10-K 1 form10k.htm PROSPER MARKETPLACE INC 10-K 12-31-2012 form10k.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 


FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2012

 
Commission
File Number
 
Exact Name of Registrant as Specified in its Charter,
State or Other Jurisdiction of Incorporation,
Address of Principal Executive Offices, Zip Code
and Telephone Number (Including Area Code)
 
I.R.S. Employer
Identification Number
     
333-147019,
333-179941-01, and
333-182599
 
PROSPER MARKETPLACE, INC.
a Delaware corporation
111 Sutter Street, 22nd Floor
San Francisco, CA 94104
Telephone: (415)593-5400
 
73-1733867
     
333-179941
 
PROSPER FUNDING LLC
a Delaware limited liability company
111 Sutter Street, 22nd Floor
San Francisco, CA 94104
Telephone: (415)593-5479
 
 
45-4526070
Securities registered pursuant to Section 12(b) of the Act:
 
Registrant
 
Title of Each Class
 
Name of Each Exchange
on Which Registered
Prosper Marketplace, Inc.
 
None
 
None
Prosper Funding LLC
 
None
 
None

Securities registered pursuant to Section 12(g) of the Act:
         
Registrant
 
Title of Each Class
   
Prosper Marketplace, Inc.
 
None
   
Prosper Funding LLC
 
None
   
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Prosper Marketplace, Inc.
 
Yes ¨ No x
           
Prosper Funding LLC
 
Yes ¨ No x
           
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Prosper Marketplace, Inc.
 
Yes ¨ No x
           
Prosper Funding LLC
 
Yes ¨ No x
           
 
Indicate by check mark whether each registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.
Prosper Marketplace, Inc.
 
Yes x No ¨
           
Prosper Funding LLC
 
Yes x No ¨
           
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Prosper Marketplace, Inc.
 
Yes x No o
           
Prosper Funding LLC
 
Yes o No ¨
           
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K (applicable to Prosper Marketplace, Inc. only). ¨
 
 
 

 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
                 
   
Large
Accelerated
Filer
 
Accelerated
Filer
 
Non-
Accelerated
Filer
 
Smaller
Reporting
Company
         
Prosper Marketplace, Inc.
 
¨
 
¨
 
¨
 
x
         
Prosper Funding LLC
 
¨
 
¨
 
¨
 
x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
                 
Prosper Marketplace, Inc.
 
Yes ¨ No x
           
Prosper Funding LLC
 
Yes ¨ No x
           
 
Prosper Marketplace Inc. and Prosper Funding LLC meet the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and are therefore filing this Form 10-K with the reduced disclosure format specified in General Instruction I(2) of Form 10-K.
 
 
Registrant
 
Aggregate Market Value of Voting and
Non-Voting Common Equity Held by
Non-Affiliates of the Registrant at
June 30, 2012
 
Number of Shares of Common
Stock of the Registrant
Outstanding at  March 13, 2013
Prosper Marketplace, Inc.
  $148,386(a)  
65,229,230
($.01 par value)
Prosper Funding LLC
 
None (b)
 
None

(a)
Solely for purposes of calculating this aggregate market value, Prosper Marketplace, Inc. has defined its affiliates to include (i) those persons who were, as of June 30, 2012, its executive officers, directors and beneficial owners of more than 10% of its common stock, and (ii) such other persons who were, as of June 30, 2012, controlled by, or under common control with, the persons described in clause (i) above.  Prosper Marketplace, Inc.’s common stock is not publicly traded; therefore, it has assumed the fair market value of its common stock is equal to the valuation of its common stock made pursuant to Section 409A of the Internal Revenue Code completed most recently before June 30, 2012.
 
(b)
All voting and non-voting common equity is owned by Prosper Marketplace, Inc.
 
THIS COMBINED FORM 10-K IS SEPARATELY FILED BY PROSPER MARKETPLACE, INC AND PROSPER FUNDING LLC.  INFORMATION CONTAINED HEREIN RELATING TO ANY INDIVIDUAL REGISTRANT IS FILED BY SUCH REGISTRANT ON ITS OWN BEHALF. EACH REGISTRANT MAKES NO REPRESENTATION AS TO INFORMATION RELATING TO THE OTHER REGISTRANT.
 


 
 

 
 
 
 
 
 
 
ITEM
 
 
Page
PART I
ITEM 1
 
6
ITEM 1A
 
45
ITEM 1B
 
69
ITEM 2
 
69
ITEM 3
 
69
ITEM 4
 
69
 
PART II
ITEM 5
 
70
ITEM 6
 
70
ITEM 7
 
71
ITEM 7A
 
84
ITEM 8
 
84
ITEM 9
 
85
ITEM 9A
 
85
ITEM 9B
 
85
 
PART III
ITEM 10
 
86
ITEM 11
 
93
ITEM 12
 
99
ITEM 13
 
103
ITEM 14
 
106
 
PART IV
ITEM 15
 
107
 
 
 
 
 
 
S-1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exhibit 31.3      
Exhibit 31.4      
 
 
 
Exhibit 32.2      
 
 
 
 
XBRL Content
 
 
 
Forward-Looking Statements
 
This Annual Report on Form 10-K includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). Forward-looking statements include all statements that do not relate solely to historical or current facts, and can generally be identified by the use of words such as “may,” “believe,” “will,” “expect,” “project,” “estimate,” “intend,” “anticipate,” “plan,” “continue” or similar expressions. In particular, information appearing under “Business,” “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” 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, Prosper Funding LLC (“Prosper Funding”) or Prosper Marketplace, Inc. (“PMI” and, collectively with “Prosper Funding, the “Registrants”) expresses an expectation or belief as to future results or events, such expectation or belief is based on the current plans and expectations of Prosper Funding and PMI’s respective managements, expressed in good faith and is believed to have a reasonable basis.  Nevertheless, there can be no assurance that the expectation or belief will result or be achieved or accomplished. The following include some but not all of the factors that could cause actual results or events to differ materially from those anticipated:
 
 
·
the performance of the Borrower Payment Dependent Notes or “Note”, which, in addition to being speculative investments, are special, limited obligations that are not secured, guaranteed or insured;

 
·
Prosper Funding’s ability to make payments on the Notes, including in the event that borrowers fail to make payments on the corresponding loans;

 
·
the reliability of the information about borrowers that is supplied by borrowers;
 
 
·
Prosper Funding and PMI’s ability to service the loans, and their ability or the ability of a third party debt collector to pursue collection against any borrower, including in the event of fraud or identity theft;

 
·
credit risks posed by the credit worthiness of borrowers, the lack of a maximum debt-to-income ratio for borrowers, and the effectiveness of the registrants’ credit rating systems;

 
·
actions by some borrowers to defraud lender members and risks associated with identity theft;

 
·
Prosper Funding and PMI’s limited operational history and lack of significant historical performance data about borrower performance;

 
·
the impact of current economic conditions on the performance of the Notes and loss rates of the Notes;

 
·
payments by borrowers on the loans in light of the facts that the loans do not impose restrictions on borrower and do not include cross-default provisions;

 
·
Prosper Funding and PMI’s compliance with applicable local, state and federal law, including the Investment Advisers Act of 1940, the Investment Company Act of 1940 and other laws;

 
·
potential efforts by state regulators or litigants to characterize Prosper Funding or PMI, rather than WebBank, as the lender of the loans originated through the platform;

 
·
the application of federal and state bankruptcy and insolvency laws to borrowers and to Prosper Funding and PMI;

 
·
the impact of borrower delinquencies, defaults and prepayments on the returns on the Notes;

 
·
the lack of a public trading market for the Notes and any inability to resell the Notes on the Note Trader platform;

 
·
the federal income tax treatment of an investment in the Notes and the PMI Management Rights;

 
·
Prosper Funding and PMI’s ability to prevent security breaches, disruptions in service, and comparable events that could compromise the personal and confidential information held on their data systems, reduce the attractiveness of the platform or adversely impact their ability to service loans;

 
·
the resolution of pending litigation involving PMI, including any state or federal securities litigation; and

 
·
Prosper Funding’s ability to compete successfully in the peer-to-peer and consumer lending industry.
 

There may be other factors that may cause actual results to differ materially from the forward-looking statements in this Annual Report on Form 10-K.  Prosper Funding and PMI can give no assurances that any of the events anticipated by the forward-looking statements will occur or, if any of them does, what impact they will have on Prosper Funding or PMI’s results of operations and financial condition. You should carefully read the factors described in the “Risk Factors” section of this Annual Report on Form 10-K for a description of certain risks that could, among other things, cause Prosper Funding and PMI’s actual results to differ from these forward-looking statements.

All forward-looking statements speak only as of the date of this Annual Report on Form 10-K and are expressly qualified in their entirety by the cautionary statements included in this Annual Report on Form 10-K. Prosper Funding and PMI undertake no obligation to update or revise forward-looking statements that may be made to reflect events or circumstances that arise after the date made or to reflect the occurrence of unanticipated events, other than as required by law.
 
 
PART I
 
Item 1. Business
 
Prosper Funding LLC (“Prosper Funding”) operates a peer-to-peer lending platform (the “platform”).  Prosper Marketplace, Inc. (“PMI” and, collectively with Prosper Funding, the “Registrants”) developed the platform and prior to February 1, 2013, owned the proprietary technology that makes operation of the platform possible.  Prior to February 1, 2013, PMI operated the platform, facilitated the origination of loans by WebBank through the platform and issued and sold notes corresponding to those loans.  Borrower loans originated and notes issued and sold by PMI are referred to as “PMI Borrower Loans” and “PMI Notes,” respectively.  On February 1, 2013, PMI transferred ownership of the platform, including all of the rights related to the operation of the platform, to Prosper Funding.  Since February 1, 2013, all Notes issued and sold through the platform are issued and sold by Prosper Funding.  Pursuant to a Loan Account Program Agreement between PMI and WebBank, PMI manages the operation of the platform, as agent of WebBank, in connection with the submission of loan applications by potential borrowers, the making of related loans by WebBank and the funding of such loans by WebBank.  Pursuant to an Administration Agreement between Prosper Funding and PMI, PMI manages all other aspects of the platform on behalf of Prosper Funding.

The platform is designed to allow people to invest money in people in an open transparent marketplace, with the aim of allowing both lenders and borrowers to profit financially as well as socially. The Registrants believe peer-to-peer lending represents a new model of consumer lending, where individuals can earn the interest spread of a traditional consumer lender but must also assume the credit risk of a traditional lender. It is people that are the drivers of credit formation in peer-to-peer lending, not institutions. PMI launched the platform to the public in 2006 and had attracted over one million members and facilitated over $443 million in consumer loans as of December 31, 2012.

The Registrants believe peer-to-peer lending presents an enormous opportunity to create a more transparent form of consumer lending. Key drivers of peer-to-peer lending include:
 
·
The possibility of lower rates and better terms for borrowers compared to traditional sources of consumer credit, such as credit cards;
 
·
A new asset class for investors with the possibility of attractive risk adjusted returns that are not directly correlated to the performance of the stock market;
 
·
An opportunity to combine social networking with financial services in a manner that allows users that help fund loans to feel they are directly helping other people while also potentially earning attractive returns; and
 
·
Growing acceptance of the Internet as an efficient and convenient forum for consumer transactions.
 
How the Platform Works

The platform is an online marketplace that matches individuals who wish to obtain consumer loans (“borrower members”) with those who are willing to help fund those loans (“lender members”).  A borrower member who wishes to obtain a loan through the platform must post a loan listing, or listing, on the platform.  Lender members can review all the loan listings on the platform and make a commitment towards any listing they wish to help fund.  A commitment is a commitment to purchase a promissory note, or “Note,” from Prosper Funding, the payments on which will be dependent on the payments Prosper Funding receives on the loan requested in the listing.  If a listing receives enough lender member commitments to be funded, WebBank, an FDIC-insured, Utah industrial bank, will originate the loan requested and then sell it to Prosper Funding and, at the same time, Prosper Funding will sell a Note to each lender member that made a commitment towards the loan in the principal amount of that commitment.  Each Note issued and sold by Prosper Funding comes attached with a PMI Management right issued by PMI.  The Notes and PMI Management Rights are referred to collectively as the “Securities.”  A borrower member who posts a loan listing is referred to as an “applicant” and an applicant who obtains a loan through the platform is referred to as a “borrower.”
 
In order to post a listing, an applicant must first complete a loan application.  PMI then obtains a credit report on the applicant and uses data from that report as well as data supplied by the applicant to assign a risk grade to the listing, which is called a “Prosper Rating.”  The listing is then posted on the platform.  The format for listings is shown below.  The images are not from actual listings, but rather depict hypothetical listings created for purposes of illustration.  Each listing includes the Prosper Rating, selected items from the applicant’s credit report, intended use of the potential loan, plus information regarding any previous loans obtained by the applicant through the platform.
 

Graphic
 
Lender members can bid on listings in amounts ranging from the entire loan amount requested to as little as $25.  Thus, it is typical to have multiple lender members bid on a single listing.  As the listing is funded, the listing will show the amount of commitments made towards that potential loan by lender members.
 
Graphic
One unique aspect of peer-to-peer lending is that it allows lender members who are friends and family of an applicant to bid on that applicant’s listing.  Friends and family bids can signal that a stronger social bond exists that could influence repayment rates.  Friends and family can also vouch for the applicant’s character.  These bids are also shown on the listing page for all lender members to review, as shown below.1
 

1 Neither Prosper Funding nor PMI verifies claims by a lender member that he is a friend or family member of an applicant.
 
Graphic
 
The registration, processing and payment systems are automated and electronic.  Prosper Funding has no physical branches, no deposit-taking and interest payment activities and limited loan underwriting activities.  Prosper Funding’s website provides detailed information about the platform, including detailed fee information, the full text of the member legal agreements, help pages and white papers.  In addition to the customer support materials available on the website, Prosper Funding makes additional customer support available to members by email and phone (which services are currently handled by PMI as servicer pursuant to the Administration Agreement).  Its customer support team is currently located at its headquarters in San Francisco, California.
 
PMI attracts lender members and borrowers to www.prosper.com through a variety of sources, including referrals from other parties (such as online communities, social networks and marketers), search engine results and online and offline advertising.  Prosper Funding is not dependent on any one source of traffic to its website.  In December 2012, the website received approximately 315,931 unique visitors.
 
Prosper Funding generates revenue by charging lender members ongoing servicing fees on the Notes they have purchased, and from licensing fees paid by PMI for Prosper Funding’s licensing of the platform to PMI.  PMI generates revenue by collecting fees from Prosper Funding under the Administration Agreement and by collecting origination fees from WebBank as compensation for its loan origination activities on WebBank’s behalf.
 
Platform Participants, Registration Requirements and Minimum Credit Criteria

All platform participants must register with Prosper Funding and agree to the platform’s rules and terms of use, including consent to receipt of disclosures electronically.  At the time of registration, individuals or authorized institutional agents must provide their name, address and an email address.  After responding to an email verification, registrants must agree to the terms and conditions (including the applicable registration agreement) for the specific role for which they are registering.
 
Borrower Members
 
A borrower member may be any natural person at least 18 years of age who is a U.S. resident in a state where loans through the platform are available, with a bank account and a social security number.  After passing the anti-fraud and identity verification process, borrower members can request unsecured borrower loans at interest rates set by PMI.  PMI sets minimum credit and other credit guidelines for borrowers, as discussed in the risk grading section.
 
When an applicant requests a loan, PMI first evaluates whether the applicant meets the underwriting criteria established in conjunction with WebBank.  WebBank makes loans to borrowers and then sells and assigns the promissory notes evidencing those loans to Prosper Funding.  The underwriting criteria apply for all borrower loans originated through the platform and may not be changed without WebBank’s consent.  The underwriting criteria require that borrowers have a minimum credit score of a specified threshold amount (currently 640, except that the minimum is 600 for borrower members who (i) previously obtained a borrower loan and paid off the loan in full, or (ii) are seeking a second loan and are otherwise eligible for a second loan), have no prior charge-offs on loans originated through the platform not have filed for bankruptcy within the last 12 months, and have at least one open trade reporting on their credit report.  In connection with the identity and anti-fraud verification process for applicants, PMI verifies the deposit account into which the loan proceeds will be deposited, to determine that the applicant is a holder of record of the account.  Even if a listing receives bids that equal or exceed the minimum amount required to fund, PMI will cancel the listing if it is unable to verify the applicant’s account.  While PMI attempts to authenticate each platform participant’s identity, its fraud checks could fail to detect identity theft, fraud and inaccuracies.  See “Item 1A. Risk Factors—Risks Related to Borrower Default” for more information.
 
 
Lender Members
 
Lender members are individuals and institutions that have the opportunity to buy Notes.  Lender members must register on the platform.  During lender registration, potential lender members must authorize Prosper Funding, or its agent, to obtain their credit report for identification purposes.  Lender members also must consent to any applicable tax withholding statement and must agree to the terms and conditions of Prosper Funding’s website.  Lender members must also enter into a lender registration agreement with Prosper Funding and PMI, which agreement governs all sales of Notes to lender members.  Lender members are not required to give credit information to the same extent as borrower members.  Both individuals and institutions may register as lender members.  An individual lender member must be a natural person at least 18 years of age and a U.S. resident, must provide his or her social security number and may be required to provide his or her state driver’s license or state identification card number.  Institutions must provide their taxpayer identification number.  At the time a lender member registers with Prosper Funding, the lender member must satisfy any minimum financial suitability standards and maximum investment limits established for the platform or the Note Trader platform by the state in which the lender member resides.  Prior to bidding on a listing, lender members must transfer funds to an account maintained on the platform (a “funding account”).  The funding account holds all funds supporting a lender member’s bids and all Note payments payable to the lender member are deposited in the funding account.
 
Relationship with WebBank
 
WebBank is a FDIC-insured, Utah-chartered industrial bank that originates all loans made through the platform. WebBank and PMI are parties to a Loan Account Program Agreement, under which PMI manages the operations of the platform that relate to the submission of loan applications by potential borrowers, the making of related loans by WebBank and the funding of such loans by WebBank in exchange for a fee equal to the origination fee charged by WebBank.  As of February 1, 2013, WebBank, Prosper Funding and PMI are parties to a Loan Sale Agreement, under which WebBank sells and assigns the promissory notes evidencing the borrower loans to Prosper Funding.  As consideration for WebBank’s agreement to sell and assign the promissory notes, Prosper Funding pays WebBank a monthly fee in addition to the purchase price of the promissory notes themselves.  Under the Loan Account Program Agreement, PMI will indemnify WebBank with respect to any damages arising from WebBank’s participation in the origination of borrower loans as contemplated in the Loan Account Program Agreement.

Risk Management

PMI’s risk management has evolved from its inception.  PMI has consistently worked to improve the information provided to lenders in order to help them make sound investment decisions.  A major source of improvement has been to progressively incorporate the historical performance of loans originated by PMI into the Prosper Ratings as more loan outcome data becomes available over time.  PMI intends to continuously refine the proprietary rating system by regularly reassessing the system and notifying Prosper Funding of any changes PMI believes should be made to the Prosper Ratings system.  For more information about how the Prosper Ratings and estimated loss rates are calculated and reassessed, see the following sections.  For more information about PMI’s obligation to regularly reassess the Prosper Ratings systems, including the reasonableness of the implied loss rates, see “About the Platform—Risk Management—Comparing Estimated Loss Rates to Actual Losses.”  PMI intends to transfer to Prosper Funding the software and intellectual property associated with the Prosper Ratings system.
 
Prosper Rating Assigned to Listings

Each listing is assigned a Prosper Rating.  The Prosper Rating is a letter that indicates the expected level of risk associated with the listing.  Each letter grade corresponds to an estimated average annualized loss rate range.  The rating associated with a listing reflects the loss expectations for that listing as of the time the rating is given.  This means that otherwise similar borrowers may have different Prosper Ratings at different points in time as the Prosper Rating is updated to incorporate more recent information.  There are currently seven Prosper Ratings, but this, as well as the loss ranges associated with each, may change over time as the marketplace dictates.  PMI intends to regularly update the loss rates associated with the Prosper Ratings to reflect the ongoing actual performance of historical borrower loans.  The updates will occur at least annually.
 
The current Prosper Ratings and the estimated loss ranges associated with them are as follows:

Prosper Rating
 
Est. Avg. Annual Loss Rate
AA
 
0.00% - 1.99 %
A
 
2.00% - 3.99%
B
 
4.00% - 5.99%
C
 
6.00% - 8.99%
D
 
9.00% - 11.99%
E
 
12.00% - 14.99%
HR
 
>=15.00%

The estimated loss rate for each listing is based primarily on the historical performance of borrower loans with similar characteristics and is primarily determined by two scores: (i) a custom Prosper Score, and (ii) a credit score obtained from a credit reporting agency.  The custom Prosper Score is updated periodically to include new information that is predictive of borrower risk as it becomes available or as the evidence supporting a particular datum becomes strong enough to merit its inclusion in the custom Prosper Score.
 
 
If a particular piece of information is found to be highly predictive of a borrower’s risk prior to a custom Prosper Score re-development, then it may be added to the rating process as an overlay until its impact on borrower risk is sufficiently captured by the combination of the custom Prosper Score and the credit bureau score.  Throughout 2011, for instance, increasingly strong evidence continued to emerge that successful performance on a previous loan through the platform was a strong predictor of borrower risk (borrowers having successfully performed on a previous loan through the platform were much less likely to default on a new loan than were comparable borrowers who had not successfully repaid a loan through the platform).  Once this evidence was sufficiently robust, the presence of a second loan became an integral determinant of a borrower’s Prosper Rating.

Prosper Score
 
The Prosper Score predicts the probability of a borrower loan going “bad,” where “bad” is the probability of going more than 60 days past due within twelve months of the application date.  To create the Prosper Score, PMI developed a custom risk model using its historical data as well as a data archive from a consumer credit bureau.  PMI built the model on its applicant population so that it would incorporate behavior that is unique to that population.  In contrast, a credit score obtained from a credit reporting agency is based on a much broader population, of which applicants through the platform are just a small subset.

To build and validate the custom risk model, PMI used applicants from April 2008 through April 2011 and measured their performance for the twelve months following their date of application.  PMI analyzed variables available at the time of listing for potential inclusion in the final model.  Potential variables included those from the credit report and also those provided by the borrower.  PMI dropped or kept variables in the final model based on their contribution and stability over time, and went through a number of iterations before finalizing the model in its current form.  The final model includes variables such as Inquiries last six months and Debt-to-Income Ratio.  The former is an example of a credit report variable and the latter uses both credit report information as well as income information provided by the borrower.

