After a significant amount of research, development and testing, results of the default prediction algorithm are now publicly available in the form of Lending Club loan recommendations. This post will discuss how the recommendations are constructed and how I use them to keep my portfolio fully invested with the best loans available.
Visiting the Tools page on this site (Smart Peer Lending Tools) you will see a new box labeled "Loan Recommendations" and two links. The links correspond to two different groups of loans. One set of recommendations for conservative investors (high credit grade loans) and one for aggressive investors (lower credit grade loans). Risk tolerance varies considerably among investors and I thought it would be useful to have a range of options.
Following the link for one of the loan groups brings up a list of Lending Club loans open for new investment (in-funding). An abbreviated example of the Aggressive Loans page from a few days ago looks like the following. To see the actual page go to Lending Club Aggressive Loan Recommendations (Free Registration Required).
The page is divided into several areas. At the top is information about the composition of the recommendations and a historical ROI of the loans with the exact same attributes. This is measured using all the loans issued in the past or currently active (i.e. age>0) using the same method desribed here Calculating Loan Return. Following that the recommendations are divided into tiers which are discussed below.
The process for generating this page and list of loans is as follows.
- Several times per day the list of currently funding loans at Lending Club is downloaded.
- Loans with a credit grade in the range A1-C5 are removed. Since this is an Aggressive list we want to keep only the lowest credit grades (D1-G5) thus the highest interest rates. On the Conservative page we do the opposite. Loans removed are in the range D1-G5.
- The set of aggressive loans is further divided into tiers based on a set of manually designed pre-filters. Each tier corresponds to one of these pre-filters (more on that in a moment).
- Remaining loans in each tier are passed through our default filter. Any loan predicted to default by our default prediction algorithm is removed.
Thats it. We now have a filtered list of high interest rate loans selected to help us achieve superior returns. At this point, you may have at a couple questions. Why are there pre-filters? And why are the loans divided into tiers?
As discussed in previous posts, manually built filters that try and remove loans likely to default are good. But their simplicity and static nature limit their effectiveness and ability to adapt. Our machine learned default prediction algorithm can help us with these issues but it is not perfect either. Training data is limited and it does not represent a perfect picture of a borrower’s ability to repay. What I have found through significant research and back testing is that the combination of the two approaches has shown to deliver much higher returns than either approach by itself. The pre-filters I am using were discovered through back testing and vary among the groups. They utilize common sense attributes widely acknowledged to boost returns such as Number of Inquiries, Delinquencies in the past 2 years, etc.
Why are the loans divided into tiers?
The Lending Club new loan flow is large and growing but loans with superior risk/reward can still be in short supply. It is possible to construct filters that are extremely tight and have very high historical returns. But the number of loans these filters pass may only be a few per month. We could also find a filter that passed as many as 100 loans per month. Returns on that pool would probably be only average. What I wanted to create was something in the middle. Generate enough loans per month to support the re-investment needs of a significant sized portfolio ($100k). In addition, highlight those loans that have historically generated the best returns for investors with smaller investment needs.
This is where tiers come in. On the Aggressive Recommended Loans page, Tier 1 loans are the strictest and likely best return loans. If that set is exhausted and you still have more money to invest then the Tier 2 loans are a good choice. And then the Tier 3 loans. If you are curious, the pre-filter for each tier is listed to give you additional confidence in the selections.
How To Invest
Using the recommended loans page of your choice (Conservative or Aggressive), the process I follow to invest in new loans is the following.
- Starting in Tier 1, scan the list of loans from the top to find those that look interesting based on length (36 or 60 month), description, etc. For convenience a column that indicates % currently funded is included. Loans nearing the fully funded amount are also highlighted in yellow (>80%) or red (>95%).
- When you find one a loan that looks good, use the link in the "Loan ID" column of the table to view loan details here on Smart Peer Lending. Or use the link in the "LC View" column to see the loan listing on Lending Club.
- If everything still looks good and you want to invest in this loan, click on the link in the "LC Order" column. This should pop up a Lending Club window and place a $25 order for that loan. To change the amount it is easy to go into your orders on the Lending Club website and edit the value. Note: If you we are not signed in, you will be prompted to do so and then be taken to the order page. If for any reason you change your mind or accidentally invest in a loan, you can still delete it from your order.
- Return to the Smart Peer Lending Loan Recommendations page and repeat the process (leave your current Lending Club window/tab open).
- When all your orders have been added go to the Lending Club window and submit your order as you would with any other investment.
This process isn't perfect. Ideally, I would like to build up a set of orders with the exact amount of investment desired and submit the orders all at once. Unfortunately, Lending Club lacks a programmatic API that makes this possible. But this works ok, and I have been using this technique for my own investments. It's relatively painless once you go through the entire process once.
Disclaimer: None of our recommendations should be construed as personalized investment advice. It's primary purpose is to share the results of our analyis on Lending Club loans we think investors should consider adding to their portfolios. Always do your own research and consider your personal situation before making any investments. As with any investment, statements on past performance is not a guarantee of future returns.Suggestions?
This is still very much a work in progress. And we will continue to improvem them over time. But as they stand today I believe these are some of the most advanced techniques publicly available to find good loans. Hope you find them useful. If you have any comments, questions or concerns, post them below or send me an email at firstname.lastname@example.org.