Investors in Prosper Marketplace have criticized the company for misrepresenting its default rates and average rates of return. Prosper first began offering loans in the tail end of 2006 and investors that funded those early loans found that they had taken on significantly more risk than they were expecting. Because of higher than expected default rates, Lenders investments’ performed rather poorly.
Some early investors are now happy that they have broken even using the service. According to one member of the Prospers.org community, Prosper loans that were originated in October of ’06 ended up having a 44.2% default rate by the time their 3 year period was up. Ouch.
Now that Lending Club is getting to the point where some of its first loans are nearing maturity, we’re getting a better idea of how Lending Club loans are performing over time. We decided to take a look at some of Lending Club’s early loans to see how they are performing as they have aged. Lending Club makes its loan data freely available to slice and review to anyone on its website. We decided to look at loans that were originated before January of 2008, meaning that they have had at least 2 years to mature.
Lending Club advertises on its website that its current annualized default rate is just 2.89%. Under Lending Club’s statistics, 8.67% of loans should hypothetically go into default over the course of the loan.
Here’s how Lending Club says they calculate their default rates:
Annualized Default Rate is calculated by dividing the total amount of loans in default by the total amount of loans issued for more than 120 days, divided by the number of months loans in default have been outstanding and multiplied by twelve. The loans issued for less than 120 days are excluded from the calculation because loans are unlikely to default during the first 120 days.
On a first glance, one might think that Lending Club is contradicting its own data, but Lending Club is providing an accurate calculation of their default rate using their measure of a default rate. However, the measure that Lending Club uses to calculate their default rate likely doesn’t give the best picture of how a typical loan will perform over the full 3 year period of the loan.
To get that picture, you need to take a look at the performance of loans that have gone through their full 3 year period. Since Lending Club didn’t start originating loans until the middle of 2007, there aren’t any loans that have completed their 3 year term. At the end of 2010, we know that loans that started in 2007 and finished in 2010 will have a total default rate of at least 26%, but it will likely climb higher during their months of the loan term.
One peer-to-peer lending blogger has tried to slice Lending Club’s data and get a better idea of how Lending Club loans will perform over time. The blogger, who goes by “Fred93”, has come up with a few charts to show how Lending Club loans have performed over time. They’re definitely worth a look at too.
At the end of the day, peer-to-peer loans are likely going to have default rates between 15% and 35%, even after Prosper and Lending Club fine tune their formulas to determine who should get a loan and that needs to be taken into consideration before investing in either service.