The model assigns weights to all of the variables based on their value in predicting the likelihood of a loan going bad.  For a given applicant, the model estimates the probability of the applicant becoming bad, which is called the applicant’s “probability of bad.”  The probability of bad for an applicant is then mapped to a Prosper Score, which is displayed as part of that listing.  Prosper Scores range from 1 to 10, with 10 being the best, or lowest risk value.  The probability of bad ranges and the corresponding Prosper Scores are as follows.

Probability Bad
 
Prosper Score
> 9.50%
 
1
8.00 < x <= 9.50%
 
2
7.00 < x <= 8.00%
 
3
6.10 < x <= 7.00%
 
4
5.30 < x <= 6.10%
 
5
4.50 < x <= 5.30%
 
6
3.80 < x <= 4.50%
 
7
3.20 < x <= 3.80%
 
8
2.50 < x <= 3.20%
 
9
0.00 < x <= 2.50%
 
10

For example, a probability of bad of 3.29% equates to a Prosper Score of 8 and a probability of bad of 12.00% equates to a Prosper Score of 1.  The probability of bad ranges may change over time as additional performance data is acquired.
 
Credit Bureau Score
 
In addition to the Prosper Score, another major element used to determine the Prosper Rating for a listing is a credit score from a consumer reporting agency.  PMI currently uses Experian’s Scorex PLUS score, although it may use one or more different scores in the future.  The minimum credit score required for a borrower to post a listing is 640, except for borrower members who (i) previously obtained a loan through the platform and paid off the loan in full, or (ii) are seeking a second loan while their first loan is still outstanding and are otherwise eligible for such second loan.  The minimum score required for previous Prosper borrowers is 600.

PMI obtains a borrower’s credit score at the time the listing is created, unless it already has a credit score on file that is not more than thirty days old.  This credit score is used to determine the Prosper Rating for the listing, and the range that credit score falls within is also included in the listing.  If available, PMI obtains updated credit scores on a monthly basis for borrowers with outstanding loans, and it includes the applicable score ranges by month in listings on the Note Trader platform.  Neither Prosper Funding nor PMI disclose the borrower’s exact credit score to any of Prosper Funding members, except for the borrower himself.
 
 
Assigning Estimated Loss Rates
 
Estimated loss rates are based on the historical performance of loans originated through the platform with similar characteristics and are primarily determined by Prosper Scores and the Experian Scorex PLUS credit score.  The starting point for this determination is the base loss rate table, shown below, which PMI created by dividing the range of Prosper Scores and the Experian Scorex PLUS credit scores into multiple segments and combining them into a single grid.  A base loss rate is estimated for each cell in the table, based on the historical performance of loans originated on the platform that occupied the same cell (i.e., that had the same point of intersection for their Prosper Score and Experian Scorex PLUS credit score).  Cells may be given the same loss rate due to small volume, similar behavior or both.  PMI reviews loan performance on a monthly basis to see how the loss rate estimates compare to the actual performance of borrower loans, and makes adjustments as necessary based on such reviews.  Please refer to the website for the estimated base loss rate table currently in use.  Estimated base loss rates for the cells in the table below correspond to those in effect for PMI applicants as of December 31, 2012.
 
 
 
1st Loans, 3 yr. term
 
 
Prosper Score
600-619
620-639
640-649
650-664
665-689
690-701
702-723
724-747
748-777
778+
Prosper Score
1
22.00%
22.00%
22.00%
22.00%
22.00%
22.00%
22.00%
22.00%
22.00%
22.00%
1
2
22.00%
22.00%
22.00%
22.00%
12.75%
12.75%
12.25%
12.25%
12.25%
12.25%
2
3
22.00%
22.00%
13.25%
12.25%
11.75%
11.25%
10.75%
10.25%
9.75%
9.25%
3
4
22.00%
22.00%
12.75%
10.75%
10.25%
9.25%
8.24%
7.99%
7.24%
6.24%
4
5
22.00%
22.00%
12.25%
10.75%
9.75%
8.74%
7.99%
7.49%
6.24%
5.99%
5
6
22.00%
22.00%
11.75%
10.25%
9.25%
8.49%
7.24%
6.24%
5.74%
5.49%
6
7
22.00%
22.00%
11.25%
9.75%
9.25%
7.99%
6.99%
5.49%
4.99%
4.49%
7
8
22.00%
22.00%
10.75%
9.25%
7.99%
5.99%
5.49%
3.24%
2.99%
2.74%
8
9
22.00%
22.00%
9.25%
8.99%
7.49%
4.99%
4.74%
2.74%
2.74%
2.49%
9
10
22.00%
22.00%
8.99%
8.49%
7.24%
4.74%
3.99%
1.99%
1.49%
0.99%
10

The table above applies to borrowers seeking their first loan through the platform.  Although borrowers with credit scores below 640 are depicted in the table above, borrowers seeking a first loan whose credit score is below 640 are not currently eligible for a loan on the platform.  PMI can make adjustments to the base loss rate to determine the final loss rate.  The final loss rate determines the Prosper Rating.  PMI currently makes adjustments if the applicant has already been a borrower on the platform and based on loan term.  The value of the adjustments are based on historical PMI data, where available, as well as observed industry performance and behavior.  An example of a potential adjustment is shown below:

Here is an example of how the final loss rate and Prosper Rating for a loan listing would be calculated:
- Applicant credit bureau score = 730 and Prosper score = 7
- Applicant has a previous Prosper loan

Base Loss Rate:
 
5.49%
Adjustments:
 
 
 
-Previous Loan:
-1.75%
Final Loss Rate:
 
3.74%
Prosper Rating:
 
A

Calculating Loss Estimates
 
Loss rates for a particular group of loans will be a function of the group’s delinquency and loss behavior over time, pre-payment behavior over time, and responsiveness to collections activity.  For loans originated through the platform, the largest driver of the loss rate is the rate at which a group of loans becomes delinquent and charges off. A loan becomes “charged off” and is considered a loss when it becomes 121+ days past due.
 
Modeling Loss Rates.  The loss rate is the balance-weighted average of the monthly loss rates for the group of loans over the term of the loans.  The gross loss rate is adjusted for principal recovery net of collection expenses to arrive at a net loss rate.

Estimating Losses.  PMI determines the loss component of the loss rate calculation by analyzing losses for historical PMI loans and adjusting to reflect anticipated deviations from historical performance that may exist due to the current macro-economic or competitive environment.  Changes in delinquency and losses have the largest impact on the expected loss rate of a group of loans, and so changes in loan delinquency and loss performance are monitored on at least a monthly basis.
 
 
Calculating Average Balance.  To calculate the average balance for each period, PMI used the amount of loan principal on loans that are still open and have not been charged-off or paid off. As loan payments are made, the principal balance of each loan declines over time.

When a loan pays faster than its amortization schedule (pre-payment), the portion of the principal that is pre-paid is no longer included in the outstanding balance for subsequent periods. Once a loan has been charged-off, the principal associated with this loan is considered a credit loss and is no longer included in the outstanding periodic balance.

Collection Expense and Recovery Adjustments.  When an account becomes past due, it may be referred to a collection agency.  All accounts that become more than 30 days past due will be referred to a collection agency.  Collection agencies are compensated by keeping a portion of the payments they collect based on a predetermined schedule.  Once an account has been charged-off, any subsequent payments received or proceeds from the sale of the loan in a debt sale are considered recoveries and reduce the amount of principal lost.
 
Comparing Estimated Loss Rates to Actual Losses

Loan performance is reviewed on a monthly basis to determine how loss rate estimates compare to the actual performance of loans.  As part of this monthly review, the processes for calculating and assigning loss rates and Prosper Ratings described in the preceding sections are reassessed to ensure continued accuracy.  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 December 31, 2012.   The loss performance is tracked by vintage, meaning each line represents all loans originated in a given period.  PMI only included loans where all loans originated have been outstanding at least 12 months.  In addition, PMI only included data for a point along the x axis if the entire vintage is at least that mature. So although loans originated in October 2011 have 14 months of performance only 12 months of performance are reflected in the graphs below because the December 2011 loans, which are also a part of the 2011 Q4 vintage, have only completed 12 months of performance.

Vintages generally contain enough loan volume for their performance curves to be meaningful.  In order to increase the significance of the curves presented, PMI Borrower Loans originated from July 13, 2009 through December 31, 2010 have been aggregated into annual vintages.  PMI Borrower Loans originated in 2011 are aggregated into quarterly vintages.

Below is a graph that shows cumulative net charge-offs as a percentage of originations across all Prosper Ratings by vintage for PMI Borrower Loans originated from July 13, 2009 to December 31, 2011.
 
 
Graphic
 
Note: Expectation lines reflect the weighted average expected loss rate across all vintages at the time of origination.  Some of the higher risk observed in the 2011 vintages is a result of increased percentages of higher risk loans being originated during this time period.  The graphs below, which show performance by Prosper Rating, are a better gauge of loss performance relative to the risk-expectations set at the time that the loans were originated.

PMI or Prosper Funding’s participation in funding loans on the platform from time to time has had, and will continue to have, no effect on the income and employment verification process, the selection of loan requests verified or the frequency of income and employment verification.
 
The graphs below show cumulative net charge-offs for PMI Borrower Loans as a percentage of originations for each Prosper Rating presented by vintage from July 13, 2009 to December 31, 2011.
 
Graphic
 
Graphic
 
Graphic
 
 
Graphic
 
Graphic
 
 
Graphic
 
Graphic
 
Note: Expectation lines represent the high end of the estimated loss rate range for each Prosper Rating, except for HR, where the high end of the range is 100% and the expectation curve was set at 24.75% cumulative principal loss.
 
In aggregate, the 2011 vintages are on track for higher cumulative losses than those experienced for the 2009Q2 and 2010 vintages.  Much of the increase is explained by the fact that the mix of loans originated in 2011 was riskier than the mix of loans originated in 2009 and 2010.  Within rating grades, the majority of vintages and rating grades are performing in-line or better than the associated expectation.  The most material exceptions include: (i) E rated loans throughout 2011 (ii) 2011Q2 loans where the B, D, E and HR rating grades are all performing worse than expectations (iii) D rated loans throughout 2011.

In instances where a material variance relative to expectations exists, analysis is conducted to understand the reason for the variance and the credit policy is adjusted to bring loan losses back in-line with expectations.  For instance, many of the higher risk (D-HR) applicants from 2011 would either be given a worse rating or would not be allowed to post a listing were they to apply for a loan today under the current credit policy.

Variances like the 2011 Q2 variance, where the majority of rating grades are performing worse than expectations, lead to analysis of macro-factors that might be causing the difference.  Examples of macro-factors that might be investigated include: general economic conditions affecting employment in the US, marketing channel-mix used during the vintage’s origination period, marketing messages used during the vintage’s origination period, and loan pricing and line assignment strategies used during the vintage’s origination period.
 

Please note that the historical performance of PMI Borrower Loans may not be indicative of the future performance of Prosper Funding’s borrower loans.  See “Item 1A. Risk Factors—Risks Related to Prosper Funding and PMI, the Platform and Prosper Funding and PMI’s Ability to Service the Notes” for more information.

Criteria for Applying for a Second Loan
 
Borrowers may have up to two loans outstanding at any one time, provided that the aggregate outstanding principal balance of both borrower loans does not exceed the then-current maximum allowable loan amount for borrower loans (currently $25,000, but which may increase to $35,000 in the future).  Any outstanding loan made through the platform is treated as a “loan” for purposes of this two loan limit.  Currently, to be eligible to obtain a second borrower loan while an existing loan is outstanding:
 
 
·
Borrowers must be current on their existing borrower loan, and must not have been more than 30 days past due in making their most recent monthly borrower loan payments for a specified number of months (between six and twelve, depending on the borrower’s credit score range at time the existing loan was obtained);
 
 
·
Borrowers may not post a listing for a second borrower loan within six to twelve months (depending on the borrower’s credit score range at time the existing loan was obtained) following the date of origination of their existing borrower loan; and
 
 
·
Borrower’s credit score must be 600 or more.
 
Underwriting requirements for borrower loans, including eligibility requirements for second loans, are subject to change from time to time.
 
Maximum Loan Amount

The maximum loan amount for a listing is determined by the applicant’s Prosper Rating.  The table below shows the maximum loan amount for each Prosper Rating:

Prosper Rating
 
Maximum Loan Amount (In Dollars)
 
AA
 
 
25,000
 
A
 
 
25,000
 
B
 
 
25,000
 
C
 
 
25,000
 
D
 
 
15,000
 
E
 
 
4,000
 
HR
 
 
4,000
 

 Borrower Identity and Financial Information Verification

Prosper Funding reserves the right in its member agreements to verify the accuracy of all statements and information provided by borrower members and lender members in connection with listings, commitments and borrower loans.  PMI verifies such information on behalf of Prosper Funding pursuant to the Administration Agreement.  PMI may conduct its review at any time before, during or after the posting of a listing, or before or after the funding of a borrower loan.  If it is unable to verify material information with respect to an applicant or listing, PMI will cancel or refuse to post the listing or cancel any or all commitments against the listing.  PMI may also delay funding of a borrower loan in order to verify the accuracy of information provided by an applicant in connection with the listing, or to determine whether there are any irregularities with respect to the listing.  If PMI identifies material misstatements or inaccuracies in the listing or in other information provided by the applicant, it will cancel the listing or related loan.
 
PMI verifies the identity of every borrower who obtains a loan through the platform using a combination of documentary and non-documentary methods.  It asks each applicant to submit a copy of her current driver’s license, passport or other government-issued, photo identification card, which are authenticated using third-party reference materials.  In addition, the information contained in the applicant’s credit report is compared with the information contained in the application, and the application information is run through a fraud database.  Finally, PMI requires the applicant to submit bank statements, cancelled checks or other documentary evidence to verify the accuracy of her bank account information.  To the extent any of these processes identify inconsistencies between the information submitted by the applicant and the information contained in another data source, the applicant must submit documentation to resolve the discrepancy to PMI’s satisfaction.  For example, the applicant might be required to submit a recent utility bill to reconcile a discrepancy between the current address listed in her application and the one listed in her credit report.  For the small number of applicants who do not have a current, government-issued photo identification card, PMI may rely on the other screening processes described above to verify their identity.  But PMI obtains and authenticates photo identification from the great majority of applicants, and performs the other processes described above for all borrowers.  If it is unable to verify the identity of an applicant in the manner described above, PMI will cancel the applicant’s listing or pending loan.
 
In addition to the identity verification processes just described, PMI verifies income and employment information for a subset of applicants based on a proprietary algorithm.  The intention of this algorithm is to identify instances where the applicant’s self-reported income is highly determinative of the applicant’s Prosper Rating.  The algorithm gives greatest weight to the following factors:
 
 
·
Prosper Rating;
 
·
loan amount;
 
·
stated income; and
 
·
debt-to-income ratio.
 
To verify an applicant’s income, PMI requires the applicant to submit a paystub from within the last thirty days and a W-2 or Form 1099 from the prior calendar year.  To verify an applicant’s employment, PMI obtains confirmation from the human resources department of the applicant’s employer, verbally or by email, or phones the main phone number of the applicant’s employer and confirms that it can be connected directly to the applicant’s work number from that main number.

Between July 14, 2009 and December 31, 2012 (based on start time of the applicable bidding period), PMI verified employment and/or income on approximately 43% of the PMI Borrower Loans originated on the platform on a unit basis (16,134 out of 37,707) and approximately 65% of originations on a dollar basis ($147,598,201 out of $228,409,710).  Breaking these numbers down by Prosper Rating:

 
for PMI Borrower Loans with a Prosper Rating of AA, A or B, PMI verified income and/or employment information on approximately 61% of the loans originated on a unit basis (8,179 out of 13,333) and approximately 80% of originations on a dollar basis ($86,019,552 out of $106,865,571);

 
for PMI Borrower Loans with a Prosper Rating of C or D, PMI verified income and/or employment information on approximately 49% of the loans originated on a unit basis (6,738 out of 13,646) and approximately 65% of originations on a dollar basis ($54,282,569 out of $83,646,929); and

 
for PMI Borrower Loans with a Prosper Rating of E or HR, PMI verified income and/or employment information on approximately 11% of the loans originated on a unit basis (1,217 of 10,728) and approximately 19% of originations on a dollar basis ($7,296,081 out of $37,897,210).
 
Between July 14, 2009 and December 31, 2012, PMI canceled 12% of the loan listings for which it verified employment and/or income information because the listings contained inaccurate or insufficient employment or income information.  PMI will continue to use the same criteria for selecting listings for employment or income verification that it used for PMI Borrower Loans.  In addition, under the Administration Agreement, PMI is required to perform borrower identity and financial information verification services in the manner and to the extent contemplated in this section.  Please note, however, that historical data regarding PMI Borrower Loans may not be indicative of the future characteristics of Prosper Funding’s borrower loans.  See “Item 1A. Risk Factors—Risks Related to the Platform and Prosper Funding and PMI’s Ability to Service the Notes” for more information.

If an applicant fails to provide satisfactory information in response to an income or employment verification inquiry, PMI will (a) request additional information from the applicant, (b) cancel the applicant’s listing or (c) refuse to proceed with the funding of the loan.  Where PMI chooses to verify an applicant’s income or employment information, the verification is normally done after the applicant’s listing has already been posted.  This allows PMI to focus its verification efforts on the listings most likely to fund, and increases the percentage of funded loans that are subject to verification.

When PMI identifies inaccurate employment or income information in an application or listing that has resulted in the applicant obtaining a different Prosper Rating or interest rate for her listing than she would have obtained if she had provided the correct information, PMI cancels the listing. If PMI identifies inaccurate information in a listing that does not trigger cancellation of the listing, it does not update the listing to include the corrected information. Cancellation automatically triggers a notice to the applicant and any lender members who made commitments that the listing has been cancelled, and PMI sends an adverse action notice to the applicant indicating the reasons for cancellation. PMI makes the funds committed by the lender members on the cancelled listing immediately available to them for bidding on other listings.
 
PMI generally does not verify information included by applicants in their listings other than identity, income and employment information.  Similarly, it does not verify the information in any recommendations from an applicant’s Prosper friends or putative friends and family. PMI derives the applicant’s debt-to-income ratio, or “DTI,” from a combination of the applicant’s self-reported income and information from the applicant’s credit report.  The credit data that appears in listings is taken directly from the applicant’s credit report.  Although applicants may provide proof of homeownership to establish homeownership status, in most instances, homeownership status is derived from the credit report as well.  For example, if the credit report reflects an active mortgage loan, the applicant is presumed to be a homeowner.  Lender members should not rely on unverified information provided by applicants.
 
PMI is continuously looking for ways to improve the verification procedures in a cost-effective manner in order to increase the repayment performance of loans.  See “Item 1A. Risk Factors—Risks Related to Borrower Default—Information supplied by applicants may be inaccurate or intentionally false. Information regarding income and employment is not verified in many cases” for more information.

Note Repurchase and Indemnification Obligations

The Indenture

Under the Indenture, if a “Repurchase Event” occurs with respect to a Note, Prosper Funding will, at its sole option, either repurchase the Note from the holder or indemnify the holder of the Note for any losses resulting from nonpayment of the Note or from any claim, demand or defense arising as a result of such Repurchase Event. A “Repurchase Event” with respect to a Note means (i) a Prosper Rating different from the Prosper Rating actually calculated by PMI (on behalf of Prosper Funding) was included in the listing for the corresponding borrower loan, as a result of which the interest of the holder in the Note is materially and adversely affected, (ii) a Prosper Rating different from the Prosper Rating that should have appeared was included in the listing for the corresponding borrower loan because either PMI (on behalf of Prosper Funding) inaccurately input data into the formula for determining the Prosper Rating or inaccurately applied the formula for determining the Prosper Rating and, as a result, the interest of the holder in the Note is materially and adversely affected, or (iii) the corresponding borrower loan was obtained as a result of verifiable identify theft on the part of the purported borrower member and a material payment default under the corresponding borrower loan has occurred.

The determination of whether verifiable identify theft has occurred is in Prosper Funding’s sole discretion, and Prosper Funding has the exclusive right to investigate such claims. Prosper Funding may, in its reasonable discretion, require proof of the identify theft, such as a copy of a police report filed by the person whose identify was wrongfully used to obtain the corresponding borrower loan, an identity theft affidavit, a bank verification letter or all of the above. Because Prosper Funding and PMI (on Prosper Funding’s behalf) are the sole entities with the ability to investigate and determine verifiable identify theft, which in turn triggers Prosper Funding’s repurchase and indemnification obligations, a conflict of interest exists. Prosper Funding believes the risk created by this conflict of interest is mitigated by three factors that incent Prosper Funding to vigorously investigate claims of identity theft. First, without the protection offered by its repurchase and indemnification obligations, fewer potential lender members will have the confidence to participate in the platform, limiting the growth and long term profitability of Prosper Funding. Second, the agreements with WebBank include a requirement—and accompanying audit function—to insure that claims of identity theft are thoroughly investigated and accurately reported. Third, California statutes provide severe penalties to victims of identity theft if it is shown that a claim of identity theft was not adequately investigated or was frivolously dismissed. See “Item 1A. Risk Factors—Risks Related to Borrower Default—The fact that PMI has the exclusive right and ability to investigate claims of identity theft in the origination of loans creates a significant conflict of interest between the lender members.”

Prosper Funding is under no obligation to repurchase a series of Notes or indemnify any holder of Notes under the indenture if a correctly determined Prosper Rating fails to accurately predict the actual losses on a borrower loan. In addition, the remedy described above for identity theft only provides protection against identity theft; in no way is it a guarantee of a borrower’s self-reported information (beyond identity) or a borrower’s creditworthiness. See “Item 1A. Risk Factors-- Risks Inherent in Investing in the Notes—Prosper Funding is not obligated to indemnify a Note holder or repurchase any Notes except in limited circumstances.” Prosper Funding expects the incidence of identity fraud on the platform to be low because of the identity verification process. From inception until December 31, 2012, PMI experienced 38 identity fraud cases affecting PMI Borrower Loans. In the cases of identity theft PMI has experienced, it received a police report and identity theft affidavit from the victim evidencing that identity theft had occurred. Please note that historical data regarding PMI Borrower Loans may not be indicative of the future characteristics of Prosper Funding’s borrower loans. See “Item 1A. Risk Factors—Risks Related to Prosper Funding and PMI, the Platform and Prosper Funding and PMI’s Ability to Service the Notes” for more information.

