10-K 1 form10k.htm PROSPER MARKETPLACE INC 10-K 12-31-2013

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 1934

For the fiscal year ended December 31, 2013

 
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
 
 
 
 
 
333-179941-01
 
PROSPER MARKETPLACE, INC.
a Delaware corporation
101 Second Street, 15th Floor
San Francisco, CA 94105
Telephone: (415)593-5400
 
73-1733867
 
 
 
 
 
333-179941
 
PROSPER FUNDING LLC
a Delaware limited liability company
101 Second Street, 15th Floor
San Francisco, CA 94105
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.

Yes¨ No x
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.
 
Yes¨ No x
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.
 
Yesx No ¨
Yesx 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).
 
Yesx No ¨
Yes x 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).
 
Yes¨ No x
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, 2013
 
Number of Shares of Common Stock of the Registrant
Outstanding at 
March 27, 2014
Prosper Marketplace, Inc.
 
$
924,012(a)
13,425,863
($.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, 2013, 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, 2013, 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, 2013.

(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.
2

 
TABLE OF CONTENTS
 
ITEM
 
 
Page
PART I
ITEM 1
 
6
ITEM 1A
 
44
ITEM 1B
 
67
ITEM 2
 
67
ITEM 3
 
67
ITEM 4
 
67
 
PART II
ITEM 5
 
68
ITEM 6
 
68
ITEM 7
 
69
ITEM 7A
 
86
ITEM 8
 
87
ITEM 9
 
87
ITEM 9A
 
87
ITEM 9B
 
87
 
PART III
ITEM 10
 
88
ITEM 11
 
95
ITEM 12
 
102
ITEM 13
 
106
ITEM 14
 
109
 
PART IV
ITEM 15
 
110
 
 
 
 
S-1
 
 
 
 
 
 
 
 
 
Exhibit 31.1
 
Exhibit 31.2
 
Exhibit 32.1
 
 
 
 
 
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 (the “Securities Act”) 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 Prosper Funding Borrower Payment Dependent Notes or “Prosper Funding Notes”, which, in addition to being speculative investments, are special, limited obligations that are not 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 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 Prosper Funding Notes and loss rates of the Prosper Funding Notes;

· payments by borrowers on the loans in light of the facts that the loans do not impose restrictions on borrowers 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 Prosper Funding Notes;

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

· the federal income tax treatment of an investment in the Prosper Funding 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”) owns and operates a peer-to-peer online credit platform (the “platform”). Prosper Marketplace, Inc. (“PMI” and, collectively with Prosper Funding, the “Registrants” or “PMI Group”) 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 unsecured, consumer loans by WebBank, an FDIC-insured, Utah-chartered industrial bank, through the platform and issued and sold borrower payment dependent notes corresponding to those loans. In this Annual Report, consumer loans originated through the platform prior to February 1, 2013 are referred to as “PMI Borrower Loans” and borrower payment dependent notes issued and sold by PMI prior to February 1, 2013 are referred to as “PMI Notes”. On February 1, 2013, PMI transferred ownership of the platform, including all of the rights related to the operation of the platform, as well as all then-outstanding PMI Borrower Loans, to its wholly-owned subsidiary, Prosper Funding. At that same time, Prosper Funding assumed all of PMI’s obligations with respect to all then-outstanding PMI Notes.  Since February 1, 2013, all borrower payment dependent notes issued and sold through the platform are issued and sold by Prosper Funding.  In this Annual Report, borrower loans originated through the platform on or after that February 1, 2013 are referred to as “Prosper Funding Borrower Loans” and borrower payment dependent notes issued and sold by Prosper Funding on or after February 1, 2013 are referred to as “Prosper Funding Notes”, respectively. 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. On February 1, 2013, Prosper Funding entered into an Administration Agreement with PMI in its capacity as licensee, corporate administrator, loan platform administrator and loan and note servicer, pursuant to which PMI provides certain back office support, loan platform administration and loan and note servicing to Prosper Funding.  In this Annual Report, any actions taken by PMI pursuant to the Loan Account Program Agreement or the Administration Agreement are described as actions taken by PMI, in spite of the fact that such actions are being taken by PMI on behalf of WebBank or Prosper Funding, respectively.
 
The platform is designed to allow people to invest money in people in an open transparent marketplace, with the aim of allowing both lender members and borrower members to profit financially as well as socially. The Registrants believe peer-to-peer lending represents a new model of consumer lending, where individuals and institutions can earn the interest spread of a traditional consumer lender but must also assume the credit risk of a traditional lender. PMI launched the platform to the public in 2006 and had attracted over two million members and facilitated over $801,000 in consumer loans as of December 31, 2013. Throughout this Annual Report, except for per share amounts and as otherwise noted, dollar amounts are presented in thousands, which is consistent with the manner of presenting such amounts in the financial statements included in this Annual Report,
 
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. PMI allocates listings to one of two lender member funding channels: (i) the first channel allows lender members to commit to purchase Prosper Funding Notes from Prosper Funding, the payments of which are dependent on the payments made on the corresponding Prosper Funding Borrower Loan (the “Note Channel”); and (ii) the second channel allows lender members to commit to purchase 100% of a Prosper Funding Borrower Loan directly from Prosper Funding (the “Whole Loan Channel”). If a listing receives enough lender member commitments to be funded, WebBank will originate the loan requested and then sell it to Prosper Funding. Each Prosper Funding Note issued and sold by Prosper Funding comes attached with a PMI Management Right issued by PMI. In this Annual Report, 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 obtain a loan through the platform, 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.”  Each time PMI posts a group of listings on the platform, it determines the relative proportions of such listings that will be allocated to the Note Channel and the Whole Loan Channel, respectively, based on PMI’s estimate of the relative overall demand in each channel. PMI then uses a random allocation methodology to allocate individual listings between the two channels based on those proportions.  PMI currently posts listing on the platform twice per day on weekdays and once per day on weekends, although the frequency with which PMI posts listings may change in the future. 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.

Within the Note Channel, lender members can bid on listings in amounts ranging from 50% of the loan amount requested to as little as $25 (not in thousands). Thus, it is typical to have multiple lender members bid on a single listing.


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, which is located at www.prosper.com, and which is referred to in this Annual Report as the “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). Prosper Funding’s customer support team is currently located in Killeen, Texas and at its headquarters in San Francisco, California.

PMI attracts lender members and borrowers to the website 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 the website. In December 2013, the website received approximately 348,971 unique visitors.

Prosper Funding generates revenue by charging lender members ongoing servicing fees on the PMI Notes, Prosper Funding Notes and Prosper Funding Borrower Loans they have purchased, and from licensing fees paid by PMI under the Administration Agreement. 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 doing business 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 borrower or lender role for which they are registering.

Borrower Members

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 may apply to become a borrower member by registering at www.prosper.com.  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. All applicants are subject to the following eligibility criteria: (1) have fewer than seven credit bureau inquiries within the last 6 months, (2) have a stated income greater than $0, (3) have a debt-to-income ratio below 50%, (4) have at least two open trades reported on their credit bureau, (5) have no reported delinquencies of 30 or more days within the last 3 months, and (6) have not filed for bankruptcy within the last 12 months. Further, borrower members who have not borrowed through the platform previously must have at least a 640 credit score. The minimum credit score is also 640 for borrower members who have (1) previously obtained a loan through the platform and paid off such loan in full, (2) have no prior charge-offs on loans originated through the platform, and (3) satisfy the following requirements:
 
Credit Score Range
 
 
Minimum # Months Since
Origination of 1st Loan
 
# of Consecutive Months
Without 31+ DPD on 1st
Loan
640-719
9
9
720+
6
6

Underwriting requirements for borrower loans, including eligibility requirements for second loans, are subject to change over time.

Borrower members may have up to two borrower loans outstanding at one time, provided that (1) the first borrower loan is current, (2) the aggregate outstanding principal balance of both borrower loans does not exceed the then-current maximum allowable loan amount for borrower loans (currently $35,000) (not in thousands) and (3) they comply with the prior borrower constrains above. Any outstanding loan made through the platform is treated as a "loan" for purposes of this two loan limit.
 
After receiving an applicant's loan request, 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 Prosper Funding Notes or Prosper Funding Borrower Loans. Lender members must register on the platform. Only lender members that are approved by Prosper Funding are eligible to participate in the Whole Loan Channel.  At a minimum, a lender member cannot participate in the Whole Loan Channel unless it is an institutional investor and meets the definition of an “accredited investor” set forth in Regulation D under the Securities Act of 1933, as amended.  During lender registration, potential lender members who are individuals 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 the website. Lender members who participate in the Note Channel must also enter into a lender registration agreement with Prosper Funding and PMI, which agreement governs all sales of Prosper Funding Notes to such lender members. Lender members who participate in the Whole Loan Channel must enter into loan purchase and loan servicing agreements with Prosper Funding.  Lender members are not required to give credit information to the same extent as borrower 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. An institutional lender member must provide its taxpayer identification number. At the time a lender member registers to participate in the Note Channel, the lender member must satisfy any minimum financial suitability standards and maximum investment limits established for the Note Channel 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 a funding account maintained on the platform. The funds of most lender members are held in a single, pooled funding account, which is referred to in this Annual Report as, the “pooled funding account”.  PMI has also established dedicated funding accounts for certain lender members that participate in the Whole Loan Channel, each of which is referred to in this Annual Report as a “dedicated funding account”.   The pooled funding account and each dedicated funding account for the benefit of the lenders (collectively the FBO Funding accounts) is a non-interest bearing, demand deposit account, currently maintained by PMI or Prosper Funding at Wells Fargo Bank, National Association (“Wells Fargo”). The pooled funding account is held in the name of Prosper Funding for the benefit of its lender members, and each dedicated funding account is held in the name of PMI or Prosper Funding for the benefit of the applicable lender member.

PMI causes all payments made or collected on any Prosper Funding Note, PMI Note or Prosper Funding Borrower Loan owned by a lender member to be deposited into the applicable funding account.  A lender member that wishes to make a commitment to purchase a Prosper Funding Note or a Prosper Funding Borrower Loan must have funds equal to the sum of such commitment and all the lender member’s other outstanding purchase commitments in the applicable funding account.  For the FBO Funding accounts, PMI maintains sub-account balances on its system to track commitments and purchases made and loan proceeds received at the lender member level. These sub-accounts are purely administrative and reflect balances and transactions concerning funds in the FBO Funding accounts. Individual lender members have no direct relationship with Wells Fargo by virtue of funds or transactions within the FBO Funding accounts or by virtue of participating on the platform. No Prosper Funding or PMI funds are commingled with the assets of lender members in any of the FBO accounts.

Each funding account is FDIC-insured on a “pass through” basis to the individual lender members, subject to applicable limits. This means that each individual lender member's cash balance is protected by FDIC insurance, up to the limits established by the FDIC. Other funds the lender member has on deposit with Wells Fargo may count against any applicable FDIC insurance limits. Funds of a lender member in a funding account can consist of amounts deposited by the lender member but never committed to Prosper Funding Note or Prosper Funding Borrower Loan purchases; amounts the lender member has committed to one or more such purchases, where origination of the corresponding Prosper Funding Borrower Loan has not yet occurred; or amounts received as principal and interest payments on Prosper Funding Notes, PMI Notes or Prosper Funding Borrower Loans owned by the lender member that the lender member has not yet withdrawn. Upon request by a lender member, PMI will transfer funds from the applicable funding account to the lender member’s designated and verified external bank account, provided such funds are not already committed to Prosper Funding Note or Prosper Funding Borrower Loan purchases.  To the extent a lender member does not withdraw any such amounts, they will remain in the applicable funding account indefinitely.
 
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 Prosper Funding 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 has agreed to indemnify WebBank with respect to any damages arising from WebBank’s participation in the origination of Prosper Funding 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 lender members 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 through the platform 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 under this discussion of “Risk Management”. 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.” As of February 1, 2013, PMI transferred 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 PMI Borrower Loans and Prosper Funding 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 PMI Borrower Loans and Prosper Funding 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.  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 defined as 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. PMI uses both the Prosper Score and a credit score to assess the level of risk associated with a listing.
 
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 11, with 11 being the best, or lowest risk value.  The probability of bad ranges and the corresponding Prosper Scores are as follows.

Probability of Bad
 
Prosper Score
> 10.50%
 
1
9.50 < x <= 10.50%
 
2
8.50 < x <= 9.50%
 
3
7.00 < x <= 8.50%
 
4
6.50 < x <= 7.00%
 
5
5.75 < x <= 6.50%
 
6
5.00 < x <= 5.75%
 
7
4.25 < x <= 5.00%
 
8
3.75 < x <= 4.25%
 
9
3.00 < x <= 3.75%
 
10
0.00 < x <= 3.00%
 
11

For example, a probability of bad of 3.29% equates to a Prosper Score of 10 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 FICO08 score, although it may use one or more different scores in the future. (PMI used Experian's Scorex PLUS score for all listings begun prior to September 6, 2013.) The minimum credit score required for a borrower to post a listing is 640.

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 credit scores.  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 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 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, 2013.

 
Experian FICO08 Credit Score
1st Loans, 3 yr. term
Prosper Score
600-
619
620-
639
640-
659
660-
679
680-
699
700-
719
720-
739
740-
759
760-
779
780-
799
800-
829
830-
850
1
22.25%
22.25%
14.75%
14.75%
13.75%
9.25%
7.49%
6.99%
6.24%
4.74%
3.24%
3.24%
2
22.25%
22.25%
14.75%
11.75%
11.25%
7.74%
7.24%
5.99%
4.74%
3.99%
3.24%
2.99%
3
22.25%
22.25%
11.75%
8.99%
6.99%
6.99%
6.24%
5.49%
4.24%
3.49%
2.99%
2.49%
4
22.25%
22.25%
8.99%
6.49%
5.99%
5.74%
4.99%
3.99%
3.99%
2.74%
1.99%
1.49%
5
22.25%
22.25%
7.24%
6.24%
5.49%
5.49%
4.49%
3.74%
3.49%
2.49%
1.74%
1.49%
6
22.25%
22.25%
6.49%
5.49%
4.49%
4.24%
3.74%
3.24%
2.99%
2.24%
1.74%
1.24%
7
22.25%
22.25%
6.24%
4.99%
3.99%
3.49%
3.49%
2.99%
2.49%
1.74%
1.74%
0.99%
8
22.25%
22.25%
4.99%
3.99%
3.74%
2.99%
2.99%
2.49%
1.99%
1.74%
1.49%
0.99%
9
22.25%
22.25%
4.74%
3.74%
3.74%
2.99%
2.74%
1.99%
1.74%
1.49%
1.24%
0.74%
10
22.25%
22.25%
4.74%
3.49%
3.24%
2.24%
1.99%
1.49%
1.49%
0.99%
0.74%
0.74%

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. For example PMI makes adjustments for whether the applicant has already been a borrower on the platform and for the term of the loan. The final loss rate determines the Proper Rating. The value of the adjustments are based on historical 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 = 6
- Applicant has a previous Prosper loan
Base Loss Rate:
 
3.74%
Adjustments:
 
 
 
-Previous Loan:
-0.50%
Final Loss Rate:
 
3.24%
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 PMI Borrower Loans and Prosper Funding Borrower Loans and making adjustments 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, PMI may collect on the account directly or refer the account to a third-party collection agency. PMI’s in-house collections department and third-party 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
 
PMI reviews the performance of PMI Borrower Loans and Prosper Funding Borrower Loans on a monthly basis to determine how loss rate estimates compare to actual performance. 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 estimated versus actual cumulative dollar loss rates by Prosper Rating for Prosper Funding Borrower Loans and PMI Borrower Loans, collectively, booked from July 13, 2009 through December 31, 2013. Performance is as of December 31, 2013. The loss performance is tracked by vintage, meaning each line represents all loans originated in a given period. The graphs only include PMI Borrower Loans and Prosper Funding Borrower Loans that have been outstanding at least 6 months. In addition, data for a point along the x axis is only included if the entire vintage is at least that mature. So, although loans originated in April 2013 have 8 months of performance, only 6 months of performance are reflected in the graphs below because the June 2013 loans, which are also a part of the 2013 Q2 vintage, have only completed 6 months of performance.
 
Vintages generally contain enough loan volume for their performance curves to be meaningful.  For presentation purposes, some of the older vintages have been grouped into annual and half-year vintages.
 
Below is a graph that shows cumulative net charge-offs as a percentage of originations across all Prosper Ratings by vintage for Prosper Funding Borrower Loans and PMI Borrower Loans, collectively, originated from July 13, 2009 to June 30, 2013. The addition of “H1” means that the information reported reflects the first six months of the year presented, while “H2” reflects loans in the second 6 months of the year presented. Similarly, “Q1” or “Q2” means that the information reported reflects the first or second quarter of the year presented.

 
Overall, vintages originated in 2012H2 and early 2013 are demonstrating meaningfully lower cumulative losses than those originated in 2011 and 2012H1. The PMI Group considers changes in the risk management process implemented at the end of 2012 and in early 2013 to be a meaningful driver of this trend.

The graphs below show cumulative net charge-offs for Prosper Funding Borrower Loans and PMI Borrower Loans, collectively, as a percentage of originations for each Prosper Rating presented by vintage from July 13, 2009 to December 31, 2013.
 

 
Note: Estimated 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 estimated curve was set at 19.50% cumulative principal loss.
 
In many rating grades, risk is trending above estimates for the 2011 and 2012 vintages. In instances such as these where a material variance relative to estimates exists, PMI performs additional analysis to understand the reason for the variance and adjusts its credit policy as necessary to bring losses back in-line with estimates. To date, all of the 2013Q1 and 2013Q2 vintages have cumulative losses below their respective estimated lines. The PMI Group considers this change in performance to be a direct result of changes made by PMI to its risk management practices at the end of 2012 and the beginning of 2013.

Please note that the historical performance of PMI Borrower Loans may not be indicative of the future performance of PMI Borrower Loans or Prosper Funding 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 Prosper Funding Notes” for more information.

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 Thousands)
AA
 
35
A
 
35
B
 
35
C
 
25
D
 
15
E
 
10
HR
 
4

 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 Prosper Funding 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 Prosper Funding 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 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.

PMI verifies the identity of every borrower who obtains a loan through the platform using a combination of documentary and non-documentary methods. PMI compares the information contained in each applicant’s credit report with the information contained in the application, and runs the application information through a fraud database. In addition, PMI asks certain applicants to submit a copy of their current driver’s license, passport or other government-issued, photo identification card, which are then authenticated using third-party reference materials. 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. 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, 2013 (based on start time of the applicable bidding period), PMI verified employment and/or income on approximately 54% of the Prosper Funding Borrower Loans and PMI Borrower Loans originated on the platform on a unit basis (39,291 out of 72,957) and approximately 76% of such loans on a dollar basis ($480,725 out of $630,364). Breaking these numbers down by Prosper Rating:
 
for Prosper Funding Borrower Loans and PMI Borrower Loans with a Prosper Rating of AA, A or B, PMI verified income and/or employment information on approximately 71% of such loans on a unit basis (20,413 out of 28,940) and approximately 87% of such loans on a dollar basis ($280,307 out of $322,982) ;

for Prosper Funding Borrower Loans and PMI Borrower Loans with a Prosper Rating of C or D, PMI verified income and/or employment information on approximately 61% of such loans on a unit basis (17,128 out of 28,227) and approximately 78% of such loans on a dollar basis ($189,606 out of $243,787) ; and

for Prosper Funding Borrower Loans and PMI Borrower Loans with a Prosper Rating of E or HR, PMI verified income and/or employment information on approximately 11% of such loans on a unit basis (1,750 of 15,790) and approximately 17% of such loans on a dollar basis ($10,812 out of $63,595) .
 
Between July 14, 2009 and December 31, 2013, PMI canceled 14% of the loan listings for which it verified employment and/or income information because the listings contained inaccurate or insufficient employment or income information. 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 characteristics of Prosper Funding Borrower Loans. See “Item 1A. Risk Factors—Risks Related to the Platform and Prosper Funding and PMI’s Ability to Service the Prosper Funding 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 to the listing 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. 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. See “Item I.A. Risk Factors—Risks Related to Borrower Default—The maximum debt-to-income ratio for all applicants is 50%” for more information.

