The new wave of Peer to Peer Lending providers allow ordinary citizens to lend and borrow money with one another, online, in a convenient, secure and legally compliant manner.  But is there a way to leverage this new financial service by combining it with a highly networked (and highly internet savvy) political support structure?

We present 2 potential synergistic use cases for “Peer to Peer Campaign Finance” - plus a handy dandy flowchart outlining one example case.

Political campaigns, by ubiquitous necessity, collect the majority of their contributions via credit card.  A contribution made via credit card is nothing but a “loan” made to the contributor by the issuer of the credit card, with the proceeds of the loan then being transferred to the campaign (or, if you’re charging lunch, to a restaurant).  This type of loan arrangement does not appear to constitute a violation of the federal prohibition on making a contribution in the name of another person or allowing one’s name to be used to effect such a contribution - everybody does it, regardless of political affiliation, and has done so for years, and will continue to do so.

But, as often occurs, new technologies and new paradigms present… new opportunities.  The advent of online Peer to Peer Lending makes it possible for individuals (or groups of individuals) to make similar types of loans to one another - without the mediation of a bank or credit card issuer.  Given that the interest rates and payment terms on each loan can be set by the individuals involved, rates and terms are often more favorable than those offered by traditional credit providers, and, additionally, affordable credit can be directly extended to those who might not otherwise have access to it at the time.

• Case 1:   Peer to Peer Lending as a convenient, fixed-rate, 36-month alternative to Credit Card contributions.
  • Potential contributors sign up with a Peer to Peer Lending marketplace and request a loan.
  • Individuals (including, potentially, fellow supporters of the borrower’s cause of choice) bid on the loan request.
  • A loan is issued to the borrower at an interest rate set by the individual lenders who have bid on the loan.
  • The borrower is then able to use the proceeds of their loan to make their chosen contribution.
  • Borrowers repay the loan over a fixed schedule (normally 36 months) with a fixed monthly payment at an interest rate which was set by the individuals who bid on the loan, and which is not subject to change.

• Case 2:  Peer to Peer Lending as a convenient means for indirect support of a particular cause.
  • Individuals sign up with a Peer to Peer Lending marketplace provider to lend.
  • Loan requests by borrowers who support a common cause with the lender are identified.
  • Individual lenders bid on the loan requests of borrowers with whom they identify.
  • A loan is issued to the borrower from the funds of the lender (or a group of lenders).
  • The borrower is then able to use the proceeds of their loan to make their contribution.
  • The individual lenders are repaid over 36 months according to the terms of the loan.

Flowchart example - one potential P2P Campaign Finance implementation, “The Obama Loan“:

Think about that for just a minute. Happy 2008 Election!

Prosper.com’s latest site update announcement (August 14, 2008 - details on their blog) included the following very brief note which signals a major shift in market dynamics - and, potentially, depending upon details which were not released (and are not apparent - and, note to Prosper, therefore not transparent), has implications even to the overall platform concept:

Faster Listings for Qualified Borrowers
In an effort to get higher-quality borrowers through the Prosper loan application process more quickly, we’re testing a streamlined listing process where some borrowers post listings without adding a title, picture, or description. You’ll start seeing these listings on the marketplace, with titles like “My personal loan for [category]“.

While there were no further details about the exact criteria for this new “streamlined” process, depending upon how Prosper has structured this process on the backend, the following cases (or a blend/mixture of these cases) are quite likely to qualify for this new “credit details only” listing type:

• Loans which have a near certainty of funding (based upon a comparison of the exact loan characteristics with the available pool of lender “portfolio plan” dollars which are waiting to be automatically bid on exactly such loans.)
• Loans which have a high probability of funding (based upon the funding of past loans of similar characteristics.)
• Loans which have a high credit quality and are therefore more subject to competition from traditional credit outlets (lowering the barrier to entry for prime/near-prime borrowers who are accustomed to instant approval)

