Well... As I predicted in my last writeup, the SEC has found Prosper.com to be in violation of the securities act of 1933. The SEC made this finding public yesterday.
The SEC's public statement can be found here:
SEC Prosper Cease & Desist Order
This SEC release explains why prosper.com has ceased operation.
From the SEC Order. . .
The loan notes issued by Prosper pursuant to this platform are securities and Prosper, from approximately January 2006 through October 14, 2008, violated Sections 5(a) and (c) of the Securities Act, which prohibit the offer or sale of securities without an effective registration statement or a valid exemption from registration.
The details are a fun read, and cover much of the territory that has been discussed here in the past.
Tuesday, November 25, 2008
Wednesday, November 19, 2008
Prosper.com - quiet period my ass
It has now been more than one year since Prosper.com's ill-fated SEC filing which attempted to create a secondary market, and apparently failed. In the meantime, Lendingclub filed, got approval, and began operating such a market. Prosper at the very least has lost its first mover advantage.
What happened? And what the hell is this thing they're calling a "quiet period"?
On 10/30/2007, a little more than a year ago, Prosper.com filed a prospectus with the SEC to allow them to sell "notes" from one lender to another. This is what Prosper calls the "resale market". I remember reading the prospectus at the time and thinking how strange it was. If these things are securities, requiring SEC registration when they're traded from one lender to another, then why aren't they securities requiring SEC registration when they're sold to the first lender? And if they are (illegal) unregistered securities when sold to the first lender, then Prosper.com has been selling illegal unregistered securities to thousands of lenders for two years. It seems likely that the SEC had similar concerns, because the prospectus was never approved. It could not possibly be approved now, because there have been material changes since it was written (Co-founder John Witchel left Prosper for example). Prosper's year-old filing therefore is dead. Can't be approved as is. They would need to file again.
For background on selling unregistered securities...
http://invest-faq.com/cbc/warn-unreg-secur.html
In the time since Prosper filed, Lendingclub came along and did the same thing. Lendingclub filed with the SEC on 06/20/08, and was approved on 10/14/08, just 116 days later.
So what's the hangup with Prosper.com?
If you read the prospectuses filed by Prosper.com and Lendingclub, you will see that they are quite different. Lendingclub admitted up front that the thing they are selling lenders is a derivative. It is an obligation of Lendingclub, which pays amounts that depend on what borrowers pay to Lendingclub. This is a pretty standard sort of thing, which the SEC has approved many times. Lendingclub structured the thing so that the SEC could easily recognize this as a kind of thing it had approved before. There existed a precedent.
From the LendingClub prospectus: "The Notes will be unsecured special, limited obligations of Lending Club."
From the Prosper.com prospectus: "The Notes represent unsecured fully-amortizing credit obligations of individual Borrowers on the Platform." and later "All Notes issued on the Platform are unsecured credit obligations of individual Borrowers."
So while Lendingclub admitted to creating derivatives, Prosper tried to step to the side and argue that the securities they were registering were actually the obligations of somebody else. This has no precedent. This is unlikely to be approved by the SEC. That I believe is one fundamental problem.
But there's another problem. If the SEC read the prospectus the way I did, they would have the same question I had about the elephant in the room. If these things Prosper sells require registration, then perhaps they require registration the first time they are sold, not just upon resale.
If the SEC believes that then Prosper is in a pickle. The securities act of 1933 considers the sale of unregistered securities a felony subject to punishment by a 5 year prison term. Its pretty much the SEC who decides what is an unregistered security. It is this consideration that gives the SEC much of its authority!
So now lets go back to the question of Prosper's "quiet period", and what the heck it means. They've called it a quiet period, but that's not what it is.
The term "quiet period" refers to a period of time around the issuance of a new stock when the issuing company is supposed to take careful precautions to avoid any appearance that they are hyping the new issue. This generally means they shouldn't give interviews hyping how great the company is, for example. It just means be quiet. It does not imply that the company should cease operation. Companies do not stop selling shoes, or refrigerators, or whatever they normally sell, during a quiet period.
Prosper has not just gone "quiet". They've stopped issuing new loans. I believe they did this because they believe they are in substantial risk of being charged by the SEC with selling unregistered securities for the last two years. We always knew there was regulatory risk associated with this new kind of business model. Well here it is.
