Saturday, January 13, 2007

Blame the Lenders? Or the Borrowers?

There is much talk of the poor quality of listings on Prosper. Many lenders complain that they cannot find quality listings to bid on. Even more lenders are complaining about the higher-than-normal* default rates that they seem to experience.

There are, in my opinion, two possible causes. One is that we are getting poor quality listings to bid on, the other is that we are making poor choices.

First, let's look at what is on offer. The following chart shows, on a month-by-month basis, the composition of all (funded, unfunded, withdrawn, whatever) listings on Prosper.

Wow! HR listings make up nearly 60% of the total listings. Add the E-grade listings and we are up to 80% of the buffet on Prosper. Slim pickings, indeed. remember, these are credit grades that banks and Experian assign great risk to.

What do lenders do in the face of such a dubious menu? See this chart.

I think we display some restraint, but not nearly enough. In the last 3 months or so, we've started allocating nearly 50% of our funds to those risky credit grades! That's ridiculous.

The great thing about writing this blog is that I can lay the blame wherever I choose. And I choose to blame high interest rates. The famed Cellardoor always found a way to introduce the phrase "adverse selection into threads.

Now the way I understand adverse selection is that we choose to do that which is wrong for us. We choose to bid on listings with high interest rates because the high interest rates appear attractive. What we don't fully factor in that those high interest rates come with great risk to our capital.

Lenders that stay on Prosper after a while see the defaults add up in their portfolios, wise up and move away from the highest risk grades. New lenders pile into these high-risk loans and make tragic mistakes. I'm going to figure out a way to plot this and see if I can prove this theory.

I think Prosper should do two things. One, make it attractive to higher-grade borrowers to come and borrow on Prosper. That include speeding up the borrowing process and inhibiting lower-grade borrowers from having so many listings on Prosper.

Two, protect lenders from themselves. Even the mighty Big Gulp eventually suffered defaults in his portfolio of HR loans. Mandate some form of restraint on lenders, be it relative portfolio allocation, minimum amounts, time as a lender, whatever. Just stop new lenders from burning themselves on the deadly, attractive flame of high interest rates.

* I'm well aware that there is no such a thing as "normal" or even "expected" returns on Prosper. The published rates are woefully inadequate and doesn't cover listings with high DTIs. The published rates doesn't seem to apply to loans on Prosper. Lenders build individual portfolios that greatly differ in performance.


Gavin Andresen said...

I don't bid on HR loans.

Prosper gives you PLENTY of warnings when bidding on high-risk loans (I bid on my first NC loan the other day, and the BIG RED MESSAGE WARNING ME THAT I MIGHT LOSE MY MONEY was pretty darn obvious).

If lenders want to gamble with their money on HR/NC loans, they should be free to do so. It's their money, as long as Prosper stays transparent (and they're VERY good about giving us information on loan performance, in my opinion), Prosper shouldn't do anything about lenders being idiots.

The only suggestion I'd have is that Prosper let you filter searches/standing orders by the number of recent listings a person has...

Anonymous said...

I do believe that Prosper needs to protect the lenders from themselves. Sure it's the lenders money, they should know what they are doing, but do they?

To protect the longevity of Prosper, they need to protect lenders from over indulging.

Not sure how or what Prosper should do to implement this, but it does need to be discussed.

Anonymous said...

Prosper needs not impose any restrictions on a lenders ability to fund the loans they feel fit with their level of risk.

Every investment vehicle has the potential to lose it's value and Prosper is not unique in this event.

As they says in the investment world "do your own due diligence".

Anonymous said...

HR people will always continue to be HR people. All of them say how importiant it is to re-establish their credit. Bla, Bla, Bla.
Made a lot of mistakes in coledge. Bla, Bla, Bla. I'm on track now and looking to get my AA rating is alot of bull SHIT. 99% will falt you. I have 23 loans and all of them are HR. More than half pay late when they feel like it. Idiots. Yes, I am the real idiot!!!!