A number of lenders have mentioned to me, in private, that they feel this change robs them of the contextual information, contained in the usual “Why do you want a loan?” narrative, written by borrowers, which they believe is necessary to make an informed decision about whether or not to lend to a particular borrower. I understand, and, having done most of my bidding on Prosper manually (without the use of standing orders or portfolio plans - and only after reading the listings), share this concern (and certainly hope that making a “traditional” listing will always be an option for all borrowers, regardless of credit grade - given that a compelling listing always has great potential to attract more bidders and lower a borrower’s final rate) — but — and this is a very important “but” - I do see the efficiency gain inherent in this change, both for lenders who wish to deploy capital more quickly and for borrowers who place a premium on their time - and for a platform which desires to increase originations, especially if those originations are to prime-ish borrowers plucked straight out of the mouth of VISA or MasterCard.

At the same time, though, and, specifically, to address, head on, the major complaint which has arisen (and which will, no doubt, become more plaintive as more of this type of listing populate the marketplace - and more lenders realize there’s been a subtle, but potentially dramatic, shift), I do not see how this change in any way alters Prosper’s positioning as a “Peer to Peer” lending and loan platform. The loans are still funded, in an open auction process, by a mixture of individual lenders - and the loans are still taken out by individual borrowers. And that still sounds like Peer to Peer Lending to me.

While the change certainly will make some percentage of listings less “personal”, and may, therefore, make interaction with the platform somewhat less “social” (or, at least, somewhat less “voyeuristic”), I fail to see how the absence of a kitty picture (and a legally non-binding paragraph about what kind of cabinets the borrower intends to install in their kitchen - to hold their estimated budget’s X dollars of food per month for which they don’t, in reality, actually budget) somehow means that the loans, or the platform, are no longer “peer to peer”.

That said, there is a certain, almost Old World, charm to the idea of “Social Lending” - a very different, if tangentially related, concept - wherein lenders select borrowers to fund based upon some affinity or connection that they might mutually share - and which connection, on Prosper anyway, can only be established through the perusal of a borrower narrative, in the traditional listing format. The days of Social Lending, at least on Prosper, and at least for many prime borrowers, may now be on their way to an end - which is a shame, given that even prime borrowers often benefit, rate-wise, from bids placed by the non-marginal percentage of lenders who enjoy the fun of clicking through listings, looking for that special one that clicks - and upon which they feel comfortable - or even good about! - clicking “Bid Now!”.

(The other side of this coin is that it’s very often possible to exclude borrowers - and therefore not bid on bad loans that may fit your credit screens or fall into your portfolio plans - based upon reading narratives that might make a highschool math or english teacher cry - or make an honest street hustler blush at the sheer brazenness. No longer being able to avoid loans - even many prime/near-prime loans - that clearly make zero sense is a tangible and real loss of informational edge.)

I’ll have more to say on these topics in the coming days - but hope, in the meantime, that Prosper will clarify its position, specifically regarding whether borrowers who qualify for this new streamlined process will retain the option to create a traditional listing, how such an option will be presented to those borrowers (who may not understand that they will be, informationally, “pricing themselves out” of receiving many bids from “social lenders” should they opt for the “streamlined” listings), and, if Prosper is feeling up to it, giving some guidance re: the vision for the marketplace as a whole - and where it may be headed - especially given the (seemingly) contradictory, Hydra-like, directionality of late: the scaling back of listing details - to which many lenders have become accustomed to rely on - for some unknown subset of loans, coupled with, at the same time, enhanced emphasis on “social” features (such as Family & Friend Lending).

Are we on the way to a more granular marketplace - a more “streamlined” prime-ish market and a more “social” sub-prime-ish market - or are we just… confused? Pending some sort of vision statement, we’re left to speculate. And that’s not a comfortable position for anyone.

I wrote about the P2P VC concept several months ago in an entry on LendingClub’s corporate blog, so I was excited to see that someone had finally figured out how to legally implement the concept and allow large groups of small, unsophisticated investors to place funds directly into startups looking for seed capital - without running afoul of SEC securities regulations.

The “creativity” of Atlanta-based startup 40billion.com’s solution surprised me, however, to say the least. While they bill themselves as the first “Friends and Family Funding Network for Entrepreneurs”, and continually make use of the term “investment” (as in: “Investors contribute as little as $50 or $100 each, but these small investments really add up” and “Investors receive social returns, financial returns, and discounts”), a close reading of the site reveals a model that, in the carefully chosen words of 40billion.com “allows many investors to give small amounts of money and spread the risk”.

