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Prosper: From Bad To Worse

Contributed by mm | November 16, 2006 12:54 AM PST

It has been almost two months since I put a hold onto underwriting more micro-loans at the people-to-people lending marketplace Prosper.com. While I certainly like the regained freedom -- I only checked Prosper.com less than once a week lately and freed up ten minutes a day -- my lending portfolio performance has been getting worse. Compared to 8 late loans in late September (including one overdue by more than a month), today my portfolio of 150+ micro-loans boasts 13 overdue loans, including 3 loans overdue for more than two months and another 4 overdue for a month.

I thought I might have made a series of bad calls, but it appears that I'm not alone. For example, among all 1592 loans originated in the Prosper.com marketplace in the first half of 2006, a total of 181 loans (11.4%) are overdue for at least 15 days, and 95 loans (6.0%) are overdue for over three months.

Those lenders who focus on high credit rate borrowers are not immune to the poor performance of the market. Among the 150 A-credit-grade loans (i.e. with borrowers' credit score between 720 and 759), 7 loans (4.7%) are overdue for over a month now. The deliquency rate of 4.7% certain surprises many lenders like me who had once put some faith behind Prosper's claim of historical average default rate of 0.90%. (Now I admit late ratio and default rate are different, but given the average age of the sample loans, it is very unlikely they will fit into the "historical" default rate.) Actually, for almost every credit grade, the performance of the H1 loans has been much worse than the average default rate statistics provided by Prosper (granted that's mostly based on loans underwritten by financial institutions).

It is, therefore, fair to say Prosper didn't do a good-enough job to create an environment that can give passionate lenders a good shot of average-average yield.

At least, I'm glad that I stopped the bleeding. It will still take another three years to unwind the damage, and time will tell me how much it cost me to indulge myself in financial adventures like this.

This Post Has Received 27 Comments. Share Your Opinions Too.


Nagel Commented on November 16, 2006

Is there any way to insulate yourself from so much risk? That seems to be an unusually high rate of borrowers failing to pay back loans--especially micro-loans.


Ralph Commented on November 16, 2006

I posted some comments about Prosper's default rates being inapplicable a while back, mainly due to the fact that they were using data for bank loans based on normal debt:income ratios. The people borrowing via Prosper tended to have much higher debt:income ratios, which is why they couldn't borrow elsewhere...

Anytime the normal risk:reward ratio seems to not apply to an investment opportunity you should carefully consider if the risk estimate is accurate...

I got some negative feedback on comments expressing caution about Propser - basically "shoot the messenger" type of thinking. I hope it turns out that people just get poor returns from investing in Prosper - I'd hate to see people lose capital. Some of the people investing in Prosper seem to have gone overboard - investing significant chucks of their available capital in this one idea. That's why diversification is a keystone of investment planning (having lots of small Prosper loans instead of one big one isn't really diversifying, as its all in the one asset class).

Regards
http://enoughwealth.blogspot.com


Mike Commented on November 16, 2006

I see prosper.com as basically a sub-prime lending source.

From what I've seen, most financial institutions that offer loans in the 10% or less interest rate range are going to require some verifiable collateral (e.g., a home or car that is pledged against repayment of the loan).

For unsecured loans, the interest rate is probably going to be higher, and everyone except sub-prime lenders will only give unsecured loans to people after they verify that they have good credit ratings. In my mind, this includes credit cards, unsecured lines of credit, things like that.

It looks to me based on the interest rates at prosper.com that they are offering a lower cost option to borrowers for unsecured credit.

They also don't really provide details about what happens on the collection end, other than saying they will assign a collection agency and you will be charged their (unspecified, but I suspect large) fee if they collect the funds.

I think most sub-prime lenders issuing unsecured credit are going to charge interest rates in the range of credit cards (or higher), partly because they know the default rates are going to be higher than "average" and they will have to write off some significant losses.

It seems to me that the borrowers are the ones getting the best deal from prosper.com, because:

- Individuals are more trusting than financial institutions, I think this is one of the primary selling propositions behind prosper.com.

- Financial institutions have plenty of data to know the real historical norms for lending under these circumstances, and

- The interest rates *sound* great to an individual who is optimistic that the vast majority of their loans will be paid back on time (or at all).

All that said, I hope things work out for you, and I appreciate you sharing your experience.


Herb Commented on November 16, 2006

I'm at 20 loans on Prosper and already have one past due for 2+ months. I've been focusing on small loan amounts, hoping that monthly payments of less than $100 would reduce default chance, but my late loan has a monthly payment of less than $60!