The Lender Member Registration Agreements

Under Prosper Funding’s lender member registration agreements, Prosper Funding  represents and warrants that (i) if a lender member uses an automated bidding tool or order execution service offered by Prosper Funding, such as Quick Invest, Auto Quick Invest or Premier, to identify Notes for purchase, each Note purchased will conform to the investment criteria provided by the lender member through such tool or service, and (ii) each Note that a lender member purchases from Prosper Funding will be in the principal amount of the bid such lender member placed and will correspond to the borrower loan on which such lender member bid. If Prosper Funding breaches either of these representations and warranties and, as a result, the Note sold to a lender member is materially different from the Note that would have been sold had the breach not occurred or if the lender member would not have purchased the Note at all absent such breach, Prosper Funding will, at its sole option, either indemnify the lender member from any losses resulting from such breach, repurchase the Note or cure the breach, if the breach is susceptible to cure. If PMI breaches any of its other representations and warranties in the lender member registration agreement and such breach materially and adversely affects a lender member’s interest in a Note, Prosper Funding will, at its sole option, either indemnify the lender member, repurchase the affected Note from such lender member or cure the breach. The determination of whether a breach is susceptible to cure is in Prosper Funding’s sole discretion.
 
 
Calculation of Repurchase Price and Indemnification Payments
 
If Prosper Funding elects to repurchase a Note in connection with a Repurchase Event or the breach of a representation or warranty under a lender member registration agreement, the repurchase price will be equal to the principal amount outstanding on the Note as of the date of repurchase and will not include accrued and unpaid interest.  If Prosper Funding elects to provide indemnification in connection with a Repurchase Event or the breach of a representation or warranty under a lender member registration agreement, Prosper Funding will not be required to take any action with respect to any losses suffered until the affected Note is at least one hundred twenty (120) days past due.  For purposes of indemnification, Prosper Funding will calculate the losses resulting from nonpayment of a Note based on the principal amount outstanding on the Note.  If Prosper Funding makes an indemnification payment, Prosper Funding will be entitled to retain any subsequent recoveries that it receives on the affected Note.

Effect on PMI Management Rights

If PFL repurchases any Notes, PMI will concurrently repurchase the related PMI Management Rights for zero consideration.
 
Historical Performance of PMI Borrower Loans

The performance of borrower loans is a function of the credit quality of borrowers and the risk and return preferences of lender members.  Lender members can choose to pursue a variety of bidding strategies, including strategies that may or may not maximize the return on their investment.  When making commitment decisions, lender members consider applicants’ Prosper Ratings, credit scores, debt-to-income ratios and other credit data and information displayed with listings.   See “Item 1A. Risk Factors—Risks Related to Borrower Default.”
 
The graph below displays the overall level of delinquency for the PMI Borrower Loan portfolio on a calendar basis.  Loss estimates for the portfolio on a vintage basis may be found in the section “Comparing Estimated Loss Rates to Actual Losses”.  Loans that are more than 30 days past due are considered to be severely delinquent due to the significant decrease in the likelihood of receiving future payment once a loan has missed two payments.

Graphic
 
The following table presents aggregated information as of December 31, 2012, grouped by Prosper Rating, for all PMI Borrower Loans originated on the platform from July 13, 2009 through December 31, 2012.  With respect to delinquent PMI Borrower Loans, the table shows the entire amount of the principal remaining due (not just that particular payment) as of December 31, 2012.
 
PMI Borrower Loan Originations
July 13, 2009 - December 31, 2012
(as of December 31, 2012)
 
   
Total Loan Originations
   
Current Loans
   
1-30 Days Past Due
 
Prosper
Rating
    #    
Amount
      #    
Origination
Amount
   
Outstanding
Principal
      #    
Origination
Amount
   
Outstanding
Principal
 
AA
    2,585     $ 26,232,209       1,550     $ 18,890,831     $ 14,689,331       8     $ 55,318     $ 21,552  
A     5,693       52,387,300       3,942       40,880,102       32,070,905       37       323,911       243,690  
B     5,329       46,262,956       4,010       36,320,311       29,150,897       84       679,216       565,575  
C     5,787       44,817,695       4,141       34,581,771       29,841,831       104       931,493       784,545  
D     8,158       52,520,004       4,946       34,853,257       27,868,418       214       1,534,224       1,209,940  
E     5,044       21,800,244       2,880       12,339,660       9,186,456       148       685,895       500,360  
HR
    5,871       20,119,506       3,813       13,157,705       10,709,728       174       646,398       531,394  
      38,467     $ 264,139,915       25,282     $ 191,023,637     $ 153,517,566       769     $ 4,856,455     $ 3,857,055  
   
avg loan size:
    $ 6,867                                                  
   
Percent of total
              65.7 %     72.3 %             2.0 %     1.8 %        
                                                                 
   
Paid In Full
   
31+ Days Past Due
   
Defaulted 1
 
Prosper
Rating
    #    
Origination
Amount
      #    
Origination
Amount
   
Outstanding
Principal
      #    
Origination
Amount
   
Net Charged
Off Principal
 
AA
    978     $ 6,847,356       4     $ 51,525     $ 39,903       45     $ 387,180     $ 276,427  
A     1,483       9,398,824       49       507,500       400,012       182       1,276,963       951,181  
B     971       7,107,510       84       702,327       572,358       180       1,453,592       1,187,662  
C     1,162       6,572,619       116       979,039       865,335       264       1,752,773       1,370,095  
D     1,952       9,867,775       219       1,633,141       1,353,868       827       4,631,607       3,790,608  
E     1,154       4,765,965       208       905,262       701,682       654       3,103,462       2,661,898  
HR
    1,057       3,488,917       244       855,331       735,955       583       1,971,154       1,642,309  
      8,757     $ 48,048,968       924     $ 5,634,125     $ 4,669,114       2,735     $ 14,576,731     $ 11,880,182  
                                                                 
percent of total
    22.8 %     18.2 %     2.4 %     2.1 %             7.1 %     5.5 %        
 
1  
Includes all loans >120 days past due
           
2  
Only includes loans where the bankruptcy notification date is prior to the date the loan became 121 days past due.  If PMI were notified of a bankruptcy after the loan reached 121 days past due, it is included in the "Default due to Delinquency” totals.
Default due to
Delinquency:
       
        2,394     $ 10,381,936  
                   
     
Default due to
Bankruptcy2 :
         
          341     $ 1,498,245  
 
From July 13, 2009 through December 31, 2012, 38,467 PMI Borrower Loans were originated on the platform with an average original principal amount of $6,867 and an aggregate original principal amount of $264,139,915.  As of December 31, 2012, 65.7% of these loans were current or had not reached their first billing cycle and 22.8% were paid in full, 2.0% were 1 to 30 days past due, 2.4% were more than 30 days past due, and 7.1% had defaulted.  A PMI Borrower Loan is considered to have defaulted when it is more than 120 days past due or has been discharged in bankruptcy.  Of these 38,467 loans, 5,130 loans, or 13.3%, have been greater than 15 days past due at any time, 4,011 loans, or 10.4%, have been more than 30 days past due at any time, and 3,377 or 8.8%, have been more than 60 days past due at any time.
 
 
Of PMI Borrower Loans originated after July 13, 2009, 2,735 have defaulted as of December 31, 2012, equaling a total net defaulted amount of $11,880,182.  Of these 2,735 defaulted loans, the borrowers of 341 loans have filed for bankruptcy, resulting in a net defaulted amount of $1,498,245.

The data in the preceding tables regarding PMI Borrower Loans may not be representative of the loss experience that will develop for Prosper Funding’s borrower loans.  In addition, the data in the preceding tables regarding prepayments may not be representative of the prepayments Prosper Funding expects over time.

The following table presents aggregate information, as of December 31, 2012, regarding the results of PMI’s collection efforts for PMI Borrower Loans originated before July 13, 2009 that became more than 30 days past due at any time, grouped by Prosper Rating.
 
Prosper
Rating
   
Loans In
Collections
   
Origination
Amount
   
Aggregate
Amount Sent
to Collections
   
Gross
Amount
Collected on
Accounts sent
to Collections
   
Number
of Loans
Charged-off
   
Gross
Aggregate
Principal
Balance of
Loans
Charged-Off
   
Gross
Amount
Recovered
on Loans
Charged-Off
   
Net
Aggregate
Charge-Off
 
AA
      57     $ 480,054     $ 29,317     $ 17,940       45     $ 218,106     $ 15,831     $ 202,275  
A       147       827,933       53,578       30,998       120       382,386       23,397       358,989  
B       46       347,200       22,611       5,310       39       166,068       4,278       161,790  
C       344       3,170,977       209,338       109,857       305       1,807,346       71,265       1,736,081  
D       536       3,901,560       261,840       167,066       459       2,075,240       151,310       1,923,930  
E       183       1,258,624       88,988       40,063       163       735,268       51,579       683,689  
HR
      3,214       34,756,301       2,486,362       1,249,513       2940       21,978,431       1,084,210       20,894,221  
N/A1       7,299       32,880,426       2,453,439       1,370,905       6653       21,037,083       1,218,616       19,818,467  
        11,826     $ 77,623,076     $ 5,605,471     $ 2,991,652       10,724     $ 48,399,928     $ 2,620,485     $ 45,779,443  
 
* This amount excludes collection agency payments that were subsequently returned by the bank.
1 includes loans with Credit Score<640 or insufficient credit data to determine Prosper Rating.
 
PMI may alter the terms or make principal reductions on some loans, which may include cases where a reduction in the initial interest rate is required by law.  The Servicemembers’ Civil Relief Act requires interest rates to be reduced to 6% while a borrower in the armed forces is on active duty.

The following table presents aggregate information, as of December 31, 2012 regarding the results of PMI's collection efforts for PMI Borrower Loans originated after July 13, 2009 that became more than 30 days past due at any time, grouped by Prosper Rating.

Prosper
Rating
   
Loans In
Collections
   
Origination
Amount
   
Aggregate
Amount Sent
to Collections
   
Gross
Amount
Collected on
Accounts sent
to Collections
   
Number
of Loans
Charged-off
   
Gross
Aggregate
Principal
Balance of
Loans
Charged-Off
   
Gross
Amount
Recovered
on Loans
Charged-Off
   
Net
Aggregate
Charge-Off
 
AA
      65     $ 554,478     $ 36,303     $ 11,698       45     $ 276,427     $ 0     $ 276,427  
A       270       2,034,020       122,036       49,225       182       969,585       18,404       951,181  
B       307       2,462,294       160,730       64,647       180       1,199,025       11,363       1,187,662  
C       439       3,065,130       212,462       78,538       264       1,390,655       20,559       1,370,095  
D       1,179       6,988,713       539,546       282,046       827       3,872,952       82,344       3,790,608  
E       976       4,524,208       402,890       212,640       654       2,697,191       35,293       2,661,898  
HR
      940       3,222,916       281,553       132,046       583       1,670,821       28,512       1,642,309  
        4,176     $ 22,851,758     $ 1,755,520     $ 830,840       2,735     $ 12,076,656     $ 196,474     $ 11,880,182  
 
* This amount excludes collection agency payments that were subsequently returned by the bank.
 
In order to comply with the Servicemembers’ Civil Relief Act, which requires interest rates to be reduced to 6% while a borrower in the armed forces is on active duty, PMI has elected to make “pre-refunds” of the interest differential to the affected borrower for the period of deployment.  The borrower then continues to make their regular payments.  In these cases, PMI has refunded the interest to the borrower from PMI’s own funds and, as a result, the payments received by the applicable lenders are unchanged.
 
 
Loan Originations
 
The following table presents aggregated information about borrowers for PMI Borrower Loans originated over the period from July 13, 2009 to December 31, 2012, grouped by Prosper Rating.

Prosper
Rating
   
Number
   
Amount
   
Average
Loan Size
   
Weighted
Average
Lender
Yield
   
Weighted
Average
Borrower
Rate
   
Weighted
Average
Borrower
APR
 
AA
      2,585     $ 26,232,209     $ 10,148       7.86 %     8.86 %     9.81 %
A       5,693       52,387,300       9,202       10.88 %     11.88 %     14.27 %
B       5,329       46,262,956       8,681       15.94 %     16.94 %     19.60 %
C       5,787       44,817,695       7,745       20.59 %     21.59 %     24.74 %
D       8,158       52,520,004       6,438       24.90 %     25.91 %     29.26 %
E       5,044       21,800,244       4,322       30.03 %     31.03 %     34.83 %
HR
      5,871       20,119,506       3,427       30.88 %     31.88 %     35.69 %
Total
      38,467     $ 264,139,915     $ 6,867       19.01 %     20.01 %     22.85 %
 
The following table presents aggregated information about borrowers for PMI Borrower Loans originated over the period from July 13, 2009 to December 31, 2012, grouped by Prosper Rating.  The information for each borrower was obtained from a credit reporting agency at the time the borrower’s loan application was submitted.  PMI has not independently verified this information:

Prosper
Rating
 
Average Experian
ScorexPlus Score
 
Average Number of
Current
Delinquencies
 
Average Number
of Open Credit
Lines
 
Average Number of
Total Credit Lines
AA
 
 
799
 
 
0.05
 
 
8.90
 
 
26.25
A
 
 
752
 
 
0.16
 
 
8.93
 
 
26.25
B
 
 
718
 
 
0.28
 
 
8.47
 
 
25.34
C
 
 
707
 
 
0.35
 
 
8.63
 
 
26.79
D
 
 
694
 
 
0.44
 
 
8.16
 
 
25.77
E
 
 
672
 
 
0.68
 
 
8.31
 
 
27.54
HR
 
 
688
 
 
0.62
 
 
8.02
 
 
26.65
 
Please note that historical data regarding PMI Borrower Loans may not be indicative of the future characteristics of Prosper Funding’s borrower loans.  See “Item 1A. Risk Factors—Risks Related to Prosper Funding and PMI, the Platform and Prosper Funding and PMI’s Ability to Service the Notes” for more information.

Posted Borrower Loan Listings
 
Once a loan listing is completed by an applicant, the listing is posted on the website and then becomes available for bidding by lender members. A loan listing is a request by the applicant for a borrower loan in a specified amount.
 
When creating a listing, the applicant may opt for partial funding.  Partial funding means the applicant’s loan does not have to receive bids for 100% of the amount requested to fund, but can be funded if it receives bids for 70% or more of the amount requested.  Each listing indicates whether the applicant has elected partial funding and, if so, the minimum amount of bids required for the loan to fund.  Prosper Funding may change the percentage threshold for partial funding, which is currently set at 70%, from time to time.  Any such change will be disclosed on the website, and will only affect listings created after such change is implemented.
 
Borrower loans are unsecured obligations of individual borrowers with an interest rate determined by PMI and with a specified loan term, currently set at one, three or five years, but which PMI may in the future extend to between three months to seven years. Applicants may currently request loans within specified minimum and maximum principal amounts (currently, between $2,000 and $25,000, but which may expand to between $500 and $35,000 in the future), which are subject to change from time to time. Borrower loans may be repaid at any time by borrowers without prepayment penalty.  A borrower loan will be made to an applicant only if the applicant’s listing has received bids equal to or exceeding the minimum amount required for the listing to fund.
 
 
In addition to the applicant’s requested loan amount, listings include:
 
 
·
the interest rate, annual percentage rate and monthly payment amount on the requested loan;
 
 
·
the servicing fee lenders must pay;
 
 
·
the lender yield percentage (interest rate on the loan, net of the servicing fee);
 
 
·
the Prosper Rating and estimated loss rate;
 
 
·
the Prosper Score and credit score range;
 
 
·
the minimum amount required for the loan to fund and whether the applicant has opted for partial funding;
 
 
·
the number of accounts on which the applicant is currently late on a payment, including unpaid derogatory accounts;
 
 
·
the total past-due amount the applicant owes on all delinquent and derogatory accounts;
 
 
·
the number of 90+ days past due delinquencies on the applicant’s credit report;
 
 
·
the number of public records (e.g., bankruptcies, liens, and judgments) on the applicant’s credit report over the last 12 months, and over the last 10 years;
 
 
·
the number of inquiries made by creditors to the applicant’s credit report in the last six months;
 
 
·
the month and year the applicant’s oldest recorded credit line (e.g., revolving, installment, or mortgage credit) was opened;
 
 
·
the total number of credit lines appearing on the applicant’s credit report, along with the number that are open and current;

 
·
the total balance on all of the applicant’s open revolving credit lines;
 
 
·
the applicant’s bankcard utilization ratio, expressed as a percentage, reflecting the ratio of the total balance used, to the aggregate credit limit on, all of the applicant’s open bankcards;
 
 
·
whether the applicant owns a home;
 
 
·
DTI percentage;
 
 
·
the applicant’s self-reported income range, occupation, employment status, and intended use of funds;
 
 
·
the amounts and dates of all lender member bids;
 
 
·
the applicant’s Prosper friends who have bid on the listing, together with any narrative recommendation from a bidding Prosper friend;
 
 
·
the applicant’s group affiliations, if any; and
 
 
·
if the applicant previously obtained one or more loans through the platform, a description of such loan activity, including the number and aggregate principal borrowed on such loans, the current outstanding principal balance of any existing loan, the payment history on such loans, and the applicant’s credit score ranges as of the four most recent dates credit reports were obtained on the applicant in connection with the applicant’s listings, with an arrow indicator denoting whether the applicant’s credit score has improved, declined or remained unchanged since the applicant’s most recent loan through the platform.
 
Part of an applicant’s credit profile displayed in listings is a DTI ratio.  DTI is one measure of the applicant’s ability to take on additional debt.  This number takes into consideration how much debt the applicant has or will have, including the requested loan amount.  DTI is expressed as a percentage and is calculated by dividing the applicant’s monthly debt payments, including the debt resulting from the borrower loan being requested, by the applicant’s monthly income.  Such debt amounts are taken from the applicant’s credit report without verification and exclude monthly housing payments, and the applicant’s income is self-reported and may not be verified by Prosper Funding or PMI.
 
 
Listings may include the applicant’s narrative description of why the loan is being requested, and of the applicant’s financial situation.

For PMI Borrower Loans funded between July 13, 2009 and December 31, 2012, borrowers identified their intended use of loan proceeds by unit distribution as follows:
 
 
·
debt consolidation (approximately 48%);
 
 
·
business use, such as financing their home-based or small businesses (approximately 9%);
 
 
·
home improvement (approximately 11%);
 
 
·
financing the purchase of an automobile (approximately 4%); and
 
 
·
other (approximately 28%).
 
Applicants typically state the use of funds in a short sentence or clause, such as “Consolidate my credit card debt and be rid of it.”  Please note that historical data regarding PMI Borrower Loans may not be indicative of the future characteristics of Prosper Funding’s borrower loans.  See “Item 1A. Risk Factors—Risks Related to Prosper Funding and PMI the Platform and Prosper Funding and PMI’s Ability to Service the Notes” for more information.
 
Loan listings and other borrower information available on the platform or in the sales and listing reports are statements made in connection with the purchase and sale of securities, and are therefore subject to Rule 10b-5 of the Exchange Act as well as the antifraud provisions of the Securities Act.  In general, Section 10b-5 and the antifraud provisions of the Securities Act provide the purchaser of securities with a right to bring a claim against the issuer for damages arising from any untrue statement of material fact or failure to state a material fact necessary to make any statements made by the issuer not misleading.  In this prospectus, Prosper Funding and PMI advise you of the limitations on the reliability of the information provided by applicants with respect to loan listings.  Accordingly, a court could determine that Prosper Funding and PMI have advised you of all material facts regarding the information supplied by applicants and your recourse in the event this information is false or misleading may be extremely limited under the securities laws because you have been so advised.  Alternatively, the SEC or a court could determine that Prosper Funding and PMI have not advised you of all of the material facts regarding an investment in the Notes and PMI Management Rights, which could give you the right to rescind your investment and obtain damages, and could subject Prosper Funding and PMI to civil fines or criminal penalties in addition to any such rescission rights or damages.
 
How to Bid to Purchase Notes

A bid on a listing is a lender member’s binding commitment to purchase a Note in the principal amount of the lender member’s bid, should the listing receive bids equaling or exceeding the amount required for the listing to fund.  Lender members bid the amount they are willing to commit to purchase a Note dependent for payment on payments Prosper Funding receives on the borrower loan described in the listing.
 
The bidding period for a listing begins when the listing is posted on the platform and ends either 14 days after posting or on the first date on which the listing has received bids totaling the loan amount requested, whichever is earlier.  Lender members cannot place bids on a listing once its bidding period has ended.  If the applicant opts for partial funding, the bidding period still will not end prior to the end of the 14 day listing period unless the listing has received bids totaling the full amount of the loan requested.
 
If the listing does not receive bids equal to or exceeding the minimum amount required for the loan to fund by the end of the bidding period, the listing will terminate and will not be funded.  Applicants whose listings expire due to an insufficient amount of bids may post a new listing on the platform, although Prosper Funding has the right under the borrower registration agreement to limit the number of listings a borrower member may post on the platform.
 
In order to bid on a listing, a lender member must have funds on deposit in his lender member account in at least the amount of the bid.  Once bids are placed, they are irrevocable.  Lender members may not cancel their bids or withdraw the amount of their bids from their accounts unless the bidding period expires without the listing having received bids in the required minimum amount, or unless the listing is withdrawn or cancelled.   See “Item 1. Business—Structure of Lender Member Accounts and Treatment of Lender Member Balances” for more information.

Currently, the minimum amount a lender member may bid is $25, and the maximum amount a lender member may bid is the amount of the requested borrower loan.  The maximum aggregate amount an individual lender member may bid on the platform is currently $25,000,000.  There is no maximum aggregate bid amount for institutional members.  Prosper Funding may change the minimum bid amount or the maximum aggregate bid amounts from time to time.  Depending on the amount of the winning bids at the end of the bidding period, there may be a winning bidder on a listing with a winning bid of less than $25.  But there cannot be more than one partial winning bid on a listing.
 
 
A listing that gets funded typically receives bids from many different lender members.  For example, from July 13, 2009 through December 31, 2012, the average aggregate size of a PMI Borrower Loan was approximately $6,867 and the average bid was approximately $81.  Please note that historical data regarding PMI Borrower Loans may not be indicative of the future characteristics of Prosper Funding’s borrower loans.  See “Item 1A. Risk Factors—Risks Related to Prosper Funding and PMI the Platform and Prosper Funding and PMI’s Ability to Service the Notes” for more information.
 
Lender members may browse online through available listings displayed on the platform by desired borrower loan amount, yield percentage, Prosper Rating, estimated loss rate, debt-to-income ratio, group or other applicant characteristics.  Alternatively, lender members can use Quick Invest, a loan search tool, to identify loan listings that meet their investment criteria.  A lender member can bid on as many listings as the lender member desires, subject to the aggregate bidding limit.  A lender member can diversify her risk of default if she elects to do so.  It is solely up to the individual lender members to select their bidding method and the credit characteristics that are acceptable to the lender member and to determine a diversification strategy.
 
Quick Invest

Quick Invest is a loan search tool that allows lender members to identify listings that meet their investment criteria.  A lender member using Quick Invest is asked to indicate (i) the Prosper Rating or Ratings she wishes to use as search criteria, (ii) the total amount she wishes to invest, and (iii) the amount she wishes to invest per Note.  If she wishes to search for Notes using criteria other than, or in addition to, Prosper Rating, she can use one or more of several dozen additional search criteria, such as loan amount, debt-to-income ratio and credit score.  The only criteria a lender member cannot specify in Quick Invest are the listing description and the monthly payment amount.