Didn’t catch it? The key word, buried in the seventh paragraph of 40billion’s launch press release, is (drumroll): “give“. That’s right - in exchange for, well, nothing - you can “invest” in as many up and coming startup companies as you like, and 40billion will pass along your investment dollars to the entrepreneur (or entrepreneurs) that you’ve chosen to “invest” in.

Of course, your “investment” will also be slightly diluted by the fact that 40billion.com will pocket “a small service fee of 5-7%” on the front end, so, instead of owning, um, -none- of the company that you have(n’t) invested in, investors will actually own none… minus 5-7%.

Personally, I think this is brilliant - and I went looking for who could have come up with such a clever and elegant solution. The “Founder & Co-Chief Venture Officer” of 40billion, one Cornelius Colin McNab, who, according to his onsite bio, “is an inventor with three patents and holds an MBA from MIT and a degree from Yale” (and whose entry into MITs 2005 Sloan School Entrepreneurship Contest was something called “Circle Funding”, which aimed to allow “the poor” to pool their savings and borrow from one another - interest free), is also the principal of “3 Guys In A Garage” (listed as the “backer” of 40billion).

3 Guys has a “Venture Wiki” where, apparently, all the big ideas are birthed - indeed, 40billion originated there! - including such concepts as the “Perfect Toothbrush” (tagline: “Don’t brush your teeth anymore!”) and the “BeerTender”, a vending machine for alcoholic beverages (why were cigarette machines outlawed again?), and, my favorite, “Totally Free TV” which is explained as follows: “What if TV were free, commercial-free. This idea seeks to pick up where Tivo left off, and eliminate commercials altogether. I think this requires a new, disruptive business model. Any thoughts?” Yeah, uh - drug testing?

To their credit, 40billion does mention in one place that entrepreneurs might “offer investors something in return for their investment (e.g., a customer discount or free sample)” and promises in one other place that support for “loans and equity investments” are forthcoming - “soon”. In the meantime, however, they do no identity verification or OFAC checking, so, if I had to guess, many of their first round of entrepreneurs, and investors, might be in the “laundry” business. I’m sure Uncle Sam will be thrilled.

On a final note, 40billion’s site indicates that its business model is patent pending. Given that the “CVO” hasn’t heard of cable television, it’s no surprise that he also hasn’t discovered long-running ventures like Fundable, ChipIn, & DropCash.

In a major development in the P2P Lending space, one that has implications for the entire P2P Lending model as it currently exists, it appears that LendingClub.com has partially ceased operations. A notification is up on their site that they are no longer accepting new P2P lender registrations and that no further loans may be made by P2P lenders, though they do apparently plan to continue issuing loans to new borrowers, however, the loans will not, strictly, be “peer-to-peer“.

The stated reason for the shut-down is that they have begun a process of registering the loans as securities (presumably with the SEC) and so must enter a “quiet period”. As well, LendingClub claims that existing loans will continue to be serviced and that lenders will still receive payments. Curiously, they also say that borrowers may still register and seek loans though those loans will be funded and owned by LendingClub.

There has been a large amount of speculation recently in many corners that the P2P Lending models might be subject to some legal uncertainty regarding whether the loans should be classified as securities (and would therefore need to be registered with the SEC). The speculation has primarily been concerned with who, in fact, owns the loans (notes), and how exactly that ownership (or various ownership interests) are transferred between the originator of the loan (the P2P Lending company) and the individual “P2P Lender” (more info here).

It is unclear whether LendingClub has ceased operations as a result of an SEC action or whether LendingClub has chosen to bite the bullet and submit to regulation voluntarily. This event could have major repercussions for other P2P Lenders in the US with similar business models.

