Posted on November 28th, 2012
OCTOBER MEDIA BRINGS INVESTORS LOOKING FOR POSITIVE RETURNS
Buoyed by press appearances on CNBC and NPR, in October Prosper posted $27m in new loan requests from potential borrowers and signed on more than 750 new investors. Loan and risk performance also continued to be strong, as the platform delivered its 38th consecutive month of positive returns to investors. In aggregate, Prosper has now returned more than $37m in interest payments to investors since its registration with the SEC in 2009, a figure that grows more rapidly with each passing month.
ASSET MARKET TRENDS SUGGEST STEADY ECONOMIC GROWTH
Election results changed investors’ focus from who will run the country to how Washington will handle the impending fiscal cliff. In many economists’ opinions, an impasse over the fiscal cliff could result in a recession as the combination of increased taxes and reduced government spending suppresses economic growth. Obviously, such a scenario would cause concern regarding how an investor would allocate capital to different investments, including Prosper loans. Do recent asset market trends support the fear of many economists? What potential strategies can a Prosper investor enact if the underlying health of the economy were to deteriorate?
Below we attempt to answer these questions.
Notwithstanding recent equity market weakness, it should be noted that the S&P 500 has had a very healthy year-to-date return, up 11.8% as of November 12th. Additionally, all major world equity markets are positive this year, with the exception of Spain and China. In short, 2012 world equity performance suggests an underlying global economy strong enough to support equity prices. Corporate high yield bonds have also shown strong performance. The BA Merrill Lynch High Yield index is up 12.9% as of October 31st. Perhaps more importantly, this index’s yield has remained remarkably steady over the past three months, suggesting that fears of a weakening economy are misplaced. If economic strains were beginning to appear, high yield bond’s interest rates should be rising.
Finally, consider two-year US government swap rates. For those not familiar with swap rates, they represent the price where two parties agree to exchange interest rate cash flows. Without getting over-complicated a high and rising swap rate indicates greater investor uncertainty about the course of future interest rates such that an investor pays more for a swap rate given this uncertainty. Note that swap rates rose prior to the beginning of each of the last three recessions (1990, 2000 and 2008) and are now back to levels not witnessed since 1993. The current level of swap rates seems to imply that fixed income investors are not overtly concerned about the direction of interest rates, or a recession. This suggests a slow but steady economic growth rather than any rapid increases or recessionary shocks. In other words, asset market data appears to suggest things will be ok.
Regardless, if investors are concerned about a recession they should look to the high credit grades of Prosper loans. Consider our back test analysis that estimates the potential variance of returns by Prosper credit grades throughout an economic cycle. Assuming an economic downturn one-third of the time in our simulation, we saw that steady performance, with little chance of principal loss, defines the likely performance of high credit grade Prosper loans. Of course, there is no free lunch, and an investor will give up additional yield by adding these to their portfolio. But the benefit of more stable returns could be exactly what the doctor ordered if tougher economic times were to prevail.
More information on October’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 firstname.lastname@example.org or 1-877-611-8797.
Joseph L. Toms
Chief Investment Officer
1To 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 chargeoff’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.
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