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.

Prosper Funding Note Repurchase and Indemnification Obligations
 
Under the terms of each Prosper Funding Note, if a “Repurchase Event” occurs with respect to that Prosper Funding Note, Prosper Funding will, at its sole option, either repurchase the Prosper Funding Note from the holder or indemnify the holder of the Prosper Funding Note for any losses resulting from nonpayment of the Prosper Funding Note or from any claim, demand or defense arising as a result of such Repurchase Event. A “Repurchase Event” with respect to a Prosper Funding 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 Prosper Funding Borrower Loan, as a result of which the interest of the holder in the Prosper Funding 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 Prosper Funding 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 Prosper Funding Note is materially and adversely affected, or (iii) the corresponding Prosper Funding 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 Prosper Funding Borrower Loan has occurred.

Under Prosper Funding’s standard form of loan purchase agreement for participants in the Whole Loan Channel, Prosper Funding will repurchase a Prosper Funding Borrower Loan from the purchaser if the Prosper Funding Borrower Loan is legally unenforceable because it did not comply with applicable laws in effect at the time the Prosper Funding Borrower Loan was originated, or if the Prosper Funding Borrower Loan was obtained as a result of verifiable identify theft on the part of the purported borrower member.
 
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 identity was wrongfully used to obtain the corresponding Prosper Funding Borrower Loan, an identity theft affidavit, a bank verification letter or all of the above. Because PMI is the sole entity with the ability to investigate and determine verifiable identity theft, which in turn triggers Prosper Funding’s repurchase or indemnification obligations, a conflict of interest exists. The PMI Group 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 Loan Program Agreement between PMI and WebBank includes a requirement—and accompanying audit function—to ensure that claims of identity theft are thoroughly investigated and accurately reported. Third, California statutes provide strong remedies to victims of identity theft whose claims are 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 Prosper Funding Notes or indemnify any holder of Prosper Funding Notes if a correctly determined Prosper Rating fails to accurately predict the actual losses on a Prosper Funding Borrower Loan. In addition, the remedy described above for identity theft with respect to Prosper Funding Notes and Prosper Funding Borrower Loans 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 Prosper Funding Notes—Prosper Funding is not obligated to indemnify a Prosper Funding Note holder or repurchase any Prosper Funding 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 2006 through December 31, 2013, Prosper Funding and PMI experienced identity fraud cases affecting 38 Prosper Funding Borrower Loans and PMI Borrower Loans. In the cases of identity theft Prosper Funding and PMI have experienced, PMI 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 Borrower Loans or PMI 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 Prosper Funding Notes” for more information.
 
Under Prosper Funding’s lender registration agreements with lender members who participate in the Prosper Funding Note Channel, 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 Prosper Funding Notes for purchase, each Prosper Funding Note purchased will conform to the investment criteria provided by the lender member through such tool or service, and (ii) each Prosper Funding 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 Prosper Funding Borrower Loan on which such lender member bid. If Prosper Funding breaches either of these representations and warranties and, as a result, the Prosper Funding Note sold to a lender member is materially different from the Prosper Funding Note that would have been sold had the breach not occurred or if the lender member would not have purchased the Prosper Funding 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 Prosper Funding Note or cure the breach, if the breach is susceptible to cure. If Prosper Funding 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 Prosper Funding Note, Prosper Funding will, at its sole option, either indemnify the lender member, repurchase the affected Prosper Funding 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 Prosper Funding Note or Prosper Funding Borrower Loan in connection with a repurchase event or breach described above, the repurchase price will be equal to the principal amount outstanding on the Prosper Funding Note or Prosper Funding Borrower Loan 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 the lender registration agreement for Note Channel participants, Prosper Funding will not be required to take any action with respect to any losses suffered until the affected Prosper Funding 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 Prosper Funding Note based on the principal amount outstanding on the Prosper Funding Note. If Prosper Funding makes an indemnification payment, Prosper Funding will be entitled to retain any subsequent recoveries that it receives on the affected Prosper Funding Note.
 
Effect on PMI Management Rights

If Prosper Funding repurchases any Prosper Funding Notes, PMI will concurrently repurchase the related PMI Management Rights for zero consideration.

Historical Performance of PMI Borrower Loans and Prosper Funding Borrower Loans
 
The performance of Prosper Funding Borrower Loans and PMI 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 Prosper Funding Borrower Loans and PMI Borrower Loans, collectively, 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.
 
 
The following table presents aggregated information as of December 31, 2013, grouped by Prosper Rating, for all Prosper Funding Borrower Loans and PMI Borrower Loans, collectively, originated on the platform from July 13, 2009 through December 31, 2013. With respect to delinquent Prosper Funding Borrower Loans and PMI Borrower Loans, the table shows the entire amount of the principal remaining due (not just that particular payment) as of December 31, 2013.
Prosper Funding Borrower Loan and PMI Borrower Loan Originations
July 13, 2009 - December 31, 2013
(as of December 31, 2013)
(in thousands, except for number amounts)

 
Total Loan Originations
 
Current Loans
 
1-30 Days Past Due
 
Prosper
Rating
 
No.
 
Origination Amount
 
No.
 
Origination
Amount
 
Outstanding
Principal
 
No.
 
Origination
Amount
 
Outstanding
Principal
 
AA
     
4,288
   
$
47,480
     
2,589
   
$
33,854
   
$
26,358
     
17
   
$
249
   
$
171
 
A
   
11,562
     
127,917
     
8,138
     
100,732
     
83.606
     
75
     
946
     
744
 
B
   
12,789
     
142,493
     
9,554
     
114,898
     
99,845
     
143
     
1,489
     
1,101
 
C
   
14,884
     
149,360
     
11,149
     
121,234
     
107,765
     
215
     
2,222
     
1,814
 
D
   
13,111
     
91,243
     
7,318
     
56,080
     
45,151
     
237
     
1,851
     
1,290
 
E
   
8,915
     
39,466
     
5,071
     
23,014
     
18,562
     
167
     
692
     
460
 
HR
     
6,830
     
23,619
     
3,055
     
10,764
     
7,233
     
140
     
516
     
343
 
        
72,379
   
$
621,578
     
46,874
   
$
460,576
   
$
388,516
     
994
   
$
7,965
   
$
5,923
 
    
avg loan size:
   
$
9
                                                 
    
Percent of total
             
64.8
%
   
74.1
%
           
1.4
%
   
1.3
%
       
                                                                    
    
Paid In Full
 
31+ Days Past Due
 
Defaulted 1
 
Prosper
Rating
 
No.
 
Origination Amount
 
No.
 
Origination
Amount
 
Outstanding
Principal
 
No.
 
Origination
Amount
 
Net
Charged Off
Principal
 
AA
     
1,594
   
$
12,427
     
16
   
$
221
   
$
156
     
72
   
$
730
   
$
536
 
A
   
2,916
     
21,960
     
67
     
858
     
664
     
366
     
3,421
     
2,533
 
B
   
2,434
     
19,920
     
153
     
1,661
     
1,303
     
505
     
4,524
     
3,585
 
C
   
2,588
     
18,019
     
220
     
2,191
     
1,780
     
712
     
5,693
     
4,650
 
D
   
3,762
     
21,334
     
250
     
1,970
     
1,537
     
1,544
     
10,006
     
7,958
 
E
   
2,259
     
9,313
     
212
     
909
     
643
     
1,206
     
5,539
     
4,399
 
HR
     
2,128
     
7,083
     
194
     
704
     
496
     
1,313
     
4,552
     
3,680
 
        
17,681
   
$
110,056
     
1,112
   
$
8,514
   
$
6,579
     
5,718
   
$
34,465
   
$
27,341
 
                                                                    
Percent of total
     
24.4
%
   
17.7
%
   
1.5
%
   
1.4
%
           
7.9
%
   
5.5
%
       

 
1
 Includes all PMI Borrower Loans and Prosper Funding Borrower Loans more than 120 days past due
 
2
 
Only includes PMI Borrower Loans and Prosper Funding Borrower Loans where the bankruptcy notification date is prior to the date the loan became more than 120 days past due. If Prosper Funding or PMI were notified of a bankruptcy after the loan was more than 120 days past due, the loan is included in the "Default due to Delinquency” totals.
 
Default due to  Delinquency:
    4,945     $ 23,490  
Default due to  Bankruptcy2 :
    773     $ 3,850
 
From July 13, 2009 through December 31, 2013, 72,379 Prosper Funding Borrower Loans and PMI Borrower Loans were originated on the platform with an average original principal amount of $9 and an aggregate original principal amount of $621,578. As of December 31, 2013, 64.8% of these loans were current or had not reached their first billing cycle, 24.4% were paid in full, 1.4% were 1 to 30 days past due, 1.5% were more than 30 days past due, and 7.9% had defaulted. A PMI Borrower Loan or Prosper Funding Borrower Loan is considered to have defaulted when it is more than 120 days past due or has been discharged in bankruptcy. Of these 72,379 loans, 9,832 or 13.6%, have been greater than 15 days past due at any time, 8,067 or 11.1%, have been more than 30 days past due at any time, and 7,169 or 9.9%, have been more than 60 days past due at any time.

Of Prosper Funding Borrower Loans and PMI Borrower Loans originated after July 13, 2009, 5,718 have defaulted as of December 31, 2013, equaling a total net defaulted amount of $27,340. Of these 5,718 defaulted loans, the borrowers of 773 such loans have filed for bankruptcy, resulting in a net defaulted amount of $3,850.

The data in the preceding tables regarding Prosper Funding Borrower Loans and PMI Borrower Loans may not be representative of the loss experience that will develop for future Prosper Funding Borrower Loans. In addition, the data in the preceding tables regarding prepayments may not be representative of the prepayments Prosper Funding experiences over time.

The following table presents aggregate information, as of December 31, 2013, 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 (in thousands except for number amounts).

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
   
$
29
   
$
18
     
45
   
$
218
   
$
18
   
$
200
 
A
   
147
     
828
     
52
     
31
     
120
     
382
     
45
     
337
 
B
   
46
     
347
     
23
     
5
     
39
     
166
     
7
     
159
 
C
   
344
     
3,171
     
208
     
110
     
305
     
1,807
     
110
     
1,697
 
D
   
536
     
3,902
     
262
     
167
     
459
     
2,075
     
164
     
1,912
 
E
   
183
     
1,259
     
89
     
40
     
163
     
735
     
82
     
653
 
HR
     
3,214
     
34,756
     
2,480
     
1,250
     
2,940
     
21,978
     
1,277
     
20,702
 
N/A1     
7,299
     
32,880
     
2,447
     
1,371
     
6,653
     
21,037
     
938
     
20,099
 
        
11,826
   
$
77,623
   
$
5,590
   
$
2,992
     
10,724
   
$
48,398
   
$
2,642
   
$
45,759
 

* This amount excludes collection agency payments that were subsequently returned due to insufficient funds.
1 Includes PMI Borrower Loans with Credit Score<640 or insufficient credit data to determine Prosper Rating.
 
The following table presents aggregate information, as of December 31, 2013, regarding the results of PMI's collection efforts for Prosper Funding Borrower Loans and PMI Borrower Loans, collectively, originated after July 13, 2009 that became more than 30 days past due at any time, grouped by Prosper Rating (in thousands except for number amounts).

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
     
107
   
$
1,091
   
$
63
   
$
17
     
72
   
$
539
   
$
8
   
$
531
 
A
   
503
     
4,798
     
272
     
114
     
366
     
2,602
     
60
     
2,542
 
B
   
763
     
7,097
     
444
     
215
     
505
     
3,641
     
51
     
3,590
 
C    
1057
     
8,864
     
588
     
324
     
712
     
4,784
     
39
     
4,745
 
D
   
2026
     
13,440
     
999
     
512
     
1544
     
8,168
     
172
     
7,996
 
E
   
1601
     
7,241
     
622
     
368
     
1206
     
4,500
     
107
     
4,393
 
HR
     
1695
     
5,924
     
514
     
301
     
1313
     
3,786
     
44
     
3,742
 
        
7,752
   
$
48,455
   
$
3,502
   
$
1,851
     
5,718
   
$
28,020
   
$
481
   
$
27,539
 

* This amount excludes collection agency payments that were subsequently returned due to insufficient funds.
 
PMI may alter the terms or make principal reductions on some Prosper Funding Borrower Loans or PMI Borrower 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. In order to comply with the Servicemembers’ Civil Relief Act, 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 lender members were unchanged.
 
Loan Originations
 
The following table presents aggregated information about borrowers for Prosper Funding Borrower Loans and PMI Borrower Loans, collectively, originated over the period from July 13, 2009 to December 31, 2013, grouped by Prosper Rating (in thousands except for number amounts).

Prosper Rating
   
Number
   
Amount
   
Average
Loan
Size
   
Weighted
Average
Lender
Yield
   
Weighted
Average B
orrower
Rate
   
Weighted
Average
Borrower
APR
 
AA
     
4,288
   
$
47,480
   
$
11
     
7.34
%
   
8.34
%
   
9.47
%
A
   
11,562
     
127,917
     
11
     
10.68
%
   
11.68
%
   
14.20
%
B
   
12,789
     
142,493
     
11
     
14.81
%
   
15.81
%
   
18.64
%
C
   
14,884
     
149,360
     
10
     
18.85
%
   
19.85
%
   
22.91
%
D
   
13,111
     
91,243
     
7
     
23.88
%
   
24.88
%
   
28.20
%
E
   
8,915
     
39,466
     
4
     
28.53
%
   
29.53
%
   
33.21
%
HR
     
6,830
     
23,619
     
3
     
30.75
%
   
31.75
%
   
35.59
%
Total
     
72,379
   
$
621,578
   
$
8.14
     
17.17
%
   
18.17
%
   
21.02
%

The following table presents aggregated information about borrowers for Prosper Funding Borrower Loans and PMI Borrower Loans originated over the period from July 13, 2009 to September 5, 2013, grouped by Prosper Rating. The information for each borrower was obtained from a credit reporting agency at the time the borrower’s 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
     
796
     
0.06
     
9.49
     
27. 52
 
A
   
752
     
0.17
     
9.65
     
27.84
 
B
   
725
     
0.27
     
9.32
     
27.19
 
C
   
706
     
0.35
     
9.26
     
27.68
 
D
   
693
     
0.46
     
8.48
     
26.23
 
E
   
674
     
0.67
     
8.66
     
27. 43
 
HR
     
689
     
0.60
     
8. 25
     
26.96
 
Total
     
719
     
0.37
     
9.02
     
27.26
 

On September 6, 2013, PMI ceased using Experian’s ScorexPlus credit score and began using Experian’s FICO08 credit score. All listings begun after this date use Experian’s FICO08 credit score.
 
The following table presents aggregated information about borrowers for Prosper Funding Borrower Loans originated over the period from September 6, 2013 to December 31, 2013, grouped by Prosper Rating. The information for each borrower was obtained from a credit reporting agency at the time the borrower’s application was submitted. PMI has not independently verified this information:

Prosper Rating
   
Average
Experian
FICO
Score
   
Average
Number of
Current
Delinquencies
   
Average
number of
Open
Credit
 Lines
   
Average
number of
Total
Credit
Lines
 
AA
     
768
     
0.03
     
11.02
     
29.30
 
A
   
721
     
0.11
     
10.87
     
28.94
 
B
   
704
     
0.20
     
10.58
     
28.94
 
C
   
691
     
0.22
     
10.61
     
28.72
 
D
   
679
     
0.32
     
9.89
     
27.91
 
E
   
666
     
0.43
     
9.29
     
27.43
 
HR
     
665
     
0.54
     
9.99
     
28.82
 
Total
     
699
     
0.26
     
10.32
     
28.58
 
 
Please note that historical data regarding Prosper Funding Borrower Loans and PMI Borrower Loans may not be indicative of the characteristics of future Prosper Funding 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 Prosper Funding Notes” for more information.
 
Posted Prosper Funding 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 Prosper Funding Borrower Loan in a specified amount.

Listings funded through the Note Channel may be partially funded. 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 posted in the Note Channel indicates the minimum amount of bids required for the listing 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. Bids placed on listings posted in the Whole Loan Channel must be for 100% of the amount requested, so partial funding cannot occur for Prosper Funding Borrower Loans funded through the Whole Loan Channel.
 
Prosper Funding Borrower Loans are unsecured obligations of individual borrowers with an interest rate determined by PMI and with a specified loan term, currently set at 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 and $35), which are subject to change from time to time. Prosper Funding Borrower Loans may be repaid at any time by borrowers without prepayment penalty. A Prosper Funding 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 lender members 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 (for listings posted in the Note Channel)

· 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; 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 Prosper Funding 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.
 
For Prosper Funding Borrower Loans and PMI Borrower Loans funded between July 13, 2009 and December 31, 2013, borrowers identified their intended use of loan proceeds by unit distribution as follows:

· debt consolidation (approximately 60%);

· business use, such as financing their home-based or small businesses (approximately 7%);

· home improvement (approximately 9%);

· financing the purchase of an automobile (approximately 3%); and

· other (approximately 21%).

Please note that historical data regarding Prosper Funding Borrower Loans and PMI Borrower Loans may not be indicative of the future characteristics of Prosper Funding 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 Prosper Funding Notes” for more information.

How to Bid to Purchase Prosper Funding Notes
 
A bid on a listing posted in the Note Channel is a lender member’s binding commitment to purchase a Prosper Funding 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 Prosper Funding Note dependent for payment on payments Prosper Funding receives on the Prosper Funding Borrower Loan described in the listing. A bid on a listing posted in the Whole Loan Channel is a lender member’s commitment to purchase the entire Prosper Funding Borrower Loan.
 
The bidding period for a listing posted in the Note Channel 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. The bidding period for a listing posted in the Whole Loan Channel ends on the earlier of a lender member committing to purchase the Prosper Funding Borrower Loan requested or approximately 1 hour after the listing is posted.  Lender members cannot place bids on a listing once its bidding period has ended.

Listings that are posted in the Whole Loan Channel and do not receive purchase commitments are re-posted for bidding in the Note Channel.  These re-posted listings are identified within the Note Channel as having already been offered in the Whole Loan Channel. If the listing posted in the Note Channel does not receive bids equal to or exceeding the minimum amount required for the Prosper Funding Borrower Loan requested 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 the applicable funding 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 the applicable funding 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, for listings posted in the Note Channel, the minimum amount a lender member may bid is $25 (not in thousands), and the maximum amount a lender member may bid is 50% of the amount of the requested Prosper Funding Borrower Loan. The maximum aggregate amount an individual lender member may bid on the platform is currently $25,000. There is no maximum aggregate bid amount for institutional lender 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 posted in the Note Channel with a winning bid of less than $25 (not in thousands). But there cannot be more than one partial winning bid on any such listing.

A listing that gets funded through the Note Channel typically receives bids from many different lender members. For example, from July 13, 2009 through December 31, 2013, the average aggregate size of Prosper Funding Borrower Loans and PMI Borrower Loans funded through the Note Channel was approximately $8 and the average purchase price paid for corresponding Prosper Funding Notes or PMI Notes was approximately $115 (not in thousands). Please note that historical data regarding Prosper Funding Borrower Loans and PMI Borrower Loans may not be indicative of the future characteristics of Prosper Funding 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 Prosper Funding 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, or other applicant characteristics. For listings posted in the Note Channel, lender members can use Quick Invest, a loan search tool, to identify loan listings that meet their investment criteria. Only lender members that have been approved to participate in the Whole Loan Channel are able to view or bid on listings posted in the Whole Loan Channel. A lender member can bid on as many listings as the lender member desires, subject, in the case of individual lender members, 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 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 in the Note Channel 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 Prosper Funding Note. If she wishes to search for Prosper Funding Notes using criteria other than, or in addition to, the 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 criterion a lender member cannot specify in Quick Invest is the monthly payment amount.

