Thursday, September 24, 2009
During Prosper's lifetime, a great many newspaper and magazine articles have contained misleading statements about the quality of Prosper.com loans. It just seems to happen again and again. That was in fact the impetus for this blog. I wanted to counterbalance the misinformation. More about history later. Lets start with the most recent outrage.
An article in the 9/19/09 Washington Post, said "Prosper's default rate is about 5 percent." That statement is bunk. Prosper loans are far worse than that. The difference between what was printed and reality is important to investors, because it makes the difference between profit and loss.
As many of you know, I've tracked Prosper loan performance for several years, and you can see from the charts I publish that Prosper loans go bad much faster than this. But lets start with a more authoritative source than me: Prosper's most recent prospectus filed with the SEC.
The prospectus says: "As of March 31, 2009, of the 29,000 borrower loans, ...5,840 loans or 20.1% had defaulted. " Well, that doesn't directly tell us a default rate, because the 29,000 loans outstanding are spread across a wide range of ages. Loans go bad over time, and many of these loans haven't had much time to go bad yet. Still, it doesn't take a genius to see that you can't get a 5% default rate from 20% of the pool having already gone bad! The Washington Post article is clearly in conflict with the prospectus.
The statement in the Washington Post is misinformation, just like the many similar examples of misinformation which have preceded it.
If we separate out Prosper.com loans by age, the facts become clear. The following chart shows Prosper.com loans broken out by month of origination, and you can clearly see that the early (ie old) cohorts are headed toward about 40% of loans going bad. The younger cohorts are doing a little better, as I've discussed before. Still they are similar. These are 3 year loans. If 40% of them go bad over 3 years, that's equivalent to roughly a 16% per year default rate. The Washington Post article is bunk.
Click on the chart to see a larger clearer version.
Now lets go back and visit some of the prior examples of misleading press. You may see a pattern. I'm sure I haven't caught this lie every time it has appeared in the press. A few should do to let you appreciate the pattern.
I first wrote about this in my very first blog entry on April 20, 2007. I was an enthusiastic Prosper investor at the time, and believed I could sway Chris Larsen's behavior by just getting the facts out to the public. Turns out I didn't have much influence.
In that blog, I wrote about an April 1, 2007 article about Prosper in the Baltimore Sun. (The article is so old now that they make you pay to read it, but you can read the abstract for free, and the abstract contains the Chris Larsen quote of interest.)
This article quotes Chris Larsen... "Larsen says the default rate - payments 120 days past due - is about 0.50 percent. But that will likely climb as the three-year loans mature, he says."
Even back then, with limited data at my disposal, I was estimating a total Prosper.com default rate around 17%/year. (I said so in my first blog entry.) That is so horribly different than 0.50% that I just couldn't imagine how Larsen could say that sort of thing to the media.
When you're a young loan company, it is easy to point to the portfolio and say "Look, not many of our loans have defaulted!" Of course that isn't what matters. What matters is the rate at which loans are going bad. Prosper doesn't default a loan until it is 4 months past due, and the first payment doesn't become due until 1 month after the loan originates, so loans younger than 5 months don't give you any defaults, and at the time of that article, most of Prosper's loans were very young. However, given the data available at the time, anyone could see, without any analysis, that Larsen's statement was incorrect. Even letting the various ages of Prosper loans be mixed together, Prosper's own data shows that on April 1, 2007, they had originated 9003 loans, and of those, 291 had already defaulted. That's 3.23% . How can you possibly get from that number to a claim of a 0.50% default rate? You can't.
I thought perhaps if I exposed this sort of thing, the misinformation would stop. It did not.
There was an AP/MSNBC article on Nov 27, 2007 "Prosper’s default rate hovers at about 2.7 percent, Larsen said, but that figure is expected to rise as more loans mature." This was misinformation.
By that time, even using the most simple possible method of dividing the number of already defaulted loans by the total number of loans would tell you that 9.15% of prosper loans had already defaulted, and remember a great many of those loans were so young they could not possibly have yet defaulted.
If, using Prosper's own data again, observing on Nov 27, 2007, we take out the loans so young that they could not possibly default, then we have 1502 defaults out of a total of 12035 loans. That's right, 12.48% of loans old enough to meet the 4-month-late criteria for default had already in fact defaulted!
The simplest possible calculations tell you that Chris Larsen's quote is terribly misleading.