Quick Invest then compiles a basket of Notes for the lender member’s consideration that meet her search criteria.  If the pool of Notes that meet her criteria exceeds the total amount she wishes to invest, Quick Invest selects Notes from the pool based on how far the listings corresponding to the Notes have progressed through the loan verification process, i.e., Notes from the pool that correspond to listings for which the loan verification process has been completed will be selected first.  If the pool of Notes that meet the lender member’s criteria and for which the loan verification process has been completed still exceeds the amount she wishes to invest, Quick Invest selects Notes from that pool based on the principle of first in, first out, i.e., the Notes from the pool with the corresponding listings that were posted on the platform earliest will be selected first.  If the pool of Notes that meet the lender member’s specified criteria exceeds the amount she wishes to invest, but the subset of that pool for which the loan verification process has been completed does not equal the amount she wishes to invest, Quick Invest selects all of the Notes that correspond to listings for which the loan verification has been completed and makes up the difference by selecting Notes from the remaining pool on a first in, first out basis.  To the extent available Notes that meet the lender member’s criteria are insufficient to fill her order, the lender member is advised of this shortfall and given an opportunity either to reduce the size of her order or modify her search criteria to make her search more expansive.

If the lender member’s search criteria included multiple Prosper Ratings, Quick Invest divides her basket into equal portions, one portion representing each Prosper Rating selected, and then attempts to fill each portion in the manner just described.  To the extent there are insufficient Notes available with a particular Prosper Rating to fill that portion of the lender member’s basket, Quick Invest attempts to make up the deficit by including additional Notes with the other Prosper Ratings selected in equal proportions. To the extent available Notes with these other Prosper Ratings are still insufficient to fill the lender member’s order, the lender member is advised of this shortfall and given an opportunity either to reduce the size of her order or to modify her search criteria to make her search more expansive.

For example, if a lender member using Quick Invest indicated that she wished to invest a total of $600 in Notes with a Prosper Rating of B, C or D, Quick Invest would first attempt to fill her order with equal portions of B, C and D Notes ($200 – B; $200 – C; $200 – D).  If there were only $100 of D Notes available, the search tool would attempt to increase the allocation of B and C Notes from $200 to $250 ($250 – B; $250 – C; $100 – D).  If there were $250 of B Notes available but only $200 of C Notes available, the search tool would then attempt to make up the remaining gap by increasing the allocation of B Notes from $250 to $300 ($300 – B; $200 – C; $100 – D). But if there were only $275 worth of B Notes available, the lender member would be given the choice of expanding her search criteria or reducing the total size of her order from $600 to $575.  If she elected to reduce the size of her order, her final order would consist of $575 of Notes: $275 of B Notes, $200 of C Notes and $100 of D Notes.

The Auto Quick Invest feature allows lender members (i) to have Quick Invest searches run on their designated criteria automatically each time new listings are posted on the platform, and (ii) to have bids placed automatically on any Notes identified by each such search.  As with a lender making manual bids, a lender member using Quick Invest is not permitted to place a bid unless the funds in her account are sufficient to cover the bid, and funds will only be debited from her account if and when her bid is successful.
 
 
Since it was first implemented in July 2011, the Quick Invest tool has experienced errors that affected 6,043 PMI Notes out of the 2,235,941 PMI Notes purchased. Of the affected lenders and PMI Notes, 600 lenders and 2,053 PMI Notes were affected by the erroneous selection by Quick Invest of all possible search criteria; 28 lenders and 2,517 PMI Notes were affected by the erroneous use of inactive searches to purchase PMI Notes; 23 lenders and 96 PMI Notes were affected by an error that resulted in a search identifying every listing’s Prosper Score as a 10 (the best rating), regardless of the actual Prosper Score; 160 lenders and 1,209 PMI Notes were affected by an error that resulted in lenders who had multiple searches with overlapping criteria bidding on the same listing more than once even though the lender had also selected an option that was supposed to preclude them from investing in the same listing more than once; and 42 lenders and 168 PMI Notes were affected by a server failure that resulted in Quick Invest bidding on the same listing more than once.  Please note that historical data regarding PMI Notes may not be indicative of the future characteristics of Prosper Funding’s Notes.  See “Item 1A. Risk Factors—Risks Related to Prosper Funding and PMI the Platform and Prosper Funding and PMI’s Ability to Service the Notes” for more information.

In the event of any errors in Quick Invest that cause a lender to purchase a Note that such lender would not otherwise have purchased or that differs materially from the Note such lender would have purchased had there been no error, Prosper Funding will either repurchase the Note, indemnify the lender against losses suffered on that Note or cure such error.

Setting Interest Rates

PMI has an interest rate committee which meets regularly to set interest rates for all borrower loans.  These rates are set forth in a rate table, which is posted at www.prosper.com.  The table specifies a range of interest rates for all borrower loans, based on Prosper Rating, loan term and the number of prior loans a borrower has obtained through the platform.  Additional factors, such as group affiliations, competitive conditions and the general economic environment affect the specific interest rate within a specified range that a borrower receives.  The yield percentage on each series of Notes is equal to the interest rate on the related borrower loan, minus a servicing fee, currently set at 1% per annum of the outstanding principal balance of the corresponding borrower loan prior to applying the current payment.  Prosper Funding may increase the servicing fee to no more than 3% per annum if its servicing costs increase or to reflect changes to the market rate for servicing similar assets.  Any change to the servicing fee will only apply to Notes offered and sold after the date of the change.
 
The interest rate committee meets on at least a monthly basis, but may meet more frequently as changes in market conditions and the general economic environment dictate.  At each meeting, the committee reviews the interest rate table and makes adjustments to it the extent the committee deems necessary.  The factors besides Prosper Rating that the committee takes into consideration in updating the table, as well as the weight the committee accords each such factor, may change from time to time.
 
The interest rate table currently in effect is set forth below.  In addition, the interest rate for each loan listing, as well as the yield percentage for the corresponding Notes, is included in the listing report filed for that listing.  This information is also included in the listing itself when it is posted on www.prosper.com.  In addition, the current interest rate table is posted on www.prosper.com.

Prosper
Loan
Borrower Rate
 
Rating
Term (yrs)
Min
Max
AA
1
5.65%
7.04%
AA
3
5.50%
8.49%
AA
5
5.69%
8.69%
 
 
 
 
A
1
7.35%
9.81%
A
3
9.24%
12.99%
A
5
9.49%
13.34%
 
 
 
 
B
1
10.33%
12.79%
B
3
13.59%
16.79%
B
5
14.19%
18.19%
 
 
 
 
C
1
13.23%
16.94%
C
3
17.34%
21.59%
C
5
18.74%
23.19%
 
 
 
 
D
1
17.30%
20.64%
D
3
21.99%
25.66%
D
5
23.59%
27.36%
 
 
 
 
E
1
21.27%
24.43%
E
3
26.39%
30.06%
E
5
28.09%
30.96%
 
 
 
 
HR
3
30.79%
31.77%
 
 
Purchase of Notes by Prosper Funding, PMI or Related Parties
 
From time to time, Prosper Funding or PMI may bid on listings and each may hold any Notes purchased as a result of such bids for its own account.  Any bid on a loan by Prosper Funding or PMI will be made public in the same manner in which bids by other bidders on a particular listing are made public.  In addition, loans upon which Prosper Funding or PMI bid will be identified to other bidders through the use of a special symbol and a user profile that are intended to make it clear that Prosper Funding or PMI is bidding on a particular listing.
 
Prosper Funding and PMI will participate in bidding on the listings under the same terms and conditions and through the use of the same information that is made available to other lender members on the platform.  In some cases, Prosper Funding or PMI’s bidding on a listing may cause it to fund, and in some cases, fund faster, than it would fund in the absence of such bid.  The amount that Prosper Funding or PMI may choose to bid on any particular listing may vary significantly and Prosper Funding and PMI each reserve the right to bid up to the entire amount of a listing.
 
Some of Prosper Funding or PMI’s executive officers, directors and 5% shareholders have bid on listings and purchased PMI Notes from time to time in the past, and may purchase Notes in the future.  As of December 31, 2012, these individuals had purchased $4,135,150 in PMI Notes or loans.  These PMI Notes and loans were obtained on the same terms and conditions as those obtained by other lender members.  However, as certain of these executive officers and directors, by virtue of their duties as employees, officers or directors of Prosper Funding and PMI, have access to information not available to the general population of lender members, Prosper Funding and PMI have adopted the following procedures to prevent or detect the improper use of non-public information in bidding activities by any of their respective officers and directors:

 
·
PMI’s corporate policies, distributed to all employees, prohibit an employee’s use of non-public information and any violation of this policy is grounds for immediate termination.
 
 
·
Security features that limit access to data only to that needed to perform particular employee job functions. These limitations are defined by “security group,” which corresponds to both job title and function and the number of PMI’s employees that have access to such non-public information on a “bulk” or “query” basis is extremely limited.
 
 
·
In addition to prevention efforts, Prosper Funding and PMI have developed an audit process that identifies and investigates bidding and funds transfer activities that are classified as “suspicious.”

Structure of Lender Member Accounts and Treatment of Lender Member Balances

Prosper Funding maintains a pooled account at Wells Fargo Bank, N.A. to hold the funds of lender members.  This account is titled “Prosper Funding LLC for the benefit of its lender members” and is referred to as the “FBO account.”  In order to bid on listings, a lender member must have sufficient funds in the FBO account.  A lender member can transfer funds into the FBO account by authorizing an electronic transfer using the Automated Clearing House, or ACH, network from the lender member’s designated and verified bank account to the FBO account.  All payments to fund purchases of Notes are made by deposit into the FBO account.  Upon request by the lender member, Prosper Funding will transfer lender member funds in the FBO account to the lender member’s designated and verified bank account by ACH transfer, provided such funds are not already committed to the future purchase of Notes.

Prosper Funding divides the FBO account into sub-accounts for each lender member.  These sub-accounts allow Prosper Funding to track and report for each lender member the funds the lender member has transferred into and out of the FBO account, the funds the lender member has committed to purchase Notes, and the payments the lender member has received on outstanding Notes.  Each lender member’s sub-account is referred to as his or her “lender member account.”  Lender members have no direct relationship with Wells Fargo Bank by virtue of having a lender member account or participating on the platform.
 
The FBO account is FDIC-insured on a “pass through” basis to the individual lender members, subject to applicable limits. This means that each lender member’s balance is protected by FDIC insurance up to the aggregate per person limit established by the FDIC.  Other funds the lender member has on deposit with the same institution where the FBO account is maintained may count against the FDIC insurance limits for that member.  Prosper Funding will always maintain the FBO account with an FDIC member financial institution.  Funds of a lender member may stay in the FBO account indefinitely and do not earn interest.  Prosper Funding never commingles its assets or any assets of PMI with the assets in the FBO account.
 
 
Borrower Loan Funding and Purchases; Sale of Notes

Once the bidding period for a listing ends, if the listing has received bids from lender members equal to or exceeding the minimum amount required to fund, the funding of the corresponding borrower loan and the sale of the Notes to the lender members who bid on the listing will proceed.
 
Applicants execute an electronic borrower registration agreement at the time they post a listing on the platform.  After expiration of the bidding period for the listing and satisfactory completion of the pre-funding verification process, the applicant executes an electronic promissory note in favor of WebBank in an amount equal to the total amount of winning bids.  WebBank then electronically endorses the promissory note to Prosper Funding and sells and assigns the promissory note to Prosper Funding without recourse. The promissory note and the borrower registration agreement contain customary agreements and covenants requiring the applicants to repay their loans and describing the process of posting listings and obtaining loans through the platform.
 
WebBank funds all loans originated on the platform, and PMI disburses the loan proceeds on WebBank’s behalf to the borrower.  Each borrower authorizes the loan proceeds to be disbursed by ACH transfer into the borrower’s designated bank account or to a merchant in satisfaction of a purchase of goods and/or services from that merchant.
 
Borrowers pay an origination fee out of the proceeds of the loan at the time of funding.  As of December 31, 2012, origination fees on PMI Borrower Loans were as follows:

Prosper Rating
 
1 Year Loan
 
3 Year Loan
 
5 Year Loan
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%

The origination fees are charged by WebBank, and PMI receives payments from WebBank equal to the origination fees as compensation for its loan origination activities on WebBank’s behalf.
 
Lender members know only the screen names, and do not know the actual names, of applicants.  The actual names and mailing addresses of the applicants are known only to Prosper Funding, PMI and WebBank.  Prosper Funding maintains custody of the electronically-executed promissory notes evidencing borrower loans as well as the Notes and PMI Management Rights in electronic form on the platform.
 
When Prosper Funding issues and sells a Note to a lender member, PMI registers the Note in the name of the lender member on Prosper Funding’s books and records.  For each loan originated on the platform, PMI transfers the principal amount of the Notes corresponding to that loan from the FBO account to WebBank.  This transfer represents the payment (i) by the lender members who have agreed to purchase the Notes to Prosper Funding of the purchase price for the Notes, and (ii) by Prosper Funding to WebBank of the purchase price for the corresponding loan.  WebBank is the lender for all borrower loans, which allows the platform to be available on a uniform basis to borrowers throughout the United States.

Borrower members are able to use the loan proceeds for any purpose other than (i) buying, carrying or trading in securities or buying or carrying any part of an investment contract security or (ii) paying for postsecondary educational expenses (i.e., tuition, fees, required equipment or supplies, or room and board) at a college/university/vocational school, as the term “postsecondary educational expenses is defined in Bureau of Consumer Finance Protection Regulation Z, 12 C.F.R. § 1026.46(b)(3), and they warrant and represent that they will not use the proceeds for any such purposes.
 
Loan Servicing and Collection

Prior to February 1, 2013, PMI owned the platform and performed all of the activities described in this section on its own behalf.  After February 1, 2013, Prosper Funding owns the platform, but PMI continues to perform the activities described in this section on behalf of Prosper Funding pursuant to the Administration Agreement.  In general, any actions described below that Prosper Funding takes in servicing the borrower loans or Notes may be taken on Prosper Funding’s behalf by PMI acting as its agent.
 
 
Under the Administration Agreement, PMI causes borrowers to make payments on borrower loans into a specific account and/or to deliver collections of such payments into such account (called the “Deposit Account”) maintained by Prosper Funding but held by the Indenture Trustee under the Indenture.  Under the Indenture, Prosper Funding removes from the Deposit Account (or instructs the Indenture Trustee to remove from the Deposit Account) the servicing fees described herein and deposits the same in a separate Prosper Funding account from which PMI is paid certain fees due to it on a monthly basis under the Administration Agreement.  Also under the Indenture, after removal from the Deposit Account of the servicing fees described herein, Prosper Funding moves funds from the Deposit Account to the FBO Account in order to make payments on the Notes.  On Notes, the payment dates fall on the sixth business day after the due date for each monthly installment of principal and interest on the corresponding borrower loan, but interest accrues on the Notes only through the relevant payment date for the related borrower loan. The stated interest rate on each Note is the lender yield percentage set forth in the loan listing.  The yield percentage is the loan interest rate net of the servicing fee.

 Prosper Funding subtracts a servicing fee from every loan payment it receives.  The amount of the servicing fee with respect to a particular payment is calculated by (a) multiplying the applicable annual servicing fee rate by a fraction, the numerator of which is equal to the number of days since the borrower’s last payment (or, in the case of the borrower’s first payment, since the date on which the relevant loan was funded) and the denominator of which is 365, and (b) multiplying the product obtained by the outstanding principal balance of the loan prior to applying the current payment.  The rate of Prosper Funding’s annual servicing fee is currently set at 1.0% per annum of the outstanding principal balance, but Prosper Funding may increase that in the future to a rate greater than 1% but less than or equal to 3% per annum.  Any change to Prosper Funding’s servicing fee will only apply to Notes offered and sold after the date of the change.

To the extent Prosper Funding does not receive the anticipated payments on a borrower loan on or before any loan payment date, it will not make any payments on the Notes related to that borrower loan on the corresponding Note payment date, and a holder of a Note does not have any rights against Prosper Funding or the borrower in respect of the Note or the corresponding borrower loan in relation to any delay in collections and Note payments or for shortfalls in accrued Note interest that result then or in relation to the final maturity of the Note.  Each holder’s right to receive principal and interest payments and other amounts in respect of that Note is limited in all cases to the holder’s pro rata portion of the amounts Prosper Funding timely receives on the corresponding borrower loan, including without limitation, all payments or prepayments of principal and interest, subject to servicing fees and other charges and other fees retained by Prosper Funding or by a third party, as set forth in the following chart.  Prosper Funding’s current collection agencies charge collection fees from 17.0% to 40.0% of the amount recovered, in addition to any legal fees incurred in the collection effort, up to the “total amount delinquent.”
 

The following table summarizes the fees that Prosper Funding charges and how these fees affect lender members:

Description of
Fee Charged by
Prosper Funding
 
 
 
Fee Amount
 
 
 
When Fee is Charged
 
 
 
Effect on Lender Member
 
 
 
 
 
 
 
 
 
Prosper Funding Borrower Payment Dependent Notes
 
 
 
 
 
 
 
 
 
 
 
 
 
Servicing fee
 
Annualized rate currently set at 1% per annum of outstanding principal balance, but which Prosper Funding may increase in the future to an amount greater than 1% but less than or equal to 3% per annum.  Any change to the servicing fee will only apply to Notes offered and sold after the date of the change. The servicing fee percentage is disclosed in all loan listings.
 
The servicing fee is payable on all payments received by Prosper Funding on borrower loans, including, without limitation, partial payments.
 
The servicing fee will reduce the effective yield below the interest rate on the borrower loan. This reduction is reflected in the yield percentage included in each listing.
 
 
 
 
 
 
 
 
 
Non-sufficient funds fee
 
$15, unless a lesser amount is required by applicable law.
 
First failed payment for each billing period.
 
Prosper Funding retains 100% of the non-sufficient funds fees to cover its administrative expenses.
 
 
 
 
 
 
 
 
 
Late payment fee
 
 
Equal to greater of 5% of the unpaid installment amount or $15, unless a lesser amount is required by applicable law.
 
After 15-day grace period, Prosper Funding assesses a late fee. The late payment fee is charged only once per payment period.
 
Any late payment fees Prosper Funding receives are paid to the lender members, subject to deductions for Collection Charges and Servicing Fees.
 
 
 
 
 
 
 
 
 
Collection Charges
 
Prosper Funding’s current collection agencies charge collection fees from 17.0% to 40.0% of the amount recovered up to the “total amount delinquent,” plus any legal fees incurred in the event legal action is taken to collect a loan.  The collection fees vary depending upon the collection agency used.
 
 
 
A borrower loan that becomes past due may be referred to a collection agency. Collection charges and any related legal fees are only charged if delinquent amounts are collected.
 
Prosper Funding’s servicing fee is also deducted from the net payments it receives as a result of any collection efforts on a delinquent borrower loan.
 
Lender members will not receive any collection fees a third-party collection agency charges, which fees will be retained by the party charging the fees as additional servicing compensation.
 
The collection fees and any related legal fees will be deducted from any borrower loan payments Prosper Funding receives. These fees will reduce the lender member’s effective yield, and are not reflected in the yield percentage shown on the listing.
 
 
 
 
 
 
 
 
 
Loan modification fees
 
Prosper Funding will not charge a fee for restructuring a borrower loan.
 
PMI may work with the borrower to structure a new payment plan in respect of the borrower loan without the consent of any holder of the Notes corresponding to the borrower loan. This generally would only occur in lieu of bankruptcy or a similar proceeding.
 
Not applicable.
 
 
 
 Prosper Funding discloses borrowers’ payment performance on loans to the relevant lender members on its website and also reports such information to consumer reporting agencies. Prosper Funding keeps lender members informed of the delinquency status of borrower loans corresponding to this Notes by identifying delinquent loans on its website as “1 month late,” “2 months late,” “3 months late,” or “current.”  Borrower loans that become more than 120 days overdue are charged off and designated as such on the website.  Through their online Prosper Funding account, lender members are able to monitor the borrower loans corresponding to their Notes, but cannot participate in or otherwise intervene in the collection process.

Late payment performance is an early indicator of charge off probability.  Of all PMI Borrower Loans originated between July 13, 2009 and December 31, 2012, 10.4% have been greater than 30 days past due at any time and 8.8% have been greater than 60 days past due at any time.  As of December 31, 2012, 4,176 or 10.9% of all PMI Borrower Loans originated between July 13, 2009 and December 31, 2012 have been referred to a collection agency for collection proceedings.  On average, through December 31, 2012, PMI Note holders have received $199, net of collection fees, on such PMI Borrower Loans.  In addition, of the 4,176 PMI Borrower Loans referred to a collection agency, a total of 2,735 or 65% of such loans have been charged off.  

Of all PMI Borrower Loans originated between November 2005 and July 12, 2009, 42.6% have been greater than 30 days past due at any time and 40.4% have been greater than 60 days past due at any time. As of December 31, 2012, 11,826 or 40.8% of all PMI Borrower Loans originated between November 2005 and July 12, 2009 have been referred to a collection agency for collection proceedings. On average, through December 31, 2012, PMI lender members have received $253, net of collection fees, on such PMI Borrower Loans.  In addition, of the 11,826 PMI Borrower Loans referred to a collection agency, a total of 10,724 or 90.7% of such loans have been charged off.

Please note that historical data regarding PMI Borrower Loans and PMI Notes may not be indicative of the future characteristics of Prosper Funding’s borrower loans and notes.  See “Item 1A. Risk Factors—Risks Related to Prosper Funding and PMI the Platform and Prosper Funding and PMI’s Ability to Service the Notes” for more information.
 
If a borrower dies while a borrower loan is in repayment, Prosper Funding requires the executor or administrator of the estate to send a death certificate to Prosper Funding.  Depending on the size of the estate and the other liabilities thereof, Prosper Funding may not be able to recover the outstanding amount of the loan.  If the estate does not include sufficient assets to repay the outstanding borrower loan in full, or allocates its assets to other liabilities, Prosper Funding will treat the unsatisfied portion of that borrower loan as charged off with zero value.  In addition, if a borrower dies near the end of the term of a borrower loan, it is unlikely that any further payments will be made on the Notes corresponding to such borrower loan, because the time required for the probate of the estate may extend beyond the final maturity date of the Notes.
 