I've always thought it was disengeious for Propser to tout the idea that people are less likely to default because it's a human being loaning them money. people pay because it's painful not to, they don't care who they're paying or who their stiffing. If it comes down to choosing, they pay the person they're most fearful of and I would argue that's probably a bank for the majority of folks.

This is really the achilles heal of Prosper. It's like if EBay would have had huge amounts of fraud when they first started out, they would have tanked pretty quickly. If Prosper can't get a handle on the default rates, then they won't last very long. Just like EBay bought PayPal to control the payment part of the transaction, Prosper might be well advised to start/buy a debt collection agency to control that part of their business risk. One way to help would be to very aggresivley and publicly pursue defaulters. This would help raise the fear level of borrowers and therefore most likely lower the default rate.


FinanceTravels Commented on November 16, 2006

I'm at 19 loans and they are all current. One of them was late by a month, but did eventually pay. I guess I've been luck.


Joe Schmoe Commented on November 16, 2006

I originally looked at prosper.com as an investment idea, but I went to the other side and am borrowing. At about 8.5% its a pretty good rate for unsecured money. I figure I will make 11% in the stock market and get a discount on the net present value of my loan by a bit based on inflation.

Statistically you're better to be leveraged over the long term, as long as your rate is under 11%.

But even if my stocks go down, at least I'm forcing myself to invest over the next three years
with the fun part up front.


MM Commented on November 16, 2006

Joe, it is probably a bad idea to invest borrowed money though. In addition, you will pay tax on investment gains (if any), and you probably cannot claim a deduction for the Prosper interest you pay.


CPA1298 Commented on November 16, 2006

I agree with MM that Joe's idea of borrowing at 8.5% to achieve a hypothetical 11% is not a good one. I would only borrow at 8.5% if I could find a low- or no-risk opportunity at least 200 basis points above that.

MM - My personal Prosper results have stunk. I funded only 4 loans back in June, because I just wanted to test the waters. One of my AA borrowers hasn't made a single payment in almost 5 months (pizzaman44); so my personal default rate is 25%. However, all my other borrowers are current. Granted, they were AA, A and C. Curiously, there has been no word that the collection agencies have collected anything. I would like to get more diversified, but with the state of things I am hesitant to lend more money. I think the rates need to increase. For example, the local credit unions were I live charge 10% + for signature loans to AA-rated borrowers, and that is with no risk of identity fraud (ie. you have to be a member to get the loan). I love the concept, and I'm hoping that the introduction of Zopa to the American market will help. Has anyone heard the latest on Zopa?


Jon K Commented on November 16, 2006

With all the negatives mentioned above, I have to chip in. I think logically as these loans age, more will become late. But for now anyway, I haven't been bitten by non-payers. I began lending in mid-June and have made 54 loans. 53 are current and one is less than 15 days late. My strategy has changed from when I first began. At first, I made $50 loans to be diversified. Now I am much pickier about who I fund, but the average amount I loan is more than $50.

As Warren Buffett says, diversification is a good thing only when you don't understand the market. When you fully understand it, you wait for that golden opportunity, and bet big.


Herb Commented on November 17, 2006

Except that I consider it impossible to understand the Prosper marketplace. You only get 4 pieces of data on a prospective borrower, which IMO isn't enough to really "know" them. On top of that, you're dealing with things that the borrower doesn't have full control of. Being AA does not mean a person has a 6-mnth emergency fund, so if they lose their job and can't find another one you're SOL on getting repaid.


CPA1298 Commented on November 17, 2006

It's amazing to me the differences in Prosper lenders' experience. I'm glad for Jon K that he has so few defaults. Like Herb said, I really don't think any of us can be 'excellent' lenders based on the slim information provided by Prosper. See below for a little table I set up. The actual results are from loans originated between 1/1/06 and 7/1/06, that are 3+ months late (I would consider this tantamount to default). Note that for the percentages, I used 'dollar volume' and not 'quantity volume'; I think the $ amount of the late loans more accurately reflects the damage done to lenders.
Credit Experian Actual
Grade Projected Results
AA 0.20% 1.67%
A 0.90% 1.04%
B 1.80% 10.81%
C 3.30% 4.10%
D 6.20% 3.81%
E 10.40% 10.34%
HR 19.10% 22.21%

What's scary is that the Experian projection is over 24 months, and the oldest Prosper loans included in this data are only 11 months old, and the 'youngest' ones are less than 5 months old. What's going to happen over the next 1 to 1.5 years to these loans' performance?


Ruby Commented on November 17, 2006

Good to warn us about the high defaults at Prosper.com. I had been thinking of lending some money but have been apprehensive about it because I didn?t feel there were enough checks and balances to ensure the money I lent would be safe. This post has confirmed it.


