Prosper to Provide Secondary Lending Market

Today I received an email from Prosper to notify me that they are entering a quiet period, as they register with the proper securities authorities for a secondary lending market. What is a secondary lending market? It is a market where you can buy and sell loans that have already been originated. This provides additional liquidity, as you are no longer bound to wait 36 months until maturity and you can sell loans before they complete the full term.

In a typical secondary market, the net present value of a loan depends on the expected future cash flows and a discount rate. The discount rate is the interest rate on the loan often with an additional risk premium. When interest rates fall, the net present value of existing loans will rise. This is because older loans were originated at higher rates and are more valuable. When interest rates rise, the net present value of existing loans falls since new loans can be originated at higher rates and provide greater cash flow.

I have a feeling that at least initially, the Prosper market will not behave like a typical secondary lending market. I think that either one of two things will happen:

  1. People that regret having tied up their money for 36 months will put their loans up for sale. In desperation they may be willing to accept very low prices for the loans. This will present a great opportunity for investors to purchase higher yielding loans.
  2. People will be greedy and attempt to sell their loans for much higher prices than they are worth. Investors will not bother buying them since they can just originate more attractive loans. It would be an illiquid market, very much like the broader credit markets are right now.

It will certainly be interesting to see exactly what happens. Perhaps neither will happen and the market will function in a relatively normal manner. I’m sure that Prosper will probably provide some tools to provide guidance to those selling loans to ensure some liquidity within the market. Prosper will want the market to be as liquid as possible, because they will very likely receive fees for sales within the secondary market.

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    I’ve been lending on Prosper for a bit over 7 months now. I’ve seen quite a few loans move in and out of late status. I suppose some borrowers prefer to “optimize their cash flow” by allowing their loan payments to lapse a few days. This is just fine with me, as long as they eventually make the payments. Unfortunately, I also have some other borrowers that have allowed their payments to lapse more than just a few days and I currently have four loans in collections. Here’s a summary of my earnings on Prosper so far:

    • Cash deposited into account: $2,500
    • Earnings from referrals: $50
    • Principal Loaned: $3,000 (includes reinvested principal received and referral bonuses invested)
    • Principal Received: $376.45
    • Interest Received: $219.78
    • Late Fees Received: $0.70
    • Servicing Fees Paid: -$10.23
    • Collection Fees Paid: -$0.24
    • Net Profit: $210.01

    Now of course, there is a high probability that at least one of my four loans in collections is going to default if not all of them. The net principal balance for the four loans in collections is $191.61, so even if all four loans defaulted, taking into account my net profit I’m still ahead of the game by $18.40. That’s about a 0.74% total return so far or about 1.1% annualized. Although EricsCC and LendingStats have my estimated ROI much higher than that, I prefer to take a more conservative approach. Warren Buffett’s first rule of investing (and mine too) is don’t lose money. So far I think I’m doing well in that regard on Prosper.

    I still think that Prosper is a good investment vehicle, and a good addition to any investment portfolio. As long as you can outpace your defaults with your average interest rates, you can make money investing in Prosper loans. Here are a few simple rules I try to stick by when I’m investing in prosper loans:

    • Don’t invest in charity cases. I’m investing my money not giving it to charity. If you do lend to someone in a charity case, don’t get mad if and when you lose your money.
    • Don’t invest in start-ups. Without proven results, investing in a start-up is more of a gamble than an investment.
    • Don’t lend for working capital. If someone needs money for working capital it typically means they do not have the positive cash flow necessary to run their operation.
    • Invest in those consolidating debt. These are my favorite kinds of loans, particularly if it will improve someone’s cash flow situation.
    • Draw a line in the sand as far as your minimum interest rate. For example, if your target rate of return is 7%, then you shouldn’t invest in loans at a rate any lower than 7%.

    I haven’t always followed these rules, but it is because I hadn’t yet formulated them in my mind. If ever I do break any of the rules now, I need a very good reason for doing so. If you’re dealing with a small portfolio (less than 100 loans), it’s easy to stick to these rules. If you’re dealing with a larger amount of money and a higher number of loans, you’ll probably want to use a portfolio plan. Either way, you should try to be as consistent as possible with your loan selection in your lending portfolio.

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  • Another P2P Student Lender

    TechCrunch has an article about a new p2p student lending site called GreenNote. In addition to facing many of the same challenges that await Fynanz, GreenNote will have additional obstacles to overcome in order to attract investors. Perhaps the biggest challenge is that the interest rate is not set by lender bidding and is fixed across all loans (currently 6.8%, the rate of a Federal Unsubsidized Stafford Loan). Not only will GreenNote have a hard time competing with Fynanz in terms of the potential returns for investors, but Fynanz also provides some protection against defaults by guaranteeing at least 50% of the principal on defaulted loans. GreenNote provides no such guarantee.

    Given that they do offer a very good interest rate for students, they will surely have no problems attracting borrowers. However, I think GreenNote has a long road ahead if they intend to attract enough investors in order to meet the demand. Unless they can eventually insure part of the loan principal as Fynanz does or provide a secondary market for liquidity, I have serious doubts as to whether they will be able to compete with Fynanz and survive the long road to profitability.