Quick Invest then compiles a basket of Prosper Funding Notes for the lender member’s consideration that meet her search criteria.  If the pool of Prosper Funding Notes that meet her criteria exceeds the total amount she wishes to invest, Quick Invest selects Prosper Funding Notes from the pool based on how far the listings corresponding to the Prosper Funding Notes have progressed through the loan verification process, i.e., Prosper Funding 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 Prosper Funding 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 Prosper Funding Notes from that pool based on the principle of first in, first out, i.e., the Prosper Funding Notes from the pool with the corresponding listings that were posted on the platform earliest will be selected first.  If the pool of Prosper Funding 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 Prosper Funding Notes that correspond to listings for which the loan verification has been completed and makes up the difference by selecting Prosper Funding Notes from the remaining pool on a first in, first out basis.  To the extent available Prosper Funding 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 Prosper Funding 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 Prosper Funding Notes with the other Prosper Ratings selected in equal proportions. To the extent available Prosper Funding 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 (not in thousands), if a lender member using Quick Invest indicated that she wished to invest a total of $600 in Prosper Funding 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 Prosper Funding Notes ($200 – B; $200 – C; $200 – D). If there were only $100 of D Prosper Funding Notes available, the search tool would attempt to increase the allocation of B and C Prosper Funding Notes from $200 to $250 ($250 – B; $250 – C; $100 – D). If there were $250 of B Prosper Funding Notes available but only $200 of C Prosper Funding Notes available, the search tool would then attempt to make up the remaining gap by increasing the allocation of B Prosper Funding Notes from $250 to $300 ($300 – B; $200 – C; $100 – D). But if there were only $275 worth of B Prosper Funding 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 Prosper Funding Notes: $275 of B Prosper Funding Notes, $200 of C Prosper Funding Notes and $100 of D Prosper Funding 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 Prosper Funding Notes identified by each such search. As with a lender member making manual bids, a lender member using Quick Invest or Auto Quick Invest is not permitted to place a bid unless the lender member’s funds in the applicable funding 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 8,630 Prosper Funding Notes and PMI Notes out of the 3,489,413 Prosper Funding Notes and PMI Notes purchased. Of the affected Prosper Funding Notes and PMI Notes, 2,053 Prosper Funding Notes and PMI Notes purchased by 600 lender members were affected by the erroneous selection by Quick Invest of all possible search criteria; 2,517 Prosper Funding Notes and PMI Notes purchased by 28 lender members were affected by the erroneous use of inactive searches to purchase Prosper Funding Notes and PMI Notes; 96 Prosper Funding Notes and PMI Notes purchased by 23 lender members were affected by an error that resulted in a search identifying every listing’s Prosper Score as the best rating, regardless of the actual Prosper Score; 1,209 Prosper Funding Notes and PMI Notes purchased by 160 lender members were affected by an error that resulted in a lender member who had multiple searches with overlapping criteria bidding on the same listing more than once even though the lender member had also selected an option that was supposed to preclude him from investing in the same listing more than once; 168 Prosper Funding Notes and PMI Notes purchased by 42 lender members were affected by a server failure that resulted in Quick Invest bidding on the same listing more than once; and 2,587 Prosper Funding Notes and PMI Notes purchased by 458 lender members were affected by an Auto Quick Invest refactor that queued orders too quickly and resulted in multiple orders being executed. Please note that historical data regarding Prosper Funding Notes and PMI Notes may not be indicative of the future characteristics of Prosper Funding 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 Prosper Funding Notes” for more information.

In the event of any errors in Quick Invest that cause a lender member to purchase a Prosper Funding Note that such lender member would not otherwise have purchased or that differs materially from the Prosper Funding Note such lender member would have purchased had there been no error, Prosper Funding will either repurchase the Prosper Funding Note, indemnify the lender member against losses suffered on that Prosper Funding Note or cure the breach. Neither Quick Invest nor Auto Quick Invest can be used to bid on listings posted in the Whole Loan Channel.
 
Setting Interest Rates
 
PMI has an interest rate committee which meets regularly to set interest rates for all Prosper Funding Borrower Loans. These rates are set forth in a rate table, which is posted on the website. The table specifies a range of interest rates for all Prosper Funding Borrower Loans, based on the Prosper Rating. Additional factors, which may change from time to time, such as 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 Prosper Funding Notes is equal to the interest rate on the related Prosper Funding Borrower Loan, minus a servicing fee, currently set at 1% per annum of the outstanding principal balance of the corresponding Prosper Funding 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 Prosper Funding Notes offered and sold after the date of the change.
 
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 Prosper Funding 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 the website.

Prosper
Borrower Rate
Borrower Rate
Rating
Min
Max
 
 
 
AA
6.05%
8.09%
 
 
 
A
8.74%
11.99%
 
 
 
B
12.24%
14.85%
 
 
 
C
15.35%
19.20%
 
 
 
D
19.60%
23.44%
 
 
 
E
24.24%
28.00%
 
 
 
HR
28.74%
30.09%
 
Purchase of Prosper Funding 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 Prosper Funding Notes or Prosper Funding Borrower Loans purchased as a result of such bids for its own account.
 
In some cases, Prosper Funding’s or PMI’s bidding on a listing posted in the Note Channel 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’s or PMI’s executive officers, directors and 5% shareholders have bid on listings and purchased Prosper Funding Notes and PMI Notes from time to time in the past, and may purchase Prosper Funding Notes in the future. As of December 31, 2013, these individuals had purchased $4,088 in Prosper Funding Notes and PMI Notes or loans. These Prosper Funding Notes and 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 or 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
 
PMI and Prosper Funding maintain the FBO Funding accounts at Wells Fargo Bank to hold the funds of lender members. In order to bid on listings, a lender member must have sufficient funds in the applicable funding account. A lender member can transfer funds into the applicable funding 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 such funding account. All payments to fund purchases of Prosper Funding Notes or Prosper Funding Borrower Loans are made by deposit into the applicable funding account. Upon request by the lender member, Prosper Funding will transfer lender member funds from the applicable funding 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 Prosper Funding Notes or Prosper Funding Borrower Loans.

For the FBO Funding accounts, PMI maintains sub-account balances on its system to track all commitments and purchases made and proceeds received by such lender member. These record-keeping sub-accounts are purely administrative and reflect balances and transactions concerning Funds in the FBO Funding accounts. Lender members have no direct relationship with Wells Fargo Bank by virtue of funds or transactions within the FBO Funding accounts or by virtue of participating on the platform.
 
Each funding account is FDIC-insured on a “pass through” basis to the individual lender members, subject to applicable limits. This means that each individual lender member's cash balance is protected by FDIC insurance, up to the limits established by the FDIC. Other funds the lender member has on deposit with Wells Fargo may count against any applicable FDIC insurance limits. Funds of a lender member in a funding account can consist of amounts deposited by the lender member but never committed to Prosper Funding Note or Prosper Funding Borrower Loan purchases; amounts the lender member has committed to one or more such purchases, where origination of the corresponding Prosper Funding Borrower Loan has not yet occurred; or amounts received as principal and interest payments on Prosper Funding Notes, PMI Notes or Prosper Funding Borrower Loans owned by the lender member that the lender member has not yet withdrawn. Upon request by a lender member, PMI will transfer funds from the applicable funding account to the lender member’s designated and verified external bank account, provided such funds are not already committed to Prosper Funding Note or Prosper Funding Borrower Loan purchases.  To the extent a lender member does not withdraw any such amounts, they will remain in the applicable funding account indefinitely.
 
Prosper Funding Borrower Loan Funding and Purchases; Sale of Prosper Funding 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 Prosper Funding Borrower Loan and the sale of the Prosper Funding Notes or Prosper Funding Borrower Loan 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 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 disburses the loan proceeds to the borrower. Each borrower authorizes the loan proceeds to be disbursed by ACH transfer into the borrower’s designated bank account.

Borrowers pay an origination fee out of the proceeds of the loan at the time of funding.  As of December 31, 2013, origination fees on Prosper Funding Borrower Loans were as follows:

Prosper Rating
 
Origination Fee % (3 Year
Loan)
 
Origination Fee % (5 Year
Loan)
AA
 
1.00% - 1.95%
 
2.95%
A
 
3.95%
 
4.95%
B
 
4.95%
 
4.95%
C - HR
 
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 to Prosper Funding, PMI and WebBank. In addition, lender members who purchase Prosper Funding Borrower Loans through the Whole Loan Channel are entitled to receive borrower application information for Prosper Funding Borrower Loans that they purchase. Such lender members are required to use a qualified custodian (as that terms is defined in the Investment Advisers Act) to hold such borrower information, and also must ensure that such information is handled in a manner that is compliant with all applicable privacy laws.
 
When Prosper Funding issues and sells a Prosper Funding Note or a Prosper Funding Borrower Loan to a lender member, PMI registers the Prosper Funding Note or Prosper Funding Borrower Loan in the name of the lender member on Prosper Funding’s books and records. Each origination of a Prosper Funding Borrower Loan through the platform is followed by a two-step sale transaction: (i) WebBank sells the Prosper Funding Borrower Loan to Prosper Funding, and (ii) Prosper Funding either resells the Prosper Funding Borrower Loan to a lender member (if the Prosper Funding Borrower Loan is funded through the Whole Loan Channel), or sells Prosper Funding Notes corresponding to the Prosper Funding Borrower Loan to a group of lender members (if the Prosper Funding Borrower Loan is funded through the Note Channel).  In connection with this two-step transaction, PMI transfers the purchase price of the Prosper Funding Notes or Prosper Funding Borrower Loan, as the case may be, from the applicable funding accounts to WebBank. This transfer represents payment of the purchase price both by the applicable lender members to Prosper Funding and by Prosper Funding to WebBank. WebBank is the lender for all Prosper Funding 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 Prosper Funding Borrower 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 Prosper Funding Borrower Loans or Prosper Funding Notes may be taken on Prosper Funding’s behalf by PMI acting as its agent.

PMI maintains certain accounts at Wells Fargo, each of which serves as a dedicated account for receipt of payments on Prosper Funding Borrower Loans purchased by a particular lender member through the Whole Loan Channel. In this Annual Report, we refer to each of those accounts as a “dedicated servicing account”.  PMI also maintains a pooled account at Wells Fargo for receipt of payments on all Prosper Funding Borrower Loans not associated with a dedicated servicing account, which is referred to in this Annual Report as the “master servicing account”.  The master servicing account and the dedicated servicing accounts are all non-interest bearing, demand deposit accounts.  The master servicing account is held in the name of Prosper Funding for the benefit of its lender members, and each dedicated servicing account is held in the name of Prosper Funding for the benefit of the applicable lender member.  PMI nets its servicing fees from any Prosper Funding Borrower Loan proceeds deposited into the master servicing account or a dedicated servicing account.  After netting out its servicing fees, PMI remits the remaining funds from the servicing account to the deposit accounts designated by the applicable lender members. The payment dates for all PMI Notes and Prosper Funding Notes fall on the sixth business day after the due date for each monthly installment of principal and interest on the corresponding Prosper Funding Borrower Loan, but interest accrues on the PMI Notes and Prosper Funding Notes only through the due date for the related Prosper Funding Borrower Loan payment. The stated interest rate on each Prosper Funding Note is the lender yield percentage set forth in the loan listing. The yield percentage is the Prosper Funding Borrower Loan interest rate net of the servicing fee.
 
Prosper Funding subtracts a servicing fee from every PMI Borrower Loan and Prosper Funding Borrower 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 Prosper Funding Borrower Loan or PMI Borrower Loan was funded) and the denominator of which is 365, and (b) multiplying the product obtained by the outstanding principal balance of the Prosper Funding Borrower Loan or PMI Borrower 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 Prosper Funding Notes and Prosper Funding Borrower Loans offered and sold after the date of the change.
 
To the extent Prosper Funding does not receive the anticipated payments on a Prosper Funding Borrower Loan or PMI Borrower Loan funded through the Note Channel on or before any loan payment date, it will not make any payments on the corresponding Prosper Funding Notes on the corresponding Prosper Funding Note payment date, and a holder of any such Prosper Funding Note will not have any rights against Prosper Funding or the borrower in relation to any such delay or for any shortfalls in accrued Prosper Funding Note interest that result then or in relation to the final maturity of the Prosper Funding Note. Each holder’s right to receive principal and interest payments and other amounts in respect of that Prosper Funding Note is limited in all cases to the holder’s pro rata portion of the amounts Prosper Funding timely receives on the corresponding Prosper Funding Borrower Loan or PMI 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.
 
PMI’s in-house collections department or third party collection agencies may charge up 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 PMI charges and how these fees affect lender members:
 
Description of
Fee Charged by
Prosper Funding
 
Fee Amount
(not in thousands)
 
When Fee is Charged
 
Effect on Lender Member
 
 
 
 
 
 
 
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 Prosper Funding Notes and Prosper Funding Borrower Loans offered and sold after the date of the change.
 
The servicing fee is payable on all payments received by Prosper Funding on Prosper Funding Borrower Loans, including, without limitation, partial payments.
 
The servicing fee reduces the effective yield for Prosper Funding Note or Prosper Funding Borrower Loan holders below the interest rate on the Prosper Funding Borrower Loan. This reduction is reflected in the yield percentage

 
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
Up to 40.0% of the amount recovered, plus any legal fees and transaction fees associated with payment processing, up to the "total amount delinquent"
Prosper Funding may collect on a Prosper Funding Borrower Loan that becomes past due directly or it may refer such Prosper Funding Borrower Loan to a third party servicer's in-house collections department or to a collection agency. Collection fees and any related legal fees are only charged if delinquent amounts are collected.
Collections fees charged by Prosper Funding, a third party servicer's in-house collections department or a third party collection agency will reduce payments and the effective yield on the related Prosper Funding Notes, and are not reflected in the yield percentage shown on the listing; collection fees will be retained by Prosper Funding, the third party servicer's in-house collection department or the third party collection agency as additional servicing compensation.
 
 
Prosper Funding's servicing fee is also deducted from the net payments it receives as a result of any collection efforts on a delinquent Prosper Funding Borrower Loan.

PMI discloses borrowers’ payment performance on Prosper Funding Borrower Loans and PMI Borrower Loans to the relevant lender members on the website and also reports such information to consumer reporting agencies. PMI keeps lender members informed of the delinquency status of Prosper Funding Borrower Loans and PMI Borrower Loans by identifying delinquent loans on the website as “1 month late,” “2 months late,” “3 months late,” or “current.” Prosper Funding Borrower Loans and PMI Borrower Loans that become more than 120 days overdue are charged off and designated as such on the website. Through the website, lender members are able to monitor the Prosper Funding Borrower Loans they have purchased and Prosper Funding Borrower Loans and PMI Borrower Loans that correspond to Prosper Funding Notes they have purchased, but cannot participate in or otherwise intervene in the collection process.
 
Late payment performance is an early indicator of charge off probability. Of all Prosper Funding Borrower Loans and PMI Borrower Loans originated, collectively, between July 13, 2009 and December 31, 2013, 11.1% have been greater than 30 days past due at any time and 9.9% have been greater than 60 days past due at any time. As of December 31, 2013, 7,752 or 10.7% of all Prosper Funding Borrower Loans and PMI Borrower Loans originated, collectively, between July 13, 2009 and December 31, 2013 have been referred to a collection agency for collection proceedings. On average, through December 31, 2013, holders of PMI Notes or Prosper Funding Notes corresponding to such PMI Borrower Loans or Prosper Funding Borrower Loans, or holders of such Prosper Funding Borrower Loans, have received $481 (not in thousands), net of collection fees, on such Prosper Funding Borrower Loans and PMI Borrower Loans. In addition, of the 7,752 Prosper Funding Borrower Loans and PMI Borrower Loans referred to a collection agency, a total of 5,718 or 73.8% have been charged off.
 
Of all PMI Borrower Loans originated between November 2005 and July 12, 2009, 56.3% have been greater than 30 days past due at any time and 54.5% have been greater than 60 days past due at any time. As of December 31, 2013, 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, 2013, holders of corresponding PMI Notes have received $2,642 (not in thousands), 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% have been charged off.
 
Please note that historical data regarding Prosper Funding Borrower Loans, PMI Borrower Loans, Prosper Funding Notes and PMI Notes may not be indicative of the future characteristics of Prosper Funding Borrower Loans and Prosper Funding 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 Prosper Funding Notes” for more information.
 
If a borrower dies while a Prosper Funding Borrower Loan or a PMI Borrower Loan is in repayment, PMI requires the executor or administrator of the estate to send a death certificate to PMI. Depending on the size of the estate and the other liabilities thereof, PMI may not be able to recover the outstanding amount of the loan. If the estate does not include sufficient assets to repay the outstanding Prosper Funding Borrower Loan or PMI Borrower Loan in full, or allocates its assets to other liabilities, PMI will treat the unsatisfied portion of that Prosper Funding Borrower Loan or PMI Borrower Loan as charged off with zero value. In addition, if a borrower dies near the end of the term of a Prosper Funding Borrower Loan or PMI Borrower Loan funded through the Note Channel, it is unlikely that any further payments will be made on any PMI Notes or Prosper Funding Notes corresponding to such Prosper Funding Borrower Loan or PMI Borrower Loan, because the time required for the probate of the estate may extend beyond the final maturity date of the Prosper Funding Notes or PMI Notes.
 
When Prosper Funding receives notice of a borrower bankruptcy filing, it ceases all automatic monthly payments on any related Prosper Funding Borrower Loan or PMI Borrower Loan and defers any other collection activity, as required by law. The status of the Prosper Funding Borrower Loan or PMI Borrower Loan, which the relevant lender members may view through the website, switches to “bankruptcy.” PMI 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, PMI 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, PMI takes no further action and assumes that no recovery will be made on the Prosper Funding Borrower Loan or PMI 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 Prosper Funding Borrower Loan or PMI Borrower 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 Prosper Funding Notes or PMI 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 Prosper Funding Notes or the PMI Notes for sale or bid on and purchase Prosper Funding Notes or PMI 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 Prosper Funding Notes and PMI 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 Prosper Funding Notes by Prosper Funding.

Subscribers who sell Prosper Funding Notes or PMI 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 Prosper Funding Note or PMI 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 Prosper Funding Notes or PMI 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 Prosper Funding Notes and PMI Notes
 
Prosper Funding Notes and PMI Notes Subject to Sale by Subscribers. All Prosper Funding Notes and PMI Notes, including Prosper Funding Notes and PMI Notes for which the corresponding Prosper Funding Borrower Loans or PMI 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 Prosper Funding Note or PMI Note may be sold on the Note Trader platform, so long as the Prosper Funding Note or PMI Note is outstanding.
 
Lender Members Eligible to Bid on Prosper Funding 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 Prosper Funding Note Listings. Subscribers may offer one or more of their Prosper Funding Notes or PMI 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 Prosper Funding Notes and PMI Notes they own and may offer to sell more than one Prosper Funding Note or PMI 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 Prosper Funding Note or PMI 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 Prosper Funding Note or PMI 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 Prosper Funding Note or PMI Note, the interest rate on the Prosper Funding Note or PMI Note, the remaining term of the Prosper Funding Note or PMI Note, and the yield to maturity that corresponds to the offered sale price. Note listings will also include the repayment status of the Prosper Funding Borrower Loan or PMI Borrower Loan corresponding to the Prosper Funding Note or PMI Note (i.e., current or delinquent), the payment history on the Prosper Funding Borrower Loan or PMI Borrower Loan and the next scheduled payment on the Prosper Funding Note or PMI 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 credit data and original bidding history) for the Prosper Funding Borrower Loan or PMI Borrower Loan that corresponds to the Prosper Funding Note or PMI 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 Prosper Funding Notes or PMI Notes listed for sale on the Note Trader platform. Subscribers may bid for and purchase one or more Prosper Funding Notes or PMI Notes from selling subscribers. As with bidding on loan listings, subscribers who bid on Note listings must have funds on deposit in the pooled funding account in at least the aggregate amount of the subscriber’s bids. Subscribers are prohibited from withdrawing amounts from the pooled 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 Prosper Funding Note or PMI Note being sold, and there may be only one winning bidder for a Prosper Funding Note or PMI 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 Prosper Funding Notes or PMI Notes. When a Note listing ends with a winning bidder, upon settlement of the sale of the Prosper Funding Note or PMI 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 balance 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 Prosper Funding Note or PMI Note is sold, transferred and assigned by the selling subscriber to the winning bidder without recourse. All further payments made on the Prosper Funding Note or PM Note following settlement of the sale will be credited to the account of the purchasing subscriber. The purchasing subscriber may retain ownership of the Prosper Funding Note or PMI Note for the remainder of its term, or list the Prosper Funding Note or PMI Note for sale on the Note Trader platform.

