Choosing the right borrower on Prosper.com
Thursday, November 23, 2006 Permanent link to this post
This post is in response to a question by StingyJoe in reply to my comment on his article on Prosper.com on his excellent blog StingyFinance. He asked me what are the most important criteria for choosing who to lend to on Prosper. Here are the heuristics I have been using, and they have served me well till now.
Rules for Investing in Prosper
Start small and build incrementally: Prosper is right now a small site with total loans outstanding of around $23 million. While its growing rapidly (new loans of $2 million between Nov 1 and 21), there are so many lenders competing for good loans that it is really difficult to grow your portfolio while keeping a high interest rate. The "gems" (low credit risk with high interest rates) are few and far between. So do not think that you can lend out $20K in one month and remain profitable. Right now I think maybe 10 loans every week fit my risk-reward criteria and if you are bidding $50-$60 on every loan - you can loan at most $500-600 every week. Now, this may be too small for people with little free time who can't do the necessary research for such small investments. However - I recommend that before you put too much money - put a little first, build very gradually and then once you are comfortable, put more money in. I am also in favor of starting off with manual order and using automated standing orders only after 5-6 months of getting to know this market.
Wait for the 4 month shock: The Lender's Forum at Prosper is abuzz with lenders who see a spike in delinquencies about 3-4 months after the loan originates. Basically it takes that much time for the excess liquidity of a new loan to die and some borrowers to fall again in financial difficulties. Some data to prove my point:
When looking at all loans that started between Jul 20 and Aug 20 (its Nov 22 today, so a loan life of 3 months), default rates are 4.63%. If we look for all loans that started between Jun 20 and Jul 20 (loan life of 4 months) 6.19%. The same figure for 5 months loan life is 7.98%, 6 months loan life has the figure 12.29%. Compare these to default rates of 1.29% for 2 months loan life. So clearly, if you have not had defaults on your first two months, do not consider yourself a Prosper genius and start pouring money. Wait for the 4-5 month default deluge - see how you are performing against the market and then, if you are comfortable, increase your exposure.
One should also note that historic default rates in Prosper (12.29%!! for 6 month old loans) is huge! So build that into your expectations. Just because you are lending at 20% rate does not mean that you will have 20% return. Expect something like 8-10% and you should not be disappointed. I personally think that with careful borrower selection a 15% return is possible and thats what I am shooting for but I know the risks and I would be happy if I am making 8% at the end of it.
Know your data, love your data: Good thing about Prosper is that all (most?) its information is online and available for your to see. For example: I can check default rates for all kinds of combinations of borrower characteristics (Credit grade D but no current defaults is my current favorite) and decide my bidding strategy. For example: if you limit yourself to bidding only on borrowers with no current delinquencies, your overall default rate at 4 month loan age is only 0.34% (compared to 6.19% overall). So if you stuck only with borrowers who do not have a current delinquency in their credit file, you would have way way lower defaults. There are several other ways to slice and dice the data and you should spend enough sleepless nights on the computer to *really* know that data. This is the key to succeeding in this market.
Groups don't matter, Group Leaders do: Most groups on Prosper are "zero-value-add" but a few groups have committed group leaders who make a difference. Over past few months, I have recognized some groups with capable group leaders including Texas Prosperers (I am a honorary member of this group even though I have never set foot in Texas) and Sonic Lenders. I am also impressed with DocProsper group and I *hate* this group.
Alright - now the disclaimers. I am a small investor and have only been with Prosper for a few months - so all my "insights" should be taken with a pinch of salt. I am putting my money where my mouth is - but it may not work for you. Also - all my insights may prove to be nothing if my loan portfolio starts backfiring and I am saddled with defaults. I will be posting updates to my Prosper portfolio here - so check back if you are interested in learning how my heuristics are faring.
Have a happy Thanksgiving and hope Notre Dame beats USC this Sat so that Michigan (Go Blue!) goes to the National Championship games and kicks Ohio State's behind! I can't believe I am cheering for Notre Dame!!
Update: I have posted a follow up of this article and its available at this link.
