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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
(Edgar Glimpses Via Acquire Media NewsEdge)
This management's discussion and analysis of financial condition and results of
operations, or MD&A, contains forward-looking statements that involve risks and
uncertainties. Please see "Forward-Looking Statements" in this Quarterly Report
on Form 10-Q for a discussion of the uncertainties, risks and assumptions
associated with these statements. This discussion should be read in conjunction
with our historical consolidated financial statements and related notes thereto
and the other disclosures contained elsewhere in this Quarterly Report on Form
10-Q. The results of operations for the periods reflected herein are not
necessarily indicative of results that may be expected for future periods, and
our actual results may differ materially from those discussed in the
forward-looking statements as a result of various factors, including but not
limited to those included elsewhere in this Quarterly Report on Form 10-Q and
those included in the "Risk Factors" section and elsewhere in our Annual Report
on Form 10-K.
Overview
We provide a peer-to-peer online credit marketplace that permits our borrower
members to apply for loans and lender members to purchase Notes issued by
Prosper, the proceeds of which facilitate the funding of specific loans to
borrowers. Our platform enables our borrower members to request and obtain
personal, unsecured loans by posting anonymous "listings" on the platform
indicating the principal amount of the desired loan. Loan terms are subject to
minimum and maximum loan amounts determined by the borrower's credit bureau
score and Prosper score, at interest rates set by Prosper. We assign a Prosper
Rating consisting of letter credit grades, based in part on the borrower's
credit score, to each borrower who requests a borrower loan. Prosper borrower
members' Prosper Rating, credit score range, debt-to-income ratios and other
credit data are displayed with their listings and are available for viewing by
lender members on an anonymous basis. Lender members access our platform and
"bid" the amount they are willing to commit to the purchase of a Note that is
dependent for payment on the corresponding borrower loan, at interest rates set
by Prosper. By making a bid on a listing, a lender member is committing to
purchase from Prosper a Note in the principal amount of the lender's bid. Lender
members who purchase the Notes will designate that the sale proceeds be applied
to facilitate the funding of the corresponding borrower loan. Loans originated
to borrower members are made by WebBank, an FDIC-insured, Utah-chartered
industrial bank, and sold and assigned to Prosper.
All loans requested and obtained by Prosper borrower members through our
platform are unsecured obligations of individual borrower members with a fixed
interest rate and a loan term currently set at one, three or five years. After
funding a loan, WebBank assigns the loan to Prosper, without recourse to
WebBank, in exchange for the principal amount of the borrower loan. WebBank does
not have any obligation to purchasers of the Notes. We verify the identity of
100% of our borrowers using a variety of methods including credit bureau data,
other electronic data sources and offline documentary procedures. We verify
income and/or employment on a subset of borrowers based on a proprietary
algorithm. The intention of the algorithm is to verify income or employment in
cases where the self-reported income of the borrower is highly determinative of
the borrower's Prosper Rating.
We derive our operating revenue by charging a transaction fee or origination fee
equal to a specified percentage of the principal amount of the borrower loan
paid by the borrower upon funding of the loan. The transaction fee is paid to
WebBank, and WebBank, in turn, pays Prosper amounts equal to the transaction
fees as compensation for its loan origination activities. We also charge lender
members a servicing fee equal to an annualized rate set at a percentage of the
outstanding principal balance of the corresponding borrower loan, which we
deduct from each lender member's share of the borrower loan payments.
Our Operating History
We incorporated in Delaware in March 2005 and launched our public website,
www.prosper.com on February 13, 2006. As of September 30, 2012, our platform has
facilitated 63,055 borrower loans since its launch totaling an aggregate
principal amount of approximately $406,250,000.
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We made significant changes to the operation of our lending platform on July 13,
2009. Prior to October 16, 2008, we purchased loans from WebBank and then sold
and assigned the loans to the lender members who bid on the listings for those
loans. From October 16, 2008 through July 12, 2009, we ceased originating loans
on our platform while we waited for the Securities and Exchange Commission to
declare effective our registration statement on Form S-1 covering our
origination activity. Since July 13, 2009, we retain the loans and issue new
securities, the Notes, to the winning lenders. Our obligation to repay the Notes
is conditioned upon the repayment of the associated borrower loan. We expect to
generate increased revenue from borrower origination fees and non-sufficient
funds fees and lender members' servicing fees as our transaction volume
increases. Over time, we expect that the number of borrowers and lender members
and the volume of borrower loans originated through our platform will increase.
We have a limited operating history and have incurred net losses since our
inception. Our net loss was $3,986,784 and $2,420,537 for the three months ended
September 30, 2012 and 2011, respectively and $11,608,254 and $5,941,094 for the
nine months ended September 30, 2012 and 2011, respectively. We earn revenues
primarily from borrower origination fees, non-sufficient funds fees and lender
member service fees. At this stage of our development, we have funded our
operations primarily with proceeds from equity financings, which are described
below under "Liquidity and Capital Resources."
Our operating plan calls for a continuation of the current strategy of
increasing transaction volume to increase revenue until we reach profitability.
