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Wed Oct 31 2007 22:07:52

Prosper and the Defaulter

By: Ina Steiner

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Prosper is a peer-to-peer lending site where you can post a listing for someone to loan you money, or you can loan other members money. It's an auction format, so lenders bid for loans. I've reserved judgement, but definitely felt uncomfortable knowing some "lenders" may not understand exactly what they are getting into and may not have a good grasp of the risk-reward principle. Prosper works on the Tupperware principle of getting your friends and associates to participate.

Having watched PayPal evolve, I learned that in early phases of cyber-versions of financial services, there are lots of lessons to be learned, usually borne by the users, not the company.

Prosper just filed with the SEC, so I checked to see what kind of performance the loans have achieved (see page 48 of the filing).

Loans are classified into risk categories, and the "NC" credit grade category of loans had such a high default rate, they discontinued it in February:

Default Rate Based on Number of Loans Defaulted: 40 percent of "NC" loans

Default Rate Based on Principal Amount of Loans Defaulted: 40.03 percent of "NC" loans

The next grade of loans was " HR" with a default rate of 19.56 percent (22.06 percent based on the amount of principal).

The total default rate across all credit grades was 5.36 percent (8.42 percent based on the amount of principal).

Those kinds of numbers would keep me up at night, caveat emptor to lenders. And as a borrower, I'd be asking if Prosper loan defaults would show up on my credit rating.

Note that Prosper does disclose the default rate in a tutorial on its site, but suggested adding the rate as a percentage to the interest you should charge lenders. Interesting!

I did a search on Google News to see who wrote about the SEC filing. Two news outlets and one well-known tech blogger wrote about it, but nowhere did they mention the default rate. To me, the default rate was the interesting part. ("Disruptive" is right!)

Look at the fees Prosper charges, and you'll understand the best investment on Prosper is Prosper itself - they get fees from borrowers and lenders - without lending a penny. (eBay founder and Chairman Pierre Omidyar's Omidyar Network is an investor in Prosper.)

So why is Prosper filing with the SEC? They want to create a secondary trading market online auction platform, or "Resale Platform," where lenders can sell their loans (called Notes). Keep in mind: "The Notes are not the obligations of Prosper, any depository bank or any collection agency. The Notes are not guaranteed or issued by any governmental agency," and "Prosper has no obligation for payment of principal of or interest or other charges on the Notes."

In reading about Prosper, I felt like I was reading about Second Life (or subprime mortgages). In case this posting was too oblique, here's my opinion: This service probably has helped some borrowers and made money for some lenders, and it has lost some people money. If you can't afford to lose the money you lend on Prosper and laugh it off, don't lend it.

Comments (6) | Permalink

Readers Comments

Perminate Link for Prosper and the Defaulter   Prosper and the Defaulter

by: Donna

Thu Nov 1 12:38:46 2007

Thanks for this expose, Ina!

Back when Prospect began, an eBay "Pink" quit eBay and joined.  She had saved the emails of people who had written to her and solicited them to join her.  It was a heavy push.

Then, another eBayer I knew began pushing it very heavily on discussion boards and in emails to me.  The spam-like sales pitch just scared me.  

It just made no sense that individuals without banking/lending experience should be able to leap in and become instant bankers and make a fortune.  

It sounded too good to be true, and now I see from your posting that, once again, the old saying was right on.

Perminate Link for Prosper and the Defaulter   Prosper and the Defaulter

by: Beady Eye Guy

Thu Nov 1 12:39:42 2007

I seriously considered putting xxx aside from our business and lending money on Prosper.  When I started to look over the various borrowers and their histories, I got scared off.  It's a great concept but there is too much competition for the better credit risks and too many dogs waiting for loans.  I feel for those who need a loan with bad credit ratings, but they should have thought of that before getting into financial trouble.

Ina, the site DOES report delinquencies to the credit agencies.  They use your credit rating as a basis for judging risk for potential lenders.  They also take fees (I believe) for collections.  Problem for me would be if I got stuck with a dog loan, how much will it cost me to collect it or would I just walk away and chalk it up on our taxes as "BAD DEBT"?

Again, Prosper is a great concept just as Lending Tree and Ebay were back in the day and sites like Mint and Facebook are today.  Problem is, they never quite work the way they were envisioned and ultimately thanks to the bad element, they always either become bland or they grow so fast that people move onto other new shiny toys.

Perminate Link for Prosper and the Defaulter   Prosper and the Defaulter

by: Peter Leeflang - CEO Leeflang Archive Corp

Thu Nov 1 13:06:52 2007

Not sure what the intent is of Ina with this article.
Prosper has a perfectly valid business model, just like any other lender/borrower mechanism in the b+m world.
Their site is actually very clear about the risks involved of ending up with a defaulting borrower.
Just like subprime lending and junk bonds, this is a great opportunity for those who have a hard time borrowing and those who want to take a higher than usuall risk in exchange for the possibility higher than usual rewards.
Unfortunately for the succesful lenders and borrowers in 'junk bonds' and 'subprime mortgages' the government, representing the 'envious of success' in our society, cut them down, this causing their downfall. It was not due to defaults. Let's hope that does not happen with Prosper. It is the only risk that cannot be assessed as it is not rational and depends on teh whim of the day amongst the enviers.

Perminate Link for Prosper and the Defaulter   Prosper and the Defaulter

by: RiskManagement

Thu Nov 1 13:30:26 2007

Its all about risk management isn't it? Some like to take big risks, while others do not. All I can say is that Prosper is performing nicely even with the low risk parameters I am using. I think 401k is more risky and as a small business you do yourself a disservice. Don't you realize you're supporting  jobs loss in America and lower standard of living for everyone by playing the stock market?

Perminate Link for Prosper and the Defaulter   Prosper and the Defaulter

by: Alex

Fri Nov 2 10:38:09 2007

A great idea. Link people that have money to invest with known deadbeats that want a loan.

This concept is so bad, eBay will probably buy the company..

Perminate Link for Prosper and the Defaulter   Prosper and the Defaulter

by: shawnspringer

Mon Nov 5 21:50:47 2007

Prosper is a great place for people who have no intention of paying their loan back to get money from a large number of well intentioned people.  Do not believe their reported default numbers - they are heavily skewed due to the fact that most of their loan growth was in 2007 and they only report those loans that are more than 4 months delinquent - most have not yet had time to show up - but just wait, they will.  I am a lender on Prosper with 26 loans.  The oldest is about 6 months old now.  Out of the 26, 4 are in collections, and 2 more are late.  Lest you think I was foolish and loaning to known deadbeats, my biggest default is from an "AA" rated borrower who made one payment and then disappeared.  The others made one or two payments and then figured out they did not really have to repay the loans.  The overall credit rating on my portfolio is "B-", not junk grade, and yet in less than 6 months I have 15% of my loans in collections (and their sucess rate in collections is dismal).  Don't try to contact Prosper about any problems - they won't do anything.  This is truly a case of Lender BEWARE!

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