Estimated Loss Rates

The estimated loss rate for each listing is based on the historical performance of Prosper loans with similar characteristics. The base loss rate is determined by two scores: 1) a custom Prosper Score and 2) Experian's Scorex Plus score. Adjustments are made to the base loss rate based on the presence of a previous Prosper loan and for certain loan terms. Any adjustments are added to the base rate to get the final loss rate, which then determines the Prosper Rating. The loss rates are not a guarantee and actual performance may differ from expected performance.

Base Loss Rate

The matrix below provides an example of how the base loss rate is determined. Each score is divided into 10 segments to create intersecting cells which contain estimated net loss rates based on the historical performance of Prosper loans that fall into the given cells. For example, a borrower listing with a Prosper score = 9 and an Experian Scorex Plus score = 715 has an estimated base loss rate = 5.95%, as shown in the table below. Both the ranges and the loss rates will be updated as more performance history is obtained.

Final Loss Rate

Adjustments can be made to the base loss rate that will increase or decrease the loss rate. Adjustments are made for the presence of a previous Prosper loan (i.e. the borrower has already taken out at least one Prosper loan) and for certain loan terms. The adjustments are additive and are used to determine the estimated final loss rate. The final loss rate then determines the Prosper Rating. Adjustment variables and their values are:

Here is an example of how the final loss rate and Prosper Rating for a loan listing are calculated:
- Borrower Experian Scorex Plus score = 715 and Prosper score = 9
- Borrower has a previous Prosper loan
- Borrower is taking a 3 year term loan

Methodology

A loan model was developed to simulate the future performance of the loans based on past performance data in order to calculate the estimated loss rates over the life of the loans.

Calculating Average Balance. To calculate the average balance for each period, we used the amount of loan principal on loans that are still open and have not been charged-off or paid off. As loan payments are made, the principal balance of each loan declines over time. It is assumed that borrowers that are making scheduled payments on these loans do so according to their amortization schedule.

When a loan is paid off early, it is no longer included in the outstanding balance for subsequent periods. Historical payoff rates were used to project the monthly payoffs and these rates were assumed to remain constant throughout the life of the loans. Similarly, once a loan has been charged-off, the principal associated with this loan is considered a credit loss and is no longer included in the outstanding periodic balance.

Estimating Delinquent and Charged-Off Loans. To estimate the number of current and delinquent accounts on a monthly basis, we applied roll rates to each group of given loans. We first calculated the historical roll rates of accounts in particular cells and then applied the historical rate to the given loans. A roll rate measures the percent of loans within a particular payment status that "roll" to the next late payment status if the loan is not paid. For example, a current account that is not paid "rolls" to a new payment status defined as 1 to 30 days past due. Similarly, an account that is already 1 to 30 days past due and does not make the next payment then "rolls" to a status of 31 to 60 days past due. An account is considered to be a loss, or charged-off, when it reaches 121+ days past due. The average historical roll rates were assumed to be constant for the life of the loan term.

Estimating Loss Rates. The estimated monthly dollar charge-offs are calculated by multiplying the estimated number of accounts that reach 121+ days past due in that month by the average balance of loans in that month.

Collection expenses and recovery payments are applied to gross losses to calculate net losses. When an account becomes more than 30 days past due, it is referred to a collection agency. Collection agencies are compensated by keeping a portion of the payments they collect based on a predetermined schedule. Payments collected by the collection agency reduce the amount of principal that is repaid to lenders. This expense is added to losses in the month the payment is made.

In addition, once an account has been charged-off, any subsequent payments received or proceeds from the sale of the loan in a debt sale are considered recoveries and reduce the amount of principal lost. Recovery assumptions are based on historical recoveries through November 2009 on accounts that were 121+ days past due in 2008. The recovery rate assumptions were:

• Prosper Rating AA-D = 6.0% annual recovery rate
• Prosper Rating E-HR = 2.0% annual recovery rate

To calculate the estimated average annualized net loss rate:

1. Calculate the monthly net loss rate:
   
   Net principal charge-offs in month X
   = Outstanding principal balance in month X
2. Calculate average annualized net loss rate:
   • annualize the monthly net loss rate
   • calculate balance-weighted average of the monthly rates over the life of the loan

For each group of loans, the average loan amount for charged-off accounts was compared to that for total loans; if there was a significant difference, the ratio of average charged-off loan amount to average total loan amount was applied to the expected loss rate to account for this differential.

Estimated loss rates determine the Prosper Rating.