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An Open Letter to The Big Money: Retract Your Story

by Prosper on 01/19/10

Today, The Big Money, an outlet we and many others respect, published a disappointingly inaccurate story about Prosper and the peer-to-peer lending industry.  It’s unfortunate that the author’s data analysis and perspective relied almost entirely on a hodgepodge of anonymous sources.  If higher reporting standards had been upheld, the reality that Prosper has shown great promise and performed well on a relative basis over the last three-years would have been self evident.

We’ve requested that the editors at The Big Money retract Mark Gimein’s erroneous perspective on Prosper and the peer-to-peer lending industry.  We look forward to their response.  In the meantime, we’d like to set the record straight.

Mr. Gimein discusses Prosper’s loans in the context of only cumulative unit default rates rather than in terms of the average annual returns lenders have earned.  For example, Mr. Gimein states that 39% of loans that have had a chance to come to maturity (originated prior to 12/31/2006) have defaulted.  What he doesn’t say is that the annual yield on these loans was 16% and the annual loss experienced by lenders was actually 20%, resulting in an annual average return of negative 4%.  Although this return is negative, put in the context of the largest recession in generations, and the performance of other asset classes during the same time period, this paints a very different and more accurate picture of how lenders have fared on Prosper.

Mr. Gimein continues to use his flawed methodology to state that 54% of loans with an interest rate of 18% or greater have defaulted, leaving the impression that lenders on these loans have lost over half of the funds that they lent, and that losses ran roughly three times the interest rate on loans.  Again Mr. Gimein is equivocating annual interest earned with cumulative default rates over a three year period.  Lenders on these loans lost 10% on an annual basis, and while not positive, it’s a far cry from the 54% loss that Mr. Giemein flawed analysis leads the reader to believe.

After quoting these cumulative loss results out of context, Mr. Gimein’s bottom line is “After you take defaults into account, investors have lost money on most of their Prosper lending.”  Mr. Gimein makes this statement without providing any actual returns data, again leaving the false impression that lenders have lost 39% to 54% on their Prosper lending.  The truth is that the median return across all Prosper lenders was negative 3.2%.  In addition, 39% of lenders have made money on their Prosper investment.  While we would have preferred all of our lenders to have made a profit, a low single digit loss for Prosper lenders in the context of the worst recession since the Great Depression shows great promise for peer-to-peer lending as an alternative asset class for investors.  Even a broad index like the S&P 500 saw an annualized loss of 6% in the past three years.  Most individual investors have experienced performance substantially worse than this in their investment portfolios and 401k accounts.  Something Mr. Gimein fails to discuss.

Mr. Gimein also fails to mention that historically there has been a significant amount of social lending through Prosper’s marketplace.  Social loans are deliberately underpriced relative to their stated risk by lenders in order to benefit borrowers with unique or challenging circumstances.  Although we do not have a way to isolate the impact of these loans on performance, there is no doubt that they have had a downward impact on some lender returns.

Mr. Gimein also seems to find fault with the steps Prosper has taken to improve the lending process and provide lenders with additional information to improve their lending decisions.  Prosper has instituted a minimum credit score requirement of 640 to request a loan from Prosper’s lenders as well as a bid floor. Prosper also introduced a new rating system in July 2009 that incorporates the historical performance of over 29,000 Prosper loans into the rating of new borrowers looking for loans.  Although the new rating system uses the same letter grades to rank order risk, the meaning of the letters has changed significantly. This has resulted in a change in the composition of Prosper’s listings, which allows lenders to more accurately assess risk and set prices for prospective borrowers.  This change in rating methodology is well documented on Prosper’s site and lenders can easily compare the impact of Prosper’s new rating system on loans originated under the older system.

The early results from the new rating system are excellent.  Prosper is estimating returns for lenders above 10% for loans originated since our July re-launch and the early data supports these expectations.  Below is a graph comparing the delinquency performance of loans originated by year with the loans originated in the third quarter of 2009.  As you can see, the proportion of loans that are 31 to 120 days past due for the loans originated under the new rating system are dramatically lower.