Sale of Loans Purchased through Whole Loan Channel
 
Prosper Funding Borrower Loans may not be sold through the Note Trader Platform.  Lender members who participate in the Whole Loan Channel may transfer ownership of Prosper Funding Borrower Loans to institutional investors that meet the eligibility requirements of the Whole Loan Channel, subject to certain notice requirements to Prosper Funding and Prosper Funding’s right to continue servicing the transferred Prosper Funding Borrower Loans.

Information About Prosper Funding LLC 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 ownership of the platform, including all of the rights related to the operation of the platform, as well as all then-outstanding PMI Borrower Loans, to its wholly-owned subsidiary, Prosper Funding. 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 Prosper Funding Borrower Loans and Prosper Funding Notes, process and record the origination of Prosper Funding Borrower Loans, the acquisition thereof by Prosper Funding, funds transfers in relation to Prosper Funding Borrower Loans and collections on Prosper Funding Borrower Loans, the issuance and transfer of Prosper Funding Notes, funds transfers in relation to purchases of and payments on Prosper Funding Notes and PMI 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. 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. On February 1, 2013, Prosper Funding entered into an Administration Agreement with PMI in its capacity as licensee, corporate administrator, loan platform administrator and loan and note servicer, pursuant to which PMI provides certain back office support, loan platform administration and loan and note servicing to Prosper Funding. 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 Prosper Funding Borrower 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.

About Prosper Funding
 
Prosper Funding owns and operates the platform. The platform is designed to allow people to invest money in people in an open transparent marketplace, with the aim of allowing both lender members and borrower members to profit financially as well as socially. 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 Amended and Restated Indenture dated January 22, 2013 and made effective February 1, 2013 between Prosper Funding, PMI and Wells Fargo (the “Amended and Restated 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.

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:

Operating Infrastructure: The platform allows Prosper Funding to economically acquire and service Prosper Funding Borrower Loans and Prosper Funding Notes, and allows WebBank to efficiently originate and fund such loans.

Proprietary Risk Management Capabilities:  PMI 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 Prosper Funding Notes, which allows it to create micro securities backed by Prosper Funding Borrower 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;
 
Brand:  The Prosper brand is well known since PMI introduced the first peer-to-peer online credit platform in the United States;

Open access:  Prosper Funding allows individuals with a wide range of credit characteristics to apply for Prosper Funding Borrower Loans and a wide variety of lender members to fund such 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 101 2nd Street, 15th Floor, San Francisco, California 94105. Its telephone number at that location is (415) 593-5479. Its website address is www.prosper.com.  The information contained on the 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 101 2nd Street, 15th Floor, San Francisco, California 94105.  PMI’s telephone number at that location is (415) 593-5400.
 
The following filings are available for download free of charge at www.prosper.com after Prosper Funding and PMI files them with the SEC: Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. 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. Prosper Funding’s and PMI’s 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 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. 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. To date, PMI’s marketing initiatives have included advertising (e-mail campaigns, presentations, direct mail solicitations and paid search), organic 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 enhance user experience.
 
From time to time, PMI 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 member or a borrower member, 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 could conduct a special promotion to attract customers who come to the website through a marketing partnership it has with another company.
 
For the twelve months ended December 31, 2013 and 2012, PMI spent approximately $14,851and $5,683, respectively, on marketing. Each marketing effort is measured, analyzed and optimized to improve scale and efficiency in each channel. Through optimization of targeting efforts 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 Digital 365 Main, LLC under an agreement that expires in August 2014. Generally, unless PMI or Digital 365 Main, 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 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 a secure off-site backups.
 
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 First Associates Loan Servicing, LLC (“First Associates”), 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 Prosper Funding Borrower Loans, PMI Borrower Loans, Prosper Funding Notes and PMI Notes. First Associates. is a financial services company that has entered into numerous successor loan servicing agreements . It is unlikely that First Associates would be able to perform functions other than servicing the existing Prosper Funding Borrower Loans, PMI Borrower Loans, Prosper Funding Notes and PMI 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 Prosper Funding 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 256-bit enable encryption certificates provided by DigiCert, Inc. Communication of sensitive data with service providers is secured utilizing authenticated VPN, SSL 256-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 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 offsite using strong multi-factor encryption on each object with a unique key, which is further encrypted with rotating master key. PMI protects 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 inpection devices. At the host level, the platform utilizes host based intrusion prevention, anti-virus, anti-spyware, and application control systems. Logging and monitoring for the 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. PMI employs a combination of proprietary technologies and commercially available licensed technologies and solutions to prevent and detect fraud. PMI employs techniques such as knowledge based authentication, or KBA, out-of-band authentication and notification, behavioral analytics and digital fingerprinting to prevent identity fraud. 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, PMI uses specialized third-party software to augment the identity fraud detection systems.  PMI also has a dedicated team which conducts 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 PMI may then evaluate further.

Engineering

PMI has made substantial investment in software and website development and PMI expects 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, 2013, PMI’s technology group consisted of twenty-four full-time employees.  These resources are made available to Prosper Funding pursuant to the Administration Agreement.

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 Prosper Funding Borrower Loan funding rates and lender member 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. 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 PMI 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 the 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, or calculating cash balances in lender members’ accounts.

Employees

Prosper Funding does not have any employees.  As of December 31, 2013, PMI employed 88 full-time employees.  Of these employees:

· 24 were in engineering;

· 42 were in operations;

· 11 were in sales and marketing; and

· 11 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.

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 December 31, 2014.  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 under a lease that will expire December 31, 2014. PMI leases its co-location facility under a non-cancelable operating lease that expires in August 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 $178,000 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 $1,000 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 $1,000 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, 2013, PMI has entered into consent orders with 34 states and has paid an aggregate of $466 in penalties to those states.
 
As of December 31, 2013 and 2012, PMI had accrued approximately $248 and $248, 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 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 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 alleged that PMI offered and sold unqualified and unregistered securities in violation of the California and federal securities laws. The lawsuit sought rescission damages 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 July 19, 2013, solely to avoid the costs, risks and uncertainties inherent in litigation, and without admitting any liability or wrongdoing, the parties to the class action litigation pending before the Superior Court, entered into a Stipulation and Agreement of Compromise, Settlement, and Release (the “Settlement”) setting forth an agreement to settle all claims related thereto. In connection with the Settlement, PMI agreed to pay the plaintiffs, and took the charge on the income statement, an aggregate amount of $10,000, payable according to the following schedule: (i) $2,000 within 10 days of entry of an order by the Court granting preliminary approval of the settlement (“Preliminary Approval”); (ii) $2,000 on the one-year anniversary of Preliminary Approval; (iii) $3,000 on the two-year anniversary of Preliminary Approval; and (iv) $3,000 on the three-year anniversary of Preliminary Approval. The settlement is subject to final approval by the Superior Court. Subject to satisfaction of the conditions set forth in the Settlement, the defendants will be released by the plaintiffs from all claims concerning or arising out of the offering of promissory notes on the platform from January 1, 2006 through October 14, 2008.
 
As a result of the Settlement, PMI recorded the Settlement in the condensed consolidated statement of operations and a reserve for class action settlement liability of $10,000 in the consolidated balance sheet as of December 31, 2013.
 
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 $2,000. Greenwich subsequently made payments to PMI in the amount of $2,000 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 $2,000. 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 $143 to PMI for pre-judgment interest. As a result, Greenwich has now satisfied its obligations with respect to PMI’s defense costs for the class action suit.

GOVERNMENT REGULATION

Overview

The peer-to-peer lending industry is highly regulated. Prosper Funding, PMI and the Prosper Funding Borrower Loans made and the Prosper Funding Notes issued 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 Prosper Funding Borrower Loans made and Prosper Funding Notes issued through the platform. In particular, these rules limit the fees that may be assessed on the Prosper Funding 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 24 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 (“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.

The Dodd-Frank Wall Street Reform and Consumer Protection Act.
 
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law.  The Dodd-Frank Act contains a number of provisions that could substantially affect our business including:
 
 
creating the Consumer Financial Protection Bureau (the “CFPB”), a new agency responsible for administering and enforcing laws and regulations relating to consumer financial products and services
 
 
making it unlawful for any provider of consumer financial products or services or a service provider to engage in any unfair, deceptive or abusive act or practice, and giving the CFPB rule-making and enforcement authority to prevent unfair, deceptive or abusive acts or practices in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service
 
 
Transferring rulemaking and enforcement authority to the CFPB with respect to most federal consumer lending laws and regulations, including the Truth-in Lending Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act and the Electronic Funds Transfer Act and their respective implementing regulations
 
Truth-in-Lending Act. The federal Truth-in-Lending Act (“TILA”), and the regulation issued and administered by the CFPB 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 Prosper Funding 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 and administered by the CFPB 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 agreements require 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 Prosper Funding 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 CFPB, 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 Prosper Funding 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”), administered by the CFPB, 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. Prosper Funding’s agreements with lender members and group leaders prohibit registered lender members and group leaders from attempting to directly collect on the Prosper Funding Notes or Prosper Funding Borrower Loans, and Prosper Funding has established procedures to ensure that lender members and group leaders do not attempt to collect on the Prosper Funding Notes or Prosper Funding Borrower Loans 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 Prosper Funding Borrower Loan is called to active military duty, PMI reduces the interest rate on the Prosper Funding Borrower Loan to 6% for the duration of the borrower’s active duty. During this period, the holders of the corresponding Prosper Funding Notes (if the Prosper Funding Borrower Loan was originated through the Note Channel) or the holder of the Prosper Funding Borrower Loan (if the Prosper Funding Borrower Loan was originated through the Whole Loan Channel) will not receive the difference between 6% and the interest rate on the Prosper Funding Notes or Prosper Funding Borrower Loan (as applicable). For borrowers to obtain an interest rate reduction on a Prosper Funding 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 CFPB 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 and administered by the CFPB 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 Prosper Funding Notes and Prosper Funding Borrower Loans 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. PMI checks customer names against the list of Specially Designated Nationals maintained by the Office of Foreign Assets Control (“OFAC”). PMI has 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.

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 have registered or qualified the offer and sale of the Securities in 30 states as well as Washington D.C., and will offer the Securities in each other jurisdiction where they obtain 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 Prosper Funding Notes are risky and speculative investments for suitable investors only.

You should be aware that the Prosper Funding Notes offered through the platform are risky and speculative investments. The Prosper Funding Notes are special, limited obligations of Prosper Funding and depend entirely for payment on Prosper Funding’s receipt of payments under the corresponding Prosper Funding Borrower Loans. Prosper Funding 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 Prosper Funding Notes you purchase, you should not invest in the Prosper Funding Notes.

Payments on the Prosper Funding Notes depend entirely on payments Prosper Funding receives on corresponding Prosper Funding Borrower Loans. If a borrower fails to make any payments on the corresponding Prosper Funding Borrower Loan related to your Prosper Funding Note, payments on your Prosper Funding Note will be correspondingly reduced.

Prosper Funding will only make payments pro rata on a series of Prosper Funding Notes after it receives a borrower’s payment on the corresponding Prosper Funding 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 Prosper Funding Notes any non-sufficient funds fees and the amounts of any attorneys’ fees or collection fees its or PMI’s in-house collections department or a third-party servicer or collection agency imposes in connection with collection efforts. Under the terms of the Prosper Funding Notes, if Prosper Funding does not receive any or all payments on the corresponding Prosper Funding Borrower Loan, payments on your Prosper Funding 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 Prosper Funding Note on the corresponding succeeding Prosper Funding 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 Prosper Funding 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 Prosper Funding Borrower Loan is funded. From the period from July 13, 2009 to December 31, 2013, PMI verified employment and/or income on approximately 54% of the Prosper Funding Borrower Loans and PMI Borrower Loans originated through the platform on a unit basis (39,291 out of 72,957) and approximately 76% of originations on a dollar basis ($480,725 out of $630,364). PMI selected these listings based on a combination of factors, 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 Prosper Funding Note. If an applicant supplies false, misleading or inaccurate information, you may lose part or all of the purchase price you pay for a Prosper Funding 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 Prosper Funding 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 Prosper Funding Borrower Loan or Prosper Funding Note.

The Prosper Funding Borrower Loans are not secured by any collateral or guaranteed or insured by any third party, and you must rely on Prosper Funding, PMI or a third-party collection agency to pursue collection against any borrower.

Prosper Funding 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 servicer and third-party collection agencies will, therefore, be limited in their ability to collect on Prosper Funding Borrower Loans. Moreover, Prosper Funding Borrower Loans are obligations of borrowers to Prosper Funding as successor to WebBank, not obligations to the holders of Prosper Funding Notes. Holders of the Prosper Funding Notes will have no recourse to the borrowers and no ability to pursue borrowers to collect payments under Prosper Funding Borrower Loans. Holders of the Prosper Funding Notes may look only to Prosper Funding for payment of the Prosper Funding Notes. Furthermore, if a borrower fails to make any payments on the Prosper Funding Borrower Loan, the holders of the Prosper Funding Notes corresponding to that Prosper Funding Borrower Loan will not receive any payments on their Prosper Funding Notes. The holders of such Prosper Funding 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 Prosper Funding Borrower Loan.

The maximum debt-to-income ratio for applicants is 50%.

DTI is a measurement of a borrower’s ability to take on additional debt. While there is an upper limit of 50% on the DTI ratio for eligible borrowers on the platform, borrowers with higher debt-to- income ratios may represent a greater risk of default than borrowers with lower debt-to-income ratios. Prosper Funding Note that the measure of DTI for eligibility decisions does not include the amount of the requested Prosper Funding Borrower Loan, whereas the measure of DTI presented in a listing includes the amount of the requested Prosper Funding Borrower Loan.

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 Prosper Funding 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.

The Prosper Rating may not accurately set forth the risks of investing in the Prosper Funding Notes and no assurances can be provided that actual loss rates for the Prosper Funding Notes will come within the estimated 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 Prosper Funding Note, Prosper Funding will indemnify the holder or repurchase the Prosper Funding Note. Prosper Funding will not, however, have any indemnity or repurchase obligation under the Amended and Restated Indenture, the Prosper Funding Notes, the lender member agreement or any other agreement associated with the Note Channel 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 Prosper Funding 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 Prosper Funding Notes, Prosper Funding’s only obligation is to pay to the Prosper Funding Note holders their pro rata shares of collections received on the related Prosper Funding Borrower Loans net of applicable fees). If Prosper Funding repurchases any Prosper Funding Notes, PMI will concurrently repurchase the related PMI Management Right for zero consideration. Prosper Funding’s repurchase obligations under the Amended and Restated Indenture, the Prosper Funding Notes, the lender member agreement or any other agreement associated with the Note Channel, 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 Prosper Funding Note. In addition, no assurances can be provided that actual loss rates for the Prosper Funding Notes will fall within the expected loss rates indicated by the Prosper Rating. The interest rates on the Prosper Funding Notes might not adequately compensate Prosper Funding Note purchasers for these additional risks. See “Item 1. Business—Prosper Funding Note Repurchase and Indemnification Obligations” for more information.

Lender members who use the Quick Invest tool may face additional risk of funding Prosper Funding Borrower Loans that have been erroneously selected by Quick Invest.

Since it was first implemented by PMI in July 2011 through December 31, 2013, the Quick Invest tool has experienced errors that affected 8,630 Prosper Funding Notes and PMI Notes out of the 3,489,413 Prosper Funding Notes and PMI Notes purchased. Of the affected Prosper Funding Notes and PMI Notes, 2,053 Prosper Funding Notes and PMI Notes purchased by 600 lender members were affected by the erroneous selection by Quick Invest of all possible search criteria; 2,517 Prosper Funding Notes and PMI Notes purchased by 28 lender members were affected by the erroneous use of inactive searches to purchase Prosper Funding Notes and PMI Notes; 96 Prosper Funding Notes and PMI Notes purchased by 23 lender members were affected by an error that resulted in a search identifying every listing’s Prosper Score as the best rating, regardless of the actual Prosper Score; 1,209 Prosper Funding Notes and PMI Notes purchased by 160 lender members were affected by an error that resulted in lender members 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; 168 Prosper Funding Notes and PMI Notes purchased by 42 lender members were affected by a server failure that resulted in Quick Invest bidding on the same listing more than once; and 2,587 Prosper Funding Notes and PMI Notes purchased by 458 lender members were affected by an Auto Quick Invest refactor that queued orders too quickly and resulted in multiple orders being executed.

In the event of any errors in Quick Invest that cause a lender member to purchase a Prosper Funding Note from Prosper Funding that such lender would not otherwise have purchased or that differs materially from the Prosper Funding Note such lender would have purchased had there been no error, Prosper Funding will either repurchase the Prosper Funding Note, indemnify the lender against losses suffered on that Prosper Funding Note or cure such error.  See “Item 1A. Risk Factors—Risks Related to Prosper Funding and PMI the Platform and Prosper Funding and PMI’s Ability to Service the Prosper Funding Notes” 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 Prosper Funding Notes in limited circumstances (including, e.g., a material payment default on the Prosper Funding Borrower Loan resulting from verifiable identity theft), it is not obligated  to indemnify you or repurchase a Prosper Funding 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, similar indicia of borrower intent and ability to repay the Prosper Funding Borrower Loan. If Prosper Funding repurchases a Prosper Funding Note, the repurchase price will be equal to the Prosper Funding Note’s outstanding principal balance and will not include accrued interest. If Prosper Funding repurchases any Prosper Funding Notes, PMI will concurrently repurchase the related PMI Management Rights for zero consideration. See “Item 1. Business—Prosper Funding 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 Prosper Funding Borrower 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 Prosper Funding Notes or indemnify the applicable Prosper Funding 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 the applicable Prosper Funding Note holders or repurchase the related Prosper Funding Notes. 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—Prosper Funding Note Repurchase and Indemnification Obligations” for more information

Prosper Funding does not have significant historical performance data about performance on the Prosper Funding Borrower Loans. Loss rates on the Prosper Funding 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 Prosper Funding 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 Borrower Loans. Due to Prosper Funding’s limited operational history, it does not have significant historical data regarding the performance of the Prosper Funding Borrower Loans, and it does not yet know what the long-term loan loss experience will be. The estimated loss rates displayed on the website and used to determine the Prosper Rating have been developed from the loss histories on Prosper Funding Borrower Loans as well as PMI’s loss histories on PMI Borrower Loans. Future Prosper Funding Borrower Loans originated through the platform may default more often than similar Prosper Funding Borrower Loans and PMI Borrower Loans have defaulted in the past, which increases the risk of investing in the Prosper Funding Notes.

If payments on the corresponding Prosper Funding Borrower Loans relating to your Prosper Funding 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 Prosper Funding Notes, and you may not recover your original purchase price.

PMI may refer Prosper Funding Borrower Loans that become past due to a third party collection agency for collection or it may collect on such Prosper Funding Borrower Loans directly. If a borrower fails to make a required payment on a Prosper Funding Borrower Loan within 30 days of the due date, PMI will pursue reasonable collection efforts in respect of the Prosper Funding Borrower Loan. Referral of a delinquent Prosper Funding Borrower Loan to a collection agency within five business days after it becomes thirty days past due will be considered reasonable collection efforts. If payment amounts on a delinquent Prosper Funding Borrower Loan are received from a borrower after the loan has been referred to PMI’s in-house collections department or an outside collection agency, PMI or that collection agency may retain a percentage of that payment as a fee before any principal or interest becomes payable to you. Collection fees may be up to 40% of recovered amounts, in addition to any legal fees and transaction fees associated with accepting payments incurred in the collection effort.

