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Collections Series – Part 2: Debt Sales and Charge-off Collections – Status and Plans

by Doug Fuller on 08/10/09

Today’s topic focuses on what in the industry is called “Recoveries”. A recovery is the amount of money that you can extract from a debtor once a loan has been charged off and the value of the asset has been written down to zero. Although effective collections on charged off loans can reduce the impact of credit losses, keep in mind that recoveries can be significantly less important to a lender’s success than loan selection, pricing for risk, and diversification.

Given the regulatory structure under which Prosper was launched, there were certain practices that Prosper could not use without the consent of a majority of lenders. Our terms of service stated that at day 31 past due we place the account with a collection agency engaged to “cure” the account. If they were not successful, when accounts reached 121 days past due, they were held in a pool (with the agency continuing collection activity) until that pool was of sufficient size to sell the accounts to an unaffiliated debt-buyer.

The debt sale portion of this process worked reasonably well through year-end 2007. Prosper had four debt sales and lenders received recoveries ranging from 2.4% (cents on the dollar of outstanding principal) to 30%. There was a different buyer for each of the four debts sales and each buyer used different criteria to segment their pricing. Factors included: credit grade at origination, home-ownership and state of resident.

Looking below the surface of these sales, there were signs of weakness in the demand for Prosper’s loans. In the cases of the early sales, although a number of debt buyers were interested in viewing the file, there were few bidders. No previous bidder ever bid on a subsequent sale. There was a downward trend in sale price from the first to the last sale. In general the feedback we received from debt buyers was that the file was too small and the collections performance of the loans was unknown.

In April 2008, we sent out a bid file for what would have been our fifth debt sale. At the time we sent out the file, we knew that the market was saturated and prices were falling rapidly. When the bidding closed, we had what it appeared to be a bid of 3%. However, as we went into contract discussions, the buyer added a number of provisions and other conditions that made the deal unworkable. The best unencumbered bid that we had was only 1.5 cents on the dollar – with no differentiation by account attributes. We concluded that taking this offer was not the best economic decision, and not in the best interest of lenders.

So what’s happened in the past 15 months? Were we right or wrong not to take the bid?

The inventory of debt for sale continues to grow. Michael Ginsberg of Kaulkin Ginberg estimates that prices have fallen by 35% or more in the past year. Moreover, in a market saturated with credit card debt, there is no appetite for a new asset class such as Prosper loans.

If you look at the population of loans that were slated to be sold plus all the loans that would have become eligible to be sold by November 30th, 2008 – this represents the universe of loans that would have been sold during Calendar Year 2008. It totals 2,697 loans with total principal balance as of DPD 121 of $30,561,042. Going from the cut-off date of the sale file – or from the date when a loan reached 121 day past due, whichever is later, and looking at the payments received net any agency commissions, we have collected $695,244.22 in “recovery payments” on these loans or 2.27% of the principal balance [note: I use quotes around "recovery payments" because we did not identify payments as such until we implemented the "Charge Off" status on 10/28].

This shows a value higher than what the loans can command in current marketplace. So that should be a good thing – still there is an issue. The $695K in payments came from only 385 loans (14.3% of the 2,697 loans that could have been sold). Those 2,697 loans were funded by 26,401 lenders.  Of these lenders, 40% (10,588) received at least one payment and 24% received more than 1.5% of principal. If you look at lenders with at least 10 loans in the population, 85% received at least one payment and 41% made more than 1.5%. This is a clear example of why diversification across many loans is important.

Why do we think not selling was the right decision? The overall dollars received are more.  The average of the individual lender recoveries was 1.94% — again better than what was possible from a debt sale. We understand that at the end of the day many lenders will fare worse than they would have with a debt sale price of 1.5 cents; however, lenders were compensated based on the payment behavior of the loans they chose to fund. Had we taken the debt sale price of 1.5%, not only would lenders as a whole be worse off, but the lenders with paying loans could argue that they were being forced to subsidize lenders who chose loans that didn’t pay.

Perhaps most importantly, the new legal structure that Prosper adopted as part of the registration process gives us the flexibility to pursue a wider range of collections.  Starting now, our plans relative to charged off accounts are as follows:

1. We continue to monitor the distressed debt market and to see if a sale is a possibility.
2. Until such time that the expected sale price exceeds the projected net recoveries for the first 12 months after charge-off, we are not going to sell.
3. We are going to place the accounts with a collection agency that specializes in charged-off accounts (the first agency has been identified and the contract is in the works).
4. The agency is going to employ a settlement strategy with settlement authority based on age, charge-off balance and current credit score. For post charge-off accounts, this is the best strategy to maximize total dollars recovered.

