THREE YEARS OF CONSISTENT PERFORMANCE

July 2012 marks Prosper 2.0’s third birthday. Consistent loan performance over the past three years demonstrates the significant improvements made since Prosper’s pioneering 1.0 model. Over the past 36 months our investors have experienced 18 months of returns greater than 1%, 35 months of returns greater than 0.80%, and not a single down month.* Prosper 2.0’s performance underscores the fundamental durability of the returns available in consumer credit, a fact that remains greatly underappreciated by the majority of investors today.

Recently, TransUnion published a report on consumer credit trends. These indicate that U.S. credit card delinquencies continue to improve.  As we review the article alongside recent Federal Reserve data, we realize that the improvement in credit delinquency trends speaks volumes to the changes in borrower behavior brought on by the calamity of the 2008 financial crisis.  Consider the graph below that charts the history of consumer credit card delinquency and charge-off rates:

The charge-off data in this chart, reported since March of 1985, shows that the current reading of 4.25% ranks in the 40th percentile of this entire data range.  In other words, 60% of the time, charge-off rates have been higher. Good, but certainly not extraordinary. Now, consider the shorter delinquency data series in grey. Beginning in March 1991, the delinquency reading was almost 6%. The current reading of 3.07% is the lowest on record.

The implications of this conclusion are profound. Delinquency rates are traditionally an excellent precursor for future charge-off rates. Low and falling delinquency rates suggest that future aggregate credit charge-off rates for consumer credit will continue to improve. However, more startling is that these improvements are occurring in the weakest economic recovery on record since World War II.  This seems counterintuitive. One would expect to see improved credit performance during periods of economic growth like the boom of the mid-90s, for instance. Or the post-bubble period last decade. Instead, we see higher economic growth, lower unemployment and better income statistics, which should lead to improving credit performance. So what gives?

In our May Update, we discussed at some length the dramatic declines in net income and net worth experienced by American families since 2000.  We think that the answer to the above question lies in the combination of this data and scars of the 2008 Financial Crisis.  Very few experts dispute that throughout the remainder of this decade, we are likely to witness a massive deleveraging of the Western World’s balance sheet.  A consequence of this will be sub-par economic growth, an environment that Bill Gross, the CIO of PIMCO, has dubbed the “new normal”.

So what would responsible credit worthy borrowers do in an environment of little future income growth and uncertain job stability?  They would tend carefully to their debt – lowering interest costs where possible and insuring pay down of outstanding debt.  And perhaps above all, they would preserve access to credit by staying current on their bills. Seen through this prism, improvements in consumer credit behavior make perfect sense as a rational adaptation to the brave new world of deleveraging. The upside? As an investor in P2P you can take advantage of this secular trend, helping creditworthy borrowers to achieve their logical goals and benefiting from consistent returns.

More information on July’s monthly performance update can be found here. For further explanation of this commentary or with any other questions or comments, please contact our investor marketing team at investorteam@prosper.com or 1-877-611-8797.

*Platform Monthly Return on Principal for All Vintages (Seasoned & Unseasoned) is the dollar-weighted average return of all the discrete loan vintage returns for a given calendar month based on outstanding principal at the beginning of the month. For a loan vintage to be considered in the calendar return, it must fall between July 2009 and the month prior to the reporting month (e.g. the December 2010 calendar return would be the average return of loan vintages from July 2009 through November 2010). The periodic return for calendar month and respective loan vintages is calculated by taking the net payments received on borrower loans (which are net of principal repayment, credit losses, and servicing costs for such loans) as a percentage of the principal outstanding at the beginning of the period.

**To calculate the Return on Principal by monthly loan vintage, all payments received on borrower loans (which are net of principal repayment, credit losses, and servicing costs for such loans) originated during the month are aggregated and then divided by the average amount of aggregate outstanding principal. To annualize this return, it is divided by the dollar-weighted average age of the loans in months and then multiplied by 12. To be included in the Seasoned Returns calculations, Notes must be associated with a borrower loan originated at least 10 months prior; this calculation uses loans originated through August 31, 2011. Our research shows that loan portfolios that have reached 10 months of age more accurately reflect the likely long-term performance as the loans have had sufficient time to experience the impact of potential defaults. Seasoned Return is not necessarily indicative of future performance of any Notes.

IMPORTANT DISCLOSURES:

Notes offered by Prospectus.

This presentation includes forward-looking statements. Forward-looking statements inherently involve many risks and uncertainties that could cause actual results to differ materially from those projected in these statements. Where, in any forward-looking statement, we express an expectation or belief as to future results or events, such expectation or belief is based on the current plans and expectations of our management and is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. You should carefully read the factors described in the “Risk Factors” section of the Prospectus for a description of certain risks that could, among other things, cause our actual results to differ from these forward-looking statements.