I received the following email which contains slightly more information than what was available in the onsite notification:

—

Dear (Peer-Lend),

Lending Club has started a process to register, with the appropriate securities authorities, promissory notes that may be offered and sold to lenders through our site in the future. Until we complete the registration process, we will not accept new lender registrations or allow new commitments from existing lenders. We will continue to service all previously funded loans during this period, and lenders will be able to access their accounts, monitor their portfolios, and withdraw available funds without changes.

The borrowing side of our site will remain generally unaffected by this registration process; borrowers can continue to apply for loans and new loans posted after April 7, 2008, will be funded and held only by Lending Club.

Until the registration process is completed, the company will undergo a quiet period and will not be able to respond to press and other inquiries about Lending Club or the registration process during that time.

Q&A:

Q1. What about money I have begun moving, but is still in transit to Lending Club?
A1.1. If you are in the process of verifying your bank account, you will be able to complete that verification but will not be able to add new funds
A1.2 If you have initiated a transfer, the funds will be displayed in your Lending Club account balance as soon as those funds are available.
A1.3 If you have uncommitted funds, you may request that Lending Club return those funds via the same method used to load the funds. For example,
• If you have initiated an ACH to add funds, these funds will be transferred into your Lending Club account but you will not be able to lend these funds out. You can go into your Lending Club account once the ACH transfer has been completed and withdraw funds back into your linked bank account..
• If you’ve wired funds into your Lending Club account and have not yet committed these funds into loans, you can send a request to support@lendingclub.com for us to wire these funds back to you at no charge.
• If you’ve sent funds by check, and have not yet committed these funds into loans, you can send a request to support@lendingclub.com for us to send you a check by mail for the same amount at no charge.

Q2. What about referrals?
A2.1 The current referral program is terminated. If you have referred someone who has already signed up as a lender or a borrower, or if you have been referred by someone and have already signed up as a lender or a borrower, you will be receiving your referral payment within the next few days.

Sincerely,

Patrick Gannon
Senior Vice President
Lending Club
440 N Wolfe Road
Sunnyvale CA 94085
www.lendingclub.com

Last week, peer-to-peer lending provider Lending Club began offering data exports containing a variety of information from their peer-to-peer lending platform/marketplace, including: data for loans that have funded to date, loans whose listings are currently active, and loans which were rejected for not meeting Lending Club’s strict credit qualifications (minimum 640 FICO, with no current delinquencies). On the heels of this release, the first independent third-party statistics site was launched to report and analyze Lending Club’s listing and loan data.

LendingClubStats.com features easy to read charts and analyses of LC’s loan data exports and also includes functionality that offers the ability to more quickly browse through active loans, as well as to sort loans by minimum interest rate and by loan amount. The site is administered by the developer of Eric’s Credit Community, one of the first statistics sites devoted to another P2P lending site, Prosper.com, which launched in early 2006. (For those who wish to slice and dice the loan data on their own, the exports are directly available from Lending Club in both CSV (comma delimited) and XML formats.)

Lending Club’s provision of marketplace data marks an important milestone in their development as a transparent peer to peer lending & loan platform. Lending Club’s main competitor, Prosper.com, the first-mover in the US P2P lending space, has offered comprehensive data downloads of all of its marketplace activity since mid-2006. A budding ecosystem of third-party statistics and analysis sites (as well as other clever uses of the data, such as “fantasy” market simulations) have grown up around Prosper’s efforts at P2P marketplace transparency, and, hopefully, this will be the beginning of a similar process around Lending Club’s efforts at same.

A collection of peer-to-peer lending tools, including links to the Lending Club statistics mentioned in this article (as well as links to the entire Prosper.com third-party ecosystem) are available on Peer-Lend’s P2P Lending Tools page.

The second Carnival of Peer-to-Peer Lending installment was hosted by BripBlap & included the following articles:

RateLadder dispenses some Not So Obvious Tips to Maximize Your Chance of Funding for Prosper borrowers (including neat graphical analysis of factors like listing time, duration, and description length), and also presents updated Prosper vintage curves (late rates, as of 1/1/08).

Pinyo at Moolanomy funds his Second P2P Loan on Prosper and muses about the relative benefits of Prosper’s portfolio plans - plus fends off a comment derailment concerning the ethics of lending & borrowing money (online or off) from someone trying to (wait for it!..) sell a book about the evils of lending & borrowing money (online or off).

