Peer to Peer lending – A quick take on ‘Prosper’

‘Peer to Peer lending’ is a loose term for individual lenders lending directly to borrowers with minimal involvement from intermediaries. This can be contrasted with the typical lending process where you place your deposits with banks or other such institutions which in turn lend to borrowers of their choice. In the typical lending process depositors don’t know who the borrowers are.

‘Prosper’ is the biggest player in this nascent ‘Peer to Peer lending’ space. It’s loan portfolio is still tiny compared to a bank and the track record is just beginning to take shape (earliest loans are dated June 2006).

Key features of Prosper

• Loans are unsecured and not FDIC insured
• Standard loan period of 3 years
• Borrowers are categorized into Credit grades of AA (760+), A (720-759), B(680-719), C(640-679), D(600-639), E (560-599)and HR (520-559). Credit scores are from Experian.
• You can automatically distribute your loan amount amongst a set of borrowers to reduce risk
• Delinquent loans are turned over to a collection agency which charges standard recovery commissions
• Prosper makes money by collecting fees from both lenders and borrowers

Given the intriguing nature of ‘Peer to Peer lending’ , I decided to do a bit of digging on how ‘Prosper’ loans pan out as an investment option. Here are some findings :

Typical Interest rates

Here are rates ( during the last 30 days) for loans between $1000- $5000. (Taken from Prosper website)

AA 7.65%
A 10.01%
B 14.32%
C 15.10%
D 21.60%
E 27.52%

Delinquency

I found a blog “Fred’s” that used Prosper’s own data (provided on its performance page) to do an analysis on how the age of a loan affects its delinquency behaviour.

This is quite an important analysis as loans recently originated are usually less likely to be 1+ month delinquent compared to older loans. The problem is more severe as Prosper’s performance reports usually mix the performance of new and old loans and thus make it difficult to judge loan behaviour over time.

The above chart (taken from Fred’s blog) shows the following for loans originated in any one month – % of loans that are 1+ month late Vs the number of elapsed days from the loan origination month. Interpreting data for one particular month – say June ‘06, it shows that 10% of loans for that month went delinquent after 180 days (from June ‘06) and 19% of loans for that month went delinquent after 360 days (from June ‘06)

Note that the curves show the same pattern across months and on average 16-24% of loans become delinquent 360 days from when they are originated. This is a staggering rate.

However, it is very important to note that this analysis is across all credit categories.

In order to analyze delinquency by credit category, I took a snap shot of Mar ‘07 loans’ performance data from Prosper website and the situation improves dramatically for AA and A categories.

AA loans – 1+ delinquency rate is 3.55% by value and 1.11% by number of loans

A loans – 1+ delinquency rate is 12.58% by value and 6.02% by number of loans

As you can see, this is a far cry from the 16-24% one year delinquency rate across all credit categories.

Collection agency effectiveness

The record is quite dismal in this respect. Over the last 3 months, their largest collection agency by volume of delinquent loans sent to it (’Amsher’) has collected only 8.47% of the dollar value sent to it for collections for AA and A borrowers and the % collected falls of to 3.92% for B-D borrowers.

Since loans are sent to the collection agency just one month after they are past due, the above recovery percentages are quite dismal and it means that once a loan goes delinquent there is little chance of getting your money back.

Sale of distressed debt

If loans stay uncollected for 3 months with the collection agency, the loans are sold to a distressed debt buyer. The metrics for the last such sale by prosper yielded 9.6% of principal amount for AA and A borrowers debt. The trend from Prosper’s metrics over the last year shows that distressed debt buyers are paying less and less of the principal which may be a reflection of the current economic environment and the general risk aversion to less than perfect debt.

Summary

It may pay to lend to AA borrowers as long as you spread your loan across a wide set of borrowers. I would not suggest lending to any other credit grades till Prosper tighten’s up borrower verification and collections effectiveness.