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Consumer Credit Trends – Q1 2015 Prosper Update

We’re now 4 months into 2015, and the consumer marketplace lending industry has continued to grow rapidly. In order to fuel increased investor demand, we’ve seen rapid growth in origination volumes across marketplace lending originators. A question on many investors’ minds is whether the growth in originations comes at the cost of borrower credit quality.  We previously performed an analysis of consumer credit trends in October, but now we’d like to revisit this topic to review the additional data we’ve received in the past 6 months.  In today’s analysis, we will explore the borrower credit characteristics and repayment performance of recent vintages.

Growth in Originations

As seen in the chart below, Prosper origination volumes grew steadily through the end of 2014.  Prosper originated $197,447,938 in December 2014, up from $157,745,187 in November and $59,775,615 in December 2013.  While we did see a slight dip in originations in November, the December numbers were very strong, reaching a new all-time high for Prosper.  Prosper hasn’t yet released its Q1 2015 origination numbers, but it will be interesting to analyze whether the growth continues at this rate.

 

plot2

Distribution by Credit Grade

In order to get an idea of borrower credit quality, let’s take a look at Prosper’s monthly origination volumes by credit grade.  The distribution is noticeably consistent month over month, especially since the start of 2014.

plot3

 

While the above graph demonstrates that the distribution based on Prosper’s internal measure of credit risk is stable, it is a good idea to also analyze the distribution based on an externally defined measure of credit risk, such as FICO. The graph below shows that the distribution based on FICO is also quite stable.  A careful review of the data even shows a moderate increase credit quality in the FICO score distribution over time.  Maintaining a stable credit distribution while undergoing such steady growth is not easy and indicates careful underwriting by Prosper.

plot4

When we look at the distribution of FICO by credit rating, we see that Prosper has clearly done some adjusting within their own credit model, but the distribution is still generally consistent.

plot5

 

Vintage Performance

As a final review of borrower credit quality, let’s review the loan performance by vintage.  What we show here is the 30+ day delinquency rates for all Prosper loans from 2008 – 2014 (Q1 – Q3).  The graph demonstrates that 2013 and 2014 are the best performing vintages so far.  The 2014 vintage performance is tracking the 2013 curve very closely, indicating consistency in underwriting.

 

plot1

Conclusion

Leading up the the financial crisis in 2008, we saw many traditional originators relaxing their credit standards in order to increase origination volumes. This approach was often cheaper than the expense of marketing to and acquiring more creditworthy borrowers, but as we saw, the outcomes can be disastrous. Borrower credit characteristics are on the forefront of many investors’ minds, and it is important to carefully investigate any changes in credit quality over time. With marketplace currently representing such a small piece of consumer lending, originators have been able to increase volumes while still focusing on high quality borrowers, and we have not yet seen any indications of relaxing credit standards. We look forward to continuing to monitor the volume, distribution, and performance of Prosper and other marketplace originators.

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  • Brett Byers

    Michael, thanks much for the detailed analysis and insights.

    In terms of whether 2013 and 2014 will be the best performing vintages, it would seem that weighted average interest rates would need to be considered as well as default rates. Have you considered the two (interest rates and default rates) together?

    My belief is that interest rates have dropped over time since Prosper’s restart in July 2009. My own net returns (I was the largest lender on Prosper from late 2009 until mid 2011) suggest that the highest returns may have been just after July 2009. My net annualized IRR in late 2009 and 2010 on Prosper’s primary market were about 20% (I then represented as much as 5% to 10% of the monthly lending volume), but it has consistent dropped since then. In the late 2009 and early 2010 time frame (when interest rates where still determined in part by lender bidding, which then sometimes resulted in higher interest rates, as the relatively high borrower demand then resulted in borrowers often starting with higher interests to attract then scarce lenders), I would often get interest rates for C rated borrowers with credit scores of 700+ well into the 20+% range. Since then, Prosper moved to setting rates at fixed amounts, but also moved interest rates down to attract borrowers (as they became scarce relative to lenders) and moved borrowers up in in the Prosper credit grading (this is even shown in your fourth chart above showing AA, A and B grades versus credit score). Moreover, since the introduction of institutions as the dominant investors on Prosper (which really accelerated through 2013), number of loans issued in the higher credit grades (which sport lower interest rates) increased, and this is indicated on your second chart above. Finally, the average loan size for higher credit grades is higher, as Prosper permits larger loans to those borrowers in the higher credit grades, As a result, increased lending to the higher credit grades has an even greater effect in reducing weighted average interest rates.

    I think that Prosper has done the right thing in these moves over time, as I think that the net returns possible in late 2009 and early 2010 (and even afterward) were often excessive, and Prosper has also merely appropriately to competitive pressures as this market matures. Indeed, I still believe that current Prosper returns are very attractive given fixed income alternatives. But I think that the conclusion above that 2013 and 2014 are or will be the best performing vintages requires consideration of weighed average interest rates as well. While default rates have dropped over time, I believe that weighed average interest rates may have dropped more quickly.