In addition, our 2012 operating plan calls for continued investment in the
development of our website, loan servicing platform, loan scoring and marketing
efforts. In 2013, our emphasis will be on using the investments in our website
and platform to improve the costs to acquire loans and to improve scale and
efficiency in each marketing channel. Loan acquisition expenses are expected to
increase, but at a slower rate than revenues. As a result of the combination of
origination revenue growth combined with efficiency gains in variable expenses,
we expect to become cash flow positive in 2013.
Our historical financial results and this discussion reflect the structure of
our lending platform and our operations both prior to and after July 13,
2009. For a discussion of the effect of our new structure on our consolidated
financial statements, see "Borrower Loans and Payment Dependent Notes" under
"Critical Accounting Policies and Estimates" below.
Trends and Uncertainties
The peer-to-peer lending industry remains a very innovative and unique industry,
and the application of federal and state laws in areas such as securities and
consumer finance to our business is still evolving. We will continue to monitor
this evolution actively in order to identify and respond quickly to any
legislative or regulatory developments that may impact our platform.
Through the first nine months of 2012, we have increased our origination volume
in terms of both units and total dollar amounts. We hope to continue this trend
of growth through marketing efforts and continued implementation of new features
on our website and platform so as to improve the borrower and lender
experience. For example, in 2012 we built a data exchange program that allows
Prosper and its partners to exchange data in a manner that enables sophisticated
lead generation, which we expect to increase qualified leads and the efficiency
of marketing spend. Also, we expect to increase our lender base as we attract
and retain lender members through marketing efforts that establish our Notes as
a viable investment alternative, providing improved investment search tools such
as Auto Quick Invest and new methods of providing data exchange specific to
lender member objectives.
Critical Accounting Policies and Estimates
Management's discussion and analysis of our financial condition and results of
operations is based on our consolidated financial statements, which we have
prepared in accordance with U.S. generally accepted accounting principles. The
preparation of financial statements requires management to make estimates,
judgments and assumptions that affect the reported amounts of assets and
liabilities, revenues and expenses and the related disclosures. Prosper bases
its estimates on historical experience and on various other assumptions that
Prosper believes to be reasonable under the circumstances. Actual results could
differ from those estimates. Our significant accounting policies which include
repurchase obligation, revenue recognition, stock-based compensation, and income
taxes are more fully described in Note 2 to our consolidated financial
statements included elsewhere in this quarterly report.
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Critical accounting policies are those policies that we believe present the most
complex or subjective measurements and have the most potential to impact our
financial position and operating results. While all
decisions regarding accounting policies are important, we believe that the
following policies could be considered critical.
Fair Value Measurement
Under Financial Accounting Standards Board (FASB) Accounting Standards
Codification (ASC) Topic 820 Fair Value Measurements and Disclosures, we
determine the fair values of our financial instruments based on the fair value
hierarchy established in that standard, which requires an entity to maximize the
use of quoted prices and observable inputs and to minimize the use of
unobservable inputs when measuring fair value. We use various valuation
techniques depending on the nature of the financial instrument, including the
use of market prices for identical or similar instruments, or discounted cash
flow models. When possible, active and observable market data for identical or
similar financial instruments are utilized. Alternatively, we determine fair
value using assumptions that we believe a market participant would use in
pricing the asset or liability.
The Company's financial instruments consist principally of cash and cash
equivalents, restricted cash, short term investments, receivables, loans held
for investment, borrower loans, accounts payable, accrued liabilities, and
borrower payment dependent notes. The estimated fair values of cash and cash
equivalents, restricted cash, accounts payable, and accrued liabilities
approximate their carrying values because of their short term nature.
We account for our short term investments, loans held for investment, borrower
loans, and borrower payment dependent notes on a fair value basis. We believe,
however, that borrower loans and borrower payment dependent notes represent a
pertinent element of our current quarter financial statement. For additional
information and discussion regarding our significant accounting policies
surrounding fair value measurement, see Note 2, Note 3, and Note 4 to the
consolidated financial statements included elsewhere in this report.
Borrower Loans and Borrower Payment Dependent Notes
On July 13, 2009, we implemented our new operating structure and began issuing
Notes. This operating structure resulted in Prosper purchasing loans from
WebBank and holding the loans until maturity. Prosper issues new securities, the
Notes, to the winning lenders. Prosper's obligation to repay the Notes is
conditioned upon the repayment of the associated borrower loan owned by
Prosper. As a result of these changes, Prosper carries the borrower loans and
the Notes on its balance sheet as assets and liabilities, respectively.
In conjunction with our new operating structure, we adopted the provisions of
ASC Topic 825, Financial Instruments. ASC Topic 825 permits companies to choose
to measure certain financial instruments and certain other items at fair
value. The standard requires that unrealized gains and losses on items for which
the fair value option has been elected be reported in earnings. We applied the
provisions of ASC Topic 825 to the borrower loans and Notes issued subsequent to
July 13, 2009 on an instrument by instrument basis. We did not apply the
provisions of ASC Topic 825 to loans issued prior to July 13, 2009. The
aggregate fair value of the borrower loans and Notes are reported as separate
line items in the assets and liabilities sections of the balance sheet using the
methods described in ASC Topic 820.
