I recently mentioned that I have been addicted to Prosper, the online marketplace that allows people-to-people micro lending. On average, I am spending 15 minutes a day on the site finding credible loan requests I want to get involved. However, is it worth the trouble -- both the time and (slightly) loss of sleep during the night -- to make some handsome returns?
Maybe the best exercise is to apply a quick mathematical model to calculate the return on my invested time. First, let's start off by assumptions:
• Based on my track record, I am underwriting micro personal loans at $80 apiece.
• The weighted average nominal rate I charged is 18%. Factoring in the Prosper fees, and some (unavoidable) charge-offs, I expect to get a return rate of 12% -- this is to assume that 1 in 20 of the loans in my portfolio will end up in collection.
• On average, I can close a loan every day, or every 15 minutes of time spent on Prosper site.
• The risk-free market rate for highly liquid money market account is at least 5% (like in the case of EmigrantDirect). If we forget about the inverted yield curve for a moment and assign some risk premium for the 3-year term nature of all Prosper loans, I would assign a comparable risk-free market rate of 6.5%, which becomes opportunity cost of underwriting more unsecured personal loans.
Here comes the calculation:
• For a typical 3-year Prosper loan of $80 and 12% interest rate held till maturity, I should be able to collect $15.66 in interest over the lifecycle of the loan.
• If I commit $80 to a risk-free vehicle at 6.5%, and gradually take out principals as the amortization schedule of the Prosper loan dictates (for an apple-to-apple comparison), I should be able to collect $8.48 in interest.
• That's a $7.18 difference per $80 loan. If we normalize the different cash flow patterns by an interest rate of 8%, the gap between the two alternatives becomes $6.59 in Net Present Value (NPV).
• In other words, for every 15 minutes I devote to personal lending, I can expect $6.59 in return, which means I earn a bit over $26 per hour by my time at Prosper.
This is really a lot of sweat!