For some non-performing Prosper Funding 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 Prosper Funding Note may receive little, if any, of the unpaid principal and interest payable under the Prosper Funding Note. You must rely on the collection efforts of PMI or the applicable collection agency to which such Prosper Funding Borrower Loans are referred. You are not permitted to attempt to collect payments on the Prosper Funding Borrower Loans in any manner.

Late payment performance is an early indicator of charge off probability. Of all Prosper Funding Borrower Loans and PMI Borrower Loans originated between July 13, 2009 and December 31, 2013, 11.1% have been greater than 30 days past due at any time and 9.9% have been greater than 60 days past due at any time. As of December 31, 2013, 7,752 or 10.7% of all Prosper Funding Borrower Loans and PMI Borrower Loans originated between July 13, 2009 and December 31, 2013 have been referred to a collection agency for collection proceedings. The average recovery on such Prosper Funding Borrower Loans and PMI Borrower Loans through December 31, 2013, is $481 (not in thousands), net of collection fees. In addition, of the 7,752 Prosper Funding Borrower Loans and PMI Borrower Loans referred to a collection agency, a total of 5,718 or 73.8% of such loans have been charged off.

Loss rates on the Prosper Funding 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.

Prosper Funding 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 Prosper Funding 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 Prosper Funding Borrower Loans relating to your Prosper Funding Notes after the final maturity date, you will not receive payments on your Prosper Funding Notes after maturity.

Each Prosper Funding Note will mature on the initial maturity date, unless any principal or interest payments in respect of the corresponding Prosper Funding Borrower Loan remain due and payable to Prosper Funding upon the initial maturity date, in which case the maturity of the Prosper Funding Note will be automatically extended to the final maturity date. If there are any amounts under the corresponding Prosper Funding 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 Prosper Funding Notes, even if it receives payments on the corresponding Prosper Funding Borrower Loan after such date.

The Prosper Funding 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 Prosper Funding Borrower Loan, which may impair your ability to receive the full principal and interest payments that you expect to receive on a Prosper Funding Note.

If a borrower incurs additional debt after the date of the Prosper Funding Borrower Loan, the additional debt may impair the ability of that borrower to make payments on his or her Prosper Funding Borrower Loan and your ability to receive the principal and interest payments that you expect to receive on a corresponding Prosper Funding 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 Prosper Funding Borrower Loan on which your Prosper Funding Note is dependent for payment. Borrowers may also choose to repay obligations under secured indebtedness or other unsecured indebtedness before repaying Prosper Funding Borrower Loans because there is no collateral securing the Prosper Funding 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 Prosper Funding Borrower Loan upon which a Prosper Funding 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 Prosper Funding Borrower Loan has his or her bank cancel the payment or request a refund of that payment. PMI withholds payments to lender members up to six business days after a related borrower payment is initiated. If the chargeback occurs six or more days after the initiation of payment, you must rely on PMI to contest the chargeback if it deems it appropriate. If a borrower successfully processes a chargeback six or more 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 Prosper Funding Borrower Loans corresponding to your Prosper Funding 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. 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 Prosper Funding Notes depends on borrowers fulfilling their payment obligations in a timely and complete manner under the corresponding Prosper Funding 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 Prosper Funding Borrower Loan upon which payment of your Prosper Funding Note is dependent or chooses not to repay his or her Prosper Funding Borrower Loan entirely, you may not be able to recover any portion of your investment in a Prosper Funding Note.

The platform may fail to comply with applicable law, which could limit Prosper Funding and PMI’s ability to collect on Prosper Funding Borrower Loans.

The Prosper Funding Borrower Loans are subject to federal and state consumer protection laws. The platform may not always be, and 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 Prosper Funding Borrower Loans. See “Item 1. 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 Prosper Funding 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 Prosper Funding Borrower Loan.

In general, the Prosper Funding 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 Prosper Funding Borrower Loan on which your Prosper Funding Notes are dependent for payment may be substantially impaired.

The Prosper Funding 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 Prosper Funding Borrower Loans do not contain cross-default provisions, a Prosper Funding Borrower 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 Prosper Funding 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 Prosper Funding 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 Prosper Funding 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 Prosper Funding Borrower Loan on hold and prevent further collection action absent bankruptcy court approval. If Prosper Funding or PMI receives notice that a borrower has filed for protection under the federal bankruptcy laws, or has become the subject of an involuntary bankruptcy petition, PMI will put the Borrower’s Loan account into “bankruptcy status.” When this occurs, PMI terminates automatic monthly ACH debits on Prosper Funding 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 Prosper Funding 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 Prosper Funding Borrower Loans and reduce the amount of interest paid on the corresponding Prosper Funding Notes.

Federal law provides borrowers on active military service with rights that may delay or impair PMI’s ability to collect on a Prosper Funding Borrower Loan corresponding to your Prosper Funding Note. The Servicemembers Civil Relief Act (“SCRA”) requires that the interest rate on preexisting debts, such as Prosper Funding Borrower Loans, be set at no more than 6% while the qualified service member or reservist is on active duty. A holder of a Prosper Funding Note that is dependent on such a Prosper Funding Borrower Loan for payment will not receive the difference between 6% and the original stated interest rate for the Prosper Funding 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 Prosper Funding Borrower Loans in default, and, accordingly, payments on the corresponding Prosper Funding Notes. If there are any amounts under such a Prosper Funding Borrower Loan still due and owing to Prosper Funding after the final maturity of the corresponding Prosper Funding Notes, Prosper Funding will have no further obligation to make payments on the Prosper Funding Notes, even if it receives payments on the Prosper Funding Borrower Loan after the final maturity of the Prosper Funding 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, PMI does not request borrower members to confirm if they are qualified service members or reservists within the meaning of the SCRA. See “Item 1. Government Regulation—Regulation and Consumer Protection Laws—Servicemembers Civil Relief Act” for more information.

From July 13, 2009 through December 31, 2013, only eight Prosper Funding Borrower Loans and PMI Borrower Loans, with an aggregate principal amount of $54, have been subject to the SCRA.
The death of a borrower may substantially impair your ability to recoup the full purchase price of Prosper Funding Notes or to receive the interest payments that you expect to receive on the Prosper Funding Notes.

If a borrower dies while his or her Prosper Funding Borrower 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 Prosper Funding Borrower Loan, it is unlikely that any further payments will be made on the corresponding Prosper Funding Notes, because the time required for the probate of the borrower’s estate will probably extend beyond the final maturity date of the Prosper Funding Notes.

RISKS INHERENT IN INVESTING IN THE PROSPER FUNDING NOTES

The Prosper Funding 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 Prosper Funding 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 Prosper Funding 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 Prosper Funding Note holders, a security interest in the Prosper Funding Borrower Loans corresponding to the Prosper Funding Notes, the payments and proceeds that Prosper Funding receives on such Prosper Funding Borrower Loans, the bank account in which such Prosper Funding Borrower Loan payments are deposited and the FBO Funding account, the Prosper Funding Note holders do not themselves have a direct security interest in the Prosper Funding Borrower Loans or the right to payment thereunder. If an event of default under the Amended and Restated Indenture were to occur, the Prosper Funding Note holders would be dependent on the indenture trustee’s ability to realize on the collateral and make payments on the Prosper Funding Notes in the manner contemplated by the Amended and Restated 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 Prosper Funding 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 Prosper Funding Note holder or repurchase any Prosper Funding Notes except in limited circumstances.

Prosper Funding is only obligated to repurchase Prosper Funding Notes or indemnify holders of Prosper Funding Notes in limited circumstances. These circumstances include if (i) a material payment default under the corresponding Prosper Funding 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 Prosper Funding Notes or indemnify holders of Prosper Funding 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 or similar indicia of borrower intent and ability to repay the loan. Nor is Prosper Funding under any obligation to repurchase a Prosper Funding Note or indemnify any holder of Prosper Funding Notes if a correctly-determined Prosper Rating fails to accurately predict the actual losses on a Prosper Funding 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.

Prosper Funding believes its fee income will be sufficient to meet its reasonably anticipated indemnification and repurchase 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, 2013, approximately $801,000 of Prosper Funding Borrower Loans and PMI Borrower Loans were originated through the platform and Prosper Funding and PMI repurchased  or made indemnification payments on such Prosper Funding Borrower Loans and PMI Borrower Loans equal to approximately $724. As of December 31, 2013, approximately $581 in Prosper Funding Borrower 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 Prosper Funding Note or indemnify a Prosper Funding Note holder, that it will be able to meet its repurchase or indemnification obligations. If Prosper Funding is unable to meet its indemnification and repurchase obligations, you may lose all of your investment in the Prosper Funding Note.

If you decide to invest through the platform and concentrate your investment in a single Prosper Funding Note, you may increase your risk of borrower defaults.

Your expected return on your investment in the Prosper Funding Notes depends on the performance of the borrowers under the corresponding Prosper Funding 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 Prosper Funding Note, your entire return will depend on the performance of a single Prosper Funding Borrower Loan. For example, if you plan to purchase $200 (not in thousands) of Prosper Funding Notes, and choose to invest the entire $200 (not in thousands) in a single Prosper Funding Note instead of in eight $25 (not in thousands) Prosper Funding Notes corresponding to the Prosper Funding Borrower Loans of eight different borrowers, your entire $200 (not in thousands)  investment will depend on the performance of a single Prosper Funding 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 Prosper Funding Notes.

The platform allows a borrower member to prepay a Prosper Funding Borrower Loan at any time without penalty. Prosper Funding Borrower Loan prepayments will extinguish or limit your ability to receive additional interest payments on a Prosper Funding Note.

Prosper Funding Borrower Loan prepayment occurs when a borrower decides to pay some or all of the principal amount on a Prosper Funding Borrower Loan earlier than originally scheduled. Borrowers may decide to prepay all or a portion of the remaining principal amount due under a Prosper Funding Borrower Loan at any time without penalty. In the event of a prepayment of the entire remaining unpaid principal amount of a Prosper Funding Borrower Loan on which your Prosper Funding Notes are dependent for payment, you will receive your share of such prepayment but further interest will not accrue on such Prosper Funding Borrower Loan or on your Prosper Funding 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 Prosper Funding 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 Prosper Funding Notes. In addition, you may not be able to find a similar rate of return on another investment at the time at which the Prosper Funding Borrower Loan is prepaid. Prepayments are subject to Prosper Funding’s servicing fee, even if the prepayment occurs immediately after issuance of your Prosper Funding Note.

Prevailing interest rates may change during the term of your Prosper Funding Notes. If this occurs, you may receive less value from your purchase of the Prosper Funding Note in comparison to other ways you may invest your money. Additionally, borrowers may prepay their Prosper Funding 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 Prosper Funding Notes.

The Prosper Funding Borrower Loans on which the Prosper Funding Notes are dependent for payment bear fixed, not floating, rates of interest. If prevailing interest rates increase, the interest rates on Prosper Funding 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 Prosper Funding Borrower Loans.

If PMI sets interest rates for Prosper Funding Borrower Loans too low, lender members may not be compensated appropriately for the level of risk that they are assuming in purchasing a Prosper Funding 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 Prosper Funding Notes that are commensurate with the risks they have assumed in acquiring such Prosper Funding Notes.

The PMI Management Rights attached to the Prosper Funding Notes will not comprise collateral for the Prosper Funding Notes nor generate any funds that will be payable to the holders of Prosper Funding 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 Prosper Funding Borrower Loans or in any way related to Prosper Funding’s payment obligations in relation to the Prosper Funding Notes. The PMI Management Rights attached to the Prosper Funding Notes will not comprise collateral for the Prosper Funding Notes nor guarantees of any Prosper Funding Borrower Loans or Prosper Funding Notes, nor generate any funds or proceeds that will be payable to Prosper Funding, the indenture trustee or holders of Prosper Funding Notes in relation to any Prosper Funding Borrower Loans or Prosper Funding Notes. Holders of Prosper Funding Notes will have no recourse to PMI or its assets in relation to payments on Prosper Funding Borrower Loans or Prosper Funding Notes. If Prosper Funding repurchases any Prosper Funding Notes, PMI will concurrently repurchase the related PMI Management Right for zero consideration. Prosper Funding’s repurchase obligations under the Amended and Restated Indenture, the Prosper Funding Notes, the lender member agreement or any other agreement associated with the Note Channel, 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 Prosper Funding Borrower Loans and Prosper Funding 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 Prosper Funding 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 platform administration and corporate administration obligations under the Administration Agreement. Holders representing at least 25% of the combined total of the outstanding Prosper Funding Notes and the PMI Note, 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 Amended and Restated 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 Prosper Funding Notes, your ability to receive principal and interest payments on your Prosper Funding Notes may be substantially impaired, even if your portfolio of Prosper Funding Notes is well diversified and the Prosper Funding Borrower 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 Prosper Funding Notes that you wish to sell, you will be forced to hold the Prosper Funding Notes for their remaining term.

Prosper Funding and PMI cannot guarantee that the Note Trader platform will continue to develop.  A Prosper Funding Note offered for sale on the Note Trader platform must be purchased in its entirety by a single lender member, and Prosper Funding 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 Prosper Funding Notes.

If you choose to post your Prosper Funding 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 Prosper Funding Borrower Loan.

The ability to sell your Prosper Funding Note on the Note Trader platform does not guarantee that you will be able to find a lender member willing to buy the Prosper Funding Note at a price acceptable to you, or at all. If the borrower becomes delinquent in payments under the corresponding Prosper Funding Borrower Loan upon which your Prosper Funding Note is dependent for payment, your ability to sell the Prosper Funding Note on the Note Trader platform will be substantially impaired. You may have to offer the Prosper Funding Note for sale at a substantial discount, and there is no guarantee that you will receive the expected value of the Prosper Funding Note or any value at all. Additionally, lender members may be less willing to bid for and purchase your Prosper Funding Note if prevailing interest rates have changed or other investing activities have proven more attractive while you have held the Prosper Funding Note.

You do not earn interest on funds held in the FBO Funding account.

Your lender member account represents an interest in a FBO Funding 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 Prosper Funding Notes are uncertain.

There are no statutory provisions, regulations, published rulings or judicial decisions that directly address the characterization of the Prosper Funding Notes or instruments similar to the Prosper Funding Notes for U.S. federal income tax purposes. However, although the matter is not free from doubt because payments on the Prosper Funding Notes are dependent on payments on the corresponding Prosper Funding Borrower Loan, Prosper Funding intends to treat the Prosper Funding 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 Prosper Funding Notes. You should be aware, however, that the IRS is not bound by Prosper Funding’s characterization of the Prosper Funding Notes and the IRS or a court may take a different position with respect to the Prosper Funding Notes’ proper characterization. For example, the IRS could determine that, in substance, each lender member owns a proportionate interest in the corresponding Prosper Funding Borrower Loan for U.S. federal income tax purposes or, for example, the IRS could instead treat the Prosper Funding 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 Prosper Funding Note. For example, if the Prosper Funding 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 Prosper Funding Borrower Loans but would not be entitled to deduct interest or OID on the Prosper Funding Notes, and (ii) payments on the Prosper Funding 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 Prosper Funding 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 Prosper Funding Notes (including any possible differing treatments of the Prosper Funding Notes).

Prosper Funding’s ability to pay principal and interest on a Prosper Funding 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 Prosper Funding 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 Prosper Funding Borrower Loan that it holds and the timing of deductions that it may be entitled to in respect of payments made on the Prosper Funding Notes that it issues. For example, if the Prosper Funding Notes are treated as contingent payment debt instruments for U.S. federal income tax purposes but the corresponding Prosper Funding 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 Prosper Funding Notes.

Participation in the funding of Prosper Funding Borrower 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 Prosper Funding Notes purchased as a result of such funding for its own individual account. Even though Prosper Funding and PMI will participate in Prosper Funding Borrower 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 lender members on the platform, such participation may be perceived as involving a conflict of interest. For example, Prosper Funding or PMI’s funding of a Borrow 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.

During the year ended December 31, 2013, PMI and Prosper Funding had purchased Prosper Funding Notes and PMI Notes for investments in the aggregate amount of approximately $204. In addition, as of December 31, 2013, Prosper Funding and PMI’s respective executive officers, directors, and 5% shareholders had purchased Prosper Funding Notes, PMI Notes and PMI Borrower Loans in the aggregate amount of $5,989. The Prosper Funding Notes, PMI Notes and PMI Borrower Loans were obtained on terms and conditions that were not more favorable than those obtained by other lender members of Prosper Funding or PMI. Of the total aggregate amount of Prosper Funding Notes, PMI Notes and PMI Borrower Loans purchased by Prosper Funding and PMI’s respective executive officers, directors and affiliates as of December 31, 2013, approximately 14% of principal has been charged off, compared to approximately 12% of principal charged off for all Prosper Funding Notes, PMI Notes and PMI Borrower Loans originated as of December 31, 2013.

RISKS RELATED TO PROSPER FUNDING AND PMI, THE PLATFORM AND PROSPER FUNDING AND PMI’S ABILITY TO SERVICE THE PROSPER FUNDING 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 Prosper Funding Notes, and Prosper Funding may be unable to collect and process repayments from borrowers.

If PMI were to become subject to a bankruptcy proceeding, PMI may have the right to assume or reject the Administration Agreement between Prosper Funding and PMI (or the loan servicing provisions thereof) because a bankruptcy court may disallow termination of the Administration Agreement (or the loan servicing provisions thereof). If PMI elected to continue to perform under the Administration Agreement (or the loan servicing provisions thereof) without expressly assuming it or elected to assume the Administration Agreement (or the loan servicing provisions thereof), PMI would continue to perform its servicing obligations with respect to the Prosper Funding Borrower Loans and the Prosper Funding Notes. If PMI were to continue as servicer during the pendency of its bankruptcy proceeding, depending on the facts and circumstances at the time, Prosper Funding would determine whether the creation of new Prosper Funding Borrower Loans would continue to be facilitated and new Prosper Funding Notes issued through the platform. If PMI elected to reject the Administration Agreement (or the loan servicing provisions thereof), or if PMI was in default in performing its obligations thereunder, and PMI was unable to cure such default, the loan servicing provisions of the Administration Agreement (and likely also the other provisions thereof) would be terminated. If the loan servicing provisions of the Administration Agreement are terminated for any reason, Prosper Funding would attempt to transfer the loan servicing obligations on the Prosper Funding Borrower Loans and Prosper Funding Notes to a third party pursuant to its contractual agreements with lender members.
 
Prosper Funding has entered into a back-up servicing agreement with a loan servicing company that is willing and able to transition servicing responsibilities from PMI. There can be no assurance, however, that this back-up servicer will be able to adequately perform the servicing of the outstanding Prosper Funding Borrower Loans and Prosper Funding Notes. If this back-up servicer assumes the servicing of the Prosper Funding Borrower Loans and Prosper Funding Notes, the back-up servicer may impose additional servicing fees, reducing the amounts available for payments on the Prosper Funding Notes. Additionally, transferring these servicing obligations to the back-up servicer, particularly if such transfer is made when PMI is in bankruptcy and already defaulting in performance of its obligations under the Administration Agreement, may result in delays in the processing of collections on Prosper Funding Borrower Loans and information with respect to amounts owed on Prosper Funding Borrower Loans or, if the platform becomes inoperable, may prevent the back-up servicer from servicing the Prosper Funding Borrower Loans and making principal and interest payments on the Prosper Funding Notes. If the back-up servicer is not able to service the Prosper Funding Borrower Loans and Prosper Funding Notes effectively, your ability to receive principal and interest payments on your Prosper Funding Notes may be substantially impaired, even if your portfolio of Prosper Funding Notes is well diversified and the corresponding Prosper Funding Borrower Loans are paying on schedule.
 
In addition, it is unlikely that the back-up servicer would be able to perform functions other than servicing the outstanding Prosper Funding Borrower Loans and Prosper Funding Notes. For instance, the back-up servicer likely would not be able to facilitate the creation of new Prosper Funding Borrower Loans through the platform, manage Prosper Funding’s marketing efforts or maintain the relationship with FOLIOfn Investments, Inc. necessary to ensure continued operation of the Note Trader Platform. Prosper Funding believes that it could find one or more other parties who could perform these and any other functions necessary to fully operate the platform in the absence of PMI. However, it could take some time to find another such party or parties who could perform the necessary functions and it could take such party or parties additional time to become comfortable with the operation of the platform.