Getting out of this pickle will require either convincing the SEC that they should go back to sleep ... everything is ok, or else filing a new prospectus and getting it approved. Until one of those two things happens, Prosper would be operating at considerable risk if they continued to sell these allegedly unregistered securities. Therefore, they had to cease.
This isn't a 'quiet period'.
Its a 'Shut the doors, turn off the lights, hide in the back, and hope the policeman won't knock down the door period'.
No one knows how long this will take. Prosper hasn't even filed yet. Prosper needs to hire a new law firm (I wish whoever wrote that last prospectus should go work for my competitor.), then write a shiny new prospectus, file it, and get it approved.
In the one month that has passed since the shutdown, I would guess that they have hired the new firm. They obviously haven't filed a new prospectus. That puts them somewhere between step 1 and 2.
When that prospectus is eventually filed, I'm betting it will say, (much like the Lendingclub prospectus does), that the notes investors purchase are obligations of Prosper.com, not obligations of the borrowers. This changes the risk profile for investors (who prosper calls lenders). When considering the purchase of an obligation of Prosper.com, we need to know something about the financial situation of Prosper.com. We need to see a balance sheet! We need to know what other obligations may be senior to ours. Will Prosper understand this and step up and do what's right in the new environment? I don't know. If I were to judge from their past "To heck with the lender" management perspective, I'd have to say no.
Derivatives such as I describe here are commonplace. Awhile back I invested in a NYSE traded floating-rate note of Daimler-Chrysler. Symbol JZD. (You can read about it at http://www.quantumonline.com/search.cfm?tickersymbol=JZD*&sopt=symbol )
Looked great, but it kept going down. Finally I realized that this is actually a derivative. It was an obligation of Lehman, who would pass thru the payments made by Daimler Chrysler, just as Lendingclub or Prosper will pass thru the payments made by borrowers. As Lehman's financial situation became less clear, these derivatives sold off. You've gotta understand the financial condition of the middleman! I was a bit naive. Now I am a bit smarter.
There could be other significant changes in the way the whole thing works too. Prosper has lost its mojo. Although they were first, they no longer act like a frontrunner.
When Lendingclub opened up with a blog full of personal finance drivel, Prosper immediately added a to their site blog full of personal finance drivel. It is as if someone at Prosper said "Oh, of course, Web 2.0, you gotta have a blog! What were we thinking?" Most recently the Prosper blog tells consumers that they should go out and borrow more, at a time when the whole world is deleveraging from the excess borrowing of the last decade. Drivel. Hey Prosper, you were a leader. You don't need to be a copycat. Personal finance drivel advice is not the answer.
I hope they don't continue with this me-to approach. For exampe, I hope they don't adopt Lendingclub's non-auction approach for setting interest rates. I think that's a disaster.
Here's some evidence that Prosper may be thinking about major changes in the platform before they reopen: Several months ago, software development slowed to a trickle.
I've written before about how back in January we were promised monthly statements on the legal-test loans. (Loans where prosper has filed suits against badly delinquent borrowers.) Its November, and no monthly statements have been produced. A lot of months have gone by.
I've written many times about the statistics on collections of late loans. I never could understand how the numbers were so bad. I've written several times about the fact that some of the numbers jumped around faster than was possible, indicating bogosity. Something was wrong, and Prosper kept ignoring it. In August, prosper admitted that the stats they'd been giving us for collection performance at Amsher were wrong, due to a bug in the software interface with Amsher. I figured they'd fix it. Instead, they simply removed the Amsher stats from their web site. August, September, October, November. Nobody fixes the bug. Nobody cares? Lenders figure this is just another sign that Prosper thinks lenders are crap, and don't deserve the data.
How can a company be run this way? It could be rationally run this way if they figured that much of the existing platform was gonna be thrown away soon.
That's just a theory of course.
I'm sure it will all be revealed at ProsperDays 2009! See 'ya there.
What happened? And what the hell is this thing they're calling a "quiet period"?
