Sunday, December 17, 2006

Who Borrows at Prosper?

Urbi et Orbi asked over in the Prosper forums: "Who is borrowing at Prosper?" (paraphrased)

So I decided to have a look. It's relatively easy to pull the Prosper listing data into Access, summarise by day of loan creation and credit grade and come up with a number. What is harder to do is to decide how to visually depict a long string of numbers. So I exported the data to Excel, created a pivot report and chart, and tried to interpret what I was seeing.

Here is the borrower population of Prosper, by credit grade as a percentage of all listings. In other words, if on day 1 there were 6 borrowers - 3 A and 3 HR, then each would show 50% and would sum to 100%. If on day 2 there were 12 borrowers, 6 A and 6 HR, they would still show as 50% and sum to 100%. You get the picture, I hope.

The orange chunk represents HR borrowers. The barely visible blue and pink lines near the bottom represents A and AA borrowers. Ignore the leftmost part of the chart, when Prosper was in start-up mode with limited release. There are not enough loans in there to make sense of the chart. The center and right portions of the chart does represent how Prosper is operating today. The vast majority of borrowers are HR grade. I've not charted NC, they make out an insignificant proportion of the population.

Looking at the data another way is also interesting. I plotted the cumulative numbers, so the top of the next chart is the total number of borrowers, and the lines depict the contribution of each credit grade to the borrowing population.

So now the growth of the HR population seems almost scary.

There is a huge population of HR loans floating around on Prosper. This has inherent risks for lenders, especially the newer lenders who may not fully realize the risk associated with HR borrowers. Heck, not even the "seasoned" 9-month veterans seem to have a handle on the risk of lending to HR borrowers.

Pninen publish a chart of late loans, and from that chart, it would seem as if the Experian default rates are not applicable to Prosper loans, especially not to HR category.

So, what are we to do? There is an increasing amount of money chasing a pool of good loans and a larger pool of risky loans. If you want to diversify and have Standing Orders (SO) bid on your loan, then the diversified risk does not seem to match the indicated or projected risk from Prosper's data. This is not Prosper's fault, they have done their best to provide guidance, but the numbers just didn't exist before the loan pool was created - they provided us with what they thought was the best approximation of risk.

An alternative is to hand-pick loans through reading the listings and interacting with the borrowers, either in Prosper email, or for the few who find the Prosper Forums, in there. The latter is tough. It feels sometimes as if one is watching a Christian being thrown to the lions in the Roman days. Some borrowers get through it, many more collapse under the pressure and a few nut-cases blow up completely.

Back to hand-picking your loans. Pensioner the biggest lender to date has indicated that this was his strategy. Look at the loans, and if you find a good one, pour a chunk of money into it. You cannot afford to hand-pick loans and then invest $50 in the loan, the numbers works out crazy.

Another option for Prosper would be to perhaps suspend listings from E and HR borrowers and let the current pool of loans mature so that we have more concrete statistics on which to base lending rates. Allow the better grades to list, but limit or prohibit Es and HRs.

I have previously alluded to what I perceive the problem with the E and HR credit grades are. These borrowers are truly risky, they probably cannot get loans anywhere else but Prosper and payday agencies, so they are willing to put up the maximum Prosper rates - 29%. Many lenders now don't fully factor in the risk and invest in these loans, fully anticipating a high return on their money. Then comes the waves of late loans and the investment turns negative and much wailing and gnashing of teeth erupts. Too late, you've sunk your portfolio into high-risk investments that doesn't make the grade.

An alternative would perhaps be for Prosper to only allow seasoned lenders with an existing portfolio of high-grade loans to diversify into the high-risk area. Perhaps limit those loans to a fixed percentage of a lender's portfolio until the lender has been lending for a year and have gained insight and experience with the performance of these high-risk loans.

In a year's time Prosper will also be able to provide its customers with better forecasting on the performance of HR and E loans.

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