We determine the fair value of the borrower loans and Notes in accordance with
the fair value hierarchy established in ASC Topic 820, which requires an entity
to maximize the use of observable inputs and minimize the use of unobservable
inputs when measuring fair value. As observable market prices are not available
for the borrower loans and Notes we hold or for similar assets and liabilities,
we believe the borrower loans and Notes should be considered Level 3 financial
instruments under ASC Topic 820. ASC Topic 820 defines fair value as the
exchange price that would be received for an asset or paid to transfer a
liability (an exit price) in the principal or most advantageous market for the
asset or liability in an orderly transaction between market participants on the
measurement date.
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In a hypothetical transaction as of the measurement date, we believe that
differences in the principal marketplace in which the loans are originated and
the principal marketplace in which we might offer those loans may result in
differences between the originated amount of the loans and their fair value as
of the transaction date. Changes in the fair value of borrower loans and Notes
subject to the provisions of ASC Topic 820 are recognized in earnings; fees and
costs associated with the origination or acquisition of borrower loans are
recognized as incurred. Prosper estimates the fair value of the borrower loans
and Notes using a discounted cash flow methodology based upon a set of valuation
assumptions Prosper believes market participants would use for similar assets
and liabilities. The main assumptions used to value the borrower loans and Notes
include default rates, discount rates applied to each credit tranche/grade,
prepayment rates, and recovery rates.
Loss rate estimates will vary based on the age and credit grade of the
underlying loan. We use historical delinquency status and default rates combined
with current performance metrics to estimate the amount and timing of
defaults. During the quarter, the Company modified the estimated default
assumptions to incorporate varying loss rates as the status of the loan
progresses. For the remaining fair value assumptions, we used the following
averages:
Monthly prepayment rate speed 1.60 %
Recovery rate 5.39 %
Discount rate * 9.97 %
* This is the weighted average discount rate among all of Prosper's credit
grades
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Key economic assumptions and the sensitivity of the current fair value to
immediate adverse changes in those assumptions at September 30, 2012 for
borrower loans and Notes are presented in the following table:
Payment
Borrower Dependent
Loans Notes
Discount rate assumption: 9.97 % 9.97 %Decrease in fair value and income (loss) to earnings from:
100 basis point increase
$ (1,743,366 ) $ (1,726,214 )
200 basis point increase (3,440,493 ) (3,406,692 )
Increase in fair value and income (loss) to earnings from:
100 basis point decrease $ 1,791,355 $ 1,773,786
200 basis point decrease 3,632,844 3,597,266
Default rate assumption:
Decrease in fair value and income (loss) to earnings from:
10% higher default rates
$ (1,209,891 ) $ (1,197,697 )
20% higher default rates (2,419,847 ) (2,395,340 )
Increase in fair value and income (loss) to earnings from:
10% lower default rates $ 1,209,945 $ 1,197,589
20% lower default rates 2,419,854 2,395,311
Overall, if the fair value of the borrower loans decrease or increase due to any
changes in our assumptions, there will also be a corresponding decrease or
increase in the fair value of the linked Notes. As a result, the effect on
Prosper's earnings of adverse changes in key assumptions is mitigated. However,
the impact of these changes in fair value could have a material adverse impact
on lender members' investments in the Notes.
As we receive scheduled payments of principal and interest on the borrower loans
we will in turn make principal and interest payments on the Notes. These
principal payments will reduce the carrying value of the borrower loans and
Notes. If we do not receive payments on the borrower loans, we are not obligated
to and will not make payments on the Notes. The fair value of a Note is
approximately equal to the fair value of the corresponding borrower loan, less
the 1.0% service fee. If the fair value of the borrower loan decreases due to
our expectation regarding both the likelihood of default of the loan and the
amount of loss in the event of default, there will also be a corresponding
decrease in the fair value of the Note (an unrealized gain related to the Note
and an unrealized loss related to the borrower loan).
For additional information and discussion, see Note 2 and Note 3 to the
consolidated financial statements, included elsewhere in this report.
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Results of Operations
Revenues
Origination Fees
Our borrowers pay an origination fee upon successful funding of the borrower
loan. The origination fee is paid by the borrower out of the proceeds of the
borrower loan at the time of funding. We charge an origination fee equal to a
specified percentage of the aggregate principal balance of the loan based on the
Prosper Rating of the loan. Origination fees are charged by WebBank, which pays
these fees to Prosper as compensation for our marketing and underwriting
activities.
From our re-launch in July 2009 to April 11, 2012, our origination fees were as
follows:
Origination Fee Origination Fee Origination Fee
Percentage Percentage Percentage
Prosper Rating (July 2009-July 2010) (July 2010-Nov 2011) (Nov 2011-Apr 11, 2012)
AA 0.50% 0.50% 0.50%
A-B 3.00%* 3.00%** 3.95%
C-HR 3.00%* 4.50%** 4.95%
*Subject to $50 minimum fee through July 2010
**Subject to $75 minimum fee July 2010 through December 20, 2010, minimum fee
eliminated December 20, 2010 for all loan listings
From April 12, 2012 to September 30, 2012, our origination fees were as follows:
Origination Fee Origination Fee Origination Fee
Prosper Rating Percentage (1 year) Percentage (3 year) Percentage (5 year)
AA 0.50% 1.95% 4.95%
A 1.95% 3.95% 4.95%
B 2.95% 4.95% 4.95%
C-HR 3.95% 4.95% 4.95%
Origination fees for the three and nine months ended September 30, 2012 were
$2.1 million and $5.2 million, respectively, representing an increase of 173%
and 198%, as compared to $762.0 thousand and $1.8 million for the three and nine
months ended September 30, 2011, respectively. Origination volume has grown
steadily in 2012 as a result of our efforts to develop additional direct
partnerships with other websites that send us qualified individuals seeking
loans, and brand development work that increases potential borrower awareness of
Prosper as a lending alternative.
