Prosper Around The Web

Time for some serious blog spam a linkfest :)

An article on Prosper from NuWire Investor:

It is common knowledge that banks make huge profits on the margin between the interest rates they charge borrowers and the rates they offer to savings account holders.

The sheer size of these institutions allows them to easily diversify among a huge pool of borrowers and account holders, and they have historically had a monopoly on the lending market. Prosper.com, the first major person-to-person lending service in the U.S., intends to change all that by connecting small-time lenders directly with borrowers.

RateLadder had debt sale comments from L5:

L5 is the 6th largest lender (pick your favorite stats site to verify) and he was on the large lender panel at Prosper Days. I asked him for insights in the aftermath of the latest debt sale that his portfolio might have uncovered. As a smaller lender I don’t necessarily have enough vision to be able to draw the most complete conclusions. He has been forthcoming and generous. Enjoy.

My Money Blog on his Prosper returns:

... A key part of that last sentence is if the default rates don’t keep rising. Sure the initial interest rate may be a snazzy 10-12%, but these loans are all three years in length, and my theory was that as time goes on more and more people will default on these loans. Or maybe some will vary between being late and becoming current again, so that the return stays pretty constant. Now that there is more history in their database, I decided to run some number to test this theory out.

We Have A Prosper Down

I went over to Prosper to see if some loans have finally gone through and funded and saw the following message:

Prosper Under Maintenance We are currently working on a system failure as of 2:20:00 PM Pacific, June 24, 2007. We are working to bring the system back online as soon as possible. Thank you for your patience. Best regards, Prosper

Wonder what's going on...

Update: Possibly some snags in yesterday's big update.

We are going to be taking the site off-line between 12:00 AM Saturday and 12:00 PM Saturday (Pacific time) on June 23 for maintenance.

We will be doing a big migration and upgrade of our infrastructure, and unfortunately, it is going to require 12 hours of downtime. During this maintenance window, we will be making significant upgrades to our network infrastructure in order to support continued growth of the community.

Update 2: From the Prosper forums

The site is back on-line as of about 9 PM last night (Sunday). We are pretty sure that the culprit was a faulty hardware component which has now been replaced. We've been monitoring the site since the new component went in, and so far things seem to be back to normal.

I apologize for the inconvenience, and thanks for your patience during yesterday's outage. Everything should be back to normal at this point.

Update 3 (7/3/07): Tom over at Prosper Lending Review notes that they still havn't gotten everything straightened out.

As of 12:12AM (PST) Prosper's website is down for maintenance. Prosper has had several outages over the past two weeks. Some of these were scheduled outages; other were not planned. I don't recall seeing a message about this outage so I'm guessing that it was not planned.

Modeling Default Rates Using Exponential Decay

This was a guest post over on RateLadder.com. Debate here or in their comments.

RateLadder proposed an exponential decay model for predicting the 3 year default rates on Prosper loans in a post on his site rateladder.com. I was quite skeptical that this was a safe model to use since it baked in a pretty hefty assumption. After a little back in forth, he invited me to respond.

By modeling default rates using an exponential decay model, you're assuming that X% of the remaining loans will go bad in a certain time period. Of the remaining good loans, the same percentage will go back after the next time period. For example, if 10% of the loans will sour every year. If you started with 100, you'd expect 90 still good after 1 year, 81 still good after 2 years, and 73 still good after 3 years. But will the default rate be constant? I think not, and, by looking at the financial cycle of the borrower, we can think through why. When the loan is funded, the Prosper borrower receives a big chunk of change - up to $25,000. They're flush with cash and can easily make the loan payments even if things not handled well. I'd expect lower than typical default rates. The extreme case is someone who borrowed the money and didn't do a thing with it. For one of my loans (picked at random), the borrower could make over 2 years worth of payments just by sitting on the cash. Not financially smart, but illustrative on how repayment can look good even when it's not sustainable.

After some time, the borrower will either be successful in their loan use (pay-off credit cards, start business) or not (rack up new credit card bills, business fails). This is loan payment crunch-time. The financially weak borrowers will default. Compared to the cash-flush period, I expect defaults to run higher as financial Darwinism hits and the weaker loans go bad. Following this crunch period and financially weaker borrowers falling out, I would expect that the remaining loan pool would be stronger with fewer defaults. There will be defaults but the remaining loans are more responsible and financially stable with the weak ones already in default.
Thus far, we have some fabulous hand waving. It looks like common sense, but common sense is sometimes deceiving. Moody's has kindly provided some insight and investigation to help with the common sense. In section of their 1999 Global Credit Research report discusses techniques used to model uncollateralized bond default rates, they discuss an "aging effect" and how default rates vary with time in a way very similar to the one hand-waved above. If it's good enough for them, there must be something to it.