On 10/30/2007, a little more than a year ago, Prosper.com filed a prospectus with the SEC to allow them to sell "notes" from one lender to another. This is what Prosper calls the "resale market". I remember reading the prospectus at the time and thinking how strange it was. If these things are securities, requiring SEC registration when they're traded from one lender to another, then why aren't they securities requiring SEC registration when they're sold to the first lender? And if they are (illegal) unregistered securities when sold to the first lender, then Prosper.com has been selling illegal unregistered securities to thousands of lenders for two years. It seems likely that the SEC had similar concerns, because the prospectus was never approved. It could not possibly be approved now, because there have been material changes since it was written (Co-founder John Witchel left Prosper for example). Prosper's year-old filing therefore is dead. Can't be approved as is. They would need to file again.
For background on selling unregistered securities...
http://invest-faq.com/cbc/warn-unreg-secur.html
In the time since Prosper filed, Lendingclub came along and did the same thing. Lendingclub filed with the SEC on 06/20/08, and was approved on 10/14/08, just 116 days later.
So what's the hangup with Prosper.com?
If you read the prospectuses filed by Prosper.com and Lendingclub, you will see that they are quite different. Lendingclub admitted up front that the thing they are selling lenders is a derivative. It is an obligation of Lendingclub, which pays amounts that depend on what borrowers pay to Lendingclub. This is a pretty standard sort of thing, which the SEC has approved many times. Lendingclub structured the thing so that the SEC could easily recognize this as a kind of thing it had approved before. There existed a precedent.
From the LendingClub prospectus: "The Notes will be unsecured special, limited obligations of Lending Club."
From the Prosper.com prospectus: "The Notes represent unsecured fully-amortizing credit obligations of individual Borrowers on the Platform." and later "All Notes issued on the Platform are unsecured credit obligations of individual Borrowers."
So while Lendingclub admitted to creating derivatives, Prosper tried to step to the side and argue that the securities they were registering were actually the obligations of somebody else. This has no precedent. This is unlikely to be approved by the SEC. That I believe is one fundamental problem.
But there's another problem. If the SEC read the prospectus the way I did, they would have the same question I had about the elephant in the room. If these things Prosper sells require registration, then perhaps they require registration the first time they are sold, not just upon resale.
If the SEC believes that then Prosper is in a pickle. The securities act of 1933 considers the sale of unregistered securities a felony subject to punishment by a 5 year prison term. Its pretty much the SEC who decides what is an unregistered security. It is this consideration that gives the SEC much of its authority!
So now lets go back to the question of Prosper's "quiet period", and what the heck it means. They've called it a quiet period, but that's not what it is.
The term "quiet period" refers to a period of time around the issuance of a new stock when the issuing company is supposed to take careful precautions to avoid any appearance that they are hyping the new issue. This generally means they shouldn't give interviews hyping how great the company is, for example. It just means be quiet. It does not imply that the company should cease operation. Companies do not stop selling shoes, or refrigerators, or whatever they normally sell, during a quiet period.
Prosper has not just gone "quiet". They've stopped issuing new loans. I believe they did this because they believe they are in substantial risk of being charged by the SEC with selling unregistered securities for the last two years. We always knew there was regulatory risk associated with this new kind of business model. Well here it is.
Getting out of this pickle will require either convincing the SEC that they should go back to sleep ... everything is ok, or else filing a new prospectus and getting it approved. Until one of those two things happens, Prosper would be operating at considerable risk if they continued to sell these allegedly unregistered securities. Therefore, they had to cease.
This isn't a 'quiet period'.
Its a 'Shut the doors, turn off the lights, hide in the back, and hope the policeman won't knock down the door period'.
No one knows how long this will take. Prosper hasn't even filed yet. Prosper needs to hire a new law firm (I wish whoever wrote that last prospectus should go work for my competitor.), then write a shiny new prospectus, file it, and get it approved.
In the one month that has passed since the shutdown, I would guess that they have hired the new firm. They obviously haven't filed a new prospectus. That puts them somewhere between step 1 and 2.
When that prospectus is eventually filed, I'm betting it will say, (much like the Lendingclub prospectus does), that the notes investors purchase are obligations of Prosper.com, not obligations of the borrowers. This changes the risk profile for investors (who prosper calls lenders). When considering the purchase of an obligation of Prosper.com, we need to know something about the financial situation of Prosper.com. We need to see a balance sheet! We need to know what other obligations may be senior to ours. Will Prosper understand this and step up and do what's right in the new environment? I don't know. If I were to judge from their past "To heck with the lender" management perspective, I'd have to say no.