Tom of Prosper Lending Review scores an Interview with Chirag Chaman of Fynanz, a new Peer-to-Peer (P2P) Lending startup that aims to take a bite out of the traditional student loan market. Very interesting to see P2P expanding in this direction, but no word on the most important question that will undoubtedly affect the dynamics of this market and whether it will go beyond just “friends and family”: Will these P2P Student Loans be just like any other unsecured debt and dischargeable in bankruptcy, or can (a much larger market of) lenders expect (and price for) these loans to be federally certified and therefore non-dischargeable?

WiseClerk channels Nostradamus and makes some predictions about the P2P Lending space in 2008. No quatrains, sadly, but still some interesting ideas regarding possible insurance products and Peer-to-Peer market expansions.

Brett at PersonalLoanPortfolio wonders Why Lending Club Denies Most Loans. This is a very interesting question, and one that I’ve asked Lending Club about in the recent past. Rob from Lending Club stops by to assure lenders that loans which are not old enough to have a payment due will no longer be included in performance calculations, as well as to explain why Lending Club has only accepted about 11% of borrower applications thus far, citing a committment to marketplace safety - though I do have to wonder if the extremity of that figure doesn’t have more to do with Lending Club’s palpable lack of guidance in the borrowing process.

DoughRoller Overcomes His Fear and Lends on Prosper.com through a process of reasoned analysis and a commitment to go slowly, and decides that Portfolio Plans will make his investing much less emotion-based. We’ll check back with him after his Portfolio Plan bids with no compunction on a listing whose text includes the word “desperate” (grossly misspelled).

Hey Prosper Lenders! Question from a Borrower.. from Amanda @ Me vs Debt, wonders aloud how lenders feel about the availability of additional loans within the Prosper marketplace. (My advice is to disclose it in your listing - since Prosper discloses it anyway! - and let the bids fall where they may.)

Rounding out the pack, MoneySmartLife offers an Overview of P2P Lending.

That wraps up the 2nd Carnival of Peer-to-Peer (P2P) Lending - anyone want to try to knock over some bowling pins? Just $1 a ball!

Lending Club, the peer-to-peer lending site, is offering a 5% cash-back bonus to lenders who lend $5,000 or more by February 3rd, 2008.

OK, that sounds neat, but what if you have access to a fair amount of capital -and- a fair number of friends with good credit who you’d trust to loan a large amount of money to for a short term? If you think like me, that slight “wait a minute!” w/accompanying head tilt = Game On!

Time for big math: For every $25,000 you lend out, you’ll get $1250 credited to your account on February 15th, 2008. Why, that’s free money!

This is an incredible deal for the properly positioned, but first the details: You must lend $5,000 to qualify for the 5% bonus. Once you hit the $5,000 mark, the 5% bonus applies to the initial $5,000 as well. You must lend this money out by February 3rd, 2008. The loans do not have to be issued by that date, but your portfolio plan (essentially, your “bid” or “bids”) must be placed by that date. Lending Club will credit your account with the 5% bonus as CASH BACK (whether you choose to lend this money out, or transfer it back to your checking account is up to you!) on Friday, February 15th, 2008.

That’s the promotion in a nutshell, but there are some important details that will affect your 5% bonus:

Depending on the credit grade of the borrower, Lending Club takes an origination fee from the principal amount of the loan (deducted from the amount the borrower receives). They also take a 1.00% payment servicing fee on all incoming payments, so that’s another 1.00% off your 5% bonus. But, here’s the sweet part: There are NO early payment or pre-payment penalties!

Here’s a table that lays out the fees (and expected return) on any monies lent to borrowers of a particular credit grade:

You can also make an additional $25 by signing up for your Lending Club account through my referral link below (I’ll get $25, too). If you sign up using the referral link and make an initial deposit of at least $1,000, then you’ll get a $50 bonus instead! And, if you have your borrower (ie, Mom) sign up through this link, she’ll make an additional $25 as well. Sweet, huh?

