Sunday, December 16, 2007 - late loan statistics update

Here's my 12/15/07 update to the late loan statistics, with some notes on default rates. You've heard me say it before. The default rate of loans is repeatedly misrepresented in the press. This trend continues.

First, today's chart...

prosperlate 2007-12-15 small

A larger more readable version of the chart is available here

An article about appeared on Yahoo today. It contains a misleading statement which has appeared in many articles about prosper. "The default rate on Prosper loans is a meager three percent."

Too bad the author, Glenn Chapman didn't do a little research. Seems likely that he just copied from the last misleading article, the November 27, 2007 Associated Press article

Its pretty easy to see that the default rate on loans is about 20%/year. You can see it in the chart above. Doing an estimate using all the loans on Prosper requires some tricky math because loans are of various ages. That is difficult to explain. To make this simple, lets look at a group of loans that are all almost exactly 1 year old. That way there's no age adjustment to do. We're just gonna estimate how bad things got during that first year. I've written about this before. This time I'm gonna talk numbers instead of theory.

Lets look at all the loans that originated in October 2006. I'm going to consider, as I do in the chart above all those loans that have gone at least 1 month delinquent. The information about such delinquency comes to us with a built-in 2 month delay. In other words, a loan's first payment isn't due until the loan is 1 month old, and that payment can't possibly be 1 month late until a 2nd month has gone by. That's why the curves jump up from zero at 2 months after origination. With that in mind, I chose Oct'06 loans, because they're just now at the point where we have observed 12 months during which it was possible to be 1 month late.

Luckily, Prosper makes all the numbers available via their performance web page. This is a good thing! Now according to Prosper, 740 loans originated in Oct '06. Of those, 81 loans have already defaulted. If we counted only loans that have already gone all the way to default, we would divide 81 by 740, giving us 10.98% of these loans defaulted in the first year.

However, we know a bit more. In Prosper's vernacular, "default" actually means that they have already disposed o the bad loan. There are a great many loans that have gone more than 4 months late, Prosper's criteria for default, but have not yet been sold to junk dealers. These loans are just as bad, but haven't yet been given the name. While it is theoretically possible for one of them to recover, we know 99% will default. In fact, this will happen within the next few days, as Prosper has scheduled a loan sale before the end of the year. Prosper tells us there are 73 of the Oct'06 loans i nthe "4+ late" category. If we add those in, we get (81+73)/740 = 20.81% of Oct'06 loans are defaulting in the 1st year. Wow. That's a lot different than the 3% mentioned in the article, isn't it?

A better estimate can be made by using more of the late data. Based on historical performance, we know that once a loan goes 1 month late, it almost always defaults. It is legitimate to count these as associated with the loan's first year, because there is such a high probability that the "stop paying" event has already occurred. Prosper tells us that of the Oct'06 loans, 13 are 3 months late, 12 are 2 months late, and 16 are 1 month late. Therefore the total number of loans that are 1 month late or worse is 81+72+13+12+16 = 195. Each of these 195 loans was sent to Prosper's collection agency when the loan was 1 month late. We know from the collection agency statistics that Prosper also publishes that about 15% of loans that have gone to the agency have recovered. We can therefore estimate that about 85% of such loans will default. That gives us a way to estimate from loans that have already gone late, how many will default. That estimate is 85% x (81+72+13+12+16) = 165.75 . Finally, if we divide this by the total number of loans, 740, we get 22.4% . Stop pay events in the first year of these loans will cause 22.4% of them to default.

If you look at the chart above, you will see that there's nothing very special about Oct'06. The curves for most other months have the same slope and general shape.

Prosper loans, so far, have been defaulting at about 20%/year, not 3% as the article claims.

This number is important for Prosper lenders to know. The simplest takeaway is this: If you want your portfolio to have a default rate better than 20%, you'd better be selective!

There are many other things I've learned from these curves. Example: I used to see people say things like "After a borrower makes 4 or 5 payments, I think the loan will be ok." Turns out, that's nonsense. If you look at the curves, you see that nonpayment events are well spread out over time. We know so far that they're pretty uniform over the first 18 months or so of the loan, and may well continue thruought the life of the loan. (ie the curves are pretty straight) Nothing magic happens after a few good months. That was a lender's fantasy.

In the last update of the charts, I noted that the Aug'07 curve took a big jump. I wondered whether this was a data glitch. Now confirmed. It was a glitch. A few days later, Prosper revised the numbers. The Aug'07 curve looks perfectly ordinary now.

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