How to Turn a Pipe Dream into a Nightmare

[Guest]

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[Jeremy]

I am eligible to lend again via Prosper, but my returns in the past were... less than stellar, to say the least. I really do think that a peer-to-peer lending model is a great idea, but the market hasn't yet learned how to price loans correctly. I think that using technology to eliminate the role of banks is a huge win, though.

I think that eventually people like me who aren't good at choosing profitable loans will leave Prosper, leaving a number of people who are able to price the loans more appropriately - making it an efficient marketplace. I guess time will tell.

[RichardF]

When I first heard about Prosper on TV, I said to myself, "Hey!  That's what I've been looking for!"

I immediately made two loans ($100 in, both now defaulted), then started reading the forums.  I was shocked and said to myself, "Whoop!"

While surfing one of the Prosper lender blogs, I read about Kiva and said to myself, "Hey! ..."

Not all that long ago, I was reading something about Kiva, stumbled across MicroPlace and said to myself, "Hmm..."

[Felipe]

Yes, it's really hard.  I've been a Prosper lender from the beginning.  Lost a bit of capital, but still at breakeven.  I classify it as a 3-year learning experience.  What I've learned:  1) stay away from credit card debt consolidations in this bad economy; 2) look for loan monthly payments of around $100, +/- 20%; 3) make sure the revolving credit balance is under $1,000 much better at under $500; 4) make sure the debt-to-income ratio doesn't exceed 20% right now; 5) stay with loans under $5-7.5K; and 5) no prior delinquencies.  Lot of this advice comes from Suze Orman.

You'll find the LendingClub.com probably more to your liking as the interest rate is fixed after underwriting, not a Dutch auction as used by Prosper.  I've been extremely careful to apply all the lessons I learned from Prosper to my activity with LendingClub.  So far so good, but always ready to modify and learn from humbling experiences.  KPM.

[Unilove]

Thank you, Felipe, for sharing your experiences and advice...

[RichardF]

Thanks, Felipe!   

You got me to take another look at Lending Club.  After looking at it a little closer, now I'm thinking I might be adding another wrinkle to my personal lending portfolio some time in the future.


Three things I particularly like about Lending Club are the preset interest rates based on trustworthy credit ratings you mentioned,  the primish loan default risk (about 2.5% of dollars loaned*), and a secondary market for the loan notes among lenders for added liquidity.

Lending Club calls what it offers social lending.  Microfinance industry types sometimes call us little shots doing the lending retail microfinance.  I believe there's still a tremendously large untapped reservoir of personal energy (money) looking for an outlet for people to offer people a hand up.  It will be interesting to see someone figure out how to set up the next level of social retail microfinance in a regulated securities market that has some of the Lending Club qualities.  I expect it will have to go country-by-country to meet all the regulations.  It also probably would be person-to-MFI, at least to start.  MFI credit ratings might come from MicroRate or such.  Maybe MicroPlace will figure out how to offer person-to-person "stories," but I don't know if it would add a secondary market.  With CD-like rates, risks and short terms available, I don't know if there would be much point.

Anyway, expanding the sustainable person-to-person lending options is all good.  For one thing, it takes some of the heat off Kiva to offer more structured loan options.  If individuals can better protect their personal lending portfolio risk by diversifying across several platforms, then they can be more forgiving of Kiva's idiosyncratic shortcomings. 

People helping people is the common thread here.  Sometimes it's about alleviating poverty.  Sometimes it's simply about improving the circumstances of peoples lives.  The reality is we're all at the beginning of a new age of connectivity - on all levels.  What we do with it is up to each of us, sort of.


Updates:

* "Defaults: A total of 3,963 notes comprising $591,463 ended in default. That translated into 2.8% of total notes and 2.5% of the total dollars borrowed." - Lending Club Investment Analysis, January 2009, p. 7. (PDF)
Upon further review...  Once again, I can't participate in the primary lending from my state of residence!   
However, the twist here is I can participate in the secondary market!   

[RichardF]

Once again, something I really like about P2P lending platforms that offer securities is that they are required to tell prospective lenders about the potential risks associate with using them.  Because Kiva doesn’t even acknowledge such a risk exists from using it on its own Risk and Due Diligence page, here’s another example from an aspirational peer in this regard.