Click here: LendingClub $25/$50 Bonus Referral Link for Lenders & Borrowers

Once you click the referral link, your referral will be tracked only for that session. So you must not close your browser or navigate away from the LendingClub web site before signing up for an account. If you do, the referral will not track (bye bye bonus!), so you must come back and click this link again and sign up in the same session to qualify. Sign up quickly! The promotion ends on February 3rd, and it takes about a week to verify your lending account and move funds in to lend!

One last note, LendingClub.com has capped this promotion at $20,000 per lender, so you can only lend out (and make the 5% bonus on) a maximum of $400,000. Sucks, huh? You know, unless Mom wants to lend, too… Let the games begin!

Promotion details available at: http://blog.lendingclub.com/thank-you and http://blog.lendingclub.com/2008/01/17/update-on-the-thank-you-program

(Note: These are not referral links, and if you sign up through these links, no sweet free money for you - or me either!)

Prosper has recently done something *wonderful* for current and future Prosper Lenders. But I bet you don’t know what it is - or, if you do, why it’s so unbelievably important.

Since it’s garnered very little attention in the P2P Lending Community thus far, I wanted to shine a little bit of light on it here, because, quite frankly, it’s a monumental step - both for Prosper Marketplace *and* for the evolution of the entire Peer to Peer Lending space. Ok, alright already… enough pre-amble.

Let’s hear it:

Since Prosper’s launch in February 2006, lenders were presented with Experian default projections as baseline guidance for predicting default rates for each credit grade. Judging by the bidding behavior of many lenders, these default projections were trusted, to a large degree, as being both accurate and applicable. I won’t go into why they turned out to be so grossly inapplicable to Prosper loans (or online Peer to Peer loans in general) - since I covered it a long time ago, and since I’m so happy to see them go! - but if you’re interested in the history behind the story, you can see one of my old posts on Prosper Default Projections.)

Regardless, they *are* history! Gone. Finito. Outta here. And none to soon.

On October 29th, 2007, Prosper released a site update which leverages historical Prosper Marketplace performance data to present lenders with *enormously* improved bidding guidance. And not only that, but they chose to display it directly on the bid entry screen. My heart goes pitter patter for all the lenders who will be saved time, money, and a considerable amount of frustration by getting a much more accurate picture of what rates they *ought (more) rationally* to be bidding.

Here is the (understated) announcement of that release:

Improved bidding guidance for lenders

As the Prosper portfolio has grown and matured, we finally have a volume of loan payment activity that has allowed us to replace the Experian historical default data with Prosper’s own estimated default data.

We have also performed some analysis on the differences between borrowers within the same credit grade, and segmented the borrower population into 54 unique segments (one segment, for example, is C-grade borrowers with no automatic funding, 0 now delinquent accounts, and 2 or more inquiries). Based on which segment the borrower belongs to, we will display the estimated loss (due to default), rate adjustment (uncollected interest and fees), and annual servicing fee, and come up with an estimated return for loans to borrowers of that type.

Here’s an example of the new bid input for the example borrower:

What the above translates to in practical language is that each time a Prosper Lender places a bid, they will now see a detailed breakdown of the past performance of Prosper loans with similar credit characteristics. Not only that, but Prosper also breaks down the estimated default loss percentage, adjusts properly for interest loss and service fees, and provides a properly calculated Estimated Return figure - all based on the past performance of *actual loans made in the Prosper Marketplace*.

Read: REAL GUIDANCE.

It took Prosper a year and a half to implement it, but, it’s important to understand that you can’t roll out a feature like this in the absence of data to base it upon. It simply took a while for the first Prosper loans to age enough for data to be available - and getting this feature out, this soon, and available to every lender, is a MAJOR coup.

At nearly the same time, on the borrower side, Prosper began providing initial interest rate guidance to borrowers, also based on historical marketplace performance data.

So, let’s look at a couple of charts.

First, loans by credit grade per month (chart courtesy of Prospers.org Statistics Wiki):

Are those the early signs of a sharp decrease in low quality loans being funded? And, if so, could there be a related increase in interest rates for loans that *do* fund?