Moreover, PMI owns and has not transferred to Prosper Funding ownership of the computer hardware that it uses to host and maintain the website or agreements with third parties relating to the hosting and maintenance of the website. Although PMI’s retention of such hardware and agreements should not bear on a bankruptcy court’s analysis of the legal separateness of PMI and Prosper Funding (or their respective assets and liabilities), the cessation of or substantial reduction of the day-to-day operations of PMI (because of or during its bankruptcy or otherwise) would materially impair and delay the ability of Prosper Funding or a back-up service provider to retrieve data and information in the possession of PMI and to operate the platform or elements thereof relevant to Prosper Funding Borrower Loan and Prosper Funding Note servicing.

Any such delay or impairment that did not affect existing Prosper Funding Note holders, because Prosper Funding or its back-up servicer proves able to continue servicing outstanding Prosper Funding Borrower Loans and Prosper Funding Notes, could nonetheless delay Prosper Funding’s ability to facilitate the creation of new Prosper Funding Borrower Loans and issue new Prosper Funding Notes through the platform, which could adversely affect Prosper Funding’s finances and customer relationships
 
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 Prosper Funding Notes could be uncertain, and payments on the Prosper Funding Notes may be limited, suspended or stopped. The recovery, if any, of a holder on a Prosper Funding Note may therefore be substantially delayed and substantially less than the principal and interest due and to become due on the Prosper Funding Note.

Although Prosper Funding has been organized and is 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 Prosper Funding 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 Prosper Funding Note even if a Prosper Funding Note holder’s portfolio of Prosper Funding Notes is well diversified and the Prosper Funding Borrower Loans are paying on schedule. For example, Prosper Funding has structured its limited liability company agreement, and agreed to covenants in the Amended and Restated 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 Funding must receive the affirmative vote of its independent board members to file for bankruptcy. There is no guarantee, however, that its fee income from license fees and loan servicing fees will be sufficient to fund its contingent and other liabilities described above or that it will not enter into transactions that cause it to face solvency issues that ultimately could cause it to file for bankruptcy. Further, although Prosper Funding has granted the indenture trustee, for the benefit of the Prosper Funding Note holders, a security interest in all of the Prosper Funding Borrower Loans, all payments and proceeds it receives on the corresponding Prosper Funding Borrower Loans and in the bank account in which the Prosper Funding Borrower Loan payments are deposited, the holders of the Prosper Funding Notes would still be subject to the following risks associated with Prosper Funding’s insolvency, bankruptcy or a similar proceeding.

If Prosper Funding becomes subject to a bankruptcy or similar proceeding, borrowers may delay payments or cease making payments at all.

Borrowers may delay or suspend making payments to Prosper Funding because of the uncertainties occasioned by its becoming subject to a bankruptcy or similar proceeding, even if the borrowers have no legal right to do so, and such delay would reduce, at least for a time, the funds that might otherwise be available to pay the Prosper Funding Notes corresponding to those Prosper Funding Borrower Loans. In addition, the commencement of the bankruptcy or similar proceeding may, as a matter of law, prevent Prosper Funding from making regular payments on the Prosper Funding Notes, even if the funds to make such payments are available. Because the indenture trustee would be required to enforce its security interest in the Prosper Funding Borrower Loans in a bankruptcy or similar proceeding, the indenture trustee’s ability to make payments under the Prosper Funding Notes would be delayed, which may effectively reduce the value of any recovery that a holder of a Prosper Funding Note may receive (and no such recovery can be assured) by the time any recovery is available.

If Prosper Funding becomes subject to a bankruptcy or similar proceeding, interest accruing upon and following such bankruptcy or similar proceeding may not be paid.

In a bankruptcy or similar proceeding for Prosper Funding, interest accruing on the Prosper Funding Notes during the proceedings may not be part of the allowed claim of a holder of a Prosper Funding Note.  If the holder of a Prosper Funding Note receives a recovery on the Prosper Funding Note (and no such recovery can be assured), any such recovery may be based on, and limited to, the claim of the holder of the Prosper Funding Note for principal and for interest accrued up to the date of the bankruptcy or similar proceeding, but not thereafter.  Because a bankruptcy or similar proceeding may take months or years to complete, a claim based on principal and on interest only up to the start of the bankruptcy or similar proceeding may be substantially less than a claim based on principal and on interest through the end of the bankruptcy or similar proceeding.
If Prosper Funding becomes subject to a bankruptcy or similar proceeding a holder of a Prosper Funding Note may not have any priority right to payment from the corresponding Prosper Funding Borrower Loan, may not have any right to payment from funds in the deposit account, and may not have any ability to access funds in an FBO Funding account.

If Prosper Funding failed to perfect the security interest properly, you may be required to share the proceeds of the Prosper Funding Borrower Loan upon which your Prosper Funding Note is dependent for payment with Prosper Funding’s other creditors, including holders of other Prosper Funding Notes, PMI Note or Prosper Funding Borrower Loans. To the extent that proceeds of the corresponding Prosper Funding Borrower Loan would be shared with Prosper Funding’s other creditors, any secured or priority rights of such other creditors may cause the proceeds to be distributed to such other creditors before any distribution is made to you on your Prosper Funding Note.
 
If a payment is made on a Prosper Funding Borrower Loan corresponding to a Prosper Funding Note before Prosper Funding’s bankruptcy or similar proceeding is commenced, and those funds are held in the deposit account Prosper Funding maintains with Wells Fargo to collect borrower payments and have not been used by Prosper Funding to make payments on the Prosper Funding Note as of the date the bankruptcy or similar proceeding is commenced, there can be no assurance that Prosper Funding will or will be able to use such funds to make payments on the Prosper Funding Note. Other creditors of Prosper Funding (including holders of other Prosper Funding Notes, PMI Note or Prosper Funding Borrower Loans) may be deemed to have rights to such funds or interests in the deposit account and monies credited thereto that are equal to or greater than the rights of the holder of the Prosper Funding Note. See “Item 1. Business—Loan Servicing and Collection” for more information.

Although Prosper Funding believes that amounts funded by lender members into the FBO Funding accounts should not be subject to claims of its creditors other than the lender members for whose benefit the funds are held, the legal title to the FBO Funding accounts, and the attendant right to administer the FBO Funding accounts would be property of Prosper Funding’s bankruptcy estate. As a result, if Prosper Funding were to file for bankruptcy protection, the legal right to administer the funds in the FBO Funding accounts would vest with the bankruptcy trustee or debtor in possession. In that case, while neither Prosper Funding nor its creditors should be able to reach those funds, the indenture trustee or the lender members may have to seek a bankruptcy court order lifting the automatic stay and permitting them to withdraw their funds. Lender members may suffer delays in accessing their funds in the FBO Funding accounts as a result. Moreover, United States Bankruptcy Courts have broad powers at law and in equity and, if Prosper Funding has failed to properly segregate or handle lender members’ funds, a bankruptcy court could determine that some or all of such funds were beneficially owned by Prosper Funding and therefore that they became available to Prosper Funding’s creditors generally. See “Item 1. Business—Loan Servicing and Collection”” for more information.

In a bankruptcy or similar proceeding for Prosper Funding, the holder of a Prosper Funding Note may be delayed or prevented from enforcing Prosper Funding’s repurchase obligations.

In a bankruptcy or similar proceeding for Prosper Funding, any right of a holder of a Prosper Funding Note to require Prosper Funding to repurchase the Prosper Funding Note or indemnify the holder of the Prosper Funding Note under the circumstances set forth in the lender member agreement or Prosper Funding Note might not be enforceable, and such holder’s claim for such repurchase may be treated less favorably than a general unsecured obligation of Prosper Funding. For a discussion of the restrictions Prosper Funding has imposed upon itself and the formalities it has adopted under its organizational documents to minimize the likelihood of its becoming subject to a bankruptcy or similar proceeding, see “Item 1. Business—Information about Prosper Funding and Prosper Marketplace, Inc.”

Although Prosper Funding has been organized in a manner that is intended to prevent it from being substantively consolidated with PMI in the event of PMI’s bankruptcy, if Prosper Funding were substantively consolidated in this manner, the rights of the holders of the Prosper Funding Notes could be uncertain, and payments on the Prosper Funding Notes may be limited, suspended or stopped.  The recovery, if any, of a holder on a Prosper Funding Note may therefore be substantially delayed and substantially less than the principal and interest due and to become due on the Prosper Funding Note.

Although Prosper Funding has been organized and is operated in a manner that is intended to prevent it from being substantively consolidated with PMI in the event of PMI’s bankruptcy, if PMI became subject to a bankruptcy or similar proceeding and Prosper Funding were substantively consolidated with PMI, the risks described in the immediately preceding risk factors regarding (i) payment delays, (ii) uncollectability of interest accrued during the bankruptcy proceeding, (iii) being subordinated to the interests of Prosper Funding’s other creditors, and (iv) the indenture trustee’s inability to access funds in the deposit account or the FBO Funding accounts would all be present and, in addition, the same considerations would apply in relation to the claims of creditors of PMI, including that such creditors of PMI may be determined to have perfected security interests or unsecured claims that take precedence over or are at least equal in priority to those of creditors of Prosper Funding (including holders of Prosper Funding Notes).

In addition, in a bankruptcy or similar proceeding of PMI, (i) the implementation of back-up servicing arrangements may be delayed or prevented, and (ii) PMI’s ability to transfer its servicing obligations to a back-up servicer or its other corporate and platform administration services and marketing services to third parties may be limited and subject to the approval of the bankruptcy court or other presiding authority. The bankruptcy process may delay or prevent the implementation of back-up servicing, which may impair the collection of Prosper Funding Borrower Loans to the detriment of holders of the Prosper Funding Notes.

For a discussion of the restrictions Prosper Funding has imposed upon itself and the formalities it has adopted under its organizational documents and agreed to in the Amended and Restated Indenture to prevent its being substantively consolidated with PMI in the event of PMI’s bankruptcy, see “Item 1. Business—Information about Prosper Funding and Prosper Marketplace, Inc.”

PMI owns and did not transfer to Prosper Funding ownership of the computer hardware that it uses to host and maintain the website or agreements with third parties relating to the hosting and maintenance of the website. Although PMI’s retention of such hardware and agreements should not bear on a bankruptcy court’s analysis of the legal separateness of PMI and Prosper Funding (or their respective assets and liabilities), the cessation of or substantial reduction of the day-to-day operations of PMI (because of or during its bankruptcy or otherwise) would materially impair and delay the ability of Prosper Funding or a back-up service provider to retrieve data and information in the possession of PMI and to operate the platform or elements thereof relevant to Prosper Funding Borrower Loan and Prosper Funding Note servicing.
 
PMI, in its capacity as servicer, has the authority to waive or modify the terms of a Prosper Funding Borrower Loan without the consent of the Prosper Funding Note holders.

Pursuant to the Administration Agreement, PMI is obligated to use commercially reasonable efforts to service and collect the Prosper Funding Borrower Loans in accordance with industry standards. Subject to that obligation, the Administration Agreement grants PMI the authority to waive or modify any non-material term of a Prosper Funding Borrower Loan or consent to the postponement of strict compliance with any such term or in any manner grant a non-material indulgence to any borrower. In addition, if a Prosper Funding Borrower Loan is in default, or PMI determines default is reasonably foreseeable, or PMI determines such action is consistent with its servicing obligation, the Administration Agreement grants PMI the authority to waive or modify a material term of a Prosper Funding Borrower Loan, to accept payment of an amount less than the principal balance in final satisfaction of a Prosper Funding Borrower Loan and to grant any indulgence to a borrower, provided that PMI has reasonably and prudently determined that such action will not be materially adverse to the interests of the relevant Prosper Funding Note holders. If PMI approves a modification to the terms of any Prosper Funding Borrower Loan it must promptly notify the corresponding Prosper Funding Note holders by e-mail of the material terms of such modification and the effect such modification will have on their Prosper Funding 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.

PMI Borrower Loans sold to PMI’s lender members through PMI’s platform from November 2005 until October 16, 2008 may be viewed as involving an offering of securities that was not registered or qualified under federal or state securities laws. See Item 3. "Legal Proceedings" For more information.
As a result of PMI’s prior operations, a lender member who holds a PMI Borrower Loan originated on the platform prior to October 15, 2008 may be entitled to rescind her purchase and be paid the unpaid principal amount of her PMI Borrower Loan, plus statutory interest. PMI has not recorded an accrued loss contingency in respect of this contingent liability, although it intends to continue to monitor the situation. Generally, the federal statute of limitations for noncompliance with the requirement to register securities under the Securities Act is one year from the violation; however, the statute of limitations periods under state laws may extend for a longer period of time. Under the Administration Agreement, PMI is generally responsible for overseeing the operation of the platform on Prosper Funding’s behalf. If a significant number of PMI’s former lender members sought rescission, PMI’s ability to perform its obligations under the Administration Agreement may be adversely affected and, in such event, Prosper Funding’s ability to continue to make payments on the Prosper Funding Notes could be materially impaired.
PMI has incurred operating losses since inception and may continue to incur net losses in the future.
 
PMI has incurred operating losses since its inception and it may continue to incur net losses in the future. For the twelve months ended December 31, 2013 and 2012 PMI had negative cash flows from operations of $24,826 and $16,162, respectively. Additionally, from its inception through December 31, 2013, PMI had an accumulated deficit of $104,080.

PMI has financed its operations to date primarily with proceeds from the sale of equity securities. At December 31, 2013, PMI had approximately $18,339 in unrestricted cash and cash equivalents and short term investments. PMI is dependent upon raising additional capital or debt financing to fund its current operating plan. PMI’s failure to obtain sufficient debt and equity financing and, ultimately, to achieve profitable operations and positive cash flow from operations could adversely affect its ability to perform its obligations under the Administration Agreement and, in such event, Prosper Funding’s ability to continue to make payments on the Prosper Funding Notes could be materially impaired.
 
Prosper Funding and PMI both have limited operating histories.  As online companies in the early stages of development, Prosper Funding and PMI face increased risks, uncertainties, expenses and difficulties.

As the number of borrowers, lender members and Prosper Funding Borrower Loans originated on the platform increases, PMI will need to increase its facilities, personnel and infrastructure in order to accommodate the anticipated greater obligations on it under the Administration Agreement as the result of the anticipated greater servicing obligations and demands on the platform. PMI must constantly add new hardware and update its software and the platform, expand customer support services, and add new employees to maintain the operations of the platform as well as to satisfy its servicing obligations on the Prosper Funding Borrower Loans and the Prosper Funding Notes and its other obligations under the Administration Agreement. If PMI is unable to increase the capacity of the platform and maintain the necessary infrastructure to perform its duties under the Administration Agreement, Prosper Funding, or one or more other third-party service providers engaged by Prosper Funding, will have to perform the duties otherwise performed by PMI, and you may experience delays in receipt of payments on your Prosper Funding Notes and periodic downtime of the platform.

Prosper Funding is a new company and with a limited operating history.

Prosper Funding is a recently formed limited purpose vehicle with a limited operating history. On February 1, 2013, PMI made an additional capital contribution to Prosper Funding in excess of $3,000. Under the Administration Agreement, Prosper Funding is entitled to receive a license fee from PMI for granting PMI a non-exclusive, worldwide license to access and use the platform. The license fee is payable on the last business day of each month and shall equal the product of $150.00 (not in thousands) and the number of borrower listings posted on the platform on any given month, provided that on the last business day of each calendar year during the term of the license on or after 2013, PMI is obligated pay Prosper Funding an additional amount equal to zero or the difference, if positive, between $2,500 and the aggregate amounts paid through such date in respect of such monthly license fee amounts already paid through such date during such calendar year. In addition, Prosper Funding will earn servicing fees in relation to the servicing of the Prosper Funding Borrower Loans and Prosper Funding Notes that it will retain from collections on the Prosper Funding Borrower Loans. The licensing fees and servicing fees received by Prosper Funding are projected to substantially exceed the fees it will pay to PMI for services rendered by PMI under the Administration Agreement and its other current obligations pursuant to its agreements with other third parties. Prosper Funding believes this fee income will be sufficient to cover its reasonably anticipated obligations. While Prosper Funding believes that it will be adequately capitalized to meet its foreseeable obligations, and that its fee income will be sufficient to meet its ongoing operating costs, its financial resources will be limited and could prove to be insufficient. In addition, Prosper Funding has no employees and will rely on PMI, as servicer, or other third-party service providers, to perform most of its day-to-day operations. While Prosper Funding generally expects the platform to present the same risks it presented when PMI operated the platform, the lack of Prosper Funding’s own employees, its limited operating history, and capitalization that is less than that of PMI could make it more difficult for Prosper Funding to operate at a level that will be sustainable. Absent the services to be provided to Prosper Funding by PMI pursuant to the Administration Agreement, Prosper Funding’s risk management process, ability to predict loss rates and the general operation of the platform would have a thinner margin for error than does PMI.

The market in which Prosper Funding participates is competitive and, if it does not compete effectively, its operating results could be harmed.

The consumer lending market is competitive and rapidly changing.  With the introduction of new technologies and the influx of new entrants, Prosper Funding expects competition to persist and intensify in the future, which could harm Prosper Funding’s ability to increase volume on the platform.

Prosper Funding’s principal competitors include major banking institutions, credit unions, credit card issuers and other consumer finance companies, as well as other peer-to-peer lending platforms, including LendingClub.  Competition could result in reduced volumes, reduced fees or the failure of the platform to achieve or maintain more widespread market acceptance, any of which could harm Prosper Funding’s business.  In addition, in the future Prosper Funding may experience new competition including companies possessing large, existing customer bases, substantial financial resources and established distribution channels.  If any of these companies or any major financial institution decided to enter the peer-to-peer lending business, acquire one of Prosper Funding’s existing competitors or form a strategic alliance with one of Prosper Funding’s competitors, Prosper Funding’s ability to compete effectively could be significantly compromised and its operating results could be harmed.

Most of Prosper Funding’s current or potential competitors have significantly more financial, technical, marketing and other resources than Prosper Funding does and may be able to devote greater resources to the development, promotion, sale and support of their platforms and distribution channels.  Prosper Funding’s potential competitors may also have longer operating histories, more extensive customer bases, greater brand recognition and broader customer relationships than Prosper Funding has.  These competitors may be better able to develop new products, to respond quickly to new technologies and to undertake more extensive marketing campaigns.  Prosper Funding’s industry is driven by constant innovation.  If Prosper Funding is unable to compete with such companies and meet the need for innovation, the use of the platform could stagnate or substantially decline.

If Prosper Funding fails to promote and maintain its brand in a cost-effective manner, it may lose market share and its revenue may decrease.

To succeed, Prosper Funding must increase transaction volumes on the platform by attracting a large number of borrower and lender members in a cost-effective manner, many of whom have not previously participated in peer-to-peer lending. If Prosper Funding is not able to attract qualified borrowers and sufficient lender member purchase commitments, it will not be able to increase its transaction volumes. Prosper Funding believes that developing and maintaining awareness of its brand in a cost-effective manner is critical to achieving widespread acceptance of the platform and attracting new borrower and lender members. Furthermore, it believes that the importance of brand recognition will increase as competition in the peer-to-peer lending industry increases. Successful promotion of its brand will depend largely on the effectiveness of marketing efforts and the member experience on the platform. These brand promotion activities may not yield increased revenues. If Prosper Funding fails to successfully promote and maintain its brand, it may lose its existing members to competitors or be unable to attract new members, which would cause its revenue to decrease and may impair its ability to maintain the platform.

Prosper Funding and PMI are subject to extensive federal, state and local regulation that could adversely impact their ability to service the Prosper Funding Notes.

Prosper Funding and PMI are subject to extensive federal, state and local regulation, non-compliance with which could have a negative impact on their ability to service the Prosper Funding Notes, provide a trading market for the Prosper Funding Notes, or maintain the platform.

