"Loan Stacking" – The Blind Spot That Could Blow Up The P2P Model
By Tyler Durden
Back in February we noted that there were cracks starting to show in the world of P2P lending, and more specifically, with LendingClub's inability to assess credit risk of its borrowers that were causing the company to experience higher write-off rates than forecast.
From that February post, here is a chart that was used in a LendingClub presentation showing just how far off the company was in predicting write-off rates – it was evident then that their algorithms weren't working very well.
Here is what we said at the time:
What the slide above shows is that LendingClub is terrible at assessing credit risk. A write-off rate of 7-8% may not sound that bad (well, actually it does, but because P2P is relatively new, we don't really have a benchmark), it's double the low-end internal estimate.
That's bad. In other words, we said, the algorithms LendingClub uses to assess credit risk aren't working. Plain and simple.
And now courtesy of Reuters, we learn of a critical blind spot in the world of online lending. The risk to these online P2P companies such as LendingClub, is that as shown above, robust enough credit checks have not been developed to gauge true credit risk of borrowers. If said borrowers had what are referred to as “stacked” loans, meaning they have taken out one loan in order to pay for a prior loan, sometimes the algorithm won't be able to pick up all of those obligations in a timely enough fashion, and the borrowers credit risk is significantly understated.
As Reuters explains:
Many online lenders have failed to detect the “stacking” of multiple loans by borrowers who slip through their automated underwriting systems, lending company executives and investors told Reuters.
The practice is proliferating in the sector – led by LendingClub, OnDeck and Prosper Marketplace – because of many lenders’ hurried, algorithmic underwriting, use of “soft” credit inquiries, and patchy reporting of the resulting loans to credit bureaus, according to online lending and consumer credit experts.
Such loopholes, they said, can result in multiple lenders making loans to the same borrowers, often within a short period, without the full picture of their rising obligations and deteriorating ability to pay.
Stacking is “causing problems with the whole industry,” said Brian Biglin, chief risk officer of LoanDepot, a five-year-old mortgage lender that last year started making personal loans online.
However, even if lenders are aware of the issue, and run further credit checks, the reporting can still be sketchy enough where the risk still is not picked up properly.
In their haste to give applicants quick loan decisions – sometimes within 24 hours – some marketplace lenders do not conduct thorough credit checks, known as “hard inquiries,” according to industry executives.
Such checks create an updated log of credit and loan applications, and they can lower a borrower's credit score. Soft inquiries don’t require the borrower’s consent and don't usually show up on credit reports.
OnDeck said it runs only soft checks. LendingClub and Prosper said they initially …read more
Source: "Loan Stacking" – The Blind Spot That Could Blow Up The P2P Model
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