Let’s take a look at the rates of funded loans by grade (courtesy: EricsCC.com):

The sharp up-trends in interest rates for funded loans, especially those of lower grades, tell the story quite well.

It might be too little or too late to save some of the early-adopters from lending pain, but you really do have to give Prosper the credit they deserve for this one.

From now on, we might still be flying partially blind - but at least now we’ve got a map!

(We now return you to your regularly scheduled Prosper-drama, already in progress.)

One of the most often misunderstood issues I see popping up on the official forums with some frequency is that of reinvestment risk. To be absolutely clear, the kind of “reinvestment risk” that I’m referring to here is that which is taken on when good borrowers make their payments or pay off their Prosper loans (remember that there are no prepayment penalties) - and lenders are, naturally, put into the position of having to attempt to re-deploy that money into a new loan (or new loans).

• As Prosper offers no interest on deposited funds at this time, having funds repaid puts the lender in the situation of earning zero return on those dollars (and having to find new loans to fund). This causes a (usually small) period of dead money, while lenders wait to find a new listing that they feel comfortable bidding on (or wait for their SO to do the same).
• In addition to the selection time involved in finding a new listing, one must also wait some number of days for that new listing to close. So, now you’re looking at 2 (business) days of undeployed funds while your borrowers payment (or payoff) clears, plus X amount of time for selection of a new listing to invest in, plus X number of days for that listing to close, plus X number of times you have to repeat this process in the event that you are outbid from your selection(s) or in the event that your selections do not fully fund.
• Add to this another 1-7 days (usually somewhere around 5 days, on average, currently) for Prosper to verify the borrower’s details (post-auction) and actually originate the loan. You don’t make any money during this downtime either - and there’s no guarantee that the borrower will pass verification. In the event that they don’t, you’re back to step 1 again.

In my opinion, the above issues (aside from the issue of Prosper not providing some sort of investment vehicle which offers interest on unlent funds - the desirability of which they ARE painfully aware) are marginal, in the grand scheme of things, and not really worth worrying about given the likely small amounts of both money and time involved. However… there are some follow-on issues which I do believe are worth giving some serious consideration:

