October 15, 2008 Comments

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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    • Investar
      I agree, "t will certainly be interesting to see exactly what happens." I doubt the secondary P2P "market will function in a relatively normal manner." It will be what's known in the book as thinly traded and inefficient for several years. An inefficient market provides enhanced opportunity for 'enhanced rewards' but offers an equivalent 'enhancement' of risk. It will be interesting!
    • 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.
    • NewHorizon
      "People that regret having tied up their money for 36 months will put their loans up for sale. "

      WB, do you fall into either of those categories - those that regret and/or those that will put their loans up for sale?
    • I was well aware that when I funded my account it would be a very long time
      before I would see my money again. In fact, I knew that if I invested
      poorly that I would never see it again, so I have no regrets. Until the
      quiet period, I had been reinvesting all of the principal and interest
      payments I had received. My total time horizon before I get my money back
      (if I make a positive return) is much longer than 36 months.

      I intend to compound the payments for 36 months and then take a look at my
      overall performance over that period of time. After 36 months I will see
      where I stand and then decide whether or not Prosper will be a good place to
      keep investing. I will not be putting up any loans for sale on the
      secondary market before then. Ask me again 36 months from now whether I
      have any regrets, and I might give you a different answer. ;)

      I will probably purchase loans for sale on the secondary market, especially
      if I am able to buy them at a discount. It may also be more convenient to
      purchase loans on the secondary market rather than the primary market.
      There will be no wait for loan approval, funding, and possible cancellation
      if the loan is not approved. The secondary market will probably become my
      market of choice when it comes to reinvesting principal and interest,
      because it will be possible to redeploy the funds much quicker.
    • NewHorizon
      "After 36 months I will see where I stand and then decide whether or not Prosper will be a good place to keep investing."

      Do you remember that in the prospers.org forum, you promised to update your readership about how well you're achieving your projected 11% ROI: "We'll see how the estimate stands by year-end when my portfolio has had the chance to complete one year of maturity." (Where "year" = 2008.)

      According to my calender, it's time to get back to us.
    • According to Prosper, my account value is currently sitting at $2,725.77, which would be a bit over 7% ROI (on $2,550). My average loan age is 290 days, so annualized it's about 8.5%. Of course, I'm not that naive to believe that my ROI is going to be 8.5% since I currently have six loans that are over 15 days past due.

      The six loans that are late, represent $280.55 of the account value and I would say most of that is at risk. The worst case would be if all six default and nothing is recovered. If that were to transpire, I would be at -4.1%, or about -5.2% annualized.
    • 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
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