# Introduction

This is an individual assignment and will be a chance for you to perform an applied data science project on a real data set.

We will be working with the loans_df data frame in this project. This data set contains information on over 4,000 individuals who secured a personal loan in 2017 from a national bank. The description of this data and the variables contained in it are provided below.

The objective of this project is to explore the factors that lead to loan default and develop a machine learning algorithm that will predict the likelihood of an applicant defaulting on their loan in the future.

To complete this assignment, students must download the R notebook template and open the file in their RStudio application. Please click the button below to download the template.

## Loan Data

The loans_df data frame contains information on 3 and 5-year loans that were originated in 2017 by a national bank for customers residing in the Middle Atlantic and Northeast regions of the United States.

The company is looking to see if it can determine the factors that lead to loan default and whether it can predict if a customer will eventually default on their loan.

The bank has experienced record levels of customers defaulting on their loans in the past couple of years and this is leading to large financial losses.

The goal is to become better at identifying customers at risk of defaulting on their loans to minimize financial losses.

Specifically, the broad questions that the bank is trying to answer include:

• What are the factors that are associated with customers defaulting on their loans?
• Is it possible to predict whether a customer will default on their loan? If so, how accurate are the predictions?
• How many costly errors is the model expected to produce (customers classified as not defaulting, but eventually do)?
• Are there any actions or policies the bank can implement to reduce the risk of loan default?

The data set contains a mixture of applicant financial information (income, debt ratios, etc..), and applicant behavior (number of open accounts, historical engagement with the bank’s products, number of missed payments, etc…)

The response variable in this data is loan_default. This variable records whether an applicant eventually defaulted on their loan and indicates a financial loss to the bank.

Note: The response variable has been coded as a factor with ‘yes’ as the first level. This is the format that tidymodels expects for calculating model performance metrics. There is no need to recode this variable in your machine learning process.

### Variable Information

Variable Definition Data Type
loan_default Did the borrower default on their loan (yes/no) Factor
loan_amount Loan amount Integer
installment Monthly paymeny amount Numeric
interest_rate Interest rate Numeric
loan_purpose Purpose of the loan Factor
application_type Loan application type (individual or joint) Factor
term Loan term (three/five year) Factor
homeownership Borrower(s) homeownership status Factor
annual_income Annual income Numeric
current_job_years Years employed at current job Numeric
debt_to_income Debt-to-income ratio at application time Numeric
total_credit_lines Total number of open credit lines Integer
years_credit_history Years of credit history Numeric
missed_payment_2_yr History of missed payments in the last 2 years (yes/no) Factor
history_bankruptcy History of bankruptcy (yes/no) Factor
history_tax_liens History of tax liens (yes/no) Factor

### Raw Data

loans_df

# Data Analysis [50 Points]

In this section, you must think of at least 5 relevant questions that explore the relationship between loan_default and the other variables in the loan_df data set. The goal of your analysis should be discovering which variables drive the differences between customers who do and do not default on their loans.

You must answer each question and provide supporting data summaries with either a summary data frame (using dplyr/tidyr) or a plot (using ggplot) or both.

In total, you must have a minimum of 3 plots (created with ggplot) and 3 summary data frames (created with dplyr) for the exploratory data analysis section. Among the plots you produce, you must have at least 3 different types (ex. box plot, bar chart, histogram, scatter plot, etc…)

See the example question below.

Note: To add an R code chunk to any section of your project, you can use the keyboard shortcut Ctrl + Alt + i or the insert button at the top of your R project template notebook file.

## Sample Question

Are there differences in loan default rates by loan purpose?

Answer: Yes, the data indicates that credit card and medical loans have significantly larger default rates than any other type of loan. In fact, both of these loan types have default rates at more than 50%. This is nearly two times the average default rate for all other loan types.

### Summary Table

loans_df %>%
group_by(loan_purpose) %>%
summarise(n_customers = n(),
customers_default = sum(loan_default == 'yes'),
default_percent = 100 * mean(loan_default == 'yes'))

### Data Visulatization

default_rates <- loans_df %>%
group_by(loan_purpose) %>%
summarise(n_customers = n(),
customers_default = sum(loan_default == 'yes'),
default_percent = 100 * mean(loan_default == 'yes'))

ggplot(data = default_rates, mapping = aes(x = loan_purpose, y = default_percent)) +
geom_bar(stat = 'identity', fill = '#006EA1', color = 'white') +
labs(title = 'Loan Default Rate by Purpose of Loan',
x = 'Loan Purpose',
y = 'Default Percentage') +
theme_light()

# Predictive Modeling [75 Points]

In this section of the project, you will fit two classification algorithms to predict the response variable,loan_default. You should use all of the other variables in the loans_df data as predictor variables for each model.

You must follow the machine learning steps below.

The data splitting and feature engineering steps should only be done once so that your models are using the same data and feature engineering steps for training.

• Split the loans_df data into a training and test set (remember to set your seed)
• Specify a feature engineering pipeline with the recipes package
• You can include steps such as skewness transformation, dummy variable encoding or any other steps you find appropriate
• Specify a parsnip model object
• You may choose from the following classification algorithms:
• Logistic Regression
• LDA
• QDA
• KNN
• Decision Tree
• Random Forest
• Package your recipe and model into a workflow
• Fit your workflow to the training data
• If your model has hyperparameters:
• Split the training data into 5 folds for 5-fold cross validation using vfold_cv (remember to set your seed)
• Perform hyperparamter tuning with a random grid search using the grid_random() function
• Refer to the following tutorial for an example - Random Grid Search
• Hyperparameter tuning can take a significant amount of computing time. Be careful not to set the size argument of grid_random() too large. I recommend size = 10 or smaller.
• Select the best model with select_best() and finalize your workflow
• Evaluate model performance on the test set by plotting an ROC curve using autoplot() and calculating the area under the ROC curve on your test data

# Summary of Results [25 Points]

Write a summary of your overall findings and recommendations to the executives at the bank. Think of this section as your closing remarks of a presentation, where you summarize your key findings, model performance, and make recommendations to improve loan processes at the bank.

Your executive summary must be written in a professional tone, with minimal grammatical errors, and should include the following sections:

1. An introduction where you explain the business problem and goals of your data analysis

• What problem(s) is this company trying to solve? Why are they important to their future success?

• What was the goal of your analysis? What questions were you trying to answer and why do they matter?

1. Highlights and key findings from your Exploratory Data Analysis section
• What were the interesting findings from your analysis and why are they important for the business?

• This section is meant to establish the need for your recommendations in the following section

1. Your “best” classification model and an analysis of its performance
• In this section you should talk about the expected error of your model on future data
• To estimate future performance, you can use your model performance results on the test data
• You should discuss at least one performance metric, such as an F1 or ROC AUC for your model. However, you must explain the results in an intuitive, non-technical manner. Your audience in this case are executives at a bank with limited knowledge of machine learning.

1. Your recommendations to the company on how to reduce loan default rates

• Each recommendation must be supported by your data analysis results

• You must clearly explain why you are making each recommendation and which results from your data analysis support this recommendation

• You must also describe the potential business impact of your recommendation:

• Why is this a good recommendation?

• What benefits will the business achieve?