Origination Volume
During the three months ended September 30, 2012, a total of 5,632 loans
amounting to $45.0 million were originated through the Company's platform and
during the nine months ended September 30, 2012, a total of 15,128 loans
amounting to $116.1 million were originated through the platform. In comparison,
during the three months ended September 30, 2011, a total of 3,093 loans
amounting to $20.2 million were originated through the platform, and during the
nine months ended on September 30, 2011, a total of 7,315 loans amounting to
$47.9 million were originated through the platform. For the three months ended
September 30, 2012, this represented a "unit," or loan, increase of 82% and a
dollar increase of 123%. For the nine months ended September 30, 2012, this
represented a "unit," or loan, increase of 107% and a dollar increase of 142%.
The graph below shows quarterly originations in volume through our platform
dating back to January 2010 and the steady origination growth we have
experienced through September 30, 2012.
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The steady increase in volume is primarily due to improvements in operating
efficiency and an increase in marketing and borrower and lender promotions. Our
increase in marketing efforts related to affiliate, online, and brand marketing
have helped steadily increase our borrower listing and lender membership
volume. We continue to leverage our existing lender and borrower base and have
seen an increase in the reinvestment of investor funds and additional capital
being placed on the platform by existing investors as well as borrowers securing
second loans. We have also focused sales effort to attract additional capital
through lender outreach programs.
Interest Income on Borrower Loans and Payment Dependent Notes
We recognize interest income on our borrower loans using the accrual method
based on the stated interest rate to the extent that we believe it to be
collectable. We record interest expense on the corresponding Note based on the
contractual interest rate.
Gross interest income earned and gross interest expense incurred were
approximately $5.0 million and $4.7 million, respectively, for the three months
ended September 30, 2012, resulting in net interest income of $311.0
thousand. Gross interest income earned and gross interest expense incurred were
approximately $2.7 million and $2.5 million, respectively, for the three months
ended September 30, 2011, resulting in net interest income of approximately
$153.9 thousand. Gross interest income earned and gross interest expense
incurred were approximately $15.4 million and $14.6 million, respectively, for
the nine months ended September 30, 2012, resulting in net interest income of
approximately $819.0 thousand. Gross interest income earned and gross interest
expense incurred were approximately $6.1 million and $5.8 million, respectively,
for the nine months ended September 30, 2011, resulting in net interest income
of approximately $338.6 thousand. Overall net interest income for the above
mentioned periods is driven by the rise in the amount of loans that we originate
and service at any given point. As discussed above, our origination volume has
increased steadily since the corresponding prior period, which resulted in
increases to our gross interest income and expense and ultimately our net
interest income. Over time, we expect that revenues and expenses related to
borrower loans and Notes will increase as total loans and note originations
grow.
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Rebates and Promotions
We account for rebates and promotions in accordance with ASC Topic 605, Revenue
Recognition. From time to time we offer rebates and promotions to our borrower
and lender members. We record these rebates and promotions as an offset to
revenue if a particular rebate or promotion is associated with loan origination
volume. Our rebate and promotions have in the past been in the form of cash back
and other incentives paid to lender and borrowers.
For the three months ended September 30, 2012 and September 30, 2011, we
incurred expenses related to rebates and promotions extended to borrowers and
lenders of $454.9 thousand and $314.3 thousand, respectively, which represented
an increase of $140.6 thousand. For the nine months ended September 30, 2012 and
September 30, 2011, we incurred expenses related to rebates and promotions
extended to borrowers and lenders of $1.0 million and $759.3 thousand,
respectively, which represented an increase of $245.0 thousand. This is due to
the increased frequency and volume of our rebates and promotion during the nine
months of 2012 as compared to the first nine months of 2011 in order to incent
borrowers and lenders.
Cost of Revenues
Cost of Services
Cost of services consists primarily of credit bureau fees, payments to
strategic partners, and other expenses directly related to loan funding and
servicing. Cost of services expenses were $375.0 thousand for the three months
ended September 30, 2012, representing an increase of 24% as compared to $303.0
thousand for the three months ended September 30, 2011. Cost of service expenses
were $1.1 million for the nine months ended September 30, 2012, an increase of
17%, as compared to $899.0 thousand for the nine months ended September 30,
2011. The primary driver for the increase in our cost of service expense during
these periods was an increase in credit bureau fees resulting from an increase
in loan listing volume.
