Prosper's $50m loan pool - high risk, high reward?

Prosper has reached a milestone of $50 million in P2P loans extended, however $10 million of these may end in default. Despite the high rate of Prosper defaults, much higher than traditional consumer credit defaults, lenders should not and may not mind if they are receiving appropriate returns.

P2P lending is emerging as a new credit category, not just in the visible ways of loan origination and delivery but also in the financial sense of how risk and reward are defined. P2P lenders are able to accept higher default rates since they are also theoretically realizing higher returns. Some portion of the 10% traditional spread in bank lending between borrowing and lending accrues to the lender.

It is clear that Prosper loans default at higher rates than traditional unsecured consumer credit loans. The chart below shows Prosper defaults in pink and Experian (as a proxy for the consumer credit market as a whole) defaults in blue. In every credit tier, Prosper loans have higher defaults. In the prime market of AA, A, B and C credit tiers, Prosper narrowly underperforms Experian. However as credit quality worsens, so do Prosper defaults with Prosper loans defaulting at double traditional rates in the E and HR (high risk) tiers.


Default data can be found at the Prosper website by scrolling to the bottom of the Performance page and selecting the Estimated ROI link. Lender ROI estimates are trickier, ranging from a blended portfolio ROI of -1% using the Prosper site data to 17% using the data from Eric's Credit Community.

The marketplace aspect of Prosper is working as sub-prime borrowers have seen the opportunity and are creating most of the volume on the site, 75% of listings and 60% of fundings. Although many loans receive funding that probably would not in traditional credit settings, the majority (75%+) of listings do not get funded.

Prosper is only about a year old and the P2P lending market needs to achieve much higher volumes before meaningful performance can be evaluated. The question is whether rates of return can be delivered which are appropriate given the higher risk from the higher defaults and if lenders can learn how to price default risk effectively in this new credit product.