Derivatives such as I describe here are commonplace. Awhile back I invested in a NYSE traded floating-rate note of Daimler-Chrysler. Symbol JZD. (You can read about it at http://www.quantumonline.com/search.cfm?tickersymbol=JZD*&sopt=symbol )
Looked great, but it kept going down. Finally I realized that this is actually a derivative. It was an obligation of Lehman, who would pass thru the payments made by Daimler Chrysler, just as Lendingclub or Prosper will pass thru the payments made by borrowers. As Lehman's financial situation became less clear, these derivatives sold off. You've gotta understand the financial condition of the middleman! I was a bit naive. Now I am a bit smarter.
There could be other significant changes in the way the whole thing works too. Prosper has lost its mojo. Although they were first, they no longer act like a frontrunner.
When Lendingclub opened up with a blog full of personal finance drivel, Prosper immediately added a to their site blog full of personal finance drivel. It is as if someone at Prosper said "Oh, of course, Web 2.0, you gotta have a blog! What were we thinking?" Most recently the Prosper blog tells consumers that they should go out and borrow more, at a time when the whole world is deleveraging from the excess borrowing of the last decade. Drivel. Hey Prosper, you were a leader. You don't need to be a copycat. Personal finance drivel advice is not the answer.
I hope they don't continue with this me-to approach. For exampe, I hope they don't adopt Lendingclub's non-auction approach for setting interest rates. I think that's a disaster.
Here's some evidence that Prosper may be thinking about major changes in the platform before they reopen: Several months ago, software development slowed to a trickle.
I've written before about how back in January we were promised monthly statements on the legal-test loans. (Loans where prosper has filed suits against badly delinquent borrowers.) Its November, and no monthly statements have been produced. A lot of months have gone by.
I've written many times about the statistics on collections of late loans. I never could understand how the numbers were so bad. I've written several times about the fact that some of the numbers jumped around faster than was possible, indicating bogosity. Something was wrong, and Prosper kept ignoring it. In August, prosper admitted that the stats they'd been giving us for collection performance at Amsher were wrong, due to a bug in the software interface with Amsher. I figured they'd fix it. Instead, they simply removed the Amsher stats from their web site. August, September, October, November. Nobody fixes the bug. Nobody cares? Lenders figure this is just another sign that Prosper thinks lenders are crap, and don't deserve the data.
How can a company be run this way? It could be rationally run this way if they figured that much of the existing platform was gonna be thrown away soon.
That's just a theory of course.
I'm sure it will all be revealed at ProsperDays 2009! See 'ya there.
Wednesday, November 12, 2008
Lendingclub - Late Loan Stats
Lendingclub has been around for more than a year now, so I figured maybe there was finally enough data to allow one to understand the default rate behavior of Lendingclub loans. I have prepared charts of the behavior of Lendingclub loans that are similar to the ones I've been making for Prosper.
These charts show statistics for the performance of all Lendingclub.com loans. Each curve represents the set of loans that were created in one calendar month. The vertical axis is the fraction of those loans that have "gone bad", in other words are 1 month late or worse (up to and including default). The horizontal axis is the observation date. All data comes from Lendingclub's performance web page.
The curves are "noisy" (ie they jump up and down a lot) and are not as orderly as the curves on the prosper chart. That's because the volume of loans at Lendingclub is still too low to get good stats. We can see that Oct'07 was a really horrible month. Those loans are now 1 year old, and 15% of them have gone bad! That's about as bad as prosper!
After Oct'07 they must have fixed something, because the later curves all seem to have a lower slope. We'll never know. Lets slide these curves over to a common origin, so we can visualize how common their shapes are...
Just look at where these curves crossed the 390 day line, (ie 30 days after the 360 day line, because it takes 30 days for a loan to become 1 month late) or visualize where they might cross the 390 day line as they extend, and that tells you what fraction of loans went bad in the first year. This is then an estimate of the annual default rate for Lendingclub loans.
There is a little problem. Although the data is still quite noisy becase there aren't enough loans, we can see that various groups of loans fall between 5% and 15% bad after 1 year.