In order to maximize dollars to lenders, Prosper is going to waive any Failed Payment Fees, Bank Draft Fees or Servicing Fees that would come to Prosper in our normal payment hierarchy.

In general, the downside of employing a settlement strategy has been that it reduces the sale value of accounts that do not pay, but were offered a settlement. The lack of a market for Prosper loans means that this strategy really has no downside for lenders.

Although these steps are a departure from our original approach to severe delinquency, I am confident that they will result in both a larger amount of recovery dollars and a better per lender result for diversified lenders.

Collection Series – Part 1


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12 Responses


John Roberts | August 10th, 2009 at 4:02 pm

Why are there no recoveries from people that file chapter 11 bankruptcy? I thought that was reorganization and those folks still had to pay their debts?

JR


Mike Kessler | August 10th, 2009 at 4:10 pm

This post has raised something I consider a serious issue. Debt buyers are allowed to parse through your accounts and filter by state, yet the lenders have no way of filtering by state when they lend.


NewHorizon | August 11th, 2009 at 8:30 am

I think that’s about the most informative blog post I’ve seen here in a good long while…

… to be surpassed, perhaps, by an update on those test lawsuits filed against 66 nonpaying borrowers 1-1/2 years ago…? Early on, a lender tried to tally the progress and came up with 1 Prosper win and 6 losses.


AJ | August 11th, 2009 at 6:17 pm

Thanks for the update on debt sales.

I agree that this strategy is far better than simply getting a net 1.5% on all debts grouped into the sale. I prefer to take my chances that my selection is better (or worse) than others.


Prosper Blog | August 12th, 2009 at 2:05 am

@NewHorizon

We will endeavor to surpass the level of informative content in the next collections related post, the last in the three part series. As you have requested, it will indeed address the results of the legal test.


HollowOak | August 12th, 2009 at 4:33 pm

The response above implies that this is the 2nd in a three-part series. For those of us that are having difficulties following the blog’s new format, could you please link the first article?

I always read with interest the many and varied ways in which Prosper evolves in response to the changes in their environment.


Prosper Blog | August 12th, 2009 at 4:35 pm

@HollowOak

The first part of the series can be read here:
http://blog.prosper.com/2009/07/27/collections-series-part-1/

We will add a link to the entry above and be sure to label the series as such. Thank you.


chirag | August 14th, 2009 at 7:36 pm

Disclosure: I am a lender with over $1000 in charged off loans.

In current market scenario, it may have gotten tough for several of borrowers to pay back.

What may need to happen, is some sort of help, so that they can afford to pay and don’t be a defaulter. For a reason that when they default, everybody loses.

Just like in a regular market, A person with a higher lending rate can do a refi to a lower rate loan and make his payments affordable, a similar method / approach should be made available…

e.g. A new category of loan, where the borrower does not get paid, but amount is used to actually payoff his existing higher interest rate prosper loan.

Or a way to allow him to ask for a lower rate from existing borrowers (as a voluntary gesture), e.g. In place of 33%, if a lender is willing to get to 13%, it may make it easier for the borrower to pay off his share.

Why this is possible? Because, we are a peer-to-peer lending community and not a collection of lending shark… is there a way prosper can make it possible?


John Roberts | August 21st, 2009 at 10:23 am

Why aren’t you suing people that appear to have the assets to pay but don’t??


Yankeefan | September 16th, 2009 at 1:13 pm

doug- It has been a month now since this blog- will we be seeing #3, with information on the test cases, soon?


Frustrated | November 12th, 2009 at 11:06 am

Very helpful blog giving insight into an area of previous very little information.

But there is one very important factor not mentioned – TAXES. It is very frustrating to have to pay taxes on interest from Prosper notes while knowing there are other notes that have become practically without value for which I have not been able to receive the tax loss benefit.

For this reason, I think Prosper SHOULD have accepted the 1.5% purchase offer. That 1.5% plus immediate tax loss benefit would have been much preferable to this uncertain holding pattern.

Is there a way that a lender could simply give away or donate charged-off loans? That ability to receive the tax loss benefit would be very welcomed.

PLEASE, Prosper, when considering these decisions, take into consideration all effects on your lenders not just your statistics!


NewHorizon | March 30th, 2010 at 7:58 am

ProsperBlog wrote, “We will endeavor to surpass the level of informative content in the next collections related post, the last in the three part series.”

Could a link to the 3rd part in this series be added to this blog entry?


posted in Lenders,Prosper News 12 comments »

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