When Prosper Funding receives notice of a borrower bankruptcy filing, it ceases all automatic monthly payments on the borrower loan and defers any other collection activity, as required by law.  The status of the borrower loan, which the relevant lender members may view through their online Prosper Funding accounts, switches to “bankruptcy.”  Prosper Funding then determines whether it has a basis to object to the inclusion of the debt in any bankruptcy action (e.g., based on the time between loan origination and bankruptcy filing).  If the proceeding is a Chapter 7 bankruptcy filing seeking liquidation, Prosper Funding attempts to determine if the proceeding is a “no asset” proceeding, based on instructions it receives from the bankruptcy court.  If the proceeding is a “no asset” proceeding, Prosper Funding takes no further action and assumes that no recovery will be made on the borrower loan.
 
In all other cases, Prosper Funding files a proof of claim involving the borrower.  The decision to pursue additional relief beyond the proof of claim in any specific matter involving a borrower will be entirely within Prosper Funding’s discretion and will depend upon certain factors including:
 
 
·
if the borrower used the proceeds of the loan in a way other than that which was described in the listing;
 
 
·
if the bankruptcy is a Chapter 13 proceeding, whether the proceeding was filed in good faith and if the proposed plan reflects a “best effort” on the borrower’s behalf; and
 
 
·
Prosper Funding’s view of the costs and benefits to it of any proposed action.
 
 Note Trader Platform

Lender members may not transfer the Notes except through the Note Trader platform operated and maintained by FOLIOfn Investments, Inc., a registered broker-dealer.  The Note Trader platform is an internet-based trading platform on which lender members may offer the Notes for sale or bid on and purchase Notes offered for sale by other lender members.  Lender members must first establish a brokerage relationship with FOLIOfn Investments, Inc. before using the Note Trader platform.  In this section, lender members who have established such brokerage relationships are referred to as “subscribers.”  Only transactions involving the sale of previously-issued Notes will be effected through the Note Trader platform; the Note Trader platform will not handle any aspect of transactions involving the initial offer and sale of Notes by Prosper Funding.
 
 
Subscribers who sell Notes on the Note Trader platform will be subject to transaction fees charged by FOLIOfn Investments, Inc.  The transaction fee is currently equal to one percent of the sale price of the Note sold.
 
Neither Prosper Funding nor PMI is a registered national securities exchange, securities information processor, clearing agency, broker, dealer or investment adviser.  All securities services relating to the Note Trader platform are provided by FOLIOfn Investments, Inc.  Neither Prosper Funding, nor PMI nor FOLIOfn Investments, Inc. will make any recommendations with respect to transactions on the Note Trader platform.  There is no assurance that lender members will be able to establish a brokerage relationship with FOLIOfn Investments, Inc.  Furthermore, Prosper Funding cannot assure subscribers that they will be able to sell Notes they offer for sale through the Note Trader platform at the offered price or any other price, nor can Prosper Funding offer any assurance that the Note Trader platform will continue to be available to subscribers.
 
Sale of the Notes
 
Notes Subject to Sale by Subscribers.  All Notes, including Notes for which the corresponding borrower loans have become delinquent, will be eligible for sale on the Note Trader platform.  There is no limit on the number of times a Note may be sold on the Note Trader platform, so long as the Note is outstanding.
 
Lender Members Eligible to Bid on Note Listings.  Lender members must first establish a brokerage relationship with FOLIOfn Investments, Inc. before using the Note Trader platform.  To open an account, FOLIOfn Investments, Inc. may require lender members to confirm that they satisfy certain minimum financial suitability standards and maximum investment limits, if any, that may be imposed by the state in which the lender member resides.  If the lender member does not satisfy these suitability requirements he or she will not be able to participate on the Note Trader platform.
 
Creation of Note Listings.  Subscribers may offer one or more of their Notes for sale on the Note Trader platform by creating and posting a “Note listing.”  Subscribers may offer to sell any or all of the Notes they own and may offer to sell more than one Note at the same time.  When posting a Note listing, the subscriber will designate a minimum sale price the subscriber is willing to receive for the Note.
 
Note listings will have a seven-day auction bidding period, but selling subscribers may elect to end the listing early at any time after a winning bid is made.  Selling subscribers may also add an “automatic sale” feature to their Note listing, which would end the bidding period on a Note listing immediately after the listing receives an initial bid equal to an automatic sale price set by the selling subscriber.  In such instances the Note would be immediately sold to the subscriber who placed the bid.
 
The selling subscriber may withdraw Note listings without charge at any time prior to expiration of the auction bidding period, before any bids are received.  Note listings with at least one bid cannot be withdrawn by the selling subscriber.
 
Display of Note Listings.  Note listings will be displayed for auction on the Note Trader platform, and include the selling subscriber’s screen name, the offered sale price of the Note, the interest rate on the Note, the remaining term of the Note, and the yield to maturity that corresponds to the offered sale price.  Note listings will also include the repayment status of the borrower loan corresponding to the Note (i.e., current or delinquent), the payment history on the borrower loan and the next scheduled payment on the Note.  In addition, Note listings will include the remaining duration of the Note listing, the number of bids, and whether the Note listing has an automatic sale feature.
 
Note listings will include a link to the original listing (including the listing title, description, credit data, recommendations and original bidding history) for the borrower loan that corresponds to the Note being offered for sale.  Although Note listings will be displayed publicly on the Note Trader platform, the borrower’s payment history and corresponding listings will be viewable only by registered subscribers.
 
Bidding on Note Listings.  Only registered subscribers are eligible to bid for and purchase Notes listed for sale on the Note Trader platform.  Subscribers may bid for and purchase one or more Notes from selling subscribers.  As with bidding on loan listings, subscribers who bid on Note listings must have funds on deposit in the subscriber’s funding account in at least the aggregate amount of the subscriber’s bids. Subscribers are prohibited from withdrawing amounts from the subscriber’s funding account to the extent any such withdrawal would reduce the balance below the aggregate amount of the subscriber’s pending bids on loan listings and Note listings.  Subscribers are not eligible to bid on their own Note listings.
 
Subscribers bidding on Note listings must bid for the full amount of the Note being sold, and there may be only one winning bidder for a Note offered for sale by a selling subscriber.
 

Bids may be made by subscribers until the end of the auction bidding period specified in the Note listing.  The selling subscriber may, however, end the auction bidding period early at any time after a winning bid is made.  The winning bidder is the subscriber who has bid the highest price as of the end of the auction bidding period (or the automatic sale price with respect to a Note listing with such a feature).
 
Proxy Bidding.  The Note Trader platform employs an automated proxy bidding system that enables bidding subscribers to place a bid higher than the then current minimum bid, and have bids continually applied against a Note listing, up to a specified maximum bid amount.  The maximum bid amount is hidden from view until competing bids push the current sale price higher than the bidder’s maximum bid.
 
Close of Bidding and Sale of Notes.  When a Note listing ends with a winning bidder, upon settlement of the sale of the Note to the winning bidder, which will normally occur on the business day following expiration of the Note listing, the final sale price is withdrawn from the winning subscriber’s funding account to pay the selling subscriber.  The transaction fee is deducted from the sale price and retained by FOLIOfn Investments, Inc.
 
Upon the selling subscriber’s receipt of the final net sale proceeds, the Note is sold, transferred and assigned by the selling subscriber to the winning bidder without recourse.  All further payments made on the Note following settlement of the sale will be credited to the account of the purchasing subscriber.  The purchasing subscriber may retain ownership of the Note for the remainder of its term, or list the Note for sale on the Note Trader platform.  The electronic original Note is retained by Prosper Funding, as servicer of the Note, for the remaining term of the Note.

Information About Prosper Funding and Prosper Marketplace, Inc.
 
About PMI

PMI developed the platform and, until February 1, 2013, owned the proprietary technology that makes operation of the platform possible. On February 1, 2013, PMI transferred the platform to Prosper Funding, giving Prosper Funding the right to operate the peer-to-peer online credit platform to originate and service borrower loans and Notes.  PMI owns and did not transfer to Prosper Funding ownership of the computer hardware that PMI uses to develop, update, maintain and operate the platform (including the website), produce and record or register loans and Notes, process and record the origination of loans, the acquisition thereof by Prosper Funding, funds transfers in relation to loans and collections on loans, the issuance and transfer of Notes, funds transfers in relation to purchases of and payments on Notes, and which PMI uses to store, backup and manage the information and data used and generated by the platform (such as in relation to the preparation of reports). PMI is a party to agreements with third parties relating to (i) the hosting and maintenance of servers and other computer and communications equipment used by PMI in relation to all of the foregoing aspects of the development, updating of, maintenance and operation of the platform and the provision of related customer support services, (ii) the backup, offsite storage and protection of all information and data produced and used by PMI in relation to all of the foregoing aspects of the development, updating of, maintenance and operation of the platform and the performance by it of all related services, and (iii) maintenance of the integrity, functionality and security of the platform from cyber-attacks and similar threats, which agreements PMI did not assign to Prosper Funding.

About Prosper Funding

Prosper Funding has been organized and is operated in a manner that is intended (i) to minimize the likelihood that it will become subject to a voluntary or involuntary bankruptcy or similar proceeding, and (ii) to minimize the likelihood that it would be substantively consolidated with PMI in the event of PMI’s bankruptcy and thus have its assets subjected to claims of PMI’s creditors. Prosper Funding and PMI believe they have achieved this by imposing through Prosper Funding’s organizational documents and covenants in the indenture certain restrictions on Prosper Funding’s activities and certain formalities designed to reinforce Prosper Funding’s status as a distinct entity from PMI. In addition, under the Administration Agreement, PMI has agreed, in its dealings with Prosper Funding and with third parties, to observe the “separateness covenants” described below as they relate to Prosper Funding.

Prosper Funding and PMI have entered into the Administration Agreement, pursuant to which PMI has agreed to provide certain administrative services relating to the platform. The Administration Agreement between Prosper Funding and PMI contains a license granted by Prosper Funding to PMI that entitles PMI to use the platform for and in relation to: (i) PMI’s performance of its duties and obligations under the Administration Agreement relating to corporate administration, loan platform services, loan and note servicing and marketing, and (ii) PMI’s performance of its duties and obligations to WebBank in relation to loan origination and funding. The license is terminable in whole or in part in relation to failure by PMI to pay the licensing fee or the termination of PMI as the provider of some or all of the aforementioned services.
 
 
Business Strengths
 
Prosper Funding and PMI believe that the following business strengths differentiate them from competitors and are key to the success of their respective businesses:
 
Scalable Operating Infrastructure: The platform allows Prosper Funding to economically acquire and service borrower loans and Notes, and allows WebBank to efficiently originate and fund such loans.  This platform is both flexible and highly scalable;
 
Proprietary Risk Management Capabilities:  PMI is the only company that has developed a proprietary risk model based on P2P specific performance data, which allows PMI to accurately gauge the riskiness of applicants and allows lender members to earn attractive risk adjusted returns;
 
Unique Regulatory Structure:  Prosper Funding has been organized and will be operated in a manner that is intended to minimize the likelihood that it will become subject to a bankruptcy proceeding and to minimize the likelihood that it would be substantively consolidated with PMI in the event of PMI’s bankruptcy.  In addition, Prosper Funding has successfully registered its continuous public offering of Notes, which allows it to create micro securities backed by consumer loans.  This organizational structure and registration process was expensive and time consuming to achieve and is not easily duplicated by competitors;
 
Management Team:  Prosper Funding and PMI have respective management teams with experience in a broad set of areas that are essential to the operation of a P2P business.  These areas include but are not limited to risk management, fraud detection, loan servicing operations, technology development, data management, financial controls, securities regulation, compliance, customer management and website development;

Open access:  Prosper Funding allows individuals with a wide range of credit characteristics to apply for loans; and

Transparency and data availability:  By making all transactions on the platform visible and available electronically for analysis, Prosper Funding allows its members to better understand its marketplace and make better decisions about their activity.

Corporate History

Prosper Funding was formed in the State of Delaware in February 2012. Its principal executive offices are located at 111 Sutter Street, 22nd Floor, San Francisco, California 94104.  Its telephone number at that location is (415) 593-5479.  Its website address is www.prosper.com.  The information contained on Prosper Funding’s website is not incorporated by reference into this annual report.

PMI was incorporated in the State of Delaware in March 2005.  Its principal executive offices are located at 111 Sutter Street, 22nd Floor, San Francisco, California 94104.  PMI’s telephone number at that location is (415) 593-5400.

Our website is located at www.prosper.com. The following filings are available on our website after we file them with the SEC: Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q. These filings are also available for download free of charge on our website.  Further, a copy of this Annual Report on Form 10-K is located at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549.  Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. Our SEC filings are also available to the public at the SEC’s Internet site at http://www.sec.gov.

Marketing

PMI’s marketing efforts are designed to attract individuals and institutions to the platform, to enroll them as members and to have them understand and utilize the services for borrowing or investing in Notes on the platform.  Prosper Funding and PMI believe there are significant opportunities to increase the number of members who use the platform through additional marketing initiatives.  For example, such marketing initiatives may, but will not necessarily, include e-mail campaigns, presentations and paid search advertisements.  PMI employs a combination of paid and unpaid sources to market the platform.  PMI also invests in public relations to build its brand and visibility.  PMI is constantly seeking new methods to reach more potential members.
 
 
PMI attracts members to the platform in a variety of ways, including advertising, search engine results and word-of-mouth referrals.  In addition, PMI and the platform have been featured in a variety of media outlets, including television and print media.
 
PMI continuously measures website visitor-to-member conversion.  It tests graphics and layout alternatives in order to improve website conversion.  It also seeks to customize the website to members’ needs whenever possible.  PMI carefully analyzes visitor website usage to understand and overcome barriers to conversion.
 
From time to time, PMI or Prosper Funding may conduct special promotions to increase the participation of existing members on the platform or to attract new members.  These promotions could include offering special incentives for registering as a lender or a borrower, posting a loan listing, moving money onto the platform, placing bids on loan listings or successfully bidding on a loan listing.  The incentives could include cash bonuses or rebates or fee discounts or waivers.  These promotions may be offered to all customers for all products or could be restricted to particular products or types of customers.  For example, PMI or Prosper Funding could conduct a special promotion to attract customers who come to www.prosper.com through a marketing partnership it has with another company.
 
For the twelve months ended December 31, 2012 and 2011, PMI spent approximately $5.7 million and $2.0 million, respectively, on marketing.  Prosper Funding expects to spend similar amounts in the future.  Each marketing effort is measured, analyzed and optimized to improve scale and efficiency in each channel.  Through optimization of targeting efforts Prosper Funding and PMI will shift marketing costs to efficient channels to balance the mix of growth and efficiency in marketing activities in subsequent quarters.

Technology

The system hardware for the platform, which is owned by PMI, is located in a hosting facility in San Francisco, California, owned and operated by Rincon 365 Borrower, LLC under an agreement that expires in August 2014.  Generally, unless PMI or Rincon 365 Borrower, LLC delivers a termination notice, the agreement is automatically renewable for three year terms.  The facility provides around-the-clock security personnel, video surveillance and biometric access screening and is serviced by onsite electrical generators and fire detection and suppression systems.  The facility has multiple interconnects to the Internet, and Internap Network Services Corporation is the Internet service provider for the platform.  It also maintains off-site backups at a secure, Tier 1 data center in Las Vegas, Nevada.  It backs up all customer data daily and replicates this data offsite via an encrypted connection.
 
PMI owns all of the hardware deployed in support of the platform.  PMI continuously monitors the performance and availability of the platform.  The infrastructure is scalable and utilizes standard techniques such as load-balancing and redundancies.
 
The platform utilizes proprietary accounting software to process electronic cash movements, record book entries and calculate cash balances in members’ funding accounts.  PMI processes electronic deposits and payments by originating ACH transactions.  This software puts these transactions in the correct ACH transaction data formats and makes book entries between individual members’ accounts using a Write-Once-Read-Many (WORM) ledger system.

Prosper Funding has entered into a back-up servicing agreement with CSC Logic, Inc., a loan servicing company that is willing and able to transition servicing responsibilities in the event that Prosper Funding and/or PMI are no longer able to service the borrower loans.  CSC Logic, Inc. is a financial services company that has entered into numerous successor loan servicing agreements and has operated in the back-up servicing market for more than twenty years.  It is unlikely that CSC Logic, Inc. would be able to perform functions other than servicing the existing borrower loans and Notes.  See “Item 1A. Risk Factors—Risks Related to Prosper Funding and PMI, the Platform and Prosper Funding and PMI’s Ability to Service the Notes—Arrangements for back-up servicing are limited.  If PMI fails to maintain operations or the Administration Agreement is rejected or terminated (in bankruptcy or otherwise), you may experience a delay and increased cost in respect of your expected principal and interest payments on your Notes, and Prosper Funding may be unable to collect and process repayments from borrowers.
 
Scalability

The platform is designed and built as a highly scalable, multi-tier, redundant system.  It incorporates technologies designed to prevent any single point of failure within the data center from taking the entire system offline.  This is achieved by utilizing load-balancing technologies at the front end and business layer tiers and clustering technologies in the back-end tiers to allow scaling both horizontally and vertically depending on platform utilization.  In addition, the core network load-balancing, routing and switching infrastructure is built with fully redundant hardware and sub-second failover between those devices.
 
 
Data integrity and security

Prosper Funding and PMI transmit all sensitive data to and from customers and service providers using a secure transport protocol.  Communication of sensitive data via the web site to customers is secured utilizing SSL 128-bit enabled encryption certificates provided by VeriSign and Thawte, Inc.  Communication of sensitive data with service providers is secured utilizing authenticated VPN, SSL 128-bit encryption and SSH protocols depending on the service providers’ requirements.  Storage of sensitive data is encrypted utilizing AES 256-bit and 3DES 168-bit cryptographic ciphers, depending upon the service providers’ requirements and internal storage policies.  Access to the data by Prosper Funding or PMI personnel is restricted based upon a least-privilege principle such that employees have access only to the information and systems needed to perform their function.  In the event of disaster, data is repeatedly stored securely at an offsite data center.
 
Prosper Funding and PMI protect the security of the platform using a multilayered defense strategy incorporating several different security technologies and points of monitoring.  At the perimeter of the network, multi-function security technologies implement firewall, intrusion prevention, anti-virus and anti-spam threat management techniques.  Internally, the network and hosts are segmented by function with another layer of firewalls and traffic inspection devices.  At the host level, the platform utilizes host based intrusion prevention, anti-virus, anti-spyware, and application control systems.  Logging and monitoring for network security devices is done in real-time with notifications to the appropriate staff upon any suspicious event or action that requires attention.  Logging and monitoring of host systems is done in real-time to a centralized database with web based reporting and additional notification to the appropriate staff for any remediation.
 
Fraud detection

Prosper Funding and PMI consider fraud detection to be of utmost importance to the successful operation of the platform.  They employ a combination of proprietary technologies and commercially available licensed technologies and solutions to prevent and detect fraud.  Prosper Funding and PMI employ techniques such as knowledge based authentication, or KBA, out-of-band authentication and notification, behavioral analytics and digital fingerprinting to prevent identity fraud.  Prosper Funding and PMI use services from third-party vendors for user identification, credit checks and for checking customer names against the list of Specially Designated Nationals maintained by the Office of Foreign Assets Control (“OFAC”).  In addition, Prosper Funding and PMI use specialized third-party software to augment the identity fraud detection systems.   PMI also has a dedicated team which conducts, on Prosper Funding’s behalf, additional investigations of cases flagged for high fraud risk.  See “Item 1. Business—Borrower Identity and Financial Information Verification” for more information.  Finally, Prosper Funding enables its lender members to report suspicious activity, which Prosper Funding or PMI may then evaluate further.
 
Engineering

PMI has made substantial investment in software and website development and Prosper Funding and PMI expect to continue to make significant investments in software and website development.  In addition to developing new products and maintaining an active online deployment, PMI’s technology team also performs technical competitive analysis as well as systematic product usability testing.  As of December 31, 2012, PMI’s technology group consisted of twenty-two full-time employees.
 
Competition

The market for peer-to-peer lending is competitive and rapidly evolving.  Prosper Funding believes the following are the principal competitive factors in the peer-to-peer lending market:
 
 
·
fee structure;
 
 
·
website attractiveness;
 
 
·
member experience, including borrower loan funding rates and lender returns;
 
 
·
acceptance as a social network;
 
 
·
branding; and
 
 
·
ease of use.
 
Prosper Funding’s primary competitors are major credit card issuers, such as JPMorgan Chase Bank, Bank of America and Citibank, other commercial banks, savings banks and consumer finance companies.  Prosper Funding also faces competition from other peer-to-peer platforms such as LendingClub.
 
 
Prosper Funding may also face future competition from new companies entering the market, which may include large, established companies, such as eBay Inc., Google Inc. or Yahoo! Inc. These companies may have significantly greater financial, technical, marketing and other resources and may be able to devote greater resources to the development, promotion, sale and support of their consumer platforms.  These potential competitors may be in a stronger position to respond quickly to new technologies and may be able to undertake more extensive marketing campaigns.  These potential competitors may have more extensive potential borrower bases.  In addition, these potential competitors may have longer operating histories and greater name recognition.  Moreover, if one or more of these competitors were to merge or partner with another competitor or a new market entrant, the change in competitive landscape could adversely affect Prosper Funding’s ability to compete effectively.
 
Intellectual Property
 
Prosper Funding’s intellectual property rights are important to its business.  Prosper Funding relies on a combination of copyright, trade secret, trademark, and other rights, as well as confidentiality procedures and contractual provisions to protect its proprietary technology, processes and other intellectual property.
 
Although the protection afforded by copyright, trade secret, trademark, written agreements and common law may provide some advantages, Prosper Funding believes that the following factors help it to maintain a competitive advantage:
 
 
·
the technological skills of the software and website development personnel who developed the platform;
 
 
·
frequent enhancements to the platform; and
 
 
 
·
high levels of member satisfaction.
 
Competitors may develop products that are similar to Prosper Funding’s technology.  For example, Prosper Funding’s legal agreements may be copied directly from its website by others.  As Loan and Note Servicer under the Administration Agreement, PMI has access to confidential information regarding Prosper Funding’s intellectual property.  PMI enters into confidentiality and other written agreements with its employees, consultants and service providers, and through these and other written agreements, attempts to control access to and distribution of the software, documentation and other proprietary technology and information.  Despite these efforts to protect Prosper Funding’s proprietary rights, third parties may, in an authorized or unauthorized manner, attempt to use, copy or otherwise obtain and market or distribute Prosper Funding’s intellectual property rights or technology or otherwise develop a product with the same functionality.  Policing all unauthorized use of intellectual property rights is nearly impossible.  Therefore, Prosper Funding cannot be certain that the steps it has taken or will take in the future will prevent misappropriations of its technology or intellectual property rights.
 
Prosper Funding and PMI use software developed by PMI.  Neither Prosper Funding nor PMI use software licensed by third parties for processing electronic cash movements, recording book entries or calculating cash balances in lender members’ accounts.
 
