Prosper launched with great fanfare back in 2006. For the first time in this country individuals could act like a bank and earn money from lending to their fellow Americans. Little did anyone know what would happen over the next three years.
It sounded like a great idea at the time I am sure – let the crowd decide what interest rates to charge and allow subprime borrowers to take out loans. But with hindsight we now realize it was a shaky premise. Even before the financial crisis hit Prosper was dealing with default rates well above their expectations. When Prosper closed down for their quiet period in October 2008 most investors were losing money on their investments. This first iteration of Prosper from 2006 until 2008 is what we call Prosper 1.0.
All Prosper 1.0 P2P Loans Have Matured
The last loan issued in Prosper 1.0 was in October 2008 so all of those loans have now reached maturity (they only issued three year loans). When we look at all Prosper 1.0 loans on Lendstats we see that Prosper issued 28,936 loans with 18,480 fully paid off and 10,456 loans that defaulted. This represents a default rate of 36.1%. In absolute dollar terms the performance was a little better (because most borrowers made some payments) – total dollars loaned out was $178,560,222 and total dollars written off was $46,671,123 – a loss rate of 26.1%.
It may surprise you that (also according to Lendstats) many investors actually made money. If you look at all 4,450 Prosper 1.0 investors who invested in at least 100 loans 858 investors had a positive return with the best ROI at 9.8%. How did these people make decent returns when most investors lost money? They avoided the higher risk loans. There is a table from Prosper’s statistics page that gives some detail behind the numbers but below is a chart based on data from Lendstats that breaks down ROI by loan grade.
As you can see the best returns on average were for those investors who stuck with the higher (AA, A and B) grade loans. In fact the graph is pretty much linear – the more risk you took the worse your returns were.
What is fascinating to me is that in Prosper 2.0 the exact opposite is true. Investors have been rewarded for taking more risk and those who stuck with AA loans have actually done slightly worse in 2.0 than they did in 1.0. The chart below shows the ROI on Lendstats for loans that originated from July 2009 until the end of December 2010. We should note that these loans are not mature – they are around 20 months old and so their final ROI will likely be somewhat different. Regardless of the final numbers I think it is safe to say that the relationship between risk and reward for investors completely shifted with Prosper 2.0.
Comparing the Loan Data for Prosper 1.0 and 2.0
When you take a few minutes to look inside some of the loan data on Lendstats of Prosper 1.0 and 2.0 you can start to see why these two time periods are so different. Back in Prosper 1.0 credit underwriting standards were much less stringent than they are today.[table "24" not found /]
You can see that on average we are looking at a very different group of borrowers today. Look at their credit data: they have less credit inquiries, a smaller percentage have current delinquencies on their credit report and they have a lower debt-to-income ratio. At the same time they are paying an average of 3% higher in interest.
Probably the biggest difference is that the credit scores minimum has changed. In Prosper 1.0 there were 3,448 loans issued to borrowers with a credit score below 560 and these people defaulted at a rate of over 60%. In Prosper 2.0 the minimum credit score is 640 (for new borrowers) and this factor alone has lead to far fewer defaults.
What Can Investors Learn From Prosper 1.0?
On Prosper 1.0 there were over 50,000 investors and the vast majority of these people lost money. On Prosper 2.0 there are currently over 22,000 investors so it is clear that most 1.0 investors have not come back and invested in 2.0. When you look at the total number of investors who have ever invested in a Prosper loan that number is now over 60,000 – so Prosper has gained around 10,000 new investors since relaunch and 12,000 Prosper 1.0 investors have made a new investment in 2.0.
It is clear that many investors have not forgiven Prosper for their mistakes in 1.0 and that is understandable. I think the real lesson here for investors is to be cautious when starting a new investment. When Prosper began p2p lending was so new that there was simply no track record and with no track record it stands to reason that it was a high risk investment. While an investment in Prosper loans is certainly not without risk today, there is at least several years of historical return data to analyze now. But If you look too deeply into the numbers for 1.0 you risk coming to some incorrect conclusions.
I know many investors are still sitting in the sidelines waiting to see what will happen with Prosper. Will they keep growing? When will they become profitable? Will these good returns maintained? When these investors decide to invest and start analyzing the Prosper data I think they should give far more weight to the Prosper 2.0 numbers.
I am interested to hear what others think. Were you an investor in Prosper 1.0? Did you change strategies when investing in 2.0? Please leave your thoughts in the comments.