When I first saw prosper, I thought it was great. I deposited $50 and lent out my first partial loan at 19%. I'm still getting payments from the person, and they're on target to pay me back the complete $50+interest at around $1.80/mo. My only complaint about the company is that you get locked into these 3 year loans. There aren't any means for folks to take out various term lengths, so that you could essentially stack your money as you would in CD investments. The only way to have a constant flow of funds that can be available immediately is to just continually fund small portions of loans each month over the next 3 years. That's kind of annoying.
All that being said, I work for a large bank, and I know how they make money. One of the main ways is to lend money on one side, and convince folks to deposit money (usually by paying them interest) on the other side. They always lend for more than they pay. It's pure arbitrage. I also know that there is often very little margin in it for banks. They need LOTS of customers to make it work. So I got to thinking, could an individual make arbitrage work at Prosper? I searched around and sure enough, there are plenty of folks lending money at 5-6% in order to then lend that money out again at 15-20% to make a profit. Unfortunately, I'm not sure it's a great living. Look at the chart I created below based on $5000 being borrowed at 6%. You need to get a very high return (which is hard, because the higher the rate, the riskier the customer).
| $5000 Arbitrage | Personal Loan @ 6% | Lend Out @ 12% | Lend Out @ 18% |
| Interest + is in, - is out | -475.96 | 978.6 | 1507.46 |
| Income minus Expenses | 502.64 | 1031.5 | |
| Income minus Expenses / 36 months | 13.96 | 28.65 | |
| Income minus Taxes (25%) minus Expenses | 257.99 | 654.64 | |
| Income minus Taxes (25%) minus Expenses / 36 | 7.16 | 18.18 |
So if you could borrow at 6% and lend at 18% with no mishaps, you would make roughly $18.18/mo off a $5000 arbitrage after taxes. To be honest, managing between 10-100 loans (depending on how large your contributions per loan is) is not going to be worth $18.18 of your time. Not unless you say live in a seriously deprived location where that might buy you a royal lifestyle for the week. In which case, you probably don't have good credit, nor access to the internet. The numbers scale linerally, so if you wanted to aim for making $1818/mo you'd need to lend 100x the $5000 or $500,000 to be exact. Now that to me, looks like A LOT of risk!
My thoughts: Arbitrage doesn't work at Prosper.
5 comments:
I too have been looking at the arbitrage oppty with Prosper (thats how I found your post). I think your right, about risk/return aspect of the site. In fact, when you do so looking around in the site and research the actual ROI for prosper loans, you actually get your best returns from the lowest risk loans. When you factor the default rates, prosper fees and collections agency fees, your ROI stinks!! You can look to earn about 5-7% off of AA rated loans and the returns are reduced into negative territory as you go down in quality.
I recommend reading this article on Prosper arbitrage:
Borrowing money to lend on Prosper: Wise or Foolish?
This is foolishness. By definition, arbitrage is supposed to be risk free, this strategy is far from that. While true arbitrage is almost impossible, you should be able to hedge most of the risk, which you cannot do here. You have default risk and reinvestment risk to consider. The only way you make money on this is by taking on risk, which is like anything else, you have to take risk to make, hence, not arbitrage. I have been in finance for 10+ years, including the capital markets, trading desks, and lenders. I have been in prosper for 2+ years. Here is the funny thing about prosper. Their default stats stink. Until recently I had over 30 loans that were 4+ months late (some were 12+ months late). Until last week, they showed up as late...but not charged off. To me that's misleading. With rare exception has a 4+ dlq loan in my portfolio ever paid. And now they are all charged off. My losses now total more than my net interest income. And I tried to do the borrow at AA and lend at A/B. It doesn't work.
To all, beware. We are in an economic downtown at a minimum. If people aren't paying a brick and mortar bank back for their credit card/home/car loans, statistically you should expcect no different result, so your incident of default will be HIGH. And since these are non-recourse unsecured loans, your severity will be pretty close to 100%.
The word arbitrage is one of the most misused terms in finance today. It's about as bad as "hedge fund", when many are not all that well hedged.
The transaction you describe above is pure leverage and credit risk. Borrowing someone elses money and investing it in riskier assets....there is no free lunch. Add in the tax effect on your interest income, and it gets really bad.
My Prosper portfolio at one point totalled over $12k, borrowed $4.5k. Look me up, dmburgess.
I work with a group that has extreme oppotunities in the bond maket right now. I am looking for Reg. U loan to purchase 10 million worth of bonds right now. I need a good source. I want to use the bonds are collateral. Anyone have a source. Thanks,
Paul
prosper stinks. I have a portfolio with risk spread from AA to D, and from credit card pay backs to business inventory purchase and real estate flippers. here's the deal. The people who borrowed say $20-25K with AA or A credit all defaulted after paying only one or two payments, those with D held on longer, and one actually paid back the principle of $50 before defaulting. Of 30+ loans, all but 9 have defaulted. I haven't lent anything for over two years and keep taking money out as fast as I can. The ROI is horrible. The collection rate on defaults is a bust. Prosper like eBay only cares about brokering the transaction where they get paid, and then they forget you. AVOID PEER-2-PEER at all costs. You have been warned.
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