Loan and Note Repurchases
Under the terms of the Notes, we may, in certain circumstances, become obligated
to repurchase a Note from a lender. Generally these circumstances include the
occurrence of verifiable identity theft, our failure to properly follow loan
listing or bidding protocols, a violation of the applicable federal/state/local
lending laws. We accrue a provision for these potential repurchase obligations
when the Notes are sold to the lender members in an amount considered
appropriate to reserve for our potential repurchase obligation. The repurchase
obligation is evaluated at least once a quarter and represents an estimate based
on the rate of historical repurchases as a percentage of originations (which
generally occur within six to nine months of origination). The repurchase
obligation may include a judgmental management adjustment due to our limited
operating history, changes in current economic conditions, the risk of new and
as of yet undetected fraud schemes, origination unit and dollar volumes and the
lack of industry comparable. We increased our repurchase obligation to $35.5
thousand at September 30, 2012 compared to $22.2 thousand at September 30,
2011. This increase reflects an increase in the estimate for investor
indemnification and repurchases consistent with our increased loan originations.
Through the first nine months of 2012 we repurchased a single Note upon the
recent notification by law enforcement authorities of an identification related
fraud for a loan originated in 2007. We continue to devote a significant amount
of attention to fraud prevention and will continue to enhance our fraud control
procedures to maintain a low level of repurchases.
Other Income
Change in Fair Value on Borrower Loans, Loans Held for Investment and Payment
Dependent Notes, net
Under the methods described in ASC Topic 820, Fair Value Measurements and
Disclosures, we elected to account for unrealized gains or losses on the
borrower loans and borrower payment dependent notes on a fair value basis. These
amounts are included as a component of other income (expense) in our statement
of operations. The total fair value adjustment for the borrower loans and loans
held for investment was an increase of $1.8 million offset by an increase of
$1.5 million in the fair value of our Notes resulting in a net unrealized gain
of $316.0 thousand for the three months ended September 30, 2012. The total fair
value adjustment for the borrower loans and loans held for investment was an
increase of $1.1 million offset by an increase of $1.5 million in the fair value
of our Notes resulting in a net unrealized gain of $390.5 thousand for the three
months ended September 30, 2011. The total fair value adjustment for the
borrower loans and loans held for investment was an increase of $2.9 million
offset by an increase of $2.1 million in the fair value of our Notes resulting
in a net unrealized gain of $835.8 thousand for the nine months ended September
30, 2012. The total fair value adjustment for the borrower loans and loans held
for investment was an increase of $2.2 million offset by an increase of $1.3
million in the fair value of our Notes resulting in a net unrealized gain of
$866.0 thousand for the nine months ended September 30, 2011.
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Insurance recoveries
As noted in Note 12 to the unaudited financial statements, Prosper and certain
of its executive officers and directors are the subject of a class action
lawsuit brought on behalf of all loan note purchasers on the platform from
January 1, 2006 through October 14, 2008 that alleges that we offered and sold
unqualified and unregistered securities in violation of the California and
federal securities law. During the first quarter of 2011 the Superior Court of
California issued a final statement of decision finding that Greenwich Insurance
Company, our insurance carrier with respect to our class action lawsuit, had a
duty to defend the suit and requiring that Greenwich pay Prosper's past and
future defense costs in the suit up to $2.0 million. During 2011, Greenwich made
aggregate payments to us in the amount of $2.0 million to reimburse us for the
defense costs we had incurred in the class action suit. There were no insurance
reimbursements received during the nine months ended September 30, 2012. On
October 2, 2012, subsequent to the balance sheet date of September 30, 2012,
Greenwich made an additional payment of $142,585 to the Company for pre-judgment
interest. Please see our Note 12 "Commitment and Contingencies" in the notes to
our consolidated financial statements contained elsewhere in this report for
further information related to this payment.
Other Income
Other income consists primarily of credit referral fees, where partner companies
pay us an agreed upon amount for referrals of customers from our website. Other
income was $144.6 thousand for the three months ended September 30, 2012, which
represented an increase of 468% over the corresponding prior year period. Other
income was $235.2 thousand for the nine months ended September 30, 2012, which
represented an increase of 254% over the corresponding prior year period. The
increase in other income during these periods was due to the addition of a
number of new partners as well as increased traffic to existing credit referral
partners.
Operating Expenses
Compensation and benefits were $2.8 million and $7.6 million for the three and
nine months ended September 30, 2012, respectively, which represented an
increase of $1.0 million and $2.7 million over the corresponding periods in
2011. The increase was largely due to the Company steadily increasing its
employee headcount in the first nine months of 2012, which in turn resulted in
increased staffing costs such as salary and wages, payroll taxes, healthcare,
accrued vacation and bonus compensation. In particular, we increased our
headcount across our engineering, operations, and administrative teams to
respond to increased volume demands. As of September 30, 2012, we had 68 full
time employees compared to 53 full time employees as of September 30,
2011. Among our employees as of September 30, 2012, our sales and marketing team
had 17 employees, our engineering team had 19 employees, our operations team had
19 employees, and our administrative team had 13 employees. We intend to
continue to increase headcount as we grow our lender and borrower bases and
carry out our business plan, however, we expect our current investment in our
lending platform and website to improve our operating expense efficiency going
forward.