RISKS RELATED TO LENDING CLUB AND THE LENDING CLUB PLATFORM

• We face a contingent liability for potential securities law violations in respect of loans sold to our lender members from May 2007 until April 7, 2008. This contingent liability may impair our ability to operate our platform and service the member loans that correspond to your Notes.
• We have a limited operating history. As an online company in the early stages of development, we face increased risks, uncertainties, expenses and difficulties.
• We will need to raise substantial additional capital to fund our operations, and if we fail to obtain additional funding, we may be unable to continue operations. In connection with their audit for the year ended March 31, 2008, our independent auditors raised substantial doubt about our ability to continue as a going concern due to our recurring losses from operations since inception.
• The market in which we participate is competitive and, if we do not compete effectively, our operating results could be harmed.
• If we fail to promote and maintain our brand in a cost-effective manner, we may lose market share and our revenue may decrease.
• We have incurred net losses in the past and expect to incur net losses in the future. If we become insolvent or bankrupt, you may lose your investment.
• Our substantial senior secured indebtedness could adversely affect our financial performance, ability to finance future operations, and our special, limited obligations in respect of the Notes.
• We have secured our debt facilities by pledging all of our assets except our intellectual property rights, the corresponding member loans and all payments we receive in respect of corresponding member loans.
• Our arrangements for backup servicing are limited. If we fail to maintain operations, you will experience a delay and increased cost in respect of your expected principal and interest payments on your Notes, and we may be unable to collect and process repayments from borrower members.
• If we were to become subject to a bankruptcy or similar proceeding, the rights of the holders of the Notes could be uncertain, and payments on the Notes may be limited and suspended or stopped. The Notes are unsecured and holders of the Notes do not have a security interest in the corresponding member loans or the proceeds of those corresponding member loans. The recovery, if any, of a holder on a Note may be substantially delayed and substantially less than the principal and interest due and to become due on the Note. Even funds held by Lending Club in trust for the holders of Notes may potentially be at risk.
• We rely on third-party banks to disburse member loan proceeds and process member loan payments, and we rely on third-party computer hardware and software. If we are unable to continue utilizing these services, our business and ability to service the member loans on which the Notes are dependent may be adversely affected.
• If the security of our members’ confidential information stored in our systems is breached or otherwise subjected to unauthorized access, your secure information may be stolen, our reputation may be harmed, and we may be exposed to liability.
• Our ability to service the member loans or maintain accurate accounts may be adversely affected by computer viruses, physical or electronic break-ins and similar disruptions.
• Any significant disruption in service on our website or in our computer systems could reduce the attractiveness of our platform and result in a loss of members.
• Competition for our employees is intense, and we may not be able to attract and retain the highly skilled employees whom we need to support our business.
• Our growth could strain our personnel resources and infrastructure, and if we are unable to implement appropriate controls and procedures to manage our growth, we may not be able to successfully implement our business plan.
• If we fail to retain our key personnel, we may not be able to achieve our anticipated level of growth and our business could suffer.
• It may be difficult and costly to protect our intellectual property rights, and we may not be able to ensure their protection.
• Purchasers of Notes will have no control over Lending Club and will not be able to influence Lending Club corporate matters.

[Jeremy]

It's definitely early days still for P2P lending models, and as much as I love the concept, I don't like losing money.

Right now, I really like MicroPlace - they have some pretty great returns, combined with the fact that the money goes toward third-world microfinance. Prosper ruined my faith in American borrowers, and Kiva has reinforced my faith in poor borrowers...

[AccountAbility]

Once again, something I really like about P2P lending platforms that offer securities is that they are required to tell prospective lenders about the potential risks associate with using them.  Because Kiva doesn’t even acknowledge such a risk exists from using it on its own Risk and Due Diligence page, here’s another example from an aspirational peer in this regard.

Richard - While I think the requirement that all potential risks be disclosed acts as an excellent checklist of what possibly could go wrong, the sheer weight of the list without any attempt at quantifying the likelihood just overwhelms the average lender.  And the same requirement that mandates the list prohibits virtually all the possible ways of adding some quantification -- leaving the lender with no real additional risk assessment tools other than the worry that one of these things will/might come to pass. 

Oh, and the knowledge that the purveyor will be able to say "We told you so." 

Dan

[RichardF]

Yes, a prospectus is full of heavy-duty lawyering.  My main point in posting these two lists was really to illustrate the chasm between saying what a legitimate risk could be and acting like no such risk exists at all.  If Kiva can't think of any sort of plausible risk it poses to lenders, then I guess that says something too.

[RichardF]

From: To: Date: Subject:

Prosper Me 7/28/2009 Collections Update

Dear Richard,

At Prosper, we strive to make investing as easy, sound, and yes—fun—as possible.

In the past year, we have seen an increase in the number of borrowers that have entered into what we call "Primary Collections," or accounts that are delinquent 31 - 121 days. We believe that the current economic environment, the worst in decades, is a significant contributing factor.

Regardless, we consider any delinquent payment to be unacceptable.

While the percent of accounts in arrears has declined recently (it appears to have peaked around year-end 2008), Prosper would like you to know that we take every delinquency very seriously. Along with raising the credit requirements of our first-time borrowers we've created the Prosper Rating system to better identify and quantify risk for lenders.

Although delinquencies are a part of being a lender, there are steps you can take to reduce the impact of a borrower delinquency such as diversifying your portfolio and adequately pricing for risk. To help, we are starting a series of blog posts covering this subject. You can read the first entry here.

Whether you're a first-time or experienced investor, we think you'll find this information useful. Please consider checking it out now.

Sincerely,
Prosper

Learn more about diversifying your portfolio by reading this paper.