Additionally, PMI holds lending licenses, collections licenses or similar authorizations in 24 states, all of which have the authority to supervise and examine PMI’s activities. Prosper Funding holds a consumer lending license in 1 state, which has the authority to supervise and examine Prosper Funding’s activities.  Because Prosper Funding currently relies on PMI, pursuant to the Administration Agreement, to oversee the operation of the platform on its behalf, if PMI does not comply with applicable laws, PMI could lose one or more of these licenses or authorizations, which may have an adverse effect on Prosper Funding’s ability to continue to perform its servicing obligations or maintain the platform. See “Item 1. Government Regulation—Regulation and Consumer Protection Laws” for more information.

The Federal Fair Debt Collection Practices Act and similar state debt collection laws regulate debt collection practices by “debt collectors” and prohibit debt collectors from engaging in certain practices in collecting, and attempting to collect, outstanding consumer loans. While Prosper Funding obligates the collection agencies it uses to comply with applicable law in collecting Prosper Funding Borrower Loans (and PMI has sought and will seek to comply with such law when it undertakes direct collection activity in relation to Prosper Funding Borrower Loans and PMI Borrower Loans), it is possible that improper collection practices may occur that could adversely affect the collectability of particular Prosper Funding Borrower Loans originated through the platform or could result in financial penalties or operating restrictions being imposed on Prosper Funding or PMI that adversely affect their ability to operate or perform their respective payment and other obligations.

The proprietary technology that makes operation of the platform possible is not protected by any patents.  It may be difficult and costly for Prosper Funding to protect its intellectual property rights in relation thereto, or to continue to develop or obtain new technologies, which could adversely affect its ability to operate competitively.
 
On February 1, 2013, PMI transferred ownership of the platform, including the proprietary technology and all of the rights related to the operation of the platform, to Prosper Funding.  Prosper Funding’s ability to maintain the platform depends, in part, upon this proprietary technology.  Both Prosper Funding and PMI intend to vigorously protect proprietary interests in such technology.  Despite their best efforts, however, Prosper Funding or PMI may not protect the proprietary technology effectively, which would allow competitors to duplicate their products and adversely affect Prosper Funding and PMI’s ability to compete.  A third party may attempt to reverse engineer or otherwise obtain and use the proprietary technology without Prosper Funding’s consent.  In addition, the platform may infringe upon claims of third-party patents and Prosper Funding or PMI may face intellectual property challenges from such other parties.  Prosper Funding or PMI may not be successful in defending against any such challenges or in obtaining licenses to avoid or resolve any intellectual property disputes.  Furthermore, the technology may become obsolete, and there is no guarantee that Prosper Funding will be able to successfully develop, obtain or use new technologies to adapt the platform to compete with other peer-to-peer lending platforms.  If Prosper Funding cannot protect the proprietary technology embodied in and used by the platform from intellectual property challenges, or if the platform becomes obsolete, its ability to maintain the platform and perform its servicing obligations could be adversely affected and, in such event, its ability to continue to make payments on the Prosper Funding Notes could be materially impaired.

Prosper Funding relies on a third-party commercial bank to process transactions.  If Prosper Funding is unable to continue utilizing these services, its business and ability to service the Prosper Funding Notes may be adversely affected.

Because Prosper Funding is not a bank, it cannot belong to or directly access the Automated Clearing House (ACH) payment network.  As a result, it currently relies on an FDIC-insured depository institution to process its transactions.  If Prosper Funding cannot continue to obtain such services from this institution or elsewhere, or if it cannot transition to another processor quickly, its ability to process payments will suffer and lender members’ ability to receive principal and interest payments on the Prosper Funding Notes will be delayed or impaired.

If the security of Prosper Funding’s lender members’ and borrower members’ confidential information stored in Prosper Funding or PMI’s systems is breached or otherwise subjected to unauthorized access, members’ secure information may be stolen, Prosper Funding and PMI’s reputations may be harmed, and they may be exposed to liability.

As with any entity with a significant Internet presence, Prosper Funding, PMI and the third party that PMI uses for website hosting occasionally have experienced cyber-attacks, attempts to breach their systems and other similar incidents, none of which have been successful.  The platform stores Prosper Funding’s lender members’ and borrower members’ bank information and other personally-identifiable sensitive data.  Any accidental or willful security breaches or other unauthorized access could cause members’ secure information to be stolen and used for criminal purposes.  Security breaches or unauthorized access to secure information could also expose Prosper Funding or PMI to liability related to the loss of the information, time-consuming and expensive litigation and negative publicity.  If security measures are breached because of third-party action, employee error, malfeasance or otherwise, or if design flaws in the relevant software are exposed and exploited, and, as a result, a third party or disaffected employee obtains unauthorized access to any lender members’ or borrower members’ data, Prosper Funding’s relationships with its members will be severely damaged, and it (or PMI) could incur significant liability.  Because techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until they are launched against a target, Prosper Funding, PMI and PMI’s third-party hosting facilities may be unable to anticipate these techniques or to implement adequate preventative measures.  In addition, many states have enacted laws requiring companies to notify individuals of data security breaches involving their personal data.  These mandatory disclosures regarding a security breach are costly to implement and often lead to widespread negative publicity, which may cause Prosper Funding’s members to lose confidence in the effectiveness of its and PMI’s data security measures.  Any security breach, whether actual or perceived, would harm Prosper Funding and PMI’s reputations, and Prosper Funding could lose members.

Any significant disruption in service on the platform or in PMI’s computer systems could adversely affect PMI’s ability to perform its obligations under the Administration Agreement.
 
PMI’s ability to perform its obligations under the Administration Agreement could be materially and adversely affected by events outside of its control.  The satisfactory performance, reliability and availability of PMI’s technology and its underlying network infrastructure are important to Prosper Funding and PMI’s respective operations, level of customer service, reputation and ability to attract new members and retain existing members.  PMI’s system hardware is hosted in a hosting facility located in San Francisco, California, owned and operated by Digital Realty Trust.  PMI also maintains an off-site backup system located in Las Vegas, Nevada.  Digital Realty Trust does not guarantee that access to the platform or to PMI’s own systems will be uninterrupted, error-free or secure.  The operation of the platform and PMI’s operation of its own systems depend on Digital Realty Trust’s ability to protect the relevant systems in Digital Realty Trust’s facilities against damage or interruption from natural disasters, power or telecommunications failures, air quality, temperature, humidity or other environmental concerns, computer viruses or other attempts to harm them, criminal acts and similar events.  If PMI’s arrangement with Digital Realty Trust is terminated, or there is a lapse of service or damage to Digital Realty Trust’s facilities, PMI could experience interruptions in providing its services under the Administration Agreement, Prosper Funding could experience interruptions in the operations of the platform, and both could experience delays and additional expense in arranging new facilities.  Any interruptions or delays in PMI’s performance of its services or in the functioning of and accessibility of the platform, whether as a result of Digital Realty Trust or other third-party error, PMI’s error, natural disasters or security breaches, whether accidental or willful, could harm Prosper Funding’s relationships with its members and its reputation.  Additionally, in the event of damage or interruption, PMI’s insurance policies may not be sufficient for PMI to adequately compensate Prosper Funding for any losses that it may incur.  PMI’s disaster recovery plan has not been tested under actual disaster conditions, and PMI may not have sufficient capacity to recover all data and services in the event of an outage at the Digital Realty Trust facility.  These factors could prevent PMI from processing or posting payments on the Prosper Funding Borrower Loans or the Prosper Funding Notes, damage Prosper Funding’s brand and reputation, divert the attention of PMI’s employees, reduce Prosper Funding’s revenue, subject PMI or Prosper Funding to liability and cause members to abandon the platform, any of which could adversely affect PMI and Prosper Funding’s respective businesses, financial condition and results of operations.

The platform may be vulnerable to computer viruses, physical or electronic break-ins and similar disruptions.

The platform may be vulnerable to computer viruses, physical or electronic break-ins and similar disruptions.  If a “hacker” were able to infiltrate the platform, members would be subject to the increased risk of fraud or borrower identity theft and may experience losses on, or delays in the recoupment of amounts owed on, a fraudulently induced purchase of a Prosper Funding Note.  Additionally, if a hacker were able to access Prosper Funding or PMI’s secure files, he or she might be able to gain access to members’ personal information.  While Prosper Funding and PMI have taken steps to prevent such activity from affecting the platform, if they are unable to prevent such activity, the value of your investment in the Prosper Funding Notes could be adversely affected.

Competition for PMI’s employees is intense, and PMI may not be able to attract and retain the highly skilled employees it needs to perform under the Administration Agreement.

Competition for highly skilled technical and financial personnel is extremely intense.  PMI may not be able to hire and retain these personnel at compensation levels consistent with its existing compensation and salary structure.  Many of the companies with which PMI competes for experienced employees have greater resources than PMI has and may be able to offer more attractive terms of employment.

In addition, PMI invests significant time and expense in training its employees, which increases their value to competitors who may seek to recruit them. If PMI fails to retain its employees, it could incur significant expenses in hiring and training their replacements and the quality of its services and its ability to serve borrower and lender members could diminish, resulting in a material adverse effect on its ability to perform its obligations under the Administration Agreement and, in such event, Prosper Funding’s ability to continue to make payments on the Prosper Funding Notes could be materially impaired.

PMI’s growth could strain its personnel resources and infrastructure, and if PMI is unable to implement appropriate controls and procedures to manage its growth, this may adversely affect its ability to perform under the Administration Agreement.

PMI’s growth in headcount and operations since its inception has placed, and will continue to place, to the extent that PMI is able to sustain such growth, a significant strain on its management and its administrative, operational and financial reporting infrastructure.

PMI’s success will depend in part on the ability of its senior management effectively to manage the growth it achieves.  To do so, PMI must continue to hire, train and manage new employees as needed.  If PMI’s new hires perform poorly, or if PMI is unsuccessful in hiring, training, managing and integrating new employees, or if PMI is not successful in retaining its existing employees, its ability to perform under the Administration Agreement may be impaired.  To manage the expected growth of PMI’s operations and personnel, PMI will need to continue to improve its operational and financial controls and update its reporting procedures and systems.  The addition of new employees and the system development that PMI anticipates will be necessary to manage its growth will increase PMI’s cost base, which will make it more difficult for PMI to offset any future revenue shortfalls by reducing expenses in the short term.  If PMI fails to successfully manage its growth, it will be unable to execute its business plan and its ability to perform under the Administration Agreement may be impaired.

Purchasers of Prosper Funding Notes will have no control over Prosper Funding or PMI and will not be able to influence their corporate matters.

Prosper Funding is not offering and will not offer equity interests in its company. Lender members who purchase Prosper Funding Notes offered through the platform will have no equity interest in Prosper Funding or in PMI and no ability to vote on or influence their decisions. As a result, PMI, which owns all of Prosper Funding’s outstanding equity interests, will continue to have sole control over Prosper Funding’s governance matters, subject to the presence of Prosper Funding’s independent directors, whose consent will be required before Prosper Funding can take certain extraordinary actions, and subject to the limitations specified in Prosper Funding’s organizational documents and the Amended and Restated Indenture. See “Item 1. Business—Information About Prosper Funding and Prosper Marketplace, Inc.” for more information.

Individuals who make misrepresentations or omissions in violation of the securities laws of the State of Washington when posting comments on the platform may be subject to sellers’ liability under the Securities Act of Washington.

Prosper Funding permits its members and loan applicants to post certain comments on the platform. Individuals who make misrepresentations or omissions in violation of section 21.20.010 of the Securities Act of Washington when posting such comments may be subject to sellers’ liability under the Securities Act of Washington. Neither Prosper Funding nor PMI monitors the comments posted on the platform for statements that might violate the securities laws of the State of Washington.

Events beyond Prosper Funding and PMI’s control may damage their ability to maintain adequate records, maintain the platform or perform the servicing obligations.  If such events result in a system failure, your ability to receive principal and interest payments on the Prosper Funding Notes would be substantially harmed.

If a catastrophic event resulted in a platform outage and physical data loss, Prosper Funding’s ability (and PMI’s ability as servicer under the Administration Agreement) to perform its servicing obligations would be materially and adversely affected.  Such events include, but are not limited to, fires, earthquakes, terrorist attacks, natural disasters, computer viruses and telecommunications failures.  In addition, PMI is responsible for storing back-up records related to the operation of the platform in offsite facilities located in San Francisco, California and Las Vegas, Nevada.  If PMI’s electronic data storage and back-up data storage system are affected by such events, Prosper Funding’s ability (and PMI’s ability as servicer under the Administration Agreement) to perform its servicing obligations could be materially and adversely affected.  In the event of any platform outage or physical data loss described in this paragraph, Prosper Funding cannot guarantee that you would be able to recoup your investment in the Prosper Funding Notes.

Prosper Funding is an “emerging growth company” under the JOBS Act of 2012, and it cannot be certain if the reduced reporting requirements applicable to emerging growth companies will make the Prosper Funding Notes less attractive to investors.

Prosper Funding is an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”) and, as such, it is eligible for certain exemptions from reporting requirements that are applicable to other public companies that are not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of section 404 of the Sarbanes-Oxley Act and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. Prosper Funding will remain an emerging growth company until the earliest of: (i) the first fiscal year after it has revenue in excess of $1,000,000, (ii) the beginning of the sixth fiscal year after its first registered sale of common equity securities in an initial public offering, (iii) the date upon which it has issued in excess of $1,000,000 of non-convertible debt during the previous three-year period, or (iv) the date on which it would be deemed a “large accelerated filer” under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Prosper Funding cannot predict if investors will find the Prosper Funding Notes less attractive because it may rely on these exemptions.

Section 107 of the JOBS Act also provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. However, Prosper Funding has elected to “opt out” of this extended transition period, and as a result, it will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-“emerging growth companies.” Its decision to opt out of the extended transition period is irrevocable.

RISKS RELATING TO COMPLIANCE AND REGULATION

The platform represents a novel approach to borrowing and lending that may fail to comply with federal and state securities laws, borrower protection laws, such as state lending laws, federal consumer protection laws, such as the Truth in Lending Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act and the Fair Debt Collection Practices Act, and the state counterparts to such consumer protection laws.  Borrowers may dispute the enforceability of their obligations under borrower or consumer protection laws after collection actions have commenced, or otherwise seek damages under these laws.  Lender members may attempt to rescind their Prosper Funding Note purchases under securities laws.  Compliance with such regulatory regimes is also costly and burdensome.

The platform represents a novel program that must comply with regulatory regimes applicable to consumer credit transactions as well as with regulatory regimes applicable to securities transactions.  The novelty of the platform means compliance with various aspects of such laws is untested.  Certain state laws generally regulate interest rates and other charges and require certain disclosures, and also require licensing for certain activities.  In addition, other state laws, public policy and general principles of equity relating to the protection of consumers, unfair and deceptive practices and debt collection practices may apply to the origination, servicing and collection of Prosper Funding Borrower Loans on the platform.  The platform is also subject to other laws, such as:

· the Federal Truth-in-Lending Act and Regulation Z promulgated thereunder, which require certain disclosures to borrowers regarding the terms of their loans;

· the Federal Equal Credit Opportunity Act and Regulation B promulgated thereunder, which prohibit discrimination in the extension of credit on the basis of age, race, color, sex, religion, marital status, national origin, receipt of public assistance or the exercise of any right under the Consumer Credit Protection Act;

· the Federal Fair Credit Reporting Act, which regulates the use and reporting of information related to each applicant’s credit history;

· the Federal Fair Debt Collection Practices Act, which regulates debt collection practices by “debt collectors” and prohibits debt collectors from engaging in certain practices in collecting, and attempting to collect, outstanding consumer loans;

· state counterparts to the above consumer protection laws; and

· state and federal securities laws, which require that any non-exempt offers and sales of the Securities be registered.

Prosper Funding and PMI may not always be in compliance with these laws. Borrowers may make counterclaims regarding the enforceability of their obligations under borrower or consumer protection laws after collection actions have commenced, or otherwise seek damages under these laws. Lender members may attempt to rescind their Prosper Funding Note purchases under securities laws, and Prosper Funding or PMI’s failure to comply with such laws could also result in civil or criminal liability. For example, in 2010 and 2011 PMI failed to timely renew its applications to offer and sell PMI Notes in several states, resulting in $76 in penalties in five states, and the repurchase of $22 of PMI Notes from Florida residents pursuant to a rescission offer. Compliance with these requirements is also costly, time-consuming and limits operational flexibility. See “Item 1. Government RegulationRegulation and Consumer Protection Laws” for more information.

Noncompliance with laws and regulations may impair PMI’s ability to facilitate the origination of or service Prosper Funding Borrower Loans.
 
Generally, failure to comply with applicable laws and regulatory requirements may, among other things, limit Prosper Funding’s, PMI’s or a collection agency’s ability to collect all or part of the principal amount of or interest on the Prosper Funding Borrower Loans on which the Prosper Funding Notes are dependent for payment. In addition, non-compliance could subject Prosper Funding or PMI to damages, revocation of required licenses, class action lawsuits, administrative enforcement actions, and civil and criminal liability, which may harm Prosper Funding’s business and ability to maintain the platform and may result in borrowers rescinding their Prosper Funding Borrower Loans.
 
Where applicable, Prosper Funding and PMI seek to comply with state lending, servicing and similar statutes. In all U.S. jurisdictions with licensing or other requirements that Prosper Funding and PMI believe may be applicable to the platform, Prosper Funding and PMI have obtained any necessary licenses or comply with the relevant requirements. Nevertheless, if Prosper Funding or PMI are found to not comply with applicable laws, Prosper Funding or PMI could lose one or more of their licenses or face other sanctions, which may have an adverse effect on PMI’s ability to continue to facilitate the origination of Prosper Funding Borrower Loans through the platform, and on Prosper Funding or PMI’s ability to perform servicing obligations or make the platform available to borrowers in particular states, which may impair your ability to receive the payments of principal and interest on your Prosper Funding Notes that you expect to receive. See “Item 1. Government Regulation—Regulation and Consumer Protection Laws—State and Federal Laws and Regulations” for more information.

Prosper Funding and PMI rely on agreements with WebBank, pursuant to which WebBank originates loans to qualified borrower members on a uniform basis throughout the United States and sells and assigns those loans to Prosper Funding. If Prosper Funding and PMI’s relationships with WebBank were to end, Prosper Funding may need to rely on individual state lending licenses to originate Prosper Funding Borrower Loans.

Prosper Funding Borrower Loan requests take the form of an application to WebBank submitted through the platform. WebBank currently makes all loans to borrowers through the platform, which allows the platform to be available to borrowers on a uniform basis throughout the United States. If Prosper Funding and PMI’s relationship with WebBank were to end or if WebBank were to cease operations, Prosper Funding may need to rely on individual state lending licenses to originate Prosper Funding Borrower Loans. Because Prosper Funding currently possesses only one state lending license, it might be forced to limit the rates of interest charged on Prosper Funding Borrower Loans in some states and it might not be able to originate loans in some states altogether. It also may face increased costs and compliance burdens if the agreements with WebBank are terminated.

Several lawsuits have sought to recharacterize certain loan marketers and other originators as lenders. If litigation or a regulatory enforcement action on similar theories were successful against Prosper Funding or PMI, Prosper Funding Borrower Loans originated through the platform could be subject to state consumer protection laws and licensing requirements in a greater number of states.

Several lawsuits have brought under scrutiny the association between high-interest “payday loan” marketers and out-of-state banks.  These lawsuits assert that payday loan marketers use out-of-state lenders in order to evade the consumer protection laws imposed by the states where they do business.  Such litigation has sought to recharacterize the loan marketer as the lender for purposes of state consumer protection law restrictions.  Similar civil actions have been brought in the context of gift cards.  Prosper Funding and PMI believe that their activities are distinguishable from the activities involved in these cases.

Nevertheless, if Prosper Funding or PMI were recharacterized as the lender of Prosper Funding Borrower Loans, such a recharacterization could render those loans voidable or unenforceable in whole or in part. In addition, Prosper Funding and PMI could be subject to claims by borrowers, as well as enforcement actions by regulators. Even if Prosper Funding or PMI were not required to cease doing business with residents of certain states or to change their business practices to comply with applicable laws and regulations, they could be required to register or obtain licenses or regulatory approvals that could impose a substantial cost on them. To date, no actions have been taken or threatened against Prosper Funding or PMI on the theory that either has engaged in unauthorized lending. However, such actions could have a material adverse effect on Prosper Funding or PMI’s businesses.

