Comparing Returns on Prosper Before and After the Auction Model Ended

Back in 2010 the management of Prosper took a gamble. They decided to do away with the auction model that had been the basis of their investing platform since launched in 2006. The change was made 18 months ago on December 19, 2010 so I thought now would be a good time to check in and see what impact this change has had on investors.

The Old Auction Model at Prosper

For all you newer investors let me explain how the auction model worked. A borrower would apply for a loan on Prosper and state a maximum interest rate that they would be willing to pay for that loan. Prosper assigned a rating to the loan and then investors would “bid” on the loan.

Let’s take an example to demonstrate how this worked. Betty wants to borrow $5,000 and is willing to pay up to 15% interest for than loan. Prosper gives Betty a B rating and investors start bidding. Many investors bid on the 15% rate, and soon she has enough bids to meet her request of $5,000.  Still some investors are interested in lending to Betty, and they are willing to go down to 14% or 13%.  The greater the investor demand, the lower Betty’s rate goes.  Betty’s loan is ultimately priced based on the pool of bids at the lowest rates totaling $5,000.  For example, if Betty had $5,000 in bids at a mix of 14% and 13%, the whole loan would be funded at 14%.

This worked ok in theory but it was a hassle for investors. The loan would stay on the platform for the full 14 days, which gave investors time to bid the loan lower even if it was fully invested.  That tended to slow down investors’ deployment of money on the platform, and some large investors did not like the uncertainty in how a particular type of listing would ultimately be priced.  Then there was the problem of constantly receiving emails saying you were outbid on a loan.

What Did This Change Mean for Investors

Regardless of which model we preferred I was curious to see how this change impacted returns. The table shows some statistics from all loans issued on Prosper in 2010 and 2011 (all the data is from

Summary returns for 2010 and 2011 at Prosper

So from this simple analysis it looks like the auction model was a better deal for investors because in 2011 returns went down. It was not a large drop: 8.22% compared with 9.52% but it was a drop nonetheless. I didn’t want to jump to any conclusions so I contacted Jim Catlin, the head of Risk Management at Prosper to get his opinion on this data.

When I asked him to explain this difference he said that while pricing and rating mix were affected by the change to fixed pricing, one of the biggest drivers of the high returns in 2010 was their evolving underwriting strategy. Here is what Catlin said:

Coming out of the quiet period in 2009 and 2010 our top priority was delivering great returns in order to build momentum with investors. In 2010 in particular we were very conservative with our underwriting in order to be sure investor returns came in better than the expectations we set with them when they invested in the loans. In that period there were some pockets of loans – for example HR loans – where actual loss performance came in at 60-70% of our expectation.  While that was great for lenders it meant that some borrowers were not getting the best possible price from us.

Over the course of late 2010 and 2011 we gradually adjusted our underwriting. We wanted to continue giving investors great, predictable returns, but we also wanted to increase the number of borrowers on our platform. The adjustments enabled more borrowers to get lower rates, and investors have still enjoyed returns consistent with the expectations we set when they invested.

Going forward we will continue to build on our impressive track record of delivering consistent, strong returns to diversified investors.  Over the last 3 years we have earned the trust of our investors by delivering returns and loss rates consistent with the expectations we set at the time of investment, and we look forward to continuing to serve our investors in that way.

In other words returns were slightly down for 2011 vintage loans over 2010 because of underwriting not because of the end of the auction model. Investors that put money to work in 2010 just got an exceptional deal – this vintage of Prosper loans may well end up providing the best returns of any year in p2p lending. Lucky for you if you were an investor during this period.

Overall I would say investors are better off with the fixed price system. I certainly prefer it over the auction model so I am glad Prosper took that gamble back in 2010. I think it has positioned them well for the future.

What do you think? If you are a long time Prosper investor did you like the auction model? As always I am interested to hear your comments.