All forward-looking statements speak only as of the date of this presentation and are expressly qualified in their entirety by the cautionary statements above and in the Prospectus. We undertake no obligation to update or revise forward-looking statements that may be made in this presentation to reflect events or circumstances that arise after the date made or to reflect the occurrence of unanticipated events.

June was an exciting month for peer to peer lending. The industry hit $1 billion in combined loans back in May, and June commenced maintaining that momentum. Prosper saw record highs in loan originations throughout June, which we attribute to the growing recognition by borrowers and investors of peer to peer lending as well as the increased need by consumers for access to funds, demonstrated in the paragraph below. The proof can be seen in the returns, as Notes issued by Prosper have enjoyed annualized returns of 10.02% since July 2009.*

The Federal Reserve’s June Consumer Credit report showed an increase of $17.1 billion, notably well above forecasts. This change was led by a jump of $8 billion in revolving credit (primarily credit cards) which was the largest increase since November, 2007.   The six month average consumer credit monthly change, reference the chart on the left below,  is now back to the highest levels seen since back in 2000 over a decade ago! This tells us that there are more people in need of consumer lending now than there have been since Prosper’s launch in 2006.

Many economists attribute consumer credit’s recent gains to the slow hiring and stubborn unemployment that is failing to generate enough wage growth to cover on-going consumer expenses.  The theory is that consumers are leveraging their balance sheets to compensate for wage shortfalls.

Is this the right interpretation?

We think not.  The large majority of consumers remain employed. We think that the draw on consumer credit lines instead reflects a growing comfort that, while the economy may not be booming, the worst has passed, resulting in increased spending, a positive economic sign.  Consider the fact that while hiring has remained extremely sluggish by past standards, the unemployment rate, which is currently at 8.2%, remains reasonably stagnant. In other words, the employed are not losing their jobs.

Performance remains strong with 9 out of 10 quarters, performing at or above our return projections. It is important to note that the one quarter that slightly underperformed is still generating high single digit returns to investors. Below is a graph that demonstrates the consistency in each month’s annualized returns with Prosper since July, 2009. Additionally, incoming data on our 5 year loans show them to be preforming above our performance estimates.

Let’s consider another data point.  Through the first six months of the year, the S&P 500 has returned 9.48% (including re-invested dividends), a strong start for equities and a sign that the country’s economy is not terrible.   More light is shed by examining the S&P 500 sub-industry group performance over this time frame, as shown in the chart on the right below.  Specifically, the Consumer Finance sub-industry index has returned 27.1% in the first six months of the year!

For additional context, consider that in the first six months of 2008, well before most understood the Financial Crisis was upon us, this same index significantly lagged the S&P 500, down 22.62% as compared to the S&P 500 being down 11.91%.  In short, the equity market a fantastic barometer of future economic conditions, suggests that the American consumer’s conditions are improving.  A great sign for P2P investors!

More information on June’s monthly performance update can be found here. Additional data can be obtained by contacting investorteam@prosper.com.

Joseph L. Toms

Chief Investment Officer

*Seasoned Return calculations represent historical performance data for the Borrower Payment Dependent Notes (“Notes”) issued and sold by Prosper since July 15, 2009. To be included in the calculations, Notes must be associated with a borrower loan originated more than 10 months ago; this calculation uses loans originated through August 31, 2011. Our research shows that Prosper Note returns historically have shown increased stability after they’ve reached ten months of age. For that reason, we provide “Seasoned Returns”, defined as the Return for Notes aged 10 months or more. To calculate the Return, all payments received on borrower loans, net of principal repayment, credit losses, and servicing costs for such loans, are aggregated and then divided by the average daily amount of aggregate outstanding principal. To annualize this cumulative return, it is divided by the dollar-weighted average age of the loans in days and then multiplied by 365. All calculations were made as of June 30, 2012. Seasoned Return is not necessarily indicative of the future performance on any Notes. In September 2011, an independent accountant examined and attested to Prosper Marketplace, Inc.’s calculation methodologies for measuring historical investment returns.

**To calculate the Return on Principal by monthly loan vintage, all payments received on borrower loans (which are net of principal repayment, credit losses, and servicing costs for such loans) originated during the month are aggregated and then divided by the average amount of aggregate outstanding principal. To annualize this return, it is divided by the dollar-weighted average age of the loans in months and then multiplied by 12. To be included in the Seasoned Returns calculations, Notes must be associated with a borrower loan originated at least 10 months prior; this calculation uses loans originated through August 31, 2011. Our research shows that loan portfolios that have reached 10 months of age more accurately reflect the likely long-term performance as the loans have had sufficient time to experience the impact of potential defaults. Seasoned Return is not necessarily indicative of future performance of any Notes.

