Posted by Peer-Lend on March 27th, 2007
AUTHOR’S NOTE: This article was written in early 2007. Prosper’s market dynamics have improved considerably since that time, and Prosper now offers real-time historical market-based performance guidance. Please see my article on
Prosper.com’s Interest Rate Guidance.
Prosper loans are an entirely new asset class.
There is, quite simply, no (truly) analogous (or available) existing historical performance data to look to for guidance – even when it comes to lending purely “by the numbers”.
History is being made each day at Prosper.com – and the performance you see in your portfolio today will set the “true” (well, relatively!) baseline for this marketplace for the coming years. Until then, we’re not exactly flying blind – but we are certainly flying in uncharted territory. I think that’s more exciting than frightening – but not because I’ve shut my eyes to the realities of the marketplace:
- Prosper’s Experian default projections should probably be used as a very rough baseline reference only.
- Keep in mind that Prosper presents projected default rates in an annualized format. That is, the default rates that are presented are for one year (12 months) – while Prosper loans are for a 3-year (36 month) term. (This is a huge point, and I hope you’re reaching for a calculator or a spreadsheet if you didn’t already realize this.)
- Here’s some mathiness to get you started:[defaultrate] = projected default rate as a decimal (ie, the 6.2% default rate for D’s would be expressed .062)(1 – (1-[defaultrate])*(1-[defaultrate])(1-[defaultrate]))
= the 3-year default rate (expressed as a decimal)If you’ve been doing: [lenderrate]-[defaultrate]=return,
don’t raise your hand, but… don’t keep doing it.
- This will only get you so far, though, as defaults occur unevenly in time . While x percent of loans may be projected to default at some point during the 3 year term, there’s a significant difference to your actual losses depending on at what point the default actually occurs (since you’ll have received payments until that point).Modelling that behavior is beyond the scope of this post, but Prosper lender “pninen” actively maintains (and updates, every 2 weeks or so) a blog on the unofficial forums with charts of the default curve that’s shaping up.
- The projected default rates presented have both an “average” and a “range”. For example, while D grade borrowers (with less than 20% DTIs) may have a projected yearly default rate of 6.20%, this 6.20% average represents a range of 4.5-8.2%. As we’re all unlikely to match Experian’s sample size of 251,000 accounts, it’s probably a good idea to expect some further anomalies here (especially due to the relative smallness of our individual loan portfolios/samples).
- The Experian default projections do not seem to be very tightly correlated with Prosper loans (as an asset class). This is likely because the Experian projections are derived from a sample that included existing credit products that have characteristics (and credit qualifications) quite dissimilar from Prosper loans.
- The Experian sample is based upon data from bank card (credit card) products. As such, the sample includes only the performance data of borrowers who qualified (based upon their credit histories) for these traditional credit products.As you delve into the mid to low credit grades of Prosper loans, keep in mind that some (not marginal) subset of those borrowers would not qualify for the credit card products used to make the default projections (very, very roughly: the worse the borrower’s credit, the less weight to give to the Experian projections).
- Also of note that is that Experian itself warns that the projections go out the window for borrowers with Debt To Income ratios > 20% (though, in the actual Prosper marketplace data to date, DTI is rather loosely correlated with performance, on the whole).
This is by no means everything you need to consider when becoming a lender, but it’s a damned good place to start!
More to come, as I find the time…