Employees

Prosper Funding does not have any employees.  As of December 31, 2012, PMI employed 74 full-time employees.  Of these employees:
 
 
·
22 were in engineering;

 
·
19 were in operations;

 
·
18 were in sales and marketing; and

 
·
15 were in general and administrative.
 
None of PMI’s employees are represented by labor unions.  PMI has not experienced any work stoppages and Prosper Funding and PMI believe that PMI’s relations with its employees are good.

PMI expects to improve its operating efficiency going forward.
 

Facilities

Prosper Funding does not lease or own any real property or equipment.  Its headquarters is located in San Francisco, California, where PMI leases workstations and conference rooms under a lease that will expire on July 31, 2013.  Prosper Funding believes that its existing facilities are adequate to meet its current needs, and that suitable additional alternative spaces will be available in the future on commercially reasonable terms.

PMI’s corporate headquarters, including its principal administrative, marketing, technical support and engineering functions, is located in San Francisco, California, where it leases workstations and conference rooms.  PMI leases its corporate office and co-location facility under non-cancelable operating leases that expire in July 2013 and August 2014, respectively.  PMI has entered into a corporate office lease through December 31, 2014.  PMI believes that its facilities are adequate to meet its current needs and that suitable additional alternative spaces will be available in the future on commercially reasonable terms.

Legal Proceedings

Prosper Funding is not currently subject to any material legal proceedings.  Prosper Funding is not aware of any litigation matters which have had, or are expected to have, a material adverse effect on it.  PMI is subject to the legal proceedings described below.

From inception through October 16, 2008, PMI sold approximately $178.1 million of PMI Borrower Loans to lender members through the initial platform structure, whereby PMI assigned promissory notes directly to lender members. PMI did not register the offer and sale of the promissory notes corresponding to these PMI Borrower Loans under the Securities Act or under the registration or qualification provisions of any state securities laws.  PMI believes that the question of whether or not the operation of the platform during this period constituted an offer or sale of “securities” involved a complicated factual and legal analysis and was uncertain. If the sales of promissory notes offered through the platform during this period were viewed as a securities offering, PMI would have failed to comply with the registration and qualification requirements of federal and state laws and lender members who hold these promissory notes may be entitled to rescission of unpaid principal, plus statutory interest. Generally, the federal statute of limitations for noncompliance with the requirement to register securities under the Securities Act is one year from the violation, although the statute of limitations period under various state laws may be for a longer period of time.

PMI’s decision to restructure the platform and cease sales of promissory notes offered through the platform effective October 16, 2008 limited this contingent liability to the period covering its activities prior to October 16, 2008.

On April 21, 2009, PMI and the North American Securities Administrators Association (“NASAA”) reached agreement on the terms of a model consent order between PMI and the states in which PMI offered promissory notes for sale prior to November 2008. The consent order involves payment by PMI of up to an aggregate of $1.0 million in penalties, which have been allocated among the states based on PMI’s promissory note sale transaction volume in each state prior to November 2008. A state that enters into a consent order receives its portion of the $1.0 million in exchange for its agreement to terminate, or refrain from initiating, any investigation of PMI’s promissory note sale activities prior to November 2008.  Penalties are paid promptly after a state enters into a consent order. NASAA has recommended that each state enter into a consent order.  However, no state is obliged to do so, and there is no deadline by which a state must make its decision. PMI is not required to pay any portion of the penalty to those states that do not elect to enter into a consent order. If a state does not enter into a consent order, it is free to pursue its own remedies against PMI, subject to any applicable statute of limitations. As of December 31, 2012, PMI has entered into consent orders with 34 states and has paid an aggregate of $466,017 in penalties to those states.

As of December 31, 2012 and 2011, PMI had accrued approximately $248,000 and $277,000, respectively, in connection with the contingent liability associated with the states that have not entered into consent orders, in accordance with ASC Topic 450, Contingencies. The methodology applied to estimate the accrual was to divide the $1,000,000 maximum fee pro-rata by state, using PMI’s promissory note sales from inception through November 2008. A weighting was then applied to each state that has not entered into a consent order, assigning a likelihood that the penalty will be claimed. In estimating the probability of a claim being made by a state, PMI considered factors such as the standard terms of the consent orders; whether the state ever gave any indication of concern regarding the sale of promissory notes through the platform; the probability of a state electing not to enter into a consent order in order to pursue its own litigation against PMI; whether the penalty is sufficient to compensate a state for the cost of processing the settlement consent order; and finally the impact that current economic conditions have had on state governments. PMI will continue to evaluate this accrual and related assumptions as new information becomes known.

On November 26, 2008, plaintiffs, Christian Hellum, William Barnwell and David Booth, individually and on behalf of all other plaintiffs similarly situated, filed a class action lawsuit against PMI and certain of its executive officers and directors in the Superior Court of California, County of San Francisco, California.  The suit was brought on behalf of all promissory note purchasers on the platform from January 1, 2006 through October 14, 2008.  The lawsuit alleges that PMI offered and sold unqualified and unregistered securities in violation of the California and federal securities laws.  The lawsuit seeks class certification, damages and the right of rescission against PMI and the other named defendants, as well as treble damages against PMI and the award of attorneys’ fees, experts’ fees and costs, and pre-judgment and post-judgment interest.
 
 
On February 25, 2011, the plaintiffs filed a Third Amended Complaint, which removed David Booth as a plaintiff and added Brian Russom and Michael Del Greco as plaintiffs.  The new plaintiffs are representing the same class and prosecuting the same claims as the previously named plaintiffs. On February 29, 2012, the court issued a procedural order granting the plaintiffs’ motion for class certification.  On October 4, 2012, PMI and the other named defendants filed a motion for summary judgment seeking dismissal of the suit.  On January 17, 2013, the motion for summary judgment was denied.

PMI’s insurance carrier with respect to the class action lawsuit, Greenwich Insurance Company (“Greenwich”), denied coverage.  On August 21, 2009, PMI filed suit against Greenwich in the Superior Court of California, County of San Francisco, California.  The lawsuit sought a declaration that PMI was entitled to coverage under its policy with Greenwich for losses arising out of the class action lawsuit as well as damages and the award of attorneys’ fees and pre- and post-judgment interest.

On January 26, 2011, the court issued a final statement of decision finding that Greenwich had a duty to defend the class action lawsuit, and requiring that Greenwich pay PMI’s past and future defense costs in the class action suit up to $2 million. Greenwich subsequently made payments to PMI in the amount of $2 million to reimburse PMI for the defense costs it had incurred in the class action suit. On July 1, 2011, PMI and Greenwich entered into a Stipulated Order of Judgment pursuant to which PMI agreed to dismiss its remaining claims against Greenwich. On August 12, 2011, Greenwich filed a notice of appeal of the court's decision regarding Greenwich’s duty to defend up to $2 million. On July 16, 2012, the California Court of Appeal affirmed the trial court’s decision. On October 22, 2012 Greenwich made an additional payment of $142,585 to PMI for pre-judgment interest. As a result, Greenwich has now satisfied its obligations with respect to PMI’s defense costs for the Hellum suit.

PMI intends to vigorously defend the class action lawsuit.  PMI cannot, however, presently determine or estimate the final outcome of the lawsuit, and there can be no assurance that it will be finally resolved in PMI’s favor.  If the class action lawsuit is not resolved in PMI’s favor, PMI might be obliged to pay damages, and might be subject to such equitable relief as a court may determine. Accordingly, PMI has not recorded an accrued loss contingency in connection with its sale of promissory notes through the platform prior to November 2008. 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 financial statements.

As of December 31, 2012, the probable outcome of the class action lawsuit cannot presently be determined, nor can the amount of damages or other costs that might be borne by PMI be estimated.

PMI’s Prior Operating Structure

From the launch of the platform in February 2006 until October 16, 2008, the operation of the platform differed from the structure described in this Annual Report, and PMI did not offer borrower payment dependent notes. Instead, the platform allowed lender members to purchase, and take assignment of, borrower loans directly. Borrower loans resulting from listings posted prior to April 15, 2008 were made by PMI; loans resulting from listings posted on or after April 15, 2008 were made by WebBank and then sold and assigned to PMI. In each case, PMI then sold and assigned such loans to the lender members who were winning bidders for the loans. Under this structure, a borrower executed a separate promissory note for each winning bid that was placed on the borrower’s listing in the amount of that bid, which note was then sold and assigned by PMI to the lender member who made the bid, subject to PMI’s right to service the loans. In addition, the Prosper Rating system did not exist during this period. Instead, PMI assigned one of seven letter credit grades to listings based on the borrower’s credit score.

In October 2008, due to legal uncertainties relating to the sales of notes offered through this prior platform structure, and as a result of discussions with the SEC and various state securities regulators, PMI decided to suspend promissory note sales and restructure the platform. Shortly after that, PMI filed a registration statement with the SEC to cover its sale of promissory notes under a revised platform structure.

From October 16, 2008 until July 13, 2009, PMI did not offer lender members the opportunity to purchase promissory notes on the platform and PMI did not accept new lender registrations. PMI continued to service all previously-funded borrower loans, and lender members had the ability to access their accounts, monitor their borrower loans and withdraw available funds. During this period, borrowers could still request loans, but those loan requests were forwarded to companies that had a pre-existing relationship with PMI that could make or facilitate a loan to the borrower.
 
 
For a brief period between April 28, 2009 and May 8, 2009, PMI’s wholly owned subsidiary Prosper Loans Marketplace, Inc. (which has subsequently been dissolved) conducted an intrastate offering under Section 3(a)(11) of the Securities Act to California residents only. PMI originated thirteen loans in connection with this offering, but did not sell any of the related promissory notes. Prior to the sale of these promissory notes, the SEC expressed concerns that the offering might violate provisions of the Securities Act. Upon learning of these concerns, PMI terminated the offering and informed the winning bidders on the thirteen loans that were made that the promissory notes could not be sold to them. PMI’s termination of these promissory notes sales was based on its representation and warranty in the lender registration agreement that it had complied in all material respects with applicable law in connection with the offer and sale of all promissory notes.
 
The SEC declared PMI’s registration statement effective on July 10, 2009 and PMI commenced its offering of notes on July 13, 2009. A portion of PMI’s historical financial results reflect the structure of the lending platform and PMI’s operations prior to July 13, 2009. For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Prosper Marketplace, Inc.”

Securities Law Compliance

From PMI’s commencement of operations in February 2006 through October 16, 2008, it sold approximately $178.1 million of loans to its lender members through an operating structure that involved the sale and assignment of promissory notes directly to lender members. PMI did not register the offer and sale of these promissory notes under the Securities Act or under the registration or qualification provisions of any state securities laws. In PMI’s view, analyzing whether or not the operation of the platform involved an offer or sale of a “security” involved a complicated factual and legal analysis and was uncertain. If the sales of promissory notes offered through the platform were viewed as a securities offering, PMI may have failed to comply with the registration and qualification requirements of federal and state law and PMI’s lender members who held these promissory notes may be entitled to rescission of unpaid principal, plus statutory interest. Generally, the federal statute of limitations for noncompliance with the requirement to register securities under the Securities Act is one year from the violation, although the statute of limitations period under various state laws may be for a longer period of time. Due to the legal uncertainty regarding the sales of promissory notes offered through the platform under PMI’s prior operating structure, and as a result of discussions with the SEC and various state securities law administrators, PMI decided to restructure its operations to resolve such uncertainty. PMI began implementation of this decision on October 16, 2008, when it ceased offering lender members the opportunity to make loan purchases on the platform, ceased accepting new lender member registrations and ceased allowing new loan purchase commitments from existing lender members. Furthermore, pursuant to this decision, PMI filed a prospectus, and registration statement of which it formed a part, with the SEC, in which PMI described the restructuring of its operations and its new operating structure. PMI resumed transactions with lender members starting July 13, 2009. PMI’s decision to restructure its operations and cease sales of promissory notes offered through the platform effective October 16, 2008 limited this contingent liability, under federal law, so that it only related to the period from February 2006 until October 16, 2008. PMI has, however, accrued approximately $248,000 as of December 31, 2012 in connection with the $1 million contingent liability arising from the settlement term sheet PMI entered into with NASAA on November 26, 2008 in accordance with ASC Topic 450. See “Item 1A. Risk Factors—Risks Related to Prosper Funding and PMI, the Platform and Prosper Funding and PMI’s Ability to Service the Notes—PMI faces a contingent liability for securities law violations in respect of PMI Borrower Loans sold to its lender members from inception until October 16, 2008. This contingent liability may impair its ability to perform its obligations under the Administration Agreement” for more information. As of December 31, 2012, PMI has entered into 34 consent order agreements pursuant to the NASAA settlement term sheet and has paid an aggregate of $466,017 in penalties.
 
The change in the operation of PMI’s platform, the resulting litigation, as well as PMI’s adoption of new accounting pronouncements, have had a significant impact on PMI’s financial statements and results of operations for periods following July 13, 2009. For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Prosper Marketplace, Inc.—Borrower Loans and PMI Notes.”
 

GOVERNMENT REGULATION
 
Overview

The consumer loan industry is highly regulated.  Prosper Funding, PMI and the borrower loans made through the platform are subject to extensive and complex rules and regulations.  Prosper Funding and PMI also are subject to licensing and examination by various federal, state and local government authorities.  These authorities impose obligations and restrictions on Prosper Funding and PMI’s activities and the borrower loans made through the platform.  In particular, these rules limit the fees that may be assessed on the borrower loans, require extensive disclosure to, and consents from, applicants and borrowers, prohibit discrimination and impose multiple qualification and licensing obligations on platform activities.  Failure to comply with these requirements may result in, among other things, revocation of required licenses or registration, loss of approved status, voiding of loan contracts, indemnification liability to contract counterparties, class action lawsuits, administrative enforcement actions and civil and criminal liability.  While compliance with such requirements is at times complicated by Prosper Funding and PMI’s novel business model, Prosper Funding and PMI believe they are in substantial compliance with these rules and regulations.  These rules and regulations are subject to continuous change, however, and a material change could have an adverse effect on Prosper Funding and PMI’s compliance efforts and ability to operate.
 
Regulation and Consumer Protection Laws

State and Federal Laws and Regulations
 
State Licensing Requirements.  PMI holds consumer lending licenses, collections licenses or similar authorizations in 20 states.  Prosper Funding holds a consumer lending license in 1 state.  PMI and Prosper Funding are subject to supervision and examination by the state regulatory authorities that administer the state lending laws.  The licensing statutes vary from state to state and variously prescribe or impose recordkeeping requirements; restrictions on loan origination and servicing practices, including limits on finance charges and the type, amount and manner of charging fees; disclosure requirements; requirements that licensees submit to periodic examination; surety bond and minimum specified net worth requirements; periodic financial reporting requirements; notification requirements for changes in principal officers, stock ownership or corporate control; restrictions on advertising; and requirements that loan forms be submitted for review.
 
WebBank is a Utah-chartered industrial bank organized under Title 7, Chapter 8 of the Utah Code and has its deposits insured by the Federal Deposit Insurance Corporation, or FDIC.  WebBank is subject to supervision and examination by the Utah Department of Financial Institutions and the FDIC.  Applicable federal law preempts state usury limitations and allows FDIC-insured depository institutions, such as WebBank, to “export” the interest rates permitted under the laws of the state where the bank is located when making loans to borrowers who reside in other states, regardless of the usury limitations imposed by the state law of the borrower’s residence.  WebBank is located in Utah, and Utah law does not limit the amount of interest that may be charged on loans of the type offered through the platform.  A few jurisdictions have elected to opt out of the federal usury preemption available to state-chartered, FDIC-insured banks.  To the extent that a WebBank borrower loan is deemed to be “made” in such a jurisdiction, the loan would be subject to the maximum interest rate limit of such jurisdiction.
 
Truth-in-Lending Act.  The federal Truth-in-Lending Act (“TILA”), and the regulation issued by the Federal Reserve Board implementing the TILA, Regulation Z, requires disclosure of, among other things, the annual percentage rate, the finance charge, the amount financed, the number of payments, and the amount of the monthly payment on consumer loans.  WebBank provides borrowers with a TILA disclosure form when borrower loans are originated and seeks to comply with TILA’s disclosure requirements relating to credit advertising.
 
Equal Credit Opportunity Act.  The federal Equal Credit Opportunity Act (“ECOA”) and the regulation issued by the Federal Reserve Board implementing the ECOA, Regulation B, prohibit discrimination in any aspect of a credit transaction on the basis of race, color, religion, national origin, sex, marital status, age (with certain limited exceptions), because all or part of the applicant’s income derives from any public assistance program, or because the applicant has in good faith exercised any right under the Consumer Credit Protection Act.  Prosper Funding, PMI and WebBank comply with the ECOA’s nondiscrimination requirements, and the lender registration agreement requires lender members to comply with the ECOA in their bidding practices.  Prosper Funding also requires individual group leaders who form groups to comply with the ECOA in that they are prohibited from excluding individuals from membership in a group on a prohibited basis.

The ECOA also requires creditors to provide consumers with notice of adverse action taken on credit applications, giving the consumer the principal reasons why adverse action was taken.  PMI and WebBank provide prospective borrowers who apply for but fail to obtain a borrower loan through the platform with an adverse action notice in compliance with the ECOA’s requirements.
 
 
Fair Credit Reporting Act.  The federal Fair Credit Reporting Act (“FCRA”), administered by the Federal Trade Commission, promotes the accuracy, fairness and privacy of information in the files of consumer reporting agencies.  In addition to requirements on credit bureaus, the FCRA requires that users of consumer credit reports have a permissible purpose to obtain a credit report on a consumer and that persons who furnish loan payment information to credit bureaus report such information accurately.  The FCRA also has disclosure requirements for creditors who take adverse action on credit applications based on information contained in a credit report.  WebBank, and PMI as its agent in relation to borrower loan originations, have a permissible purpose for obtaining credit reports on borrower members and they report loan payment and delinquency information to the credit bureaus in compliance with the FCRA.  PMI and WebBank’s adverse action notices contain the disclosures required by the FCRA.
 
Fair Debt Collection Practices Act.  The federal Fair Debt Collection Practices Act (“FDCPA”) provides guidelines and limitations on the conduct of third party debt collectors in connection with the collection of consumer debts.  The FDCPA limits certain communications with third parties, imposes notice and debt validation requirements, and prohibits threatening, harassing or abusive conduct in the course of debt collection.  While the FDCPA applies to third party debt collectors, debt collection laws of certain states, including California, impose similar requirements on creditors who collect their own debts.  In order to ensure compliance with the FDCPA, Prosper Funding has contracted with professional third party debt collection agencies to engage in debt collection activities.  Prosper Funding’s agreements with lender members and group leaders prohibit registered lender members and group leaders from attempting to directly collect on the Notes, and Prosper Funding  has established procedures to ensure that lender members and group leaders do not attempt to collect on the Notes themselves.
 
Servicemembers Civil Relief Act.  The federal Servicemembers Civil Relief Act (“SCRA”) allows military members to suspend or postpone certain civil obligations so that military members can devote their full attention to military duties.  In accordance with the SCRA, PMI must adjust the interest rate of borrowers on active duty and other military personnel who qualify for and request relief.  If a borrower with an outstanding borrower loan is called to active military duty, PMI will reduce the interest rate on the borrower loan to 6% for the duration of the borrower’s active duty.  During this period, the holders of the corresponding Notes will not receive the difference between 6% and the interest rate on the Notes.  For borrowers to obtain an interest rate reduction on a borrower loan due to military service, PMI requires the borrowers to send it a written request and a copy of the borrower’s mobilization orders.  PMI does not take military service into account in assigning Prosper Ratings to listings.
 
Other Lending Regulations.  Prosper Funding and PMI are subject to and seek to comply with other state and federal laws and regulations applicable to consumer lending, including additional requirements relating to loan disclosure, credit discrimination, credit reporting, debt collection and unfair, deceptive or abusive business practices.  These laws and regulations may be enforced by state consumer credit regulatory agencies, state attorneys general, the Federal Trade Commission, and private litigants, among others.  Given Prosper Funding and PMI’s novel business model and the subjective nature of some of these laws and regulations, particularly laws regulating unfair or deceptive business practices, Prosper Funding and PMI may become subject to regulatory scrutiny or legal challenge with respect to their compliance with these requirements.

Electronic Funds Transfer Act.  The federal Electronic Funds Transfer Act (“EFTA”) and the regulation issued by the Federal Reserve Board implementing the EFTA, Regulation E, place guidelines and restrictions on the electronic transfer of funds from consumers’ bank accounts, including preauthorized electronic fund transfers from consumers’ accounts to make loan payments.  Most transfers of funds in connection with the origination and repayment of Notes and bidding on the platform are done by Automated Clearing House (“ACH”) electronic transfers of funds subject to detailed timing and notification rules and guidelines administered by the National Automated Clearinghouse Association (“NACHA”).  Transfers of funds on the platform are done in conformity with the EFTA and its regulations, as well as NACHA guidelines.
 
Electronic Signatures in Global and National Commerce Act.  The federal Electronic Signatures in Global and National Commerce Act (“ESIGN”) and similar state laws authorize the creation of legally binding and enforceable agreements, including electronic loan agreements, utilizing electronic records and electronic signatures.  ESIGN imposes special requirements on businesses that want to use electronic records or signatures in consumer transactions, and requires businesses to obtain from consumers electronic consent or confirmation to receive information electronically that a law requires be in writing.  When a platform participant registers on the platform, PMI obtains his or her consent to transact business electronically with Prosper Funding and WebBank and maintains electronic records in compliance with ESIGN requirements.
 
Privacy and Data Security Laws.  The federal Gramm-Leach-Bliley Act (“GLBA”) limits the disclosure of nonpublic personal information about a consumer to nonaffiliated third parties and requires financial institutions to disclose certain privacy policies and practices with respect to its information sharing with both affiliates and nonaffiliated third parties.  A number of states have enacted privacy and data security laws requiring safeguards on the privacy and security of consumers’ personally identifiable information.  Prosper Funding and PMI have privacy policies that conform to GLBA requirements.  In addition, both Prosper Funding and PMI have policies and procedures intended to maintain platform participants’ personal information securely, and neither entity sells or rents such information to third parties for marketing purposes.
 
 
OFAC and Bank Secrecy Act.  Prosper Funding and PMI check customer names against the list of Specially Designated Nationals maintained by the Office of Foreign Assets Control (“OFAC”).  Prosper Funding and PMI have also instituted procedures to comply with the anti-money laundering requirements of the USA PATRIOT Act and the Bank Secrecy Act.
 