CPA1298 Commented on November 17, 2006

To answer my own question regarding Zopa....
I've been playing around at the company's British site. I really like their platform;

a) lenders' uninvested cash earns 3.75% - Prosper has nothing like this
b) you basically lend to a 'mutual fund' of borrowers in a certain credit grade (A - C; no HR or NC) for a certain amortization (12 to 60 months) - Prosper doesn't allow variable amorts, nor the diversification of uber-micro lending in baskets of very small loans, and resembles the high-end debt markets, with CMOs, etc..
c) borrowers undergo strenuous vetting by Zopa; identify, credit, bank account - I think it is safe to say that Prosper doesn't research enough. The Zopa blog was full of people complaining....that they were not allowed to apply for loans. This is in stark contrast to the carping about the high Prosper delinquencies. Per Zopa, they have had no charge-offs to date (Spring 2005 inception).
d) Zopa offers borrowers credit default insurance - this would eliminate Propser's deliquency issue.
e) the rates look reasonable, given the extensive vetting.

http://www.quickcompare.co.uk/loans/index.asp?results=true&amount=1000&period=12&affiliateid=&calcMethod=loanAmount

12 months, A = 8%, B = 9%, C = 10%. Granted, these are rates in the UK, but I assume we can make an apples-to-apples comparison.

I couldn't find anything about the progress of Zopa USA. I'm eagerly awaiting.


guest Commented on November 17, 2006

Yes thanks for the posts to all bloggers on Prosper.com; I had a wait and see attitude and have been following closely before I invest and most of my fears seem to be coming true. The biggest issue I've always had was that LENDERS wouldn't be prudent enough to lend wisely and manage risk appropriately. I've read too many bloggers posts about too much money chasing too few people and people settle. An over liquid market is never a good thing....


Jon K Commented on November 18, 2006

Herb and CPA mentioned that it is hard to understand the Prosper marketplace with the information provided in a loan request, which is why I actively use the "contact" feature to ask more questions. I think it would be a good idea for Prosper to include correspondence at the bottom of the request, like ebay does with an auction. That way everyone is privy to the further information the lender has provided.

You are correct that none of us can predict what will happen to a borrower down the road, but history does help- I generally do not loan to ANYONE who has a current delinquency, and I am extra cautious if there has been one in the past. I also consider how responsive they are to my questions- do they respond within 24 hours, do they actually answer the question and not dodge it, and do they get defensive by the questions I ask. All are red flags to me.

One of the largest loans I made was to a lady out in California who wanted to consolidate credit card debt. If I had not asked her anything, this is all I would have known: her DTI was 105% (!!!) and she owned two stores. But we corresponded 5 or 6 times, and by the time the loans closed, I knew the type of business, the locations, the health of the retail market in the area (through external research), etc. The lady commented that she has always paid her bills on time, and her credit report backed her up. Some people, myself included, would sell assets or go to other desparate measures before we would not pay a bill. I think she's one of them.

So, I absolutely know some of my loans will default- I've just been lucky none have yet. But I feel good knowing that I've done as much research into a request before I offer someone my hard-earned money.


Wiseclerk prosper loan stats Commented on November 18, 2006

Sorry to hear about your bad performance


jj Commented on November 18, 2006

I have mixed feelings about mm's experience. On the one hand it is a warning flag... on the other hand, when I check his loan portfolio his average interst rate is 17.5%. This still puts him close to 11% ROI or so, and I don't believe all those lates will turn to defaults. These loan portfolios, like any other investment, will go up and down over time. The outright frauds will, of course tend to default early. On the lates, the fees will more than offset the delayed payments. I think one of the reasons for dissapointment is people believing they can net 15% return. Why would you think so? 10-12% is the realistic max, IMHO. So, if you netted 10% would you think it a bad investment? Maybe, maybe not, but it is also a form of diversification from the stock & bond market, for example. Compare it to junk bond yields and risks, too.
Unrealistic expectations is the basis for dissapointment primarily.
Of course, none of us really know how this will all turn out, especially since breakeven on a typical loan is roughly 28 months.


how much mortgage Commented on November 20, 2006

If you currently pay, say, 6 percent for the mortgage and can get a total refi at 6.5 percent, it might be a much better deal than keeping a small balance first mortgage at 6 percent and getting a second loan at a much higher interest rate. how much mortgage [URL=http://xdesign.ucsd.edu/mrtg/calculator/Loan-Amortization-Calculator.html] how much mortgage[/URL] http://xdesign.ucsd.edu/mrtg/calculator/Loan-Amortization-Calculator.html


Ryan Commented on November 25, 2006

I've been lucky with my loans at Prosper thus far, but I only have 9 and I was pretty select on my borrowers (my avg. rate is about 10.90%) The problem is, it's only going to take one bad apple in my group to pretty much make the whole thing a bust.
I was considering adding more funds for awhile, but I've finally decided it's simply not worth it. I'll just ride out these loans for three years and consider it a fun experiment.