Marketing and advertising costs consist primarily of online affiliate marketing,
search engine marketing, online and offline campaigns, and public relations.
Marketing and advertising costs were $1.6 million for the three months ended
September 30, 2012 as compared to $375.2 thousand for the three months ended
September 30, 2011, representing an increase of $1.2 million. Marketing and
advertising costs were $4 million for the nine months ended September 31, 2012
as compared to $1.2 million for the nine months ended September 30, 2011,
representing an increase of $2.8 million. The costs associated with search
engine marketing are specifically related to increased volume and systematic
testing to attract new borrowers through Google and other search engines. The
affiliate marketing expense is deployed through direct partnerships with other
websites that send to us qualified individuals seeking loan options. Other
marketing costs are associated with online advertising campaigns specifically
targeted at attracting new lenders to the platform and brand development work.
Each marketing effort is measured, analyzed and optimized to improve scale and
efficiency in each channel. Through optimization of targeting efforts we will
shift marketing costs to efficient channels to balance the mix of growth and
efficiency in our marketing activities in subsequent quarters.
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Depreciation and amortization expense was $166.7 thousand for the three months
ended September 30, 2012, an increase of 46% from the $114.5 thousand expense
for the three months ended September 30, 2011. Depreciation and amortization
expense was $493.0 thousand for the nine months ended September 30, 2012, an
increase of 42%, from the $347.8 thousand expense for the nine months ended
September 30, 2011. This increase is mostly due to the capitalization of
various internally developed software projects placed in service during the last
year, which in turn increased depreciation expense taken on those assets during
the first nine months of 2012.
General and Administrative Expenses
Professional service expenses are comprised of legal expenses, audit and
accounting fees, consulting services, and other outside costs. For the three
months ended September 30, 2012 professional service expenses were $863.2
thousand, a 76% increase from the $489.2 thousand expense for the three months
ended September 30, 2011. For the nine months ended September 30, 2012
professional service expenses were $2.5 million, a 53% increase from the $1.6
million expense for the nine months ended September 30, 2011. The overall
increase for professional service expenses as compared to the prior year period
was due to a large increase in legal expenses related to the formation of
Prosper Funding LLC, a Delaware limited liability company ("PFL"), and the
preparation and filing of a registration statement for PFL, which is intended to
allow us to begin offering borrower payment dependent notes through PFL instead
of Prosper.
Facilities and maintenance expenses consist primarily of rents paid for our
corporate office lease and data co-location facility, software licenses and
subscriptions, office supplies and expenses, repairs and maintenance expense and
equipment and software costs that did not meet capitalization criteria.
Facilities and maintenance expenses for the three months ended September 30,
2012 were $302.0 thousand, an increase of 53% relative to the $197.0 thousand
cost corresponding to the prior year period. Facilities and maintenance expenses
for the nine months ended September 30, 2012 were $927.0 thousand, an increase
of 77% relative to the $523.0 thousand cost corresponding to the prior year
period. These increases were primarily due to higher general facility costs
caused by the expansion of our corporate office facilities, and additional
software licenses and subscriptions.
Other general and administrative expenses consist of bank service charges, dues
and subscriptions, insurance costs, travel and entertainment expenses, taxes and
licenses costs, communications costs, recruiting costs and administrative
expenses. For the three months ended September 30, 2012, other general
administrative expenses were $319.6 thousand, an increase of $110.0 thousand, as
compared to the $210.0 thousand cost for the three months ended September 30,
2011. For the nine months ended September 30, 2012, other general
administrative expenses were $1.2 million, an increase of $523.9 thousand, as
compared to $645.8 thousand for the nine months ended September 30, 2011. The
increase for the three and nine months ended September 30, 2012 was primarily
due to the expansion of our business which resulted in higher banking and
insurance costs, state licensing fees related to the formation of PFL, and
recruiting fees for new employees.
Liquidity and Capital Resources
We have incurred operating losses since our inception and we anticipate that we
will continue to incur net losses through the end of 2012. We had negative cash
flows from operations of $11.7 million and $6.7 million for the nine months
ended September 30, 2012 and 2011, respectively. As reflected in the
accompanying consolidated financial statements, Prosper has incurred net losses
and negative cash flows from operations since inception, and has an accumulated
deficit of approximately $72.4 million as of September 30, 2012.
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At September 30, 2012, the Company had approximately $8.0 million in available
cash and cash equivalents and short term investments. Since its inception,
Prosper has financed its operations primarily through equity financing from
various sources. The Company is dependent upon raising additional capital or
debt financing to fund its current operating plan, however we believe that our
current cash position is sufficient to meet our current liquidity needs.
Net cash used in operating activities during the first nine months of 2012 and
2011 was $11.7 million and $6.7 million, respectively and $3.3 million and $2.9
million for the three months ended September 30, 2012 and 2011, respectively.
The increase in cash used in operating activities was used to fund ongoing
operations to improve our borrower and lender customer experience on our lending
platform and resulted in increased compensation and benefit expenses,
particularly in our engineering and operations teams. As our business expanded
we also incurred increased legal and accounting services and marketing expenses.