IMPORTANT DISCLOSURES:

This presentation includes forward-looking statements. Forward-looking statements inherently involve many risks and uncertainties that could cause actual results to differ materially from those projected in these statements. Where, in any forward-looking statement, we express an expectation or belief as to future results or events, such expectation or belief is based on the current plans and expectations of our management and is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. You should carefully read the factors described in the “Risk Factors” section of the Prospectus for a description of certain risks that could, among other things, cause our actual results to differ from these forward-looking statements.

All forward-looking statements speak only as of the date of this presentation and are expressly qualified in their entirety by the cautionary statements above and in the Prospectus. We undertake no obligation to update or revise forward-looking statements that may be made in this presentation to reflect events or circumstances that arise after the date made or to reflect the occurrence of unanticipated events.

Last year, President Obama named November “Military Family Month”. We are pleased to support our troops, veterans, and their families because they deserve to be recognized and we appreciate their loyalty to our country.

In honor of Military Family Month, we want to reward all veterans and active military with their 2^nd payment free*(a value of up to $250) when they get a loan through Prosper! Continue reading Prosper Joins Forces With the National Military Family Association (NMFA) to Support Military Families

The Wall Street demonstrations spreading across the country are a tremendous opportunity to focus energy on changing what’s wrong with our financial system. Certainly part of that will be stopping old destructive practices from happening again. But an even more powerful opportunity quickly transformed industries like music and print news. Considering the change in technology in just the last 5 years and keeping in mind that banking is a digital product, we could transform the banking industry in a very short period of time.

Already hundreds of innovative models have developed and are changing the way consumers engage in the banking experience: crowdfunding, peer-to-peer lending and social finance sites like Prosper, Kickstarter, Progreso Financiero, Billfloat, RSF Social Finance are just a few that have emerged in the last few years gaining hundreds of thousands of customers. Hundreds more start-ups will come – most will be small, some may be irrelevant, and a handful will become the new banking models of the future.

We all have a role in contributing to this transformation.

For the protesters, while it’s important to keep up the demands for change, we also need you to start using these new technologies and spreading the word when you find one that excites you. Use a crowdfunding site to support a project, make a $25 bid on a peer-to-peer lending site. Start-ups are, well, start-ups, and every show of community support could make the difference between obscurity and escape velocity. Vote with your wallet.

For the Banks, you don’t have to just stand by and get pummeled. And the answer isn’t just some new PR campaign about how you’re lending billions to small businesses. Help support change. Banking start-ups need access to your infrastructures including your electronic payments systems, your national charters and, most importantly, your customers. Even if these start-ups are tiny now and even if their stated mission is to destroy your franchise, partner with them. Technology is not going away, it’s accelerating with or without you. It’s time to stop cutting your R&D budgets and start embracing new, big ideas.

For the regulators, you have a tough balancing act that frankly needs more thoughtful attention. You need to start discerning between the legal innovation that has dominated our financial system and the true innovation that is America’s key competitive advantage. Unfortunately, your response to the crisis has been overly negative – attempting to thwart any innovation rather than embracing breakout technologies that could also pressure the big banks to be more competitive and transparent. You need to start fighting a two-front war – fixing the old while nurturing the new. Why isn’t there a Facebook of Banking yet? The obstacles are too many and the playing field is too uneven. Just a few examples of how regulators can help:

1.      Among the biggest roadblocks to new banking models is simply getting permission to operate. Today, there are essentially no new bank charters being given out and buying an existing bank is not something a new start-up can do. Shockingly, the only open path for start-ups to access national markets is to partner with an existing Bank. That’s right, banking start-ups need to gain permission from the companies they’re trying to destroy!  For the vast majority of new ventures – this is a non-starter. Banking regulators need to find a workable path for responsible start-ups to access national markets. H.R. 1909, the FFSCC Charter Act of 2011, is a step in the right direction.

2.      With reasonable protections, let crowdfunding sites pay interest or other financial returns on their projects. As a charity, crowdfunding is a small niche. As a new way to raise capital that pays a fair return, it’s a potential game changer. H.R. 2930, the Entrepreneur Access to Capital Act, is a good start.

3.      Stop the ridiculous burden that requires $100K in filing costs to fund a $10K peer-to-peer small business loan as if it were the same as a $100 million corporate bond. Surely there is a more reasonable technology-based disclosure that would foster small business fundraising while still protecting investors.

I believe we all recognize that our financial system is still broken and that financial reform didn’t change enough. A great outcome of the Wall Street demonstrations would be a renewed focus on fixing the problem that includes a long-term view of how innovation and technology can create an entirely new banking system.

We recently announced that Prosper’s seasoned portfolio returns have increased to 10.69%.* Given the turmoil in the financial markets we are extremely proud of these returns. Not only have they helped our investors during trying times, they are a clear validation of the robustness of our credit model, the experienced team that runs it, and the opportunity that we think lies ahead.  

Continue reading An Update on Peer-to-Peer Lending Performance