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  • Prosper Greasemonkey Script for Firefox

    I finally downloaded and tried out Greasemonkey for Firefox extension the other day. I had heard of it before, but never installed it until recently. Greasemonkey is a Firefox extension that allows you to manipulate any web page you visit in Firefox. It uses JavaScript code that runs as if it were embedded into the website. It also provides some additional functions that let you do magical things such as cross-site scripting (which can also be dangerous if you install a malicious script). I actually had written a few JavaScript “bookmarks” to do some quick stuff for me on the Prosper website, but Greasemonkey provides a much better interface. It allows me to do what my bookmarks were doing and even more. Here are the features I’ve put into the script so far:

    • Auto-login
    • This is disabled by default. In order to enable it, right-click on the monkey, and click “Disable Automatic Login” under the User Script Commands. When the prompt appears asking if you want to disable the auto-login, click Cancel and it will enable the automatic login. I realize this probably isn’t the most intuitive thing in the world, but I was too lazy to develop my own dialog and I just used the window.confirm() JavaScript method. Your username and password is stored locally within your browser and is not transmitted anywhere other than to the Prosper website.

      I assure you that that the auto-login feature does nothing evil. I have it disabled by default in case you don’t believe me. Your username and password will be stored as configuration values within Firefox. If you navigate to about:config in the browser, you’ll see them under greasemonkey.scriptvals. Please note that the password is not encrypted. If you’re using a public machine or someone else’s computer, you may want to think twice about using the auto-login feature.

    • Total Revolving Credit and Total Available Credit
    • If there is more than 0% utilization, then the calculated total revolving credit and total available credit is displayed. If utilization is 0%, it is displayed as Indeterminate.

    • Estimations on Listing and Search pages
    • The estimated loss, adjustments, fees, and estimated return will be displayed on listing pages. On search pages, I display just the estimated return and estimated loss (to take up a bit less space than displaying all 4 numbers). You will need to be logged in for this feature to work.

    If you’d like to try it out, first install Greasemonkey on Firefox. Then click the button below to install:

    If you have any suggestions for new features to add, please feel free to let me know and I’ll be glad to see what I can do to accomodate.

    Update: I’ve added a user script command called “Set Investment Preferences.” It allows you to specify a minimum desired return, bid amount, and maximum loss amount. When you run searches, as the estimates are loaded in, listings will be removed if they are below the minimum desired return or if they have an estimated loss higher than the max loss.

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  • The WealthBoy Strict ROI for Prosper Lenders

    As I was writing my Rule of 72 on Prosper article for the official Prosper Blog, I began to think about developing my own ROI calculation based on what I had written. I had attempted creating an ROI calculation once before that was based on actual payments received, but I became frustrated with the lack of the detail payment data in the LoanPerformance table of the private export. I took another crack at developing an ROI calculation based on actual payments, and think I’ve come up with something that’s reasonable. If you’re interested in the actual implementation, you may want to check out the technical details and link to the SQL code here:

    Once I’ve constructed the tables necessary to calculate the payments that a lender has received, I have all of the information necessary to calculate the WealthBoy Strict ROI. The WBSROI performs two return calculations: TotalROI and AnnualizedROI. The TotalROI calculation is calculated by dividing the total profit (interest less servicing fees) by the total amount invested (which excludes reinvested loans). The calculation does not take into account the declining balances, hence the “strict” designation. If you have been lending successfully for a long time, it is certainly possible to have a TotalROI more than 100%. Here is the formula in a nutshell:

    TotalROI = (Total Interest Received – Fees – Losses on Defaults) / (Total Loan Originations – Reinvested Loans)

    The AnnualizedROI is calculated by dividing the TotalROI by the weighted average loan age and multiplying by 12. The weight for each bid is the amount lent as a percentage of the total originations. This may not be the best way to perform the AnnualizedROI calculation, but it was the best I could come up with. I believe the TotalROI is relatively indisputable, barring the errors in the payment calculations. The AnnualizedROI could probably use some enhancements.

    I like the idea of having a strict ROI calculation that doesn’t account for the declining balances. Many lenders on Prosper may not even be aware of what a declining balance is. Others may know about declining balances, but they just want to know what kind of return they’ve received on the total amount they’ve invested. That is what the WealthBoy Strict ROI attempts to do, and I believe it does it reasonably well. If you are reinvesting loans, your strict ROI should be reasonably close to your average interest rate less fees and your default rate.

    So what about late loans? Why aren’t they part of the calculation? Well, one of the nice things about of my calculation is that it really doesn’t take much more effort to account for the probability of late loans eventually defaulting. With the information provided in the calculation, you know the total investment and you know the total profit. All you need to do to account for late loans is to incorporate the loss estimation into the profit and presto! You have your new ROI including the probability of late loans defaulting.

    I decided to exclude any default projections from the initial announcement of my ROI calculation. Although it probably wouldn’t take much more effort to incorporate it, I think there is something to be said for an ROI calculation that doesn’t make any kind of suppositions. The WealthBoy Strict ROI calculates how much went in and how much came out. It makes no assumptions about the future value of loans. I have left it to others to make whatever assumptions they wish to make about estimating defaults.

    I do realize that not everyone has the expertise and/or resources to put together a Microsoft SQL Server database for analyzing Prosper data. Unfortunately, I don’t have a web application connected to my database so that people can see their WBSROI. If you would like me to provide you with your WBSROI, just post your screen name into a comment here. I’ll post the data in a responding comment. If I become overwhelmed with responses to the post, I may not be able to respond to requests any longer. If it does become a popular metric, perhaps someone with a popular stats site may be willing to add my calculations to their site. Here is what the WBSROI on my account looks like:

    Screen Name:WealthBoy
    Total Bid Count: 45
    Total Reinvested Bids: 3
    Total Originations (total amount loaned): $2,250
    Total Investment (total amount loaned excluding reinvested bids): $2,100
    Total Income (total principal and interest less fees): $209.22
    Total Profit (total interest less fees and defaults): $60.53
    Total ROI: 2.88%
    Average Loan Age: 1.76 months
    Annualized ROI: 19.62%

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