State Securities Laws.  Prosper Funding and PMI are subject to the securities laws of each state in which the registration or qualification to offer and sell the Securities has been approved.  Certain of these state laws require Prosper Funding and PMI to renew their registration or qualification on an annual basis.  In August 2010 and October 2011, PMI was inadvertently late in filing applications to renew its registrations or qualifications in several states.  Although all of these renewal applications were approved, PMI agreed to pay the following penalties in connection with the late filings: (i) $300 to the State of Washington, (ii) $25,000 to the State of California, (iii) $45,000 to the State of Connecticut, (iv) $500 to the State of Illinois, and (v) $5,000 to the State of Maine.  In addition, the Florida Office of Financial Regulation required PMI to make a rescission offer to any Florida resident who purchased a note from PMI during the period in which PMI inadvertently allowed its registration in Florida to expire.  PMI made this rescission offer on February 4, 2011.  The offer expired on March 6, 2011, and on March 20, 2011, PMI repurchased $21,900 of Notes from persons who accepted the rescission offer.
 
Foreign Laws and Regulations
 
Prosper Funding does not permit non-U.S. residents to register as members on the platform and neither Prosper Funding nor PMI operate outside the United States.  Therefore, neither Prosper Funding nor PMI are subject to foreign laws or regulations.

States in Which Prosper Funding and PMI Currently Operate
 
The platform operates online only and is available to borrower members in all states except Iowa, Maine and North Dakota.  Prosper Funding and PMI intend to register or qualify the offer and sale of the Securities in 40 states as well as Washington D.C., and will offer the Securities in each jurisdiction where they obtain such qualification or where such registration is declared effective, subject to any applicable state suitability requirements.
 
 
Item 1A. Risk Factors

The Securities involve a high degree of risk.  You should carefully consider the risks described below before making a decision to invest in the Securities.  If any of the following risks actually occurs, you might lose all or part of your investment in the Securities.  Before making an investment decision, you should carefully consider these risks. The risks and uncertainties described are not the only ones facing Prosper Funding and PMI.  Additional risks and uncertainties not presently known or that Prosper Funding and PMI currently deem immaterial may also affect Prosper Funding and PMI’s respective business operations.

RISKS RELATED TO BORROWER DEFAULT

The Notes are risky and speculative investments for suitable investors only.
 
You should be aware that the Notes offered through the platform are risky and speculative investments.  The Notes are special, limited obligations of Prosper Funding and depend entirely for payment on Prosper Funding’s receipt of payments under the corresponding borrower loans.  Notes are suitable only for lender members of adequate financial means.  If you cannot afford to lose the entire amount of your investment in the Notes you purchase, you should not invest in the Notes.
 
Payments on the Notes depend entirely on payments Prosper Funding receives on corresponding borrower loans.  If a borrower fails to make any payments on the corresponding borrower loan related to your Note, payments on your Note will be correspondingly reduced.
 
Prosper Funding will only make payments pro rata on a series of Notes after it receives a borrower’s payment on the corresponding borrower loan, net of servicing fees.  Prosper Funding also will retain from the funds received from the relevant borrower and otherwise available for payment on the Notes any non-sufficient funds fees and the amounts of any attorneys’ fees or collection fees a third-party servicer or collection agency imposes in connection with collection efforts.  Under the terms of the Notes, if Prosper Funding does not receive any or all payments on the corresponding borrower loan, payments on your Note will be correspondingly reduced in whole or in part.  If the relevant borrower does not make a payment on a specific monthly loan payment date, no payment will be made on your Note on the corresponding succeeding Note payment date.
 
Information supplied by applicants may be inaccurate or intentionally false.  Information regarding income and employment is not verified in many cases.
 
Applicants supply a variety of information regarding the purpose of the loan, income, occupation, and employment status that is included in borrower listings.  Neither Prosper Funding nor PMI verifies the majority of this information, which may be incomplete, inaccurate or intentionally false.  Applicants may misrepresent their intentions for the use of borrower loan proceeds.  Neither Prosper Funding nor WebBank, nor PMI as agent of either of them, verifies any statements by applicants as to how loan proceeds are to be used nor confirms after loan funding how loan proceeds were used.  All listings are posted on the platform without Prosper Funding or PMI verifying the information provided by the applicant, including the borrower’s stated income, employment status or occupation.  Lender members should not rely on an applicant’s self-reported information such as income, employment status, or occupation in making investment decisions.  In the cases in which PMI selects applicants for income and employment verification, the verification is normally done after the listing has been created but prior to the time the borrower loan is funded.  From the period from July 13, 2009 to December 31, 2012, PMI verified employment and/or income on approximately 43% of the PMI Borrower Loans originated through the platform on a unit basis (16,134 out of 37,707) and approximately 65% of originations on a dollar basis ($147,598,201 out of $228,409,710).  PMI selected these listings based on the same combination of factors it will use in selecting Prosper Funding listings for additional verification, including amount of loan requested, Prosper Rating, debt-to-income ratio and stated income.  Listings do not disclose the identity of applicants, and lender members have no ability to obtain or verify applicant information either before or after they purchase a Note.  If an applicant supplies false, misleading or inaccurate information, you may lose part or all of the purchase price you pay for a Note.  Under Prosper Funding’s Administration Agreement with PMI, PMI is required to perform borrower identity and financial information verification services for Prosper Funding.  See “Item 1. Business—Borrower Identity and Financial Information Verification” for more information.  The number or percentage of applicants whose income and employment information is verified by PMI in relation to listings made after the date hereof may differ from the historical information supplied above.  No assurance is made that such information will be verified with respect to any particular applicant or borrower.  Neither the indenture trustee nor holders of any Notes will have any contractual or other relationship with any borrower that would enable the indenture trustee or such holder to make any claim against such borrower for fraud or breach of any representation or warranty in relation to any false, incomplete or misleading information supplied by such borrower in relation to the relevant loan or Note.
 
 
The borrower loans are not secured by any collateral or guaranteed or insured by any third party, and you must rely on Prosper Funding or a third-party collection agency to pursue collection against any borrower.
 
Borrower loans are unsecured obligations of borrower members.  They are not secured by any collateral, and they are not guaranteed or insured by Prosper Funding, PMI or any third party or backed by any governmental authority in any way.  Prosper Funding and its designated third-party collection agencies will, therefore, be limited in their ability to collect on borrower loans.  Moreover, borrower loans are obligations of borrowers to Prosper Funding as successor to WebBank, not obligations to the holders of Notes.  Holders of the Notes will have no recourse to the borrowers and no ability to pursue borrowers to collect payments under borrower loans.  Holders of the Notes may look only to Prosper Funding for payment of the Notes.  Furthermore, if a borrower fails to make any payments on the borrower loan, the holders of the Notes corresponding to that borrower loan will not receive any payments on their Notes.  The holders of such Notes will not be able to pursue collection against the borrower and will not be able to obtain the identity of the borrower in order to contact the borrower about the defaulted borrower loan.
 
Some of the borrowers on the platform have “subprime” credit ratings, are considered higher than average credit risks, and may present a high risk of loan delinquency or default.
 
A “subprime” credit rating is traditionally defined as a FICO score below 640.  Although PMI uses Experian’s Scorex PLUS credit score, not FICO, and thus cannot precisely identify which of the borrowers on the platform meet the traditional definition of “subprime,” there may be borrowers on the platform who have “subprime” credit ratings.  Most of these borrowers are people who have had difficulty obtaining loans from other sources, including banks and other financial institutions, on favorable terms, or on any terms at all, due to credit problems, limited credit histories, adverse financial circumstances, or high debt-to-income ratios, but who have successfully borrowed through the platform on at least one prior occasion.   Based on the historical performance of such second-time borrowers on the platform, PMI believes the risk profile of such loans is superior to that of loans made by traditional consumer finance lenders to borrowers who have “subprime” credit ratings.  Nevertheless, acquiring Notes that are dependent on payments Prosper Funding receives on the corresponding borrower loans of such borrowers may present a high risk of loan delinquency or default.  See “Item 1. Business—Risk Management—Credit Score” for more information.

Prior to February 1, 2013, PMI operated the platform, facilitated the origination of loans by WebBank through the platform and issued and sold notes corresponding to those loans.  From July 13, 2009 to December 31, 2012 PMI facilitated 38,467 PMI Borrower Loans with an average original principal amount of $6,867 and an aggregate original principal amount of $264,139,915 on the platform.  As of December 31, 2012, of these 38,467 PMI Borrower Loans, 65.7% were current or had not reached their first billing cycle, 22.8% were paid in full, 2.0% were 1- 30 days past due, 2.4% were more than 30 days past due, and 7.1% had defaulted (a PMI Borrower Loan is considered to have defaulted when it is more than 120 days past due or has been discharged in bankruptcy).  In addition, of these 38,467 PMI Borrower Loans:
 
 
·
5,130, or 13.3%, have been more than 15 days past due on at least one occasion;

 
·
4,011, or 10.4%, have been more than 30 days past due on at least one occasion; and

 
·
3,377, or 8.8%, have been more than 60 days past due on at least one occasion.
 
There can be no assurance that historical loss rates for PMI Borrower Loans will be indicative of future loss rates or the likelihood of the delinquency or default on Prosper Funding’s borrower loans. See “Item 1. Business—Historical Performance of PMI Borrower Loans” and “Item 1A. Risk Factors—Risks Related to Prosper Funding and PMI, the Platform and Prosper Funding and PMI’s Ability to Service the Notes” for more information.
 
There is a lower minimum credit score threshold for certain borrowers who have previously obtained a loan through the platform.  A borrower whose credit score has declined, but who satisfies the lower credit score threshold, may present a greater risk of loan delinquency or default than a borrower with a higher credit score.

The minimum credit score required for an applicant to post a listing is 640, except for applicants who (i) previously obtained a borrower loan or a PMI Borrower Loan and paid off the loan in full or (ii) are seeking a second loan while their first loan is still outstanding, and such loan is current and has not been more than thirty days past due at any time during the preceding twelve months.  The minimum score required for any such second-time borrower is 600.  A borrower who initially possessed a credit score of 640 or greater, but whose credit score has declined below 640, may present a greater risk of loan delinquency or default than a borrower whose credit score has not declined, even if the borrower whose credit score declined previously paid off a loan through the platform and maintains a credit score above 600.
 
 
There is no maximum debt-to-income ratio for applicants.
 
There is no maximum debt-to-income ratio (or “DTI”) for applicants who post listings on the platform.  DTI is a measurement of a borrower’s ability to take on additional debt.  Because there is no maximum DTI for applicants, borrower loans may have a higher risk of default than would otherwise be the case if there were a maximum DTI.
 
The credit information of an applicant may be inaccurate or may not accurately reflect the applicant’s creditworthiness, which may cause you to lose all or part of the price you paid for a Note.
 
PMI obtains applicant credit information from consumer reporting agencies, and assigns Prosper Ratings to listings based in part on the applicant’s credit score.  A credit score that forms a part of the Prosper Rating assigned to a listing may not reflect the applicant’s actual creditworthiness because the credit score may be based on outdated, incomplete or inaccurate consumer reporting data.  Similarly, the credit data taken from the applicant’s credit report and displayed in listings may also be based on outdated, incomplete or inaccurate consumer reporting data.  Neither Prosper Funding nor PMI verifies the information obtained from the applicant’s credit report.   Moreover, lender members do not, and will not, have access to financial statements of applicants or to other detailed financial information about applicants.
 
Although the letter grades assigned to listings prior to July 2009 used the same seven letters as the Prosper Rating system, letter grades and Prosper Ratings are different, and you should not consider the performance of pre-July 2009 borrower loans with a particular letter grade to be indicative of how borrower loans with the same letter as a Prosper Rating will perform.
 
PMI implemented a new credit rating system on July 13, 2009.  Each listing is now assigned a Prosper Rating that indicates the level of risk associated with the listing and corresponds to an estimated average annualized loss rate range for the listing.  The Prosper Rating is derived from two scores:  a consumer reporting agency score and the Prosper Score, an in-house custom score calculated using the historical performance of previous borrower loans with similar characteristics.  Prior to July 13, 2009, credit grades were assigned to listings based solely on the applicant’s credit score.  Although the seven letters used to represent the Prosper Rating were previously used to indicate credit grade, the two systems are not comparable as they are computed in a different manner and represent a different risk profile.  Moreover, PMI adopted the new Prosper Rating system, in part, due to variations in loss rates among borrowers with the same credit grade due to other variations in borrower credit characteristics.  Accordingly, you should not consider the performance history of pre-July 13, 2009 PMI Borrower Loans with a particular letter grade to be indicative of how a borrower loan with a Prosper Rating that uses the same letter will perform.

The Prosper Rating may not accurately set forth the risks of investing in the Notes and no assurances can be provided that actual loss rates for the Notes will come within the expected loss rates indicated by the Prosper Rating.
 
If PMI includes in a listing a Prosper Rating that is different from the Prosper Rating calculated by PMI or calculates the Prosper Rating for a listing incorrectly, and such error materially and adversely affects a holder's interest in the related Note, Prosper Funding will  indemnify the holder or repurchase the Note.  Prosper Funding will not, however, have any indemnity or repurchase obligation under the Indenture, the Notes, the Lender Registration Agreement or any other agreement associated with the platform as a result of any other inaccuracy with respect to a listing’s Prosper Score or Prosper Rating.  For example, the Prosper Rating for a listing could be inaccurate because the applicant’s credit report contained incorrect information.  Similarly, the Prosper Rating does not reflect the substantial risk associated with the facts that (i) neither Prosper Funding nor PMI verifies much of the applicant information on which the Prosper Rating is based, and (ii) much of such information is provided directly by the applicants themselves, who remain anonymous to potential Note purchasers.  In addition, the Prosper Rating does not reflect Prosper Funding’s credit risk as a debtor (such credit risk exists even though, as the debtor on the Notes, Prosper Funding’s only obligation is to pay to the Note holders their pro rata shares of collections received on the related borrower loans net of applicable fees).  If Prosper Funding repurchases any Notes, PMI will concurrently repurchase the related PMI Management Right for zero consideration.  Prosper Funding’s repurchase obligations under the Indenture, the Notes, the Lender Registration Agreement or any other agreement associated with the platform, and PMI’s concurrent repurchase of the related PMI Management Rights, do not affect your rights under federal or state securities laws.  A Prosper Rating is not a recommendation by Prosper Funding or PMI to buy, sell or hold a Note.  In addition, no assurances can be provided that actual loss rates for the Notes will fall within the expected loss rates indicated by the Prosper Rating. The interest rates on the Notes might not adequately compensate Note purchasers for these additional risks. See “Item 1. Business—Note Repurchase and Indemnification Obligations” for more information.
 
 
Some borrowers may use the platform to defraud lender members, which could adversely affect your ability to recoup your investment.
 
PMI uses identity and fraud checks with external databases to authenticate each borrower’s identity. There is a risk, however, that these checks could fail and fraud may occur.  In addition, applicants may misrepresent their intentions regarding loan purpose or other information contained in listings, and neither Prosper Funding nor PMI verifies the majority of this information.  While Prosper Funding will indemnify you or repurchase Notes in limited circumstances (including, e.g., a material payment default on the borrower loan resulting from verifiable identity theft), it is not obligated to indemnify you or repurchase a Note from you if your investment is not realized in whole or in part due to fraud (other than verifiable identity theft) in connection with a loan listing, or due to false or inaccurate statements or omissions of fact in a listing, whether in credit data, a borrower member’s representations, user recommendations, group affiliations or similar indicia of borrower intent and ability to repay the borrower loan.  If Prosper Funding repurchases a Note, the repurchase price will be equal to the Note’s outstanding principal balance and will not include accrued interest. If Prosper Funding repurchases any Notes, PMI will concurrently repurchase the related PMI Management Rights for zero consideration.  See “Item 1. Business—Note Repurchase and Indemnification Obligations” for more information.
 
The fact that Prosper Funding has the exclusive right and ability to investigate claims of identity theft in the origination of loans creates a significant conflict of interest between Prosper Funding and the lender members.

Prosper Funding has the exclusive right to investigate claims of identity theft and determine, in its sole discretion, whether verifiable identity theft has occurred.  Verifiable identity theft triggers an obligation by Prosper Funding to either repurchase the related Notes or indemnify the applicable Note holders.  As Prosper Funding is the sole entity with the ability to investigate and determine verifiable identity theft, which triggers its repurchase or indemnification obligation, a conflict of interest exists.  Lender members rely solely on Prosper Funding to investigate incidents that might require it to indemnify them or repurchase a loan.  The denial of a claim under Prosper Funding’s identity theft guarantee would save Prosper Funding from its indemnification or repurchase obligation.  See “Item 1. Business—Note Repurchase and Indemnification Obligations” for more information.

Prosper Funding does not have significant historical performance data about performance on the borrower loans.  Loss rates on the borrower loans may increase and prior to investing you should consider the risk of non-payment and default.
 
Prosper Funding is in the early stages of its development and has a limited operating history.  It did not offer borrower loans through the platform prior to February 1, 2013.  PMI began offering PMI Borrower Loans through the platform in February of 2006, but the performance of PMI Borrower Loans may not be indicative of the future performance of Prosper Funding’s borrower loans.  Due to Prosper Funding’s limited operational history, it does not have significant historical data regarding the performance of the borrower loans, and it does not yet know what the long-term loan loss experience will be.  The estimated loss rates displayed on Prosper Funding’s website and used to determine the Prosper Rating have been developed from PMI’s loss histories on PMI Borrower Loans.   Accordingly, borrower loans originated on the platform may default more often than similar PMI Borrower Loans have defaulted in the past, which increases the risk of investing in the Notes.
 
If payments on the corresponding borrower loans relating to your Notes become more than 30 days overdue, it is likely you will not receive the full principal and interest payments that you expect to receive on your Notes, and you may not recover your original purchase price.
 
Under the Administration Agreement, PMI may service borrower loans directly or it may refer borrower loans that become past due to a third party collection agency for collection.  If a borrower fails to make a required payment on a borrower loan within 30 days of the due date, PMI will pursue reasonable collection efforts in respect of the borrower loan.  Referral of a delinquent borrower loan to a collection agency within five (5) business days after it becomes thirty days past due will be considered reasonable collection efforts.

If PMI refers a borrower loan to a collection agency, it will not have any other obligation to attempt to collect that borrower loan.  PMI also may handle collection efforts in respect of a delinquent borrower loan directly as servicer of the loans.  If payment amounts on a delinquent borrower loan are received from a borrower more than 30 days after their due date, and the loan has been referred to an outside collection agency, that collection agency will retain a percentage of that payment as a fee before any principal or interest becomes payable to you.  Collection fees range from 17% to 40% of recovered amounts, in addition to any legal fees incurred in the collection effort.
 
For some non-performing borrower loans, PMI may not be able to recover any of the unpaid loan balance and, as a result, a lender member who has purchased a corresponding Note may receive little, if any, of the unpaid principal and interest payable under the Note.  You must rely on the collection efforts of PMI or the applicable collection agency to which such borrower loans are referred.  You are not permitted to attempt to collect payments on the borrower loans in any manner.

Late payment performance is an early indicator of charge off probability.  Of all PMI Borrower Loans originated between July 13, 2009 and December 31, 2012, 10.4% have been greater than 30 days past due at any time and 8.8% have been greater than 60 days past due at any time.  As of December 31, 2012, 4,176 or 10.9% of all PMI Borrower Loans originated between July 13, 2009 and December 31, 2012 have been referred to a collection agency for collection proceedings.  On average, through December 31, 2012, PMI Note holders have received $199, net of collection fees, on such PMI Borrower Loans.  In addition, of the 4,176 PMI Borrower Loans referred to a collection agency, a total of 2,735 or 65% of such loans have been charged off.  
 
 
Loss rates on the borrower loans may increase as a result of economic conditions beyond Prosper Funding or PMI’s control and beyond the control of the borrower member.
 
Borrower loan loss rates may be significantly affected by economic downturns or general economic conditions beyond Prosper Funding or PMI’s control and beyond the control of individual borrowers.  In particular, loss rates on borrower loans may increase due to factors such as prevailing interest rates, the rate of unemployment, the level of consumer confidence, residential real estate values, the value of the U.S. dollar, energy prices, changes in consumer spending, the number of personal bankruptcies, disruptions in the credit markets and other factors.
 
In the unlikely event that Prosper Funding receives payments on the borrower loans relating to your Notes after the final maturity date, you will not receive payments on your Notes after maturity.
 
Each Note will mature on the initial maturity date, unless any principal or interest payments in respect of the corresponding borrower loan remain due and payable to Prosper Funding upon the initial maturity date, in which case the maturity of the Note will be automatically extended to the final maturity date.  If there are any amounts under the corresponding borrower loan still due and owing to Prosper Funding on the final maturity date, Prosper Funding will have no further obligation to make payments on the related Notes, even if it receives payments on the corresponding borrower loan after such date.

The borrower loans do not restrict borrowers from incurring additional unsecured or secured debt, nor do they impose any financial restrictions on borrowers during the term of the borrower loan, which may impair your ability to receive the full principal and interest payments that you expect to receive on a Note.
 
If a borrower incurs additional debt after the date of the borrower loan, the additional debt may impair the ability of that borrower to make payments on his or her borrower loan and your ability to receive the principal and interest payments that you expect to receive on a corresponding Note.  In addition, the additional debt may adversely affect the borrower’s creditworthiness generally, and could result in the financial distress, insolvency, or bankruptcy of the borrower.  To the extent that the borrower has or incurs other indebtedness and cannot pay all of his or her indebtedness, the borrower may choose to make payments to other creditors, rather than to Prosper Funding.
 
To the extent borrowers incur other indebtedness that is secured, such as a mortgage, a home equity line or an auto loan, the ability of the secured creditors to exercise remedies against the assets of the borrower may impair the borrower’s ability to repay the borrower loan on which your Note is dependent for payment.  Borrowers may also choose to repay obligations under secured indebtedness or other unsecured indebtedness before repaying borrower loans because there is no collateral securing the borrower loans.  A lender member will not be notified if a borrower incurs additional debt after the date a loan listing is posted.
 
A borrower may request that his or her bank “chargeback” a payment on a borrower loan upon which a Note is dependent for payment and request a refund on that payment, resulting in a delinquency on the payment and a possible negative cash balance in your lender member account.
 
A borrower chargeback is a process by which a borrower who has made a payment on a borrower loan has his or her bank cancel the payment or request a refund of that payment.  Prosper Funding withholds payments to lender members up to six business days after a related borrower payment is initiated.  If the chargeback occurs between six and 60 days after the initiation of payment, you must rely on Prosper Funding to contest the chargeback if it deems it appropriate.  If a borrower successfully processes a chargeback between six and 60 days after initiation of payment, such payment will be deducted from your lender member account, and if you have withdrawn funds in the interim, a negative cash balance may result.  Amounts received on borrower loans corresponding to your Notes payments and deposited into your lender member account are subject to set-off against any negative balance or shortfall in your lender member account. In 2012, 218 payments on PMI Borrower Loans, in the aggregate amount of approximately $76,000, were subject to chargebacks, which resulted in such payments being deducted from the accounts of the corresponding PMI Note holders.  See “Item 1. Business—Structure of Lender Member Accounts and Treatment of Lender Member Balances” for more information.
 