• Defaults occur unevenly in time. That is to say: Defaults occur at different points during the lifespan of any particular loan. If a loan defaults in month 30, you will suffer less of a loss (maybe even still managing to make a small profit, depending on rate) than if a loan defaults in month 3.
• Since defaults occur unevenly in time, it is instructively necessary to plot aggregate loan performance data in order to get some rough idea of the default behavior we should expect over the life of the average 36-month Prosper loan.
• Plotting this data yields us a “default curve”. The default curve is simply a visual representation of the behavior (over time) of Prosper loans. We look at the totality of the loans made in the marketplace (though you can certainly be more specific, if you’d like) and say “x loans defaulted in month one, y loans defaulted in month two, etc”, all the way up to 36 months, and then present this information in “bar graph” format. We then fit a single line to connect each peak on the graph in order to form a curve. Basic stuff.
• You may find it helpful to think of this curve as something like a “roller-coaster”. Every new dollar (and every reinvested dollar) that you invest in a Prosper loan can be thought to follow this curve, from origination at month 0 to payoff at month 36.
• Keep in mind, though, that there’s no “safety restraint” holding individuals borrowers to their seats: borrowers may pay early or pay off their loan entirely, at any point and with no penalty (ie, they may jump out of their “car” at any point during the ride). They may also default at any point in time.
• When reinvestment is necessary, either because of borrowers making their normal payments or paying off early, the dollars that you have invested with them (that they have just repaid) are sent to get back in “line” and to be reinvested into a new loan (”to go for another ride on the Default Curve Express”).
• Why does that matter? It matters because, just as with a roller coaster, some parts of the default curve are more dangerous (or “exciting”) than others. We only have approximately six months worth of viable data at this point, but there is already a clear initial incline (just as many roller coasters start by pulling you up to some height) - an incline which, it is hoped, will be followed by a distinct drop and levelling off (of defaults).
• Let me say that in another way: If, for example (and I’m not saying this is the case, it’s still too early to tell), the first six months of a loan are when it is most at risk for defaulting, then, each time you have to reinvest repayments into new loans, you are forcing those dollars not only back “into line” (and into the delays mentioned above), but also, once the new loan originates, those dollars will be travelling the riskier initial parts of the default curve. (ie, your dollars were tooling along in the virtual flats, post loop-de-loop, of the latter parts of the ride, coming safely back into the station - but, a few bucks decided to get off early, and now they get to start over and do the “fun” parts again).
• When you take this default curve behavior into account, you are able to approximate the risk differential (or expected return) between a loan aged, say, 3 months (still travelling the dangerous first parts of the ride - with plenty of track left to cover), and a loan aged, say, 30 months (that has already successfully passed most of the risky parts of the curve - and therefore presents less of a risk).
• Quantifying this risk is difficult, due to the lack of historical data. But, it is a safe bet that there will be parts of the curve that are more risky than others - perhaps substantially so.
• Though we can’t extrapolate out very far from the data that we do currently have, there are, at least, some hypothetical assumptions (probable psychological effects) that may come into play and give us some idea of what to expect (such as a possible slope in default behavior toward the latter part of the life of a loan, perhaps driven by something like a “no sense ruining your credit now that you’ve only got six payments left to make” or an “almost-there” effect). That kind of thing is exceptionally hand-wavy and uncertain, but it does underline the uncharted-ness of the territory, and the lengths one has to go to in order to “guess”.
• The indisputable, and non-hand-wavy, fact, though, is that subjecting repaid funds to another go on the 36-month default curve roller coaster incurs an increased level of risk for those funds. We might not know exactly what it is yet, but it’s certainly there…
• The fear that follows from this uncertainty is thus: That good borrowers will make their payments on time or pay off early, and that, since the “good” borrowers return funds to us that must be reinvested (and since the bad borrowers do not return some percentage of funds to us), that there may be an amplification of negative effects. Since our money is so often made to travel the riskier parts of the curve - and, since it is therefore, much more often than we would like, exposed to new borrowers in new loans - it is therefore to exposed to the higher risk of default/loss. Couple that with the fact that at the beginning of a loan we have the most outstanding principal, “good money”, at risk (exposed to the entirety of the “risk track”) and you begin to see why this may become a non-negligible issue in the long-term (and one that should certainly be watched in the short term).
• In particular, if loans that will default will also tend to default early in the life of the loan, then we may find ourselves open to losing larger (initial) amounts of principal at an increased frequency (increased, at least, from the frequency that one might think if one considered only “default rate” in their risk calculations).

• Prosper.com uses a proprietary & predictive credit scoring model called Experian ScoreX PLUS(sm) to calculate borrower credit scores. Prosper then assigns a letter grade based upon specific score ranges.
• While the score ranges may look similar to FICO(tm) scores, they are not FICO(tm) scores.
• As ScoreX is a predictive model, the credit grade that borrowers are assigned by Prosper (based upon the numeric ScoreX score) may differ considerably (sometimes better than you might think appropriate - sometimes worse than you might think appropriate) from the credit grade that would be assigned if a more traditional FICO(tm) or FICO-like scoring product were employed.
• ScoreX is built for assessing risk for new accounts on different types of existing credit products. Prosper loans are a new credit product, and one which has little in common with several of the types of data included in the sample that the ScoreX model uses for prediction.
• Of the types of credit products that the ScoreX sample consists of (auto finance loans, mortgages, home equity lines, and credit cards), many are credit products that are secured by real property - whereas Prosper loans are unsecured.
• The same caveats about “credit qualification” that apply to the Experian default projections also apply to the ScoreX model: The sample consists of the performance of borrowers who were approved for new accounts on traditional banking products. Many Prosper borrowers in the mid to lower credit grades would not qualify for traditional bank or credit card products, and so correlation (and therefore predictive ability) seems to decline sharply as credit quality falls.
• After close observation of ScoreX over the last year, it is at least clear that the majority of the same factors that would lower your traditional credit score also affect your ScoreX score - though perhaps not to the same degree. For example, DTI and utilization of available credit seem to be more heavily weighted in the ScoreX model, as does length of credit history.

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.
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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…