Calculation of Estimated Return

In order to allow Prosper lenders to understand how loans with certain characteristics can be expected to contribute to their portfolio return, Prosper has enhanced the Marketplace Performance page with a projection of estimated return for the selected loan criteria. The estimated return tool will allow lenders to see a projection of credit losses and returns based on the actual performance of the loans to date. The tool is designed to help lenders understand the risk and return characteristics of loans that are similar to listings for which they are considering placing a bid. The tool enables lenders to derive expected losses based on more refined criteria than credit grade.

There are a minimum number of payment observations needed to calculate meaningful projections of net credit losses. Annual average returns will only be displayed for portfolios originated over a minimum one month period containing at least 200 payment observations. It is important for users to keep in mind that portfolios with more payment observations will exhibit less volatility over time as future payment observations are incorporated.

There are four major components of the average annual return calculation: average balance, net interest yield, net credit loss, and servicing fees. The analysis assumes a period is 1 month. The return for any given period is net interest received less net principal losses and servicing fees divided by the average balance for the period. Returns are annualized by dividing periodic returns by the number of days in the period and multiplying by 365. The annualized return for each period is averaged for all periods by weighting the periodic returns by the average balance for each period. The result is an annual average return that facilitates comparing the return from a given portfolio of loans to alternative investment returns and is consistent with the Experian data currently available on Prosper.

Sample Calculation

For illustrative purposes, a portfolio of 1,000 loans with a credit grade of C is shown below. These sample loans are assumed to be loans in the amount of $6,000 with a lender rate of 16.9%. All loans are amortizing loans with a 36 month term. In addition, the servicing fee is assumed to be 1%, consistent with Prosper’s recently announced pricing changes.

Calculating Average Balance

The average balance for a given period is the amount of loan principal for which interest is accrued. As principal is paid over the life of the loan it is returned to the lenders. The principal is no longer subject to interest charges and as a result is no longer included in the average balance for the portfolio. When a loan pays off early it is no longer included in the average balance for subsequent periods. Once a loan is more than 150 days past due, the principal associated with this loan is considered a credit loss and no longer included in the average periodic balance.

In order to allow a user to dynamically calculate an expected return for a portfolio of loans, it was necessary to make some simplifying assumption with respect to periodic average balance. It is assumed that loans that are making scheduled payments do so according to their amortization schedule.

Calculating Net Interest Yield

Net interest yield for a period is the interest and fees accrued during the period less uncollected interest and fees, divided by the average balance for the period. The interest accrued for any period can be calculated by multiplying the unpaid principal for current accounts and delinquent accounts less than 150 days past due times the periodic interest rate for the period. Interest accrued but never collected is subtracted from accrued interest in the net interest yield calculation. This will result in an effective rate that is less than the lender rate.

An additional component of net interest is late fees charged for late payments. These fees are charged when a lender is late by more than 15 days. Late fees charged to borrowers vary by state. The estimated return calculation uses an average late fee of $11 for all portfolios. Late fees that are charged, but never collected are not counted in the lender returns.

Net Credit Loss Calculation

Net credit loss has three components: principal never repaid by borrowers, commissions paid to collection agencies, and proceeds from the loans after they are 150 days past due (recoveries). The amount of principal that is never repaid by borrowers is a key determinant of the net return for any portfolio of loans. The number of accounts that stop making payments on their loans for a period in excess of 150 days is projected by applying roll rates to current and delinquent accounts, also known as a “unit roll forward.” A roll rate measures the percent of loans in a given status that do not pay. A current account that does not pay “rolls” to a new status defined as 1 to 30 days past due. In the example below, the roll rate from current to 1 to 30 days past due is 3%. The number of loans that are 1 to 30 days past due that miss their second consecutive payment “rolls” to a new status defined as 31 to 60 days past due. In the example below this rate is 25%. This progression of roll rates is applied until a loan is more than 150 days past due at which time it is considered a credit loss and marketed to a debt buyer.

In addition to accounts that do not pay during a period, there are accounts that pay in full each period. In the example above it is assumed that 1.3% of current accounts will pay in full each month. Once an account has paid in full, the loan is no longer counted as a current loan. The percentage of loans that pay in full each period is assumed to be constant for each credit grade as shown in the table below. These assumptions are based on actual pay offs observed for loans originated between June 2006 and October 2007.