Peer-to-peer lending is a new lending method and the platform has a limited operating history.  Borrowers may not view or treat their obligations to Prosper Funding as having the same significance as loans from traditional lending sources, such as bank loans.
 
The investment return on the Notes depends on borrowers fulfilling their payment obligations in a timely and complete manner under the corresponding borrower loan.  Borrowers may not view peer-to-peer lending obligations originated on the platform as having the same significance as other credit obligations arising under more traditional circumstances, such as loans from banks or other commercial financial institutions.  If a borrower neglects his or her payment obligations on a borrower loan upon which payment of your Note is dependent or chooses not to repay his or her borrower loan entirely, you may not be able to recover any portion of your investment in a Note.
 
 
The platform may fail to comply with applicable law, which could limit Prosper Funding and PMI’s ability to collect on borrower loans.
 
The borrower loans are subject to federal and state consumer protection laws.  The platform may not always be, and the equivalent platform previously operated by PMI may not always have been, in compliance with these laws.  Failure to comply with the laws and regulatory requirements applicable to the platform may, among other things, limit Prosper Funding’s, PMI’s or a collection agency’s ability to collect all or part of the principal of or interest on borrower loans.  See “Government Regulation—Regulation and Consumer Protection Laws” for more information.
 
PMI regularly reviews the requirements of these laws and takes measures aimed at ensuring that the borrower loans originated on the platform meet the requirements of all applicable laws.  However, determining compliance with all applicable laws is a complex matter and it is possible that PMI’s determination may be inaccurate or incorrect.  Also, changes in law, either due to court decisions, regulatory interpretations or rulings, or new legislation, may adversely affect the collectability of a borrower loan.
 
In general, the borrower loans do not contain any cross-default or similar provisions.  If a borrower defaults on any of his or her other debt obligations, Prosper Funding and PMI’s ability to collect on the borrower loan on which your Notes are dependent for payment may be substantially impaired.
 
The borrower loans do not contain cross-default provisions.  A cross-default provision makes a default under certain debt of a borrower an automatic default on other debt of that borrower.  Because the borrower loans do not contain cross-default provisions, a borrower’s loan will not be placed automatically in default upon that borrower’s default on any of the borrower’s other debt obligations.  If a borrower defaults on debt obligations owed to a third party and continues to satisfy the payment obligations under the borrower loan, the third party may seize the borrower’s assets or pursue other legal action against the borrower before the borrower defaults on the borrower loan.
 
Borrowers may seek the protection of debtor relief under federal bankruptcy or state insolvency laws, which may result in the nonpayment of your Notes.
 
Borrowers may seek protection under federal bankruptcy law or similar laws.  If a borrower files for bankruptcy (or becomes the subject of an involuntary petition), a stay will go into effect that will automatically put any pending collection actions on the borrower loan on hold and prevent further collection action absent bankruptcy court approval.  If Prosper Funding receives notice that a borrower has filed for protection under the federal bankruptcy laws, or has become the subject of an involuntary bankruptcy petition, it will put the borrower’s loan account into “bankruptcy status.” When this occurs, Prosper Funding terminates automatic monthly ACH debits on borrower loans and neither Prosper Funding nor PMI will undertake collection activity without bankruptcy court approval.  Whether any payment will ultimately be made or received on a borrower loan after a bankruptcy status is declared depends on the borrower’s particular financial situation.  In most cases, however, unsecured creditors such as Prosper Funding receive nothing, or only a fraction of their outstanding debt.  See “Item 1. Business—Loan Servicing and Collection” for more information.
 
Federal law entitles borrowers who enter active military service to an interest rate cap and certain other rights that may inhibit the ability to collect on loans and reduce the amount of interest paid on the corresponding Notes.
 
Federal law provides borrowers on active military service with rights that may delay or impair Prosper Funding and PMI’s ability to collect on a borrower loan corresponding to your Note.  The Servicemembers Civil Relief Act (“SCRA”) requires that the interest rate on preexisting debts, such as borrower loans, be set at no more than 6% while the qualified service member or reservist is on active duty.  A holder of a Note that is dependent on such a borrower loan for payment will not receive the difference between 6% and the original stated interest rate for the borrower loan during any such period.  The SCRA law also permits courts to stay proceedings and execution of judgments against service members and reservists on active duty, which may delay recovery on any borrower loans in default, and, accordingly, payments on the corresponding Notes.  If there are any amounts under such a borrower loan still due and owing to Prosper Funding after the final maturity of the corresponding Notes, Prosper Funding will have no further obligation to make payments on the Notes, even if it receives payments on the borrower loan after the final maturity of the Notes.  PMI does not take military service into account in assigning a Prosper Rating to loan listings.  In addition, as part of the borrower registration process, neither Prosper Funding nor PMI requests borrower members to confirm if they are qualified service members or reservists within the meaning of the SCRA.  See “Government Regulation—Regulation and Consumer Protection Laws—Servicemembers Civil Relief Act” for more information.

From July 13, 2009 through December 31, 2012, only six PMI Borrower Loans, with an aggregate principal amount of $34,500, have been subject to the SCRA.
 
 
The death of a borrower may substantially impair your ability to recoup the full purchase price of Notes or to receive the interest payments that you expect to receive on the Notes.
 
If a borrower dies while his or her loan is still outstanding, generally, PMI will seek to work with the executor of the borrower’s estate to obtain repayment of the loan.  However, the borrower’s estate may not contain sufficient assets to repay the loan, or the related executor or trustee may prioritize repayment of other creditors.  In addition, if a borrower dies near the end of the term of his or her loan, it is unlikely that any further payments will be made on the corresponding Notes, because the time required for the probate of the borrower’s estate will probably extend beyond the final maturity date of the Notes.

RISKS INHERENT IN INVESTING IN THE NOTES

The Notes are special, limited obligations of Prosper Funding only and are not directly secured by any collateral or guaranteed or insured by PMI or any third party.

The Notes will not represent an obligation of borrowers, PMI or any other party except Prosper Funding, and are special, limited obligations of Prosper Funding.  The Notes are not guaranteed or insured by PMI, any governmental agency or instrumentality or any third party.  Although Prosper Funding has granted the indenture trustee, for the benefit of the Note holders, a security interest in the borrower loans, the payments and proceeds that Prosper Funding receives on the borrower loans, the bank account in which the borrower loan payments are deposited and the FBO account, the Note holders do not themselves have a direct security interest in the borrower loans or the right to payment thereunder.  If an event of default under the indenture were to occur, the Note holders would be dependent on the indenture trustee’s ability to realize on the collateral and make payments on the Notes in the manner contemplated by the indenture.  In addition, although Prosper Funding will take all actions that it believes are required under applicable law to perfect the security interest of the indenture trustee in the collateral, if its analysis of the required actions is incorrect or if it fails timely to take any required action, the indenture trustee’s security interest may not be effective and holders of the Notes could be required to share the collateral (and any proceeds thereof) with Prosper Funding’s other creditors, or, if a bankruptcy court were to order the substantive consolidation of PMI and Prosper Funding (as described below), PMI’s creditors.

Prosper Funding is not obligated to indemnify a Note holder or repurchase any Notes except in limited circumstances.

Prosper Funding is only obligated to repurchase Notes or indemnify holders of Notes in limited circumstances.  These circumstances include if (i) a material payment default under the corresponding borrower loan occurs as a result of verifiable identify theft or (ii) PMI includes a Prosper Rating in a listing that is different from the Prosper Rating calculated by PMI or calculates the Prosper Rating incorrectly.  Prosper Funding is not required to repurchase Notes or indemnify holders of Notes, however, if the holder’s investment is not realized in whole or in part due to fraud other than identity theft, or due to other false or inaccurate statements or omissions of fact in a listing, whether in credit data, borrower representations, user recommendations, group affiliations or similar indicia of borrower intent and ability to repay the loan.  Nor is Prosper Funding under any obligation to repurchase a Note or indemnify any holder of Notes if a correctly-determined Prosper Rating fails to accurately predict the actual losses on a borrower loan.

Prosper Funding might incur indemnification and repurchase obligations that exceed its projections, in which case it may not have sufficient capital to meet its indemnification and repurchase obligations.

On February 1, 2013, PMI made a capital contribution to Prosper Funding in excess of $3 million, which Prosper Funding believes will be sufficient to meet its reasonably anticipated indemnification and repurchase obligations during the first six months of operations.  After Prosper Funding’s first six months of operations, it believes its fee income will be sufficient to cover such obligations.  In determining its expected capital needs with respect to indemnification and repurchase obligations, Prosper Funding reviewed the history of such obligations incurred by PMI.  From the inception of the platform in November 2005 through December 31, 2012, approximately $443 million of PMI Borrower Loans were originated through the platform and PMI repurchased or made indemnification payments on approximately $724,000, or 0.16%, of corresponding PMI Notes.  As of December 31, 2012, approximately $116,300 in loans receivable were indemnified.  Prosper Funding believes this approach to estimating its future repurchase and indemnification obligations gives it a reasonable basis to conclude that it will be adequately capitalized to meet such obligations.  Nonetheless, there can be no assurance that if it is obligated to repurchase a Note or indemnify a Note holder, that it will be able to meet its repurchase or indemnification obligation.  If Prosper Funding is unable to meet its indemnification and repurchase obligations, you may lose all of your investment in the Note.
 
 
If you decide to invest through the platform and concentrate your investment in a single Note, you may increase your risk of borrower defaults.
 
Your expected return on your investment in the Notes depends on the performance of the borrowers under the corresponding borrower loans.  There are a wide range of Prosper Ratings and listings on the platform and Prosper Funding expects some borrowers to default on their loans.  If you decide to invest through the platform and concentrate your investment in a single Note, your entire return will depend on the performance of a single borrower loan.  For example, if you plan to purchase $200 of Notes, and choose to invest the entire $200 in a single Note instead of in eight $25 Notes corresponding to the borrower loans of eight different borrowers, your entire $200 investment will depend on the performance of a single borrower loan.  It may be desirable to diversify your portfolio in order to reduce the risk that you could lose your entire investment due to a single default, or a small number of defaults.  However, diversification does not eliminate the risk that you may lose some, or all, of your investment in the Notes.
 
The platform allows a borrower member to prepay a borrower loan at any time without penalty.  Borrower loan prepayments will extinguish or limit your ability to receive additional interest payments on a Note.
 
Borrower loan prepayment occurs when a borrower decides to pay some or all of the principal amount on a borrower loan earlier than originally scheduled.  Borrowers may decide to prepay all or a portion of the remaining principal amount due under a borrower loan at any time without penalty.  In the event of a prepayment of the entire remaining unpaid principal amount of a borrower loan on which your Notes are dependent for payment, you will receive your share of such prepayment but further interest will not accrue on such borrower loan or on your Note after the date on which the payment is made.  If the borrower prepays a portion of the remaining unpaid principal balance, the term of the borrower loan will not change, but interest will cease to accrue on the prepaid portion, and you will not receive all of the interest payments that you originally expected to receive on your Notes.  In addition, you may not be able to find a similar rate of return on another investment at the time at which the borrower loan is prepaid.  Prepayments are subject to Prosper Funding’s servicing fee, even if the prepayment occurs immediately after issuance of your Note.
 
Prevailing interest rates may change during the term of your Notes.  If this occurs, you may receive less value from your purchase of the Note in comparison to other ways you may invest your money.  Additionally, borrowers may prepay their borrower loans due to changes in interest rates, and you may not be able to redeploy the amounts you receive from prepayments in a way that offers you the return you expected to receive from the Notes.
 
The borrower loans on which the Notes are dependent for payment bear fixed, not floating, rates of interest.  If prevailing interest rates increase, the interest rates on Notes you purchase might be less than the rate of return you could earn if you invested the purchase price in a different investment.
 
PMI may not set appropriate interest rates for borrower loans.

If PMI sets interest rates for borrower loans too low, lender members may not be compensated appropriately for the level of risk that they are assuming in purchasing a Note, while setting the interest rate too high may increase the risk of non-payment.  In either case, failure to set rates appropriately may adversely impact the ability of lender members to receive returns on their Notes that are commensurate with the risks they have assumed in acquiring such Notes.

The PMI Management Rights attached to the Notes will not comprise collateral for the Notes nor generate any funds that will be payable to the holders of Notes.

There are no payment obligations on the part of PMI or any third party under or in relation to the PMI Management Rights that are in any way related to borrower obligations in relation to the loans or in any way related to Prosper Funding’s payment obligations in relation to the Notes.  The PMI Management Rights attached to the Notes will not comprise collateral for the Notes nor guarantees of any loans or Notes, nor generate any funds or proceeds that will be payable to Prosper Funding, the indenture trustee or holders of Notes in relation to any loans or Notes.  Holders of Notes will have no recourse to PMI or its assets in relation to payments on loans or Notes.  If Prosper Funding repurchases any Notes, PMI will concurrently repurchase the related PMI Management Right for zero consideration.  Prosper Funding’s repurchase obligations under the Indenture, the Notes, the Lender Registration Agreement or any other agreement associated with the platform, and PMI’s concurrent repurchase of the related PMI Management Rights, do not affect your rights under federal or state securities laws.
 
 
Holders of the PMI Management Rights, collectively through the indenture trustee, have a limited contractual ability to enforce PMI’s obligations under the Administration Agreement.  As a result, you will have a limited contractual ability to require that PMI perform its obligations under the Administration Agreement.

Pursuant to the Administration Agreement, PMI provides three kinds of services to Prosper Funding: (i) Loan Platform Administration Services (managing the operation of the platform), (ii) Corporate Administration Services (providing back-office services to Prosper Funding, such as maintaining books and records, making periodic regulatory filings, performing limited cash management functions, etc.), and (iii) Loan and Note Servicing Services (servicing the loans and notes originated through the platform). Holders of PMI Management Rights do not have the contractual right, individually, to enforce PMI’s obligations under the Administration Agreement. Holders representing at least 25% of the outstanding Notes offered hereby, collectively, have the contractual right to cause the indenture trustee to take action as a third-party beneficiary of the Administration Agreement to enforce PMI’s platform administration and corporate administration obligations under the Administration Agreement.  Holders representing at least 25% of the combined total of the outstanding Notes offered hereby and the PMI Notes, collectively, have the contractual right to cause the indenture trustee to take action as a third-party beneficiary of the Administration Agreement to enforce PMI’s loan servicing obligations under the Administration Agreement.  All such collective contractual rights are subject to certain conditions set forth in the indenture. Those conditions include, for example, that the holders indemnify the trustee for taking such action. If PMI fails to adequately perform Loan and Note Servicing Services under the Administration Agreement, and if Prosper Funding is unable to timely replace PMI as the servicer of the Notes, your ability to receive principal and interest payments on your Notes may be substantially impaired, even if your portfolio of Notes is well diversified and the loans are paying on schedule.  In addition, although Prosper Funding has a back-up provider in place for PMI as Loan and Note Servicer under the Administration Agreement, Prosper Funding does not have a back-up provider for the Loan Platform Administration Services or the Corporate Administration Services that PMI is obligated to provide.  The failure of PMI to adequately perform those services could adversely affect your ability to benefit from those services. PMI's obligations to provide services under the Administration Agreement may be terminated by PMI or by Prosper Funding under certain circumstances.

Notwithstanding the limitations on the ability of holders of PMI Management Rights to contractually enforce PMI’s obligations under the Administration Agreement, holders of PMI Management Rights will have rights under the federal securities laws that are not limited, contractually or otherwise.

The Securities will not be listed on any securities exchange, will not be transferable except through the Note Trader platform, and can be held only by Prosper Funding’s lender members.  You should be prepared to hold the Securities you purchase until they mature.
 
The Securities will not be listed on any securities exchange.  All Securities must be held by Prosper Funding’s lender members.  The Securities will not be transferable except through the Note Trader platform and there can be no assurance that a market for Securities will continue to develop on the Note Trader platform, or that the Note Trader platform will continue in operation.  Therefore, lender members must be prepared to hold their Securities to maturity.  See “Item 1. Business—Note Trader Platform” for more information.

If the Note Trader platform fails to develop, or if the Note Trader platform develops but you cannot find a purchaser for the Notes that you wish to sell, you will be forced to hold the Notes for their remaining term.
 
Prosper Funding and PMI cannot guarantee that the Note Trader platform will continue to develop.  A Note offered for sale on the Note Trader platform must be purchased in its entirety by a single lender member, and Notes with a high outstanding principal balance may be more difficult to sell due to the smaller number of lender members with the ability to purchase such Notes.
 
If you choose to post your Notes for sale on the Note Trader platform, you may not realize the expected return on your investment due to changes in the creditworthiness of the borrower under the corresponding borrower loan.
 
The ability to sell your Note on the Note Trader platform does not guarantee that you will be able to find a lender member willing to buy the Note at a price acceptable to you, or at all.  If the borrower becomes delinquent in payments under the corresponding borrower loan upon which your Note is dependent for payment, your ability to sell the Note on the Note Trader platform will be substantially impaired.  You may have to offer the Note for sale at a substantial discount, and there is no guarantee that you will receive the expected value of the Note or any value at all.  Additionally, lender members may be less willing to bid for and purchase your Note if prevailing interest rates have changed or other investing activities have proven more attractive while you have held the Note.
 
You do not earn interest on funds held in your lender member account.
 
Your lender member account represents an interest in a pooled bank account that does not earn interest.  See “Item 1. Business—Structure of Lender Member Accounts and Treatment of Lender Member Balances” for more information.
 
 
The U.S. federal income tax consequences of an investment in the Notes are uncertain.
 
There are no statutory provisions, regulations, published rulings or judicial decisions that directly address the characterization of the Notes or instruments similar to the Notes for U.S. federal income tax purposes.  However, although the matter is not free from doubt because payments on the Notes are dependent on payments on the corresponding borrower loan, Prosper Funding intends to treat the Notes as its debt instruments that have original issue discount (“OID”) for U.S. federal income tax purposes.  Where required, Prosper Funding intends to file information returns with the U.S. Internal Revenue Service (“IRS”) in accordance with such treatment unless there is a change or clarification in the law, by regulation or otherwise, that would require a different characterization of the Notes.  You should be aware, however, that the IRS is not bound by Prosper Funding’s characterization of the Notes and the IRS or a court may take a different position with respect to the Notes’ proper characterization.  For example, the IRS could determine that, in substance, each lender member owns a proportionate interest in the corresponding loan for U.S. federal income tax purposes or, for example, the IRS could instead treat the Notes as a different financial instrument (including an equity interest or a derivative financial instrument).  Any different characterization could significantly affect the amount, timing, and character of income, gain or loss recognized in respect of a Note.  For example, if the Notes are treated as Prosper Funding’s equity, (i) Prosper Funding would be subject to U.S. federal income tax on income, including interest, accrued on the corresponding loans but would not be entitled to deduct interest or OID on the Notes, and (ii) payments on the Notes would be treated by the holder for U.S. federal income tax purposes as dividends (that may be ineligible for reduced rates of U.S. federal income taxation or the dividends-received deduction) to the extent of Prosper Funding’s earnings and profits as computed for U.S. federal income tax purposes.  A different characterization may significantly reduce the amount available to pay interest on the Notes.  You are strongly advised to consult your own tax advisor regarding the U.S. federal, state, local and non-U.S. tax consequences of the purchase, ownership, and disposition of the Notes (including any possible differing treatments of the Notes).
 
Prosper Funding’s ability to pay principal and interest on a Note may be affected by its ability to match the timing of its income and deductions for U.S. federal income tax purposes.
 
You should be aware that Prosper Funding’s ability to pay principal and interest on a Note may be affected by its ability, for U.S. federal income tax purposes, to match the timing of income it receives from a corresponding loan that it holds and the timing of deductions that it may be entitled to in respect of payments made on the Notes that it issues.  For example, if the Notes are treated as contingent payment debt instruments for U.S. federal income tax purposes but the corresponding borrower loans are not, there could be a potential mismatch in the timing of Prosper Funding’s income and deductions for U.S. federal income tax purposes, and Prosper Funding’s resulting tax liabilities could affect its ability to make payments on the Notes.
 
Participation in the funding of loans could be viewed as creating a conflict of interest.
 
As is the practice with other peer-to peer lending companies, including Prosper Funding and PMI’s competitor, LendingClub, from time to time, Prosper Funding or PMI may fund portions of qualified loan requests on the platform and hold any Notes purchased as a result of such funding for its own individual account.  Even though Prosper Funding and PMI will participate in loans on the platform under the same terms and conditions and through the use of the same information that is made available to other potential lenders on the platform, such participation may be perceived as involving a conflict of interest.  For example, Prosper Funding or PMI’s funding of a loan may cause the loan to fund, and in some cases, fund faster, than it would fund in the absence of Prosper Funding or PMI’s participation, which could benefit Prosper Funding to the extent that it ensures that PMI generates the revenue associated with the loan.

As of December 31, 2012, PMI had purchased PMI Notes for investments in the aggregate amount of approximately $147,000.  In addition, as of December 31, 2012, PMI’s executive officers, directors, affiliates and 5% shareholders had purchased PMI Notes and loans in the aggregate amount of $4,135,150.  The PMI Notes and loans were obtained on terms and conditions that were not more favorable than those obtained by other lender members of PMI.  Of the total aggregate amount of PMI Notes and loans purchased by PMI’s executive officers, directors and affiliates as of December 31, 2012, approximately 6% of principal has been charged off, compared to approximately 13% of principal charged off for all PMI Notes and loans originated as of December 31, 2012.
 
 
RISKS RELATED TO PROSPER FUNDING AND PMI, THE PLATFORM AND PROSPER FUNDING AND PMI’S ABILITY TO SERVICE THE NOTES

Although Prosper Funding has been organized in a manner that is intended to minimize the likelihood that it will become subject to a bankruptcy proceeding, if this were to occur, the rights of the holders of the Notes could be uncertain, and payments on the Notes may be limited, suspended or stopped. The recovery, if any, of a holder on a Note may therefore be substantially delayed and substantially less than the principal and interest due and to become due on the Note.

Although Prosper Funding has been organized and will be operated in a manner that is intended to minimize the likelihood that it will become subject to a bankruptcy or similar proceeding, if this were to occur, the recovery, if any, of a holder of a Note may be substantially delayed in time (for example, due to the imposition of a stay on payments by the bankruptcy court) and may be substantially less in amount than the principal and interest due and to become due on the Note even if a Note holder’s portfolio of Notes is well diversified and the loans are paying on schedule.  For example, Prosper Funding has structured its limited liability company agreement, and agreed to covenants in the indenture, that limit its activities in a manner that is intended to limit the possibility that it would voluntarily file for or could be required to file for bankruptcy.  Among other things, Prosper Fundin