August saw Prosper’s platform produce a 1.027% return, our 37th consecutive month of positive returns. Interestingly, in the past few months we have witnessed a strong increase in demand from borrowers in our highest credit grades, AA and A. Today an investor can purchase a five-year AA-rated Prosper Note with a current yield of 11.08%, an estimated loss rate of 1.74% and estimated return of 9.33%.1 As we will discuss in more detail below, we think that these Notes represent compelling value.
Last week all eyes turn to the Federal Reserve. In accordance with what many economists predicted, the weak August jobs report contributed to the Fed initiating new quantitative easing at its September 12th meeting. Combined with the European Central Bank’s recent announcement of “unlimited” bond buying of shorter-term European sovereign debt, it looks as if interest rates will remain low for an extended time. In fact, recent forecasts indicate that the Fed funds rate will remain below 0.5% through August 2015.
Not surprisingly, given the benign outlook for interest rates, investors have poured money into fixed income instruments, driving prices higher and yields lower. A recent Morgan Stanley research report highlighted the risks of rising fixed income prices, citing that long-dated investment grade corporate debt may represent the “biggest risk” in the U.S. corporate bond market and that they could lose 25% in value if rates were to return to pre-crisis levels. In short, it is our (and many others’) opinion that the sustained period of low rates has indeed altered the traditional risk/reward relationship for many fixed income instruments.
Consider current yields, durations, and long-term weighted average default data for corporate grades in contrast with Prosper’s platform inventory. As the Morgan Stanley report identifies, it is clear that high grade corporate debt (AAA-A) yields are indeed extremely low and that the average duration of 6+ years place these grades at risk if yields were to rise.
What also stands out is that Prosper’s historical seasoned default rate of 6.86% is similar to the equivalent of a B-rated corporate bond. Yet the pre-default yield is currently 2.9 times higher than corporate B bonds. Further, the average duration is 60% lower! In short, we think the data makes a compelling case to consider the risks and opportunities that exist in fixed income today. In the case of corporate bonds it appears that investment grade debt, while avoiding default risk, could suffer significant price risk since yields can’t make up for the length of the typical duration. In lower grade corporate debt investors incur default risk but receive some compensating yield, albeit perhaps not enough to completely offset price risk. In light of these options we would argue that Prosper’s platform, while incurring default risk, offers investors the chance to earn substantive yields with less price risk since the durations are significantly below those of typical corporate bond portfolios. For that reason an allocation to Prosper represents not only a sound investment but also provides substantive portfolio benefits in this trying fixed income environment.
More information on August’s monthly performance update can be found here. For further explanation of this commentary or with any other questions or comments, please contact our investor marketing team at [email protected] or 1-877-611-8797.
Joseph L. Toms
Chief Investment Officer
1Estimated return is the difference between the estimated effective yield and the estimated loss rate. Estimated effective yield is equal to the current yield (borrower interest rate minus the 1% servicing fee) (i) minus estimated uncollected interest on charge-offs, (ii) plus estimated collected late fees. The estimated loss rate is the estimated principal loss on charged off loans. All estimates are based on the historical performance of Prosper loans for borrowers with similar characteristics. The calculations of estimated return, estimated effective yield, and estimated loss rate require significant assumptions about the repayment of loans, and lenders should make their own judgments with respect to the accuracy of these assumptions. Actual performance may differ from estimated performance.
2To calculate the Annualized Returns on Principal By Monthly Loan Vintage, all payments received on borrower loans originated during that month (i) minus principal payments (ii) minus servicing fees (iii) minus charge-off’s, are aggregated and then divided by the average outstanding principal balance. To annualize this return, it is divided by the dollar-weighted average age of the loans in months and then multiplied by 12. Seasoned vintages are categorized as those vintages that are at least 10 months old.
3The current yield is based on the dollar weighted current yield for all loans originated in August of 2012.
4The Prosper Default figure of 6.86% is the “Seasoned” annualized loss rate associated with our annualized “Seasoned” return of 10.02%. To calculate the annualized loss rate, the net credit losses corresponding to eligible Notes are aggregated then divided by the average daily amount of aggregate outstanding principal for such loans providing a gross loss rate. To annualize the loss rate it is divided by the dollar-weighted average age of the portfolio in days and then multiplied by 365.
Notes offered by Prospectus.
This presentation includes forward-looking statements. Forward-looking statements inherently involve many risks and uncertainties that could cause actual results to differ materially from those projected in these statements. Where, in any forward-looking statement, we express an expectation or belief as to future results or events, such expectation or belief is based on the current plans and expectations of our management and is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. You should carefully read the factors described in the “Risk Factors” section of the Prospectus for a description of certain risks that could, among other things, cause our actual results to differ from these forward-looking statements.
All forward-looking statements speak only as of the date of this presentation and are expressly qualified in their entirety by the cautionary statements above and in the Prospectus. We undertake no obligation to update or revise forward-looking statements that may be made in this presentation to reflect events or circumstances that arise after the date made or to reflect the occurrence of unanticipated events.