David Commented on November 30, 2006

I don't have much money to invest since I just purchased a condo so I decided to invest a very small amount in prosper as an experiment. Currently I have 11 loans which are current and the average rate I lend at is 12.9%. Granted I only started about 3 months ago and the max amount I loan out to is $150 to try to hedge my risk as much as possible, even if this still considered one asset class as one person had already mentioned.

12.9% - prosper's fees vs. a 5%+ savings account like emigrant direct seems like a pretty good trade off even with the added element of risk.


Adam Commented on December 2, 2006

All these comments are very good and reflect my personal experience with Prosper as well. One problem I have noticed also that no one really touched on is that fact that the average rate of return by credit grade has been streadily dropping. I was getting 13 to 15 % on B and C loans early on and now when I look these guys are getting loans at 10 and 11 %. That's not a healthy trend for us as lenders. Overall I have 13 loans, 11 current. My average rate is 13.5%. I don't regret getting involved but my initial euphoria over the concept has certainly come and gone.


Philanthropy Commented on December 2, 2006

I joined Prosper after first reading about it on this blog and so far I have not regretted it. I joined in August and have 98 loans in place. Currently I have 4 loans that are late but they are all less than a month late. I have had numerous previously late loans that caught up. Looking at a sampling of mm's late loans, I would not have bid on any of them except one. One of mm's borrowers had 9 current delinquencies at the time of the loan. Using the criteria I bid by all borrowers are 98.9% current. I know this will degrade with time, but I am still hopeful that this is a good investment. My current estimated ROI according to Eric's CC is 18.08%.


The Y.U.P Commented on December 6, 2006

I also joined prosper but mainly just to check out the scene. When I first saw it I was initially blown back and thought this would have a huge impact on lending money. But as I check in periodically I find that most loans that are about to end within an hour are not even close to being 100% funded. Lack of lenders?


Tommy Commented on December 7, 2006

I've been doing prosper for about 5 months now (I'm shooting for 6 months and then making a decision to go full bore or stop and unwind over the next 3 years) and I can say that I'm about 75% over on the "unwind" side. The issue is the protection for lenders. We simply are not protected enough to profit reasonably well enough to hit this risk. For example, I can buy a tanked Candian energy trust and earn about 15-20% in dividends per year and have a chance that the share price will sky rocket after the tax laws get fixed to make them advantagous to these trusts again. This is basically risk free because these trusts are at extreme historic lows.

Now on Prosper, to make 15% , I'd have to focus on D or worse rated paper and factor in that I'm goin to loose about 10% of those loans (so I need an average rate of 25%!!). It just doesn't make sense.


makingourway Commented on December 30, 2006

I had a very interesting experience recently with prosper.
One of my loans went into default. It was for $100 with $11 due in interest. The entire $100 principal was repaid when it was sold. I couldn't believe it happened - but I did get my money back - still not sure how it actually happened - what debt buyer would pay 100%?
My thoughts are that the borrower group had excess rewards and prosper dipped into them to offset losses.
regards,
makingourway


Greg Commented on January 2, 2007

In response to Tommy's blog I too wonder why my Canadian Energy Trust (Enterra Energy) which currently pays a 16-18% dividends which comes in montly distributions could be replaced by some high risk loan portfolio yielding 12-13%. I see many fraudsters ending up on these sites. I will experiment with a few loans to start because I'm curious but I have my doubts.


Points Of Note Commented on January 28, 2007

I signed up for Prosper ~6 months ago, bid on a few loans but never closed on any.

I'm particularly concerned about "adverse selection". It seems to me that borrowers from all credit grades go to Prosper after they've first tried to get financing at lower rates from traditional sources. You're only loaning to the B-grade guy after all the banks and credit cards have stopped making B-type loans to him. I didn't think the rates of return compensated for this.

I also agree with the earlier commentor that you can get better returns for less risk elsewhere.

Finally, who is going to do a better job of making unsecured loans to consumers? Professionally-run and bank-managed credit companies with billions of dollars or website amateurs looking to plunk down a hundred bucks? I'd rather buy shares in American Express than try to run my own mini-bank.

On the other hand, I think its a good place to borrow from.


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