In general, roll rates used to project future delinquencies and credit losses are based on actual observed roll rates for the portfolio to date. However, in situations where there is inadequate data to calculate meaningful roll rates (less than 20 bucket observations in credit grades B-HR, 15 observations in AA-A) for loans delinquent more than 31 days past due, a roll rate based on the expected average performance of loans in the credit grade is applied. These roll rates are based on payment behavior observed for loans originated from June 2006 through October 2007. If there is inadequate data to calculate the roll rate from current to 1 to 30 days past due, an estimated return will not be calculated. The likelihood of a default roll rate being applied diminishes as the number of loans in the selected portfolio increases.

Payments made by accounts that are more than 30 but less than 150 days past due are from accounts that have been referred to a collection agency. Collection agencies are compensated by keeping a portion of the payments they collect based a predetermined schedule. The effect of the payments to the collection agencies is to reduce the amount of principal that is repaid to lenders and the expense is added to losses in the period the payment is made.

Once a loan is delinquent for more than 150 days it is considered a loss and the remaining principal on that loan is subtracted from the interest received during the period in which the loan defaults. As part of Prosper’s process, loans that are more than 150 days past due are marketed to a debt buyer. Any proceeds from the sale of loan (recoveries) reduce the amount of principal lost. Recovery assumptions are based on the proceeds for debt sales that have been executed. The table below shows the recovery rate assumptions by credit grade.

An additional expense to lenders is the servicing fee owed to Prosper. This expense is calculated by multiplying the periodic servicing rate for the portfolio times the average balance for the period and subtracting the portion of servicing fee associated with uncollected interest.

Consolidating Components of Average Annual Return

Once the periodic net interest payments and net credit losses are calculated they are divided by the periodic average balance and annualized, resulting in an annual return for the period.

	Month 1	Month 2	Month 3	Month 4	Month 5	Month 6
Interest charged	$84,500	$81,661	$78,860	$76,105	$73,393	$70,358
Uncollected interest	($362)	($700)	($1,025)	($1,336)	($1,635)	($1,560)
Late fees paid	$0	$333	$341	$347	$352	$345
Net interest	$84,138	$81,293	$78,176	$75,116	$72,110	$69,144
Credit loss	-	-	-	-	($25,672)	($24,049)
Collection expense	-	-	($144)	($218)	($272)	($266)
Recoveries	-	-	-	-	$5,160	$4,834
Net credit loss	-	-	($144)	($218)	($20,784)	($19,481)
Servicing fee	($4,979)	($4,791)	($4,606)	($4,424)	($4,246)	($4,071)
Net return	$79,160	$76,503	$73,427	$70,474	$47,080	$45,592

Calculating the average of periodic returns weighted by the average balance for each period results in an expected average annual return for the loan portfolio.

	Total	Month 1	Month 2	Month 3	Month 4	Month 5	Month 6
Average balance ($000)		$6,000	$5,798	$5,600	$5,404	$5,211	$4,996
Interest charged	16.90%	16.90%	16.90%	16.90%	16.90%	16.90%	16.90%
Uncollected interest	-0.35%	-0.07%	-0.14%	-0.22%	-0.30%	-0.38%	-0.37%
Late fees paid	0.12%	-	0.07%	0.07%	0.08%	0.08%	0.08%
Net interest	16.67%	16.83%	16.82%	16.75%	16.68%	16.60%	16.61%
Credit loss	-4.90%	-	-	-	-	-5.91%	-5.78%
Collection expense	-0.09%	-	-	-0.03%	-0.05%	-0.06%	-0.06%
Recoveries	0.98%	-	-	-	-	1.19%	1.16%
Net credit loss	-4.00%	-	-	-0.03%	-0.05%	-4.79%	-4.68%
Servicing fee	-0.98%	-1.00%	-0.99%	-0.99%	-0.98%	-0.98%	-0.98%
Net return	11.69%	15.83%	15.83%	15.74%	15.65%	10.84%	10.95%

For a portfolio with credit losses, the net interest yield will be less than the lender rate charged on the loan. This is due to interest that is accrued on balances included in the average balance calculation but never collected due to a credit loss. This also results in a corresponding reduction in the effective servicing fee rate the lender pays because servicing fees are only owed on collected interest payments.

The estimated return displayed on the Performance Page is intended to help lenders understand the risk and return associated with selected portfolios of loans. Actual performance may vary from estimated performance and users of this information should make their own judgments concerning impact of simplifying assumptions on calculated results.

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