Tuesday, November 6, 2007

Prosper.com - Oops... (they) did It again!


I've been critical of some of Prosper's misleading advertisements and newsletters in the past. Last time I caught them making incorrect statements in the newsletter, a Prosper spokesman wrote "Going forward with the newsletter, we will diligently fact-check each story before publication." Ok. Great in fact.

They just published their November newsletters. So how did they do this time? If you'll pardon the slightly mangled and heavily overused words of Britney Spears, the title says it all. How can this be?

The November lenders' newsletter contains the "stories" of two lenders. I'll look briefly at each one.

In one story, lender hcjack2208 writes

Right now I have 30 loans that I have invested in.

Even with a few defaulted loans, I am still making a 13% rate of return on my money.

Wow. This dude is making 13%! Cool.

Thanks to Prosper's data export, we can look at the status of hcjack2208's loans. The lendingstats.com web site makes it easy for us. We learn that he has 42 loans and 7 of these are late. A pretty substantial fraction of lates. If we estimate his rate of return with the assumption that loans in his portfolio will go bad in the future at the same rate they have in the past (the assumption that lendingstats ROI calculation makes), then hcjack2208 is achieving a rate of return of 4.6%, not 13%. Big difference, eh? Oops.

You can view the details of hcjack2208's portfolio here.

Next there's a story about lender davesax. Davesax writes

At this point I've got $23,000 invested in 200 loans with a gross yield of 14.25% (less 1/2 point for Prosper) and only a few late pays, but none over 15 days at present.

Wow. 200 loans and nothing over 15 days late. This gives the impression that davesax's return will be something close to that gross yield of 14.25% that he quotes. That really sounded great, so figured I should look at his portfolio.

Davesax now has 360 loans, of which 13 are late. 1 loan is 4+ months late. 3 are 3 months late. 2 are 2 months late. 3 are 1 month late. 4 are >15 days late. The facts don't match the statement in the newsletter at all. Well, that's misleading.

If you want to do the davesax rate of return calculation in your head, note that those 13 late loans are about 3.5% of his portfolio. Because his portfolio is less than 6 months late, you've got to more than double that to get an annual default rate. You end up with something around 7%/year estimated defaults. He started with a little over 14% gross interest rate, so you would expect his return to be something a little less than 7%/year. I won't bore you with the numerical details. Lendingstats does a much more careful calculation, applying appropriate roll rates and loss rates.

The lendingstats ROI esimate for davesax comes out 6.29% .

You can view the details of davesax's portfolio here.

The sin in the above examples is that Prosper took quotes from relatively new lenders, then used them more than 4 months later. New lenders often think they are doing better than they really are, because they don't project losses appropriately.

Most lenders don't have the mathematical sophistication to compute how well they're doin'. That's why the portfolio calculations at lendingstats are so very useful. Prosper itself offers a similar calculation, on their "performance" web page, but they don't let you apply the calculation to your portfolio. You can only apply the calculation to various subsets of the whole-prosper portfolio, based on a list of filter criteria (date, credit grade, etc). I believe it is terribly important to make lenders understand their own performance. To do anything less is misleading.

Toward that end, I have suggested that Prosper adjust their "performance" web page so that it will compute the ROI of a lender's portfolio. In the meantime, lenders can use lendingstats.


Google advertisements being run by Prosper recently deliver those who click to a landing page that contains the following graphic:

9.4% advertisement

Unfortunately, the word "average" is pretty well defined, and the average portfolio on Prosper is not earning 9.4% as the ad implies. The mean lender portfolio ROI is 4.39%. (again using the excellent Lendingstats calculations) You can read a discussion of the distribution of Prosper portfolio returns here.

The 9.4% number is obtained by filtering for a small subset of Prosper loans, as explained in a footnote. Showing the results of a cherry-picked set and calling it "average" is well...

I think the ad is misleading. Regulators came down hard on the securities industry for this sort of shenanigans in the 60's and 70's. Now there are quite well defined rules for how one calculates the return of a mutual fund, or an investment manager. The SEC created uniform rules for how mutual funds would present their performance. An industry self-reguating group known as CFA (formerly known as AIMR) created detailed rules describing how investment managers should report their performance. (One of the rules says you don't cherry-pick.)

Prosper believes it is outside of such rules and regulations. This is true only because Prosper's product is new and different, and the regulators aren't engaged. I don't even know what regulator has oversight of the prosper & lender relationship. The regulators don't know yet either. Meanwhile, the best course of action for Prosper would be to very carefully avoid misleading people.

Some good news

Prosper has made some positive changes lately. Until recently, Prosper presented lenders with a set of default rate statistics provided by Experian. These statistics guided lenders by giving them default rate estimates for borrowers in each of the Prosper credit grades. Unfortunately, as long as a year ago we could see that the default rates of Prosper borrowers were running several times higher than the Experian-provided statistics, but Prosper continued to present these misleading numbers to lenders. In a recent upgrade, Prosper did away with the bogus Experian numbers and replaced them with stats derived from historical Prosper loans.

Bravo. One great big misleading thing has been removed.

But the newsletter... still misleading.

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