The best test is to look at Prosper's loan data. Does it show aging effects? For this, the loans were placed into age groups based on month and the 3-year default rate predicted using RateLadder's exponential decay mode (ugly calculation: r = 1-e^(ln(pct_good_loans)/t). If the default rates change with age, there's an indicator for caution in using the exponential model.



As we can see, there are large variations in the loan failure rates, even after ignoring the first few months. Equally, most loan grades show some "aging effect". D is the most profound with a ramp up to a crunch followed by a slow decline.

But is the exponential decay model good enough? For the AA space, predictions for the 3-year default rates range from 1.5% to 9% (and more) based on with age group is used. The D space shows variations from 15% to 38%. HR is ugly regardless of what we do - the lender is screwed regardless of how it's modeled. From these curves, it is difficult to determine which predicted default rate should be used. This validates that the "aging effect" should be considered and makes it a dangerous model to use without a more careful understanding of the dynamics involved.

Handling Defaulted Loans

There's been rumblings about Prosper's defaulted debt handling. As in, they hadn't been handling it. It's resulted in some vocal criticisms on the Prosper forums. Well, the gates have opened and the defaulted debt has started selling

Yesterday Prosper began a delinquent debt sale. This happens when loans are 4 months or more late and are sold to delinquent debt buyers…

Loans receive different amounts depending on the credit grade and other borrower information. From my standpoint (observer as I have no loans in the debt sale) it appears that the better prices are paid for higher credit grades and homeowners.

John Witchel has also posted a blog entry on their debt collection and sale process

Collections are not a new business. A key objective of the program is ensuring legal compliance. This determines the majority of what we can and can't do. (We can't go to someone's house unannounced, for example. We can't impound their car. We can't call their employer. We can't harass or threaten people. No company can.) As a result, the process we follow is virtually identical to every other collections process under the sun.

We will continue to improve collections in the coming months (like fraud I can't talk much about what we're planning) but hopefully we'll all start to see incremental improvement. What I can say is that we are well-aware of the critical importance of collections as a condition of Prosper success.

This is all useful stuff as it helps with modeling loan returns. I had originally modeled defaults as destroying the entire value of the loan. This was wildly conservative, but I had no information to guide a more realistic default valuation. Better default modeling allows the lender to better gauge risk and (possibly) accept a lower loan rate.

Avoid Real-Estate

Some Prosper lenders who want to be socially responsible and bid on loans that some might consider risky because it's for a good cause. I'm not one of them. I'm interested in seeing my money come back to me and not disappear into a good cause gone bad. I've been watching the blog Calculated Risk and observing the deteriorating conditions in the mortgage and real-estate market. Just today, they noted the increased delinquency problems in mortgages:

... our latest subprime numbers are 14.4% delinquent by at least one payment, plus another 4.5% in foreclosure, for a total of 18.9% either delinquent or in foreclosure. For just subprime ARMs that number is 21.1%...

For this reason I've avoided listings that discuss using funds for real-estate problems. The real-estate market is troubled and I am unconvinced that the risks justify the attempt. I find this especially true since people get irrational about their homes, and will do quite irrational things to keep their homes. I've picked one example to highlight what I'm referring to:

My financial situation: I am a hard working, single mom and have been employed in the insurance industry for over 28 years. I also served four years in the US Navy. Once I am caught up on my mortgage payments, Wells Fargo Mortgage Company will offer me a loan modification - this will lower my current payment and enable me to repay a Prosper loan.
....
If I cannot pay my past due mortgage payments, I will have no choice but let our home go into foreclosure.

I cannot understand why lenders are bidding on this. They published a budget showing them $500 in the hole each month, admit that they cannot make payments on their current loans, and think that a 23% loan will fix problems with a loan that's most likely <10%. Almost 2/3s of their budget is the house - the loanee should run (not walk, but run) from the house if they were serious about solving their problems. And yet, lenders still bid.