Regular readers of this blog will know how much I like the repeat borrower segment of p2p lending. Only officially available on Prosper, this has been one of the best performing segments of borrowers in all of p2p lending, and it happens to be where I focus most of my Prosper investments.
To be clear, when I talk about previous borrowers I am referring to those borrowers who have successfully been issued with a loan on Prosper, are in good standing on that loan, and are now looking to apply for a new loan. Their previous loan may or not have been fully paid off. Prosper allows borrowers to create a second loan listing within 6-12 months as long as certain conditions are met.
Lower Interest Rates for Borrowers, Higher Returns For P2P Investors
On Friday of last week, in this detailed blog post, Prosper announced they are adjusting the interest rates on repeat borrowers. At the same time they are making adjustments to their proprietary Prosper ratings system that will mean many repeat borrowers will jump a loan grade, say from Grade D to Grade C. This will mean lower interest rates for these borrowers.
At the same time Prosper has recalculated their all-important expected loss rates so in effect these interest rate changes will result in a higher expected return for investors. For example, D-rated repeat loans will now receive an expected 13.63% return going forward versus a 12.43% before. But D-grade borrowers will now be offered a 25.74% interest rate versus 30.99% rate before (because these borrowers were an E-grade before).
If this works out the way Prosper expects this is great news for investors and repeat borrowers. My biggest complaint about repeat borrowers is that there are not enough of them. With my strict filtering criteria I only find 4-6 loans a week to invest in and I would like to see many more loans. Hopefully, this change will increase the number of available loans that meet my criteria while maintaining the high ROI on these loans.
No More Repeat Borrowers with HR Grade
The interesting part is that interest rates have not dropped across the board. In fact, some interest rates for previous borrowers have increased slightly. But with the changing calculation for assigning a loan grade it will mean reduced rates for most repeat borrowers.
Also, along with this change repeat borrowers with an HR rating are no longer allowed. The reason for this seems to be that eligible borrowers that would have had an HR rating will now be classified with an E rating.
Why Previous Borrowers on Prosper Are So Good
You just need to look at the data on Lendstats to appreciate previous borrower loans. Looking at Prosper 2.0 loans (those originated from July 2009 onwards) Lendstats has an estimated ROI on all loans (as of today) at 9.33%. When looking at all previous borrower loans that estimated ROI jumps to 13.14%, almost four full percentage points.
When you look at the risker loan grades this difference is even greater. All D,E and HR loan grades on Prosper 2.0 are returning an estimated ROI of 11.93% at Lendstats. When looking at just previous borrower loans in those grades the estimated ROI jumps to 16.95% or more than five percentage points higher. Clearly this is a very good performing segment and one that has probably been overpriced for some time.
My Own Experience with Previous Borrowers
I started investing in previous borrower loans almost exclusively on Prosper about six months ago. My average age of these loans in my portfolio is just 4.5 months so I know these loans are still very young. But the thing that has amazed me about my previous borrower loans is that they are all still current. There is not one late loan among the 81 loans that I have invested in. And I am investing in only the risker loans – those loans rated D, E and HR with an interest rate of more than 20%.
I have invested in these loans expecting a default rate of more than 10%. Of course, maybe I will end up seeing defaults close to this number but when I look at my own portfolio on Prosper and see every single loan current I am very pleasantly surprised to say the least.
These changes in borrower ratings and interest rates are quite complicated and I don’t really have the space here to cover it fully. I highly recommend that investors read the PDF file Prosper released that contains a thorough explanation of these changes.
It will be very interesting to see how these changes play out a few months and years from now. What do other Prosper investors think? Is this a good move by Prosper? I am always interested to hear your thoughts.