We expect our efforts to improve our cost efficiency to generate greater
increases in origination revenue and reduce our ongoing cash requirements.
Net cash used in investing activities during the first nine months of 2012 and
2011 was $64.5 million and $32.0 million, respectively. The increase in cash
used is primarily related to increased borrower loan originations and payments
in 2012 which totaled $116.1 million and $46.3 million. In addition, net cash
used in investing activities included purchases of short term investments of
approximately $3.0 million, maturities of short term investments of $9.0
million, the origination of $164.0 thousand in loans held for investment,
repayments of $93.9 thousand related to loans held for investment. By
comparison, in the first nine months of 2011, loan originations and repayments
totaled $47.9 million and $16.9 million.
Net cash used in investing activities for the three months ended September 30,
2012 was $24.1 million which consisted of $45.1 million in borrower loan
originations offset by $18.3 million in borrower loan principal repayments,
maturities of short term investments totaling $3 million, the origination of
$6.4 thousand in loans held for investment, repayments of $31.6 thousand related
to loans held for investment, and purchases of property and equipment of $290.5
thousand.
Net cash provided by financing activities was $71.0 million and $48.0 million
for the nine months ended September 30, 2012 and 2011, respectively. The
increase in cash provided is related to increased note issuances which provide
the funding for the issuance of borrower loans. Net cash provided by the
proceeds from the issuance of notes was $116.1 million and was offset by
payments of $45.2 million on notes. In addition, cash from financing activities
included, proceeds from the issuance of common stock of $19.0 thousand. By
comparison, in 2011 net cash provided by financing activities included the net
proceeds from the issuance of convertible preferred stock of $16.7 million and
common stock of $39.1 thousand. Cash provided by note issuances totaled $47.9
million was offset by payments of $16.4 million and the repayment of a note
payable of $300.0 thousand.
Net cash provided by financing activities for the three months ended September
30, 2012 was $27.2 million which consisted of proceeds from the issuance of
notes held at fair value of $45.1 million, proceeds from the issuance of common
stock of $16.0 thousand, offset by $17.8 million in payment of notes held at
fair value.
As discussed in Note 12 of our consolidated financial statements, "Commitments
and Contingencies," contained elsewhere in this report, and in the "Insurance
Recoveries" section above, as of September 30, 2012, Greenwich had made payments
to the Company in the amount of $2.0 million to reimburse the Company for the
defense costs it had incurred in the class action suit. On October 2, 2012,
subsequent to the balance sheet dated September 30, 2012, Greenwich made an
additional payment of $142,585 to the Company for pre-judgment interest. As a
result, Greenwich has now satisfied its obligations with respect to the
Company's defense costs for the Hellum suit.
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With regard to the class action lawsuit, Prosper cannot presently determine or
estimate the final outcome of the lawsuit, and there can be no assurance that it
will be finally resolved in our favor. If the class action lawsuit is not
resolved in our favor, Prosper may be obliged to pay damages, and might be
subject to such equitable relief as a court may determine. Accordingly, the
Company has not recorded an accrued loss contingency in connection with the sale
of promissory notes to lender members. Accounting for loss contingencies
involves the existence of a condition, situation or set of circumstances
involving uncertainty as to possible loss that will ultimately be resolved when
one or more future event(s) occur or fail to occur. An estimated loss in
connection with a loss contingency shall be recorded by a charge to current
operations if both of the following conditions are met: first, the amount can be
reasonably estimated; and second, the information available prior to issuance of
the financial statements indicates that it is probable that a liability has been
incurred at the date of the consolidated financial statements. Based on this
standard, Prosper currently is unable to reasonably estimate the amount of loss,
if any, that could arise in connection with this lawsuit. We will continue to
evaluate these matters based on subsequent events, new information and future
circumstances. For more information, see Note 12 of our financial statements
located elsewhere in this report.
Since our inception, inflation and changing prices have not had a material
effect on our business and we do not expect that inflation or changing prices
will materially affect our business in the foreseeable future.
Income Taxes
We incurred no income tax provision for the three and nine months ended
September 30, 2012 and 2011. Given our history of operating losses and
inability to achieve profitable operations, it is difficult to accurately
forecast how our results will be affected by the realization and use of net
operating loss carry forwards.
ASC Topic 740, Income Taxes provides for the recognition of deferred tax assets
if realization of such assets is more likely than not. Based upon the weight of
available evidence, which includes our historical operating performance and the
reported cumulative net losses in all prior years, we have provided a full
valuation allowance against our net deferred tax assets. We will continue to
evaluate our ability to realize the deferred tax assets on a quarterly basis.
Off-Balance Sheet Arrangements
In February 2012, we formed Prosper Funding LLC, a Delaware limited liability
company ("PFL"). We are the sole member of PFL and its accounts have been
included in the consolidated financial statements presented in this report. PFL
has been organized and will be operated in a manner that is intended to minimize
the likelihood that it will (i) become subject to bankruptcy proceedings or (ii)
be substantively consolidated with the Company, and thus have its assets subject
to claims by the Company's creditors, in the event the Company becomes subject
to a bankruptcy proceeding. We intended to restructure the platform so borrower
loans are held by PFL and PFL issues and sells the borrower payment dependent
notes tied to the loans. On March 7, 2012, PFL filed a registration statement on
Form S-1 with the SEC for a continuous offering and sale of such notes, which
remains under review by the SEC and has not yet been declared effective. Prosper
Funding LLC has not commenced operations as of the date of this report.