Rules for Investing in Prosper
Start small and build incrementally: Prosper is right now a small site with total loans outstanding of around $23 million. While its growing rapidly (new loans of $2 million between Nov 1 and 21), there are so many lenders competing for good loans that it is really difficult to grow your portfolio while keeping a high interest rate. The "gems" (low credit risk with high interest rates) are few and far between. So do not think that you can lend out $20K in one month and remain profitable. Right now I think maybe 10 loans every week fit my risk-reward criteria and if you are bidding $50-$60 on every loan - you can loan at most $500-600 every week. Now, this may be too small for people with little free time who can't do the necessary research for such small investments. However - I recommend that before you put too much money - put a little first, build very gradually and then once you are comfortable, put more money in. I am also in favor of starting off with manual order and using automated standing orders only after 5-6 months of getting to know this market.
Wait for the 4 month shock: The Lender's Forum at Prosper is abuzz with lenders who see a spike in delinquencies about 3-4 months after the loan originates. Basically it takes that much time for the excess liquidity of a new loan to die and some borrowers to fall again in financial difficulties. Some data to prove my point:
When looking at all loans that started between Jul 20 and Aug 20 (its Nov 22 today, so a loan life of 3 months), default rates are 4.63%. If we look for all loans that started between Jun 20 and Jul 20 (loan life of 4 months) 6.19%. The same figure for 5 months loan life is 7.98%, 6 months loan life has the figure 12.29%. Compare these to default rates of 1.29% for 2 months loan life. So clearly, if you have not had defaults on your first two months, do not consider yourself a Prosper genius and start pouring money. Wait for the 4-5 month default deluge - see how you are performing against the market and then, if you are comfortable, increase your exposure.
One should also note that historic default rates in Prosper (12.29%!! for 6 month old loans) is huge! So build that into your expectations. Just because you are lending at 20% rate does not mean that you will have 20% return. Expect something like 8-10% and you should not be disappointed. I personally think that with careful borrower selection a 15% return is possible and thats what I am shooting for but I know the risks and I would be happy if I am making 8% at the end of it.
Know your data, love your data: Good thing about Prosper is that all (most?) its information is online and available for your to see. For example: I can check default rates for all kinds of combinations of borrower characteristics (Credit grade D but no current defaults is my current favorite) and decide my bidding strategy. For example: if you limit yourself to bidding only on borrowers with no current delinquencies, your overall default rate at 4 month loan age is only 0.34% (compared to 6.19% overall). So if you stuck only with borrowers who do not have a current delinquency in their credit file, you would have way way lower defaults. There are several other ways to slice and dice the data and you should spend enough sleepless nights on the computer to *really* know that data. This is the key to succeeding in this market.
Groups don't matter, Group Leaders do: Most groups on Prosper are "zero-value-add" but a few groups have committed group leaders who make a difference. Over past few months, I have recognized some groups with capable group leaders including Texas Prosperers (I am a honorary member of this group even though I have never set foot in Texas) and Sonic Lenders. I am also impressed with DocProsper group and I *hate* this group.
Alright - now the disclaimers. I am a small investor and have only been with Prosper for a few months - so all my "insights" should be taken with a pinch of salt. I am putting my money where my mouth is - but it may not work for you. Also - all my insights may prove to be nothing if my loan portfolio starts backfiring and I am saddled with defaults. I will be posting updates to my Prosper portfolio here - so check back if you are interested in learning how my heuristics are faring.
Have a happy Thanksgiving and hope Notre Dame beats USC this Sat so that Michigan (Go Blue!) goes to the National Championship games and kicks Ohio State's behind! I can't believe I am cheering for Notre Dame!!
Update: I have posted a follow up of this article and its available at this link.
Therer are 5 Comments. Post a Comment
Great post Sanjeev! I included a link to your article as part of the article that I wrote!
StingyJoe
http://www.StingyFinance.com
StingyJoe
http://www.StingyFinance.com
Very good set of articles. Thanks for the info. Well, I will have a look prosper and will see how I can make best out of it. Thanks again,
http://internetbazaar.blogspot.com
http://internetbazaar.blogspot.com
LFC Fan - Prosper requires you to be a resident of US - and I have the impression that you are based out of US - so you may not be able to make use of it. Look up Zopa.com in UK and I am sure there are other such sites in Europe.
Sanjeev
Sanjeev
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