Notify of
Newest Most Voted
Inline Feedbacks
View all comments
Jun. 15, 2012 5:48 am

hello, in comunitae we have also gone to the fixed rate model in 2012. the auction system has been abandoned due it was not understood by investors. people prefer the simple method, quicker and straight forward. regards.

Dan B
Dan B
Jun. 15, 2012 5:10 pm
Reply to  jaime

So is daily life in Spain still pretty normal or are things getting as bad as the news says?

Bryce M.
Bryce M.
Jun. 15, 2012 11:52 am

My gut reaction is that the true effect of the auction model is negative on ROI. We see a positive total effect, but an admission that much of it had to do with underwriting. My suspicion is that most people on Prosper do not have the quantitative skills to know when to stop bidding down interest rates commensurate with the risk. I feel the average investor benefits from the human capital at the platform that sets interest rates appropriately.

Jun. 26, 2012 10:41 pm
Reply to  Bryce M.

Bryce, I agree 100%. Not to mention, how can investors be comfortable putting capital to work in an adjustable rate unsecured note which is esentially what the auction model produced. Spreads widen in economic crisis and if credit isn’t priced appropriatly for that risk, it’s BYE BYE birdie and no fun #prosperloans

Dan B
Dan B
Jun. 15, 2012 1:01 pm

I wasn’t a Prosper investor during the “auction” years so I won’t comment on that directly……………….. & though I agree it’s a bit off topic, I think that something that should not go unmentioned here is that return numbers of 9.5% & 8.2% are quite outstanding in todays environment.

Part of the reason why these types of numbers don’t get the praise that they deserve is that a number of commentators here & on other blogs have boxed themselves into a corner with their naive/unrealistic & very public comments/expectations of mid or even high teen long term returns. These comments serve no purpose except to suggest to the average investor that they are somehow under performing in comparison. Rather than having discovered the keys to the chocolate factory, these temporary high performers should have known better & been more responsible in helping set realistic expectations………………..something that I’ve been encouraging them to do for years now.

Then maybe they can join the rest of us in recognizing the impressive above average returns that we’ve been seeing here the last few years.

Jun. 16, 2012 11:18 am

Nostalgia aside, I do miss the utility of being able to offer preferential rates (to particular borrowers) for affinity related reasons. In the same vein, it was very easy to formalize a loan to friends and/or family (also at preferential rates) using Prosper’s earlier dynamics.

While I hope for a return to those days, in some form, and while I’m aware that there are alternative ways to accomplish the same goals (though without the ease), I think a move toward a fixed pricing model was good for the long-term growth and scale of the market.

The more personal aspects were, unfortunately, what had to go in order to be efficient…

Jun. 18, 2012 2:53 pm

I did not like the change from the auction to fixed price model when the change was first made. I have definitely changed my mind over time and like the fixed price model much better now. Investing money quickly is much easier now.

Jun. 26, 2012 6:00 pm

I believe Prosper is failing its investors with all the changes it has made. I have been both an investor/borrower on Prosper but started to notice some trends that cause me some alarm. First, the number of A+ borrowers vs D borrowers is high which will bring down the ROI. Second, Prosper is still banned in some states and I don’t believe they have done enough to help change laws in other states which could open a huge market. Lastly, a number of complaints from former borrowers about not being approved even though they met the credit criteria.
Just a thought.

Dan B
Dan B
Jun. 26, 2012 6:32 pm

JR…….The fact that Prosper (or Lending Club, for that matter) isn’t available to investors in certain states has little to do with Prosper or p2p itself. Rather it is due to the individual laws that exist in each of the states which specify where a company needs to be financially speaking. in order for them to be allowed to issue notes directly to residents of those states. These laws predate Prosper or p2p & apply to a large number of companies across all industries. The GAO report from last April cites specific examples of this.
As for the ratio of A to D notes………..though what you say may in fact be theoretically accurate, I don’t see how they would actually apply to you or anyone else unless they were buying every single note offered (which no one does) or they buy randomly. There are better approaches. Peter & other contributors here have presented numerous strategies that improve ROI substantially & frankly, without that much extra effort.