Additional Information about the Prosper Marketplace Loan Platform
Comparing Estimated Loss Rates to Actual Losses
Loan performance is reviewed on a monthly basis to determine how loss estimates
compare to the actual performance of loans. Actual performance relative to
expectations is a major factor when deciding on adjustments to loss expectations
going forward. The graphs below show the expected versus actual cumulative
dollar loss rates by Prosper Rating for PMI Borrower Loans booked from July 13,
2009 through December 31, 2011. Performance is as of September 30, 2012. Loss
performance is tracked by vintage and the rating segments shown are those that
appeared on the note at the time it was funded. The graphs include quarterly and
semi-annual vintages where all PMI Borrower Loans originated during that period
have been outstanding at least 12 months.
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The plot below shows the vintage cumulative losses of all loans originated
during the period of interest and compares those losses to an origination-dollar
weighted average expectation.
[[Image Removed]]
The remaining plots show the actual vintage performance within each Prosper
Rating grade. The rating segments are divided according to the rating that the
loan was given at the point it was originated. All loans underwritten on the
platform for the period of interest are shown.
[[Image Removed]]
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[[Image Removed: IMAGE4]]
[[Image Removed]]
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[[Image Removed]]
[[Image Removed]]
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[[Image Removed]]
[[Image Removed]]
Note: Expectation line reflects the weighted average expected loss rate across
all vintages at the time of origination
In aggregate, actual losses for each vintage and Prosper Rating have been
well-calibrated relative to our expectations. Some vintages came in slightly
higher than expectations and some slightly lower, but there have not been any
instances of losses systemically or materially deviating from expectations. We
track loan performance relative to our estimates regularly and adjust those
estimates to the extent we deem appropriate to more accurately reflect
anticipated deviations from historical performance that may arise due to changes
in the macro-economic or competitive environment. But we have not made any
fundamental changes to our methodology for estimating loss rates or calculating
Prosper Ratings based on any such review. Please note that the historical
performance of PMI Borrower Loans may not be indicative of the future
performance of Prosper Funding borrower loans.
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Loan Originations
The tables below show loan volume, average loan size, average lender yield,
average credit scores and other pertinent data by Prosper Rating for
originations from July 13, 2009 to September 30, 2012:
Prosper Rating Number Amount Average Loan Size
Dollar Percentage
AA 2,182 21,007,369 9,628 9 %
A 5,018 44,642,178 8,896 20 %
B 4,807 40,447,550 8,414 18 %
C 4,869 36,589,969 7,515 16 %
D 7,396 46,703,452 6,315 20 %
E 4,622 20,076,700 4,344 9 %
HR 5,148 17,645,779 3,428 8 %
Total 34,042 $ 227,112,997 $ 6,672 100 %
Weighted Average Weighted Average Weighted Average Average Experian Weighted Average
Prosper Rating Borrower Rate Estimated Loss Lender Yield ScorexPlus Score Borrower APR
AA 8.76 % 1.36 % 7.76 % 802 9.51 %
A 11.84 % 2.88 % 10.84 % 753 14.20 %
B 16.88 % 5.47 % 15.88 % 718 19.48 %
C 21.72 % 7.90 % 20.72 % 707 24.86 %
D 26.05 % 10.74 % 25.05 % 694 29.41 %
E 31.15 % 14.37 % 30.15 % 671 34.96 %
HR 31.89 % 17.71 % 30.89 % 688 35.67 %
Total 20.23 % 7.79 % 19.23 % 711 23.06 %
The tables below show loan volume, average loan size, average lender yield,
average credit scores and other pertinent data by Prosper Rating for
originations from July 1, 2012 to September 30, 2012:
Prosper Rating Number Amount Average Loan Size Dollar Percentage
AA 321 $ 4,565,443 14,223 10 %
A 789 8,623,695 10,930 19 %
B 768 7,581,645 9,872 17 %
C 1,117 9,964,052 8,920 22 %
D 1,006 8,447,370 8,397 19 %
E 538 2,072,000 3,851 5 %
HR 1,093 3,820,259 3,495 8 %
Total 5,632 $ 45,074,464 8,003 100 %
Weighted Average Weighted Average Weighted Average Average Experian Weighted Average
Prosper Rating Borrower Rate Estimated Loss Lender Yield ScorexPlus Score Borrower APR
AA 9.36 % 1.39 % 8.36 % 792 11.07 %
A 12.57 % 2.92 % 11.57 % 747 15.17 %
B 17.63 % 5.32 % 16.63 % 712 20.81 %
C 21.88 % 7.80 % 20.88 % 708 25.07 %
D 25.41 % 10.56 % 24.41 % 694 28.68 %
E 29.85 % 14.23 % 28.85 % 673 33.66 %
HR 31.77 % 16.55 % 30.77 % 692 35.80 %
Total 19.98 % 7.35 % 18.98 % 710 23.02 %
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