Prosper was launched to the public in February of 2006 and was about 18 months old when the credit crisis turned our economy upside down.  The crisis that followed saw a dramatic increase in defaults for all classes of consumer loans.  Large banks with years of lending experience saw a dramatic increase in consumer defaults and posted significant losses.  Prosper was clearly not immune from the economic environment, but looked at in the proper context, peer-to-peer lending has weathered the storm relatively well and as a result is well positioned for a bright future.  At a time when financial markets are in upheaval and consumers are facing a dwindling set of credit alternatives, Peer-to-Peer lending deserves better than a flawed, out of context evaluation from a seasoned journalist, and a respected Web site, that should hold themselves to a higher standard.

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10 Responses

Justmee | January 20th, 2010 at 8:34 am

I have been a lender since 2006. It has been a learning experience. I would not have traded this experience for any other investment platform. I learned about my credit, other people’s credit and how to adapt to a changing financial environment. I lost some money in the stock market during the economic downturn…I am happy to say that I made money in Prosper during the same period of time. Best of all, I feel that I am part of a community of like-minded individuals. I have no doubt that Prosper’s future data will prove Mr. Mark Gimein wrong. The worse of the unexpected largest recession (unexpected being the key here) is behind us and the lenders have learned and mature with the market!!!! I know that I am a much WISER investor than in 2006. No doubt there are plenty of other lenders out there that feel the same way.

Brandon | January 20th, 2010 at 9:30 am

To convince me that it’s worth lending on this site again, I need to see Prosper put their money where their mouth is and take a 10% stake in every loan created. Otherwise we have another example of what went wrong with the housing bubble: brokers pushing to close deals without any fear of losing money because they collect their fees and push the risk off to the market. Lenders would do much better to invest in a CD than in Prosper.

Prosper Blog | January 20th, 2010 at 3:38 pm

@Xenon481 commented: Can you please comment as to whether this graph contains data for loans that are greater than 120 days past due? The labels on your graph indicate that such data is not included. Any delinquency graph that does not contain that information is useless and errant.

Prosper Response:

The new loans are not old enough to have gone 120 days past due. A graph that compared loans past 120 days past due on the new loans versus the old loans would be both flattering and misleading. We did a delinquency comparison because we have relevant data to compare because delinquencies happen earlier than defaults. It is common to do this type of comparison of seasoned and unseasoned vintages to get an early indication of future default performance.

Colin Henderson | January 21st, 2010 at 11:55 pm

Nice response. There has been a lot of development, change and evolution in peer-to-peer lending, and my own belief is that its too easy to second guess 2005 decisions in 2010. Certainly time will tell regarding the different nuances in models that are out there in US, UK and Canada, and only time will tell.

Best wishes to you guys.

Cow Dog | January 22nd, 2010 at 8:39 pm

Wonderful post!

Prosper leaves no doubt with this stunning rebuttal!

NewHorizon | January 24th, 2010 at 4:18 pm

Will Prosper let the Prosper readership know if there’s any reply to this request for retraction?

Prosper Blog | January 28th, 2010 at 12:58 pm

Here is the response… “An Exchange on Prosper.com”… http://bit.ly/89caF8

One thing to note is that we have requested a correction to the statement “that’s a total of 30 percent over three years—on the subset of those loans (those that charged 18 percent or more)”

It should state, “that’s a total of 16 percent…”

Because Prosper loans are three year amortizing loans with monthly principal payments, an average annual loss rate of 10 percent equates to a cumulative dollar loss rate of approximately 16 percent (we rounded up) over the life of a loan rather than the 30 percent loss rate the calculation of three times 10 percent suggests.


posted in Borrowers,Featured,Lenders,Prosper News 10 comments »

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