Lendingclub has given us estimates of the annual default rate for their loans. This used to be on the web site, but is now found in the prospectus. For their best grade, "A1" they predict a 0.16%/year default rate. (Yes, that's really zero point one six percent!) For their worst grade, "G5" they predict a 5.25%/year default rate.
Ideally we would gather statistics for each credit grade and compare them to these default rates that Lengingclub assumed. Unfortunately, if we split the monthly pools of loans into all the different credit grades, there would be very few loans in each group, and the stats would be horribly noisy.
What we can do however is look at all the Lendingclub loans together. If Lendingclub's numbers were right, the default rate would be something between 0.16%/year and 5.25%/year, so it might come out something like say... 2.5%. However, looking at the picture, you can see they're way off. No month is anywhere near 2.5% at the 390 day line. The curves show us that the average might be more like 8%/year. Hard to be precise with such a small amount of data.
If Lendingclub has used faulty estimates of default rate, then the interest rates on Lendingclub loans are all too low. Seems likely.
In the beginning, Prosper.com gave their lenders default rate estimates that came from Experian (their data supplier), showing their experience with a large number of credit card accounts. Many lenders initially used those estimates to determine the rates they bid. Unfortunately, actual Prosper loans turned out to behave very differently than the Experian credit card statistics. Anonymous internet P2P loans apparently don't behave like historical credit card accounts. Sorry. Later, Prosper deleted the hilarously low Experian numbers from their web site, and showed lenders only their own historical performance data. This was a landmark improvement.
Likewise, Lendingclub obtained estimates from historical account data at Transunion (their credit data supplier) and naively used these to calculate the interest rates they offer on their loans. The assumptions aren't holding, so the rates are too low.
Luckily, Lendingclub added a term in the interest rate formula that they call "adjustment for risk and volatility". They set this term equal to 2x the expected default rate, and added it into the interest rate. (There's a good theoretical basis for doing something like this, which I won't bore you with.) The effect is that interest rates end up adjusted for 3x the assumed (bogus) default rate. That provides a little wiggle room, especially for the lower credit grades. For the high credit grades (ie A) however, I suspect they're just way off.
Lendingclub has originated between 100 and 400 loans in each of the months shown above. Unfortunately, the recent months have very low numbers of loans originated, because Lendingclub was not taking in lender money while they fought some regulatory battles. They're only now ramping back up. We really need them to get over 500 loans/month and then accumulate data for several months (a year?) before we can understand Lengingclub loan performance in a more seriously quantitative way.
Best discussion among P2P lenders occurs at www.prospers.org.
These charts show statistics for the performance of all Lendingclub.com loans. Each curve represents the set of loans that were created in one calendar month. The vertical axis is the fraction of those loans that have "gone bad", in other words are 1 month late or worse (up to and including default). The horizontal axis is the observation date. All data comes from Lendingclub's performance web page.
The curves are "noisy" (ie they jump up and down a lot) and are not as orderly as the curves on the prosper chart. That's because the volume of loans at Lendingclub is still too low to get good stats. We can see that Oct'07 was a really horrible month. Those loans are now 1 year old, and 15% of them have gone bad! That's about as bad as prosper!
After Oct'07 they must have fixed something, because the later curves all seem to have a lower slope. We'll never know. Lets slide these curves over to a common origin, so we can visualize how common their shapes are...
Just look at where these curves crossed the 390 day line, (ie 30 days after the 360 day line, because it takes 30 days for a loan to become 1 month late) or visualize where they might cross the 390 day line as they extend, and that tells you what fraction of loans went bad in the first year. This is then an estimate of the annual default rate for Lendingclub loans.
There is a little problem. Although the data is still quite noisy becase there aren't enough loans, we can see that various groups of loans fall between 5% and 15% bad after 1 year.
Lendingclub has given us estimates of the annual default rate for their loans. This used to be on the web site, but is now found in the prospectus. For their best grade, "A1" they predict a 0.16%/year default rate. (Yes, that's really zero point one six percent!) For their worst grade, "G5" they predict a 5.25%/year default rate.
Ideally we would gather statistics for each credit grade and compare them to these default rates that Lengingclub assumed. Unfortunately, if we split the monthly pools of loans into all the different credit grades, there would be very few loans in each group, and the stats would be horribly noisy.
