Idle ramblings of a wandering mind...

In my last post on borrower selection at Prosper.com, I emphasized drilling into the delinquencies data that Prosper.com provides. It was in response to StingyJoe's question in his excellent blog - StingyFinance. StingyJoe was kind enough to put a link to my post on his blog post. I am continuing the chain of thought and detailing various kinds of data exploration you can do and helpful insights that you can gather.

If you are a member if Prosper, then you can access all the data on the Lending -> Performance page. You can change performance criteria and see the impact on default rates. Here are the results of my dabbling with this page (all these results are for loans originating between July 1 to Oct 20).

Rules for Investing in Prosper - II

There is a sweet spot: Most people believe that one should focus only on really high credit borrowers (AA, A and B rated) on Prosper because risks are too high. However, when you go with AA and A borrowers, you are likely to get an interest rate of 8-10% - not too different from what you could get from a CD with minimal risk. I believe that there is a sweet spot in the middle where interest rates are high and risk is lower than the reward. For me - this sweet spot is credit rating D. Look at default rates by different credit ratings:

Credit Rating---AA---A----B----C----D----E----HR---Overall
Default Rate(%) 0.00 0.59 1.05 2.72 0.67 4.38 6.28 2.36

Look at the amazing performance of D credit - its almost reaching levels of A rated borrowers. You can get an interest rates of 18-22% for a D borrower and for the performance shown above - it is a bargain. That's why if you look at my portfolio in Prosper - you will find that D borrowers have the biggest claim on my money. Look at the screenshot of my portfolio at Prosper:


Past predicts the future: If a borrower is carrying multiple current delinquencies on their credit right now then their cost of adding one more to the list is quite low. However, if a borrower has zero current delinquencies, then they would be extra careful to cross over to one current DQs. So - if you want to play safe - lend only to borrowers that have zero current DQs. Lets see what is the performance of different credit ratings if we limit ourselves only to borrowers with zero current DQs.

Credit Rating---AA---A----B----C----D----E----HR---Overall
Default Rate(%) 0.00 0.38 0.57 2.28 0.00 0.53 4.73 0.79

Wow! Look at that. Compare this table to the table in the beginning and see the difference it makes when we limit ourselves to lending to borrowers with zero current DQs. Performance improves for all credit grades. Improvement is dramatic for D credit: Zero Defaults!! So if you are lending to D credit with no current DQs - you can sleep soundly at night - your money is not going anywhere while earning you a solid 15-18% interest.

Greed is bad: The whole idea behind Prosper is that lender will bid down the interest rate to the one that the market can support (an economist will call it price discovery). Why then would a borrower opt for "Automatic Funding" which essentially completes the transaction the moment the loan is fully funded without giving other lenders an opportunity to bid down the interest rate. Its completely irrational for a borrower to have automatic funding, and since my inner economist core strongly dislikes irrational behavior, I stay away from loans with automatic funding. Lets see what that does to performance of loans:

Credit Rating---AA---A----B----C----D----E----HR---Overall
Default Rate(%) 0.00 0.78 0.70 0.52 0.40 2.35 1.81 0.76

Again - using simple logic gives us phenomenal improvement in performance. My favorite D credit borrowers are again providing really good performance for comparatively lower risk.

Okay - so to summarize: if you are lending at Prosper.com - keep in mind the following: D credit borrowers are your best risk-reward bet at the moment, borrowers with zero current DQs are outperforming others by miles and finally - stay away from loans with automatic funding.

Hope all this is of help. As I look deeper into this data I will post updates to how to select the right borrower on Prosper.

Labels: Investing, Prosper