then check the detailed information on LendingClub. In general, using the sorting and filtering features on our site and LendingClub should help you narrow the number of loans to review. Of course, at that point, there is some copy/paste required. Since we recommend focusing on the top 10% of loans within each grade, and some of these loans sell out quickly, there are generally very few loans that we consider investment grade. Therefore, it should not take too long to review them.
Member: Thanks for the clarifications! Just one more question about the ratings. I understand that you guys consider your ratings over 50 to be "investment grade", and of course the higher the rating the better. You also mentioned that you don't put a lot of consideration into the credit score. It seems that Lending Club assigns their A-E grades based primarily on the credit score. If credit score is not meaningful to your rating, can we just primarily use your rating number, and not worry much about what grade the loan is? Or am I missing something (which is usually the case...)?
For instance, is a grade D loan with a 62 rating a "better" loan than a grade C loan with a 58 rating? I guess what I am trying to ask is would it be appropriate to just use the numerical rating, and not pay as much attention to the letter grade, as Lending Club (not Peer Loan Advisor software) assigns the letter grade? Thanks again for all the insight you provide!
Cody: In theory, a grade D loan with a 62 rating is consider a better investment that a grade C loan with a 58 rating, based on the expected risk/return ratio. This means that, while the grade D loan is riskier, the return of these loans (after defaults are considered) with a rating of 62 will more likely be higher than grade C loans with a rating of 58. However, the best answer I can give is that I don't know for certain. I suppose we could try to compare every grade/rating combination to all of the other combinations, but this may not even yield statistically valid results. Even if the test was valid, we are still dealing with past data and the future could vary significantly. This fact makes me hesitant to publish such a study. The key point is that, testing our algorithm against past loans shows that selecting highly rated loans in any grade will likely result in a lower default rate than randomly selecting loans.
In general, lower grade loans should (but do not always as we will see below) have a higher rate of return after defaults are considered. However, that does not mean you should only select grade D loans. The lower the grade, the higher the risk. Risk can mean several things including more defaults as well as higher volatility. Volatility means that for some periods returns may be higher than expected but on the flip side there can be periods where returns are lower than expected. Another thing to consider is that we don't know how the various grades will perform in changing economic conditions. Again, this makes lower grade loans riskier. All of this means that it depends on your level of risk tolerance. If you want safety, then go for the higher grades. If you are ok with the possibility of poor returns in exchange for a chance at really high returns then go for the lower grades. Many investment advisors will recommend a mix of grades and finding good loans, no matter what the grade is.
I also want to mention that for certain periods, higher grade loans have outperformed lower grades. As noted in the graphic on the homepage of our site, grade C loans were actually the best performers over a period of 6 years. Also, grades A and B performed very well compared to grades D and E.
Another point is that good loans are sometimes hard to get, especially in the lower grades. They can fill up in a matter of minutes. Investors seem to be unable to resist the potentially high returns. You may see days or even weeks where very few lower grade loans are available. You may get equal returns just by taking highly rated grade A and B loans, rather than lower rated C and D loans.
As with ratings or recommendations for any investment, they are no substitute for education and experience. They are just tools and insight that can help you perfect your strategy. Your P2P lending strategies should be based on your goals, risk tolerance and assessment of available loans.
The loan ratings provided by PeerLoanAdvisor.com is an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. Analysis on this site, including ratings, and and information provided are statements of opinion as of the date they are published and not statements of fact. Loan ratings are not recommendations to invest in any loans or to make any specific investment decisions. PeerLoanAdvisor.com assumes no obligation to update the loan ratings for content following publication in any form or format. Loan ratings and information on this site should not be relied on and are not a substitute for the skill, judgment and experience of the user and their investment advisors when making investment decisions.