The true default rate, ie the rate at which loans were going bad could be easily estimated by looking at the slope of the curves on my charts, and this told me loans were going bad somewhere in the range of 15% to 20% per year. How could he say 2.7% to the press? ...and thereby the investing public?
There was a Dec 16, 2007 article (now expired) on Yahoo news which said "The default rate on Prosper loans is a meager three percent." They probably just copied from the AP article. The misleading information echoes and repeats over and over.
Chicago Tribune article of 01/13/07 talks of a 4.7% default rate. (Article may be offline now. The links I had no longer work.)
The long series of misinformation continues with the recent Washington Post article's statement "Prosper's default rate is about 5 percent."
No my dear. Prosper's loans have experienced a default rate of something like 17% per year. As anyone can plainly see from my charts, about 40% of Prosper.com loans go bad over their 3 year life.
When you're loaning money to someone, especially someone anonymous, your estimate of the default rate is really important. It is the most important piece of information you use to judge what interest rate to charge the borrower. That's why I began tracking the numbers. I was an enthusiastic early Prosper.com investor, and I wanted to understand.
On Prosper.com, lenders must rely on their understanding of historical default rates.
The continued material misrepresentation of this important data in the press, apparently driven by interviews with Prosper's CEO Chris Larsen, is disturbing.
PS: Great discussion among P2P investors can always be found at prospers.org
Friday, September 18, 2009
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 or "charge off" as it is now called). The horizontal axis is the observation date. All data comes from Prosper.com's performance web page.
Prosper loans created in the worst month so far, October '06, are now more than 43% bad! This number could still go higher! These are 3-year loans, but we don't know the final number of loans that have gone bad until 3 years + 4 months after origination, because loans are "charged off" when they are 4 months late. On March 1, 2010 we'll know the final numbers for loans originated in October 2006.
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
Many of the very early posts in this blog are still on point, and provide background on prosper, from a lender's perspective. If you're new to this, please read old posts before sending questions. Thanks.
The basic fact about Prosper.com loans so far is that about 40% of the loans go bad.
Something unexpected happened this month. The Securities and Exchange Commission has begun to disclose (on their web site) some of the correspondence between the SEC and Prosper while Prosper was attempting to get SEC approval to reopen. I've not seen such correspondence released before, but it seems like a great thing.
From some of these documents we learn that the SEC reads Fred93's blog! A few issues that have often been discussed here are mentioned, and in one place Fred93's blog is referenced by name.
Here are some snips from a June 12 2009 letter from SEC to Prosper:
"We note analysis of the prosper loan originations posted by prosper members which shows loans that are not paying according to their terms approaching 40% for your oldest tranches."
"...there have been concerns expressed about the number of reported loans that closed during a particular month changing. ... Please refer to http://fred93blog.blogspot.com ."
Right on! I was surprised but pleased to learn somebody reads this stuff.
To see the correspondence, go to the SEC's list of Prosper.com filings, and scan thru pages and pages of documents looking for the keyword "UPLOAD" in the first column. Only the letters from the SEC to Prosper are available, so this is like listening to only one side of a conversation. (I wish I could see Prosper's answer to the # of loans originated changing over time issue. I asked Prosper about that myself several times, but never got an answer.) Still reading the SEC letters is quite educational. The SEC really got into the details.
PS: The best discussion among P2P and Prosper.com lenders are found on prospers.org. See you there!
Saturday, September 5, 2009
The curves are "noisy" (ie they jump up and down a lot) and are not as orderly as the curves on my charts of prosper.com loan performance. That's because the volume of loans at Lendingclub is still too low to get really good stats.
Lets slide these curves over to a common origin, so we can compare their shapes ...
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.
Loans originated during the first few months of lendingclub's operation have performed very poorly. Oct, Nov 2007, and Jan 2008 have had about 15% of loans go bad during the first year. This is similar to the performance of Prosper.com loans.
Loans originated in later months have performed much better. This gives investors some hope, but...
Why have Lendingclub's later loans performed better than earlier Lendingclub loans? It seems that Lendingclub management must have learned some things and improved their verification criteria. Perhaps they learned how to filter out more of the identity theft or professional deadbeat borrowers. Unfortunately, I don't know what they changed. That makes it difficult to have faith that the improved quality of loans will continue.
The best discussion among P2P lenders occurs at http://www.prospers.org/forum/. See you there!