What we can do however is look at all the Lendingclub loans together. If Lendingclub's numbers were right, the default rate would be something between 0.16%/year and 5.25%/year, so it might come out something like say... 2.5%. However, looking at the picture, you can see they're way off. No month is anywhere near 2.5% at the 390 day line. The curves show us that the average might be more like 8%/year. Hard to be precise with such a small amount of data.
If Lendingclub has used faulty estimates of default rate, then the interest rates on Lendingclub loans are all too low. Seems likely.
In the beginning, Prosper.com gave their lenders default rate estimates that came from Experian (their data supplier), showing their experience with a large number of credit card accounts. Many lenders initially used those estimates to determine the rates they bid. Unfortunately, actual Prosper loans turned out to behave very differently than the Experian credit card statistics. Anonymous internet P2P loans apparently don't behave like historical credit card accounts. Sorry. Later, Prosper deleted the hilarously low Experian numbers from their web site, and showed lenders only their own historical performance data. This was a landmark improvement.
Likewise, Lendingclub obtained estimates from historical account data at Transunion (their credit data supplier) and naively used these to calculate the interest rates they offer on their loans. The assumptions aren't holding, so the rates are too low.
Luckily, Lendingclub added a term in the interest rate formula that they call "adjustment for risk and volatility". They set this term equal to 2x the expected default rate, and added it into the interest rate. (There's a good theoretical basis for doing something like this, which I won't bore you with.) The effect is that interest rates end up adjusted for 3x the assumed (bogus) default rate. That provides a little wiggle room, especially for the lower credit grades. For the high credit grades (ie A) however, I suspect they're just way off.
Lendingclub has originated between 100 and 400 loans in each of the months shown above. Unfortunately, the recent months have very low numbers of loans originated, because Lendingclub was not taking in lender money while they fought some regulatory battles. They're only now ramping back up. We really need them to get over 500 loans/month and then accumulate data for several months (a year?) before we can understand Lengingclub loan performance in a more seriously quantitative way.
Best discussion among P2P lenders occurs at www.prospers.org.
Monday, November 10, 2008
Prosper.com - 11/01/08 late loan stats update
Here's the November 1, 2008 update to to my Prosper.com late loan statistics charts.
These charts show statistics for the performance of all prosper.com loans. Each curve represents the set of loans that were created in one calendar month. The vertical axis is the fraction of those loans that have "gone bad", in other words are 1 month late or worse (up to and including default). The horizontal axis is the observation date. All data comes from Prosper.com's performance web page.
A larger, more readable version of that chart can be found here
Here's a chart of the same data in which each curve has been slid to the left to a common origin. The horizontal axis is now days since loan origination month.
Explanation of methodology can be found in my prior postings in this blog, and in forum discussions on the old prosper forum, now archived at www.prosperreport.com
PS: Best discussion among Prosper.com lenders can be found at http://prospers.org/
Saturday, November 8, 2008
Prosper.com - Google says Site Not Available
This just struck me as funny. Every now and then Prosper takes their web site down to update software. During this time, they put up a "site not available" page.
For several weeks now I have noticed that google has been indexing this "site not available" page. If you did a google search for prosper, "site not available" would be one of the pages listed. That was funny. The google robot must have wandered thru a few times while the site not available page was up.
Yesterday Google decided that "Site Not Available" is the name of Prosper's main page! Oops.
I decided to capture this for posterity.
I checked again today and note that it is already back to normal. Google is quick. Could happen again any day tho.
Note to Prosper webmasters: Consider adding a META command with NAME="robots", CONTENT="noindex", to the site-not-available version of the main page.
For several weeks now I have noticed that google has been indexing this "site not available" page. If you did a google search for prosper, "site not available" would be one of the pages listed. That was funny. The google robot must have wandered thru a few times while the site not available page was up.
Yesterday Google decided that "Site Not Available" is the name of Prosper's main page! Oops.
I decided to capture this for posterity.
I checked again today and note that it is already back to normal. Google is quick. Could happen again any day tho.Note to Prosper webmasters: Consider adding a META command with NAME="robots", CONTENT="noindex", to the site-not-available version of the main page.
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