As Internet commerce develops, federal and state governments may draft and propose new laws to regulate Internet commerce, which may negatively affect Prosper Funding and PMI’s businesses.

As Internet commerce continues to evolve, increasing regulation by federal and state governments becomes more likely.  Prosper Funding and PMI’s businesses could be negatively affected by the application of existing laws and regulations or the enactment of new laws applicable to peer-to-peer lending.  The cost to comply with such laws or regulations could be significant and would increase Prosper Funding and PMI’s operating expenses, and Prosper Funding and PMI may be unable to pass along those costs to Prosper Funding’s members in the form of increased fees.  In addition, federal and state governmental or regulatory agencies may decide to impose taxes on services provided over the Internet.  These taxes could discourage the use of the Internet as a means of consumer lending, which would adversely affect the viability of the platform.
 
If Prosper Funding or PMI is required to register under the Investment Company Act, their ability to conduct business could be materially adversely affected.
 
The Investment Company Act of 1940, or the “Investment Company Act,” contains substantive legal requirements that regulate the manner in which “investment companies” are permitted to conduct their business activities. Prosper Funding and PMI believe each has conducted its business in a manner that does not result in being characterized as an investment company. If, however, Prosper Funding is deemed to be an investment company under the Investment Company Act, it may be required to institute burdensome compliance requirements and its activities may be restricted, which would materially adversely affect its business, financial condition and results of operations. Any determination that PMI is an investment company under the Investment Company Act similarly could impair its ability to perform its obligations under the Administration Agreement and thereby impair Prosper Funding’s ability to make payments on the Prosper Funding Notes. If Prosper Funding or PMI were deemed to be an investment company, Prosper Funding or PMI may also attempt to seek exemptive relief from the SEC, which could impose significant costs and delays on their businesses.

If Prosper Funding or PMI is required to register under the Investment Advisers Act, their ability to conduct business could be materially adversely affected.

The Investment Advisers Act of 1940, or the “Investment Advisers Act,” contains substantive legal requirements that regulate the manner in which “investment advisers” are permitted to conduct their business activities.  Prosper Funding believes that its business consists of providing a platform for peer-to-peer lending for which investment adviser registration and regulation do not apply under applicable federal or state law, and does not believe that it is required to register as an investment adviser with either the SEC or any of the various states. The SEC or a state securities regulator could reach a different conclusion, however.   Registration as an investment adviser could adversely affect Prosper Funding’s method of operation and revenues. For example, the Investment Advisers Act requires that an investment adviser act in a fiduciary capacity for its clients.  Among other things, this fiduciary obligation requires that an investment adviser manage a client’s portfolio in the best interests of the client, have a reasonable basis for its recommendations, fully disclose to its client any material conflicts of interest that may affect its conduct and seek best execution for transactions undertaken on behalf of its client.  It could be difficult for Prosper Funding to comply with this obligation without meaningful changes to its business operations, and there is no guarantee that it could do so successfully.  If Prosper Funding were ever deemed to be in non-compliance with applicable investment adviser regulations, it could be subject to various penalties, including administrative or judicial proceedings that might result in censure, fine, civil penalties (including treble damages in the case of insider trading violations), the issuance of cease-and-desist orders or other adverse consequences.  Similarly, any determination by regulators that PMI must register as an investment adviser could materially adversely affect PMI and impair its ability to continue to administer the platform on Prosper Funding’s behalf.

PMI’s previous administration of an automated bidding plan system and the administration of Quick Invest by PMI under its previous offering and by Prosper Funding under its current offering, could create additional liability for PMI or Prosper Funding and such liability could be material.

PMI’s former automated plan system allowed lender members to create their own automated bidding plans.  By creating such a plan, a lender member could have bids placed automatically on her behalf on loan listings that met loan criteria selected by her. In creating an automated bidding plan, the member could design those criteria herself, use a group of model criteria selected by PMI, or customize one of those groups of model criteria as she saw fit.   Each automated bidding plan consisted of a group of loan criteria, such as loan amount, minimum yield percentage, Prosper Rating, income and employment characteristics, and debt-to-income ratio. That group of criteria was divided into sub-groups, each of which were referred to as a “slice.”  The specific loans on which the lender member bid through her automated bidding plan were determined by the criteria in each of her plan slices.  If a loan listing was posted that satisfied all of the criteria in any one of her plan slices, a bid would automatically be placed on the listing on her behalf.

On July 6, 2011, PMI replaced the former automated plan system with a new loan search tool called Quick Invest. Under Quick Invest, lender members are no longer able to create automated plans and instead must identify Prosper Funding Notes that meet their investment criteria. A lender 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 Prosper Funding Note. Quick Invest then compiles a basket of Prosper Funding Notes for her consideration that meet her search criteria. If the pool of Prosper Funding Notes that meet her criteria exceeds the total amount she wishes to invest, Quick Invest selects Prosper Funding Notes from the pool based on how far the listings corresponding to the Prosper Funding Notes have progressed through the loan verification process, i.e., Prosper Funding 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 Prosper Funding 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 Prosper Funding Notes from that pool based on the principle of first in, first out, i.e., the Prosper Funding Notes from the pool with the corresponding listings that were posted on the website earliest will be selected first. If the member’s search criteria include multiple Prosper Ratings, Quick Invest divides her basket into equal portions, one portion representing each Prosper Rating selected. To the extent available Prosper Funding Notes with these Prosper Ratings are insufficient to fill the lender’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. 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 place bids on any Prosper Funding Notes identified by each such search. See “Item 1. Business—How to Bid to Purchase Prosper Funding Notes—Quick Invest” for more information.

Since the Prosper Funding Notes purchased through Quick Invest are the same as Prosper Funding Notes purchased manually, they present the same risks of non-payment as all Prosper Funding Notes that may be purchased through the platform. For example, there is a risk that a Prosper Funding Borrower Loan or PMI Borrower Loan identified through an automated plan or Quick Invest may become delinquent or default, and the estimated return and estimated loss for that loan individually, or the estimated loss or return for the plan or the basket of Prosper Funding Notes or PMI Notes selected by Quick Invest as a whole, may not accurately reflect the actual return or loss on such loan. If this were to occur, a lender member who purchased a PMI Note through an automated plan or Quick Invest could pursue a claim against PMI in connection with its representations regarding the performance of the PMI Borrower Loans bid upon through the plan or Quick Invest, and a lender member who purchases a Prosper Funding Note from Prosper Funding through Quick Invest could pursue a claim against Prosper Funding in connection with its representations regarding the performance of the Prosper Funding Borrower Loans bid upon through Quick Invest. A lender member could pursue such a claim under various antifraud theories under federal and state securities law. In addition, the SEC or a lender member may take the position that the plans created pursuant to the automated bidding plan model involved the offer and sale of a separate security. Since PMI did not register the automated bidding plans as separate securities, such a claim, if successful, could give lender members who invested in PMI Notes through such plans a rescission right under state or federal law and possibly subject PMI to civil fines or criminal penalties under federal or state law. If such a theory were sustained, PMI could be liable for sales through automated bidding plans that took place prior to July 6, 2011. To date, no actions have been taken or threatened against PMI on this theory. However, such actions could have a material adverse effect on PMI’s business.

Prosper Funding and PMI may face liability under state and federal securities law for statements in this Annual Report and in other communications that could be deemed to be an offer to the extent that such statements are deemed to be false or misleading.

Loan listings and other borrower information available on Prosper Funding’s website as well as in sales and listing reports are statements made in connection with the purchase and sale of securities that are subject to the antifraud provisions of the Exchange Act and the Securities Act.  In general, these liability provisions provide a purchaser of the Securities with a right to bring a claim against Prosper Funding or PMI for damages arising from any untrue statement of material fact or failure to state a material fact necessary to make any statements made not misleading.  Even though Prosper Funding and PMI have advised you of what they believe to be the material risks associated with an investment in the Securities, the SEC or a court could determine that they have not advised you of all of the material facts regarding an investment in the Securities, 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.

The activities of Prosper Funding and PMI in connection with the offer and sale of securities on the platform could result in potential violations of federal securities law and result in material liability to Prosper Funding and PMI.

Prosper Funding and PMI’s respective businesses are subject to federal and state securities laws that may limit the kinds of activities in which Prosper Funding and PMI may engage and the manner in which they engage in such activities.  For example, changes to the manner in which Prosper Funding offers and sells Prosper Funding Notes or other securities on the platform could be viewed by the SEC or a state securities regulator as involving the creation or sale of new, unregistered securities.  In such circumstances, the failure to register such securities could subject Prosper Funding and PMI to liability and the amount of such liability could be meaningful.  In addition, PMI previously entered into a settlement with the SEC and consented to the entry of a Cease and Desist order that requires PMI to cease and desist from committing or causing any violations or any future violations of the securities laws.  Failure to comply with that order could result in material civil or criminal liability, which could materially adversely affect PMI’s business and Prosper Funding’s offering of Prosper Funding Notes.

Item 1B.
Unresolved Staff Comments

Not applicable.
 
Item 2. 
Properties
 
The information set forth in Item 1 under the caption “Item 1. Business—Information About Prosper Funding and Prosper Marketplace, Inc. —Facilities” is incorporated herein by reference.
 
Item 3. 
Legal Proceedings

The information set forth in Item 1 under the caption “Item 1. Business—Information About Prosper Funding and Prosper Marketplace, Inc. —Legal Proceedings” is incorporated herein by reference.

Item 4. 
Mine Safety Disclosures

Not applicable.
Part II

Item 5. 
Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

On July 13, 2009, PMI commenced a continuous public offering of up to $500,000 in principal amount of the PMI Notes pursuant to a registration statement on Form S-1 (Registration Statement No. 333- 147019). The offering was a continuous offering and was declared effective by the SEC on July 10, 2009. From July 13, 2009 to January 31, 2013, PMI sold $273,961 in principal amount of PMI Notes at 100% of their principal amount. The PMI Notes were offered only through the website, and there were no underwriters or underwriting discounts. During the period from July 13, 2009 to January 31, 2013, PMI incurred estimated expenses of approximately $4,862 in connection with the offering, none of which were paid by PMI to its directors, officers, persons owning 10% or more of any class of PMI's equity securities or affiliates. As set forth in the prospectus for such offering, PMI used the proceeds of each series of PMI Notes to fund a corresponding PMI Borrower Loan designated by the lender members purchasing such series of PMI Notes. None of the proceeds from the PMI Notes were paid by PMI to its directors, officers, affiliates or persons owning 10% or more of any class of PMI’s equity securities.

PMI does not have publicly traded equity securities. At December 31, 2013, there were approximately 234 holders of record of PMI’s common stock. PMI has not paid cash dividends since inception, and does not anticipate paying cash dividends in the foreseeable future.

During the year ended December 31, 2013, PMI granted warrants to acquire 2,460 shares of PMI’s common stock at an exercise price of $0.10 per share.  These securities were sold in reliance on the exemption from the registration requirements of the Securities Act set forth in Section 4(2) of the Securities Act and Regulation D promulgated thereunder relative to sales by an issuer not involving a public offering.

During the year ended December 31, 2013, PMI issued 820 shares of common stock upon the exercise of warrants for an aggregate exercise price of $8.20.  These securities were sold in reliance on the exemption from the registration requirements of the Securities Act set forth in Section 4(2) of the Securities Act and Regulation D promulgated thereunder relative to sales by an issuer not involving a public offering.

On February 1, 2013, Prosper Funding and PMI commenced a continuous public offering pursuant to a registration statement on Form S-1 (Registration Statement Nos. 333-179941 and 333-179941-01).  The offering covers the issuance by Prosper Funding of up to $500,000 in principal amount of Prosper Funding Notes.  Each Prosper Funding Note comes attached with a PMI Management Right issued by PMI. The offering is a continuous offering and was declared effective by the SEC on December 27, 2012. From February 1, 2013 to December 31, 2013, Prosper Funding sold $621,578 in principal amount of Prosper Funding Notes at 100% of their principal amount. The Prosper Funding Notes were offered only through the website, and there were no underwriters or underwriting discounts. During the period from February 1, 2013 to December 31, 2013, Prosper Funding incurred estimated expenses of approximately $4,862 in connection with the offering, none of which were paid by Prosper Funding to its directors, officers, affiliates or persons owning 10% or more of Prosper Funding’s equity interests. As set forth in the prospectus for the offering, Prosper Funding is using the proceeds of each series of Prosper Funding Notes issued to fund a corresponding Borrower Loan through the platform.  None of the proceeds from the Prosper Funding Notes were paid by Prosper Funding to its directors, officers, affiliates or persons owning 10% or more of Prosper Funding’s equity interests.

Item 6.
Selected Financial Data

Not applicable.
Item 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION

PROSPER MARKETPLACE, INC.
 
This management’s discussion and analysis of financial condition and results of operations, or MD&A, contains forward-looking statements that involve risks and uncertainties. Please see “Forward-Looking Statements” in this Annual Report on Form 10-K for a discussion of the uncertainties, risks and assumptions associated with these statements. This discussion should be read in conjunction with PMI's historical financial statements and related notes thereto and the other disclosures contained elsewhere in this Annual Report on Form 10-K. The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods, and PMI's actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those included in the “Risk Factors” section and elsewhere in this Annual Report on Form 10-K. In this MD&A, the unsecured, consumer loans originated through the platform, which are referred to elsewhere in this Annual Report as “PMI Borrower Loans” and “Prosper Funding Borrower Loans”, are referred to collectively as “Borrower Loans”, and the borrower payment dependent notes issued through the platform, which are referred to elsewhere in this Annual Report as “PMI Notes” and “Prosper Funding Notes”, are referred to collectively as “Notes”, which is consistent with the manner of presentation in the financial statements included in this Annual Report.

Overview
 
PMI developed and began operating the platform in 2006, which permitted borrower members to apply for Borrower Loans and lender members to purchase Notes, the proceeds of which facilitated the funding of Borrower Loans. In February 2012, PMI formed Prosper Funding to hold Borrower Loans and issue Notes. Prosper Funding has been organized to operate in a manner that is intended to minimize the likelihood that Prosper Funding would be substantively consolidated with PMI in a bankruptcy proceeding. PMI is the sole equity member of Prosper Funding. Prosper Funding commenced operations on February 1, 2013.

On February 1, 2013, PMI transferred ownership of the platform, including all of the rights related to the operation of the platform as well as all then-outstanding Borrower Loans, to Prosper Funding. Beginning February 1, 2013, all Notes issued and sold through the platform are issued, sold and serviced by Prosper Funding. At that same time, Prosper Funding assumed all of PMI’s obligations with respect to all then-outstanding Notes. Pursuant to an Administration Agreement between PMI and Prosper Funding, PMI manages all aspects of the platform on behalf of 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 Borrower Loans by WebBank and the funding of such Borrower Loans by WebBank. In this Annual Report, any actions taken by PMI pursuant to the Loan Account Program Agreement or the Administration Agreement are described as actions taken by PMI, in spite of the fact that such actions are being taken by PMI on behalf of WebBank or Prosper Funding, respectively.

The platform enables borrower members to request and obtain Borrower Loans by posting listings on the platform indicating the principal amount of the desired loan. PMI assigns a Prosper Rating consisting of letter grades, based in part on the borrower’s credit score, to each member who requested a Borrower Loan. Borrower members’ Prosper Rating, credit score range, debt-to-income ratios and other credit data are displayed with their listings and are available for viewing by lender members on an anonymous basis.

Listings are allocated to one of two lender member funding channels: (i) the Note Channel allows lender members to commit to purchase Notes from Prosper Funding, the payments of which are dependent on the payments made on the corresponding Borrower Loan; and (ii) the Whole Loan Channel allows lender members to commit to purchase 100% of a Borrower Loan directly from Prosper Funding. Each time PMI posts a group of listings on the platform, it determines the relative proportions of such listings that will be allocated to the Note Channel and the Whole Loan Channel, respectively, based on PMI’s estimate of the relative overall purchase demand in each channel. PMI then uses a random allocation methodology to allocate individual listings between the two channels based on those proportions.  PMI currently posts listing on the platform twice per day on weekdays and once per day on weekends, although the frequency with which PMI posts listings may change in the future.  If a listing is not funded through the Whole Loan Channel within the first hour after its posting, the listing will be removed from the Whole Loan Channel and posted to the Note Channel for the remainder of its listing period. Such listing will include a designation indicating that the listing came from the Whole Loan Channel. The Whole Loan Channel was launched in April 2013 and is only available to certain institutional investor lender members approved by PMI that meet the definition of an accredited investor under Regulation D under the Securities Act of 1933, as amended. The Whole Loan Channel is an important and growing part of Prosper Funding’s business. Lender members who participate in the Whole Loan Channel are required to enter into loan purchase and loan servicing agreements with Prosper Funding that specify the parties’ rights and obligations with regard to the sale of Borrower Loans through the Whole Loan Channel and which name Prosper Funding as the servicer of such Borrower Loans.

All Borrower Loans are made by WebBank, an FDIC-insured, Utah-chartered industrial bank, and sold to Prosper Funding. WebBank sells the loan to Prosper Funding, without recourse to WebBank, in exchange for the principal amount of the Borrower Loan. WebBank does not have any obligation to any purchasers of Notes, or Borrower Loans. PMI verifies the identity of 100% of borrowers using a variety of methods including credit bureau data, other electronic data sources and offline documentary procedures. PMI verifies income and/or employment on a subset of borrowers based on a proprietary algorithm. The intention of the algorithm is to verify income or employment in cases where the self-reported income of the borrower is highly determinative of the borrower’s risk rating.

PMI derives operating revenue from fees paid by WebBank under the Loan Account Program Agreement. Upon funding a Borrower Loan, WebBank charges the borrower an origination fee equal to a specified percentage of the principal amount of such Borrower Loan. WebBank, in turn, pays PMI amounts equal to the origination fees as compensation for PMI’s loan origination activities on WebBank’s behalf. Prior to February 1, 2013, PMI also derived revenue from charging lender members a servicing fee on Notes, which was equal to an annualized percentage of the outstanding principal balance of the corresponding Borrower Loan, which PMI deducted from payments on the Borrower Loans.

Since February 1, 2013, following transfer of the platform from PMI to Prosper Funding, PMI no longer earns servicing fees. Instead, PMI derives revenue from the fees it receives from Prosper Funding for the services it provides pursuant to the Administration Agreement.

PMI has a limited operating history and has incurred net losses since its inception. PMI’s net loss was $27,181 and $16,110 for the years ended December 31, 2013 and 2012, respectively. Historically, PMI earned revenues primarily from borrower origination fees, non-sufficient funds fees and lender member service fees. As of February 1, 2013, PMI began earning revenues primarily from origination fees and the fees it receives from Prosper Funding for the services it provides pursuant to the Administration Agreement. PMI has funded its operations primarily with proceeds from equity financings, which are described below under “Liquidity and Capital Resources.”

PMI’s operating plan calls for a continuation of the current strategy of increasing transaction volume on the platform to increase revenue until PMI reaches profitability and becomes cash-flow positive.  As of December 31, 2013, the platform had facilitated approximately 101,000 Borrower Loans since its launch, totaling an aggregate principal amount of approximately $801,000.

Trends and Uncertainties

The peer-to-peer lending industry remains a very innovative and unique industry, and the application of federal and state laws in areas such as securities and consumer finance to the industry is still evolving. PMI will continue to monitor this evolution actively in order to identify and respond quickly to any legislative or regulatory developments that may affect the platform.

During 2013, the platform’s origination volume increased consistently in terms of both units and total dollar amounts. PMI hopes to continue this trend of growth as the platform’s borrower and lender member bases continue to strengthen and become more familiar with the platform. Over time, PMI expects the platform’s lender member base to grow as the platform gains more exposure to potential lender members and the Notes and Borrower Loans are established as a viable investment alternatives.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of PMI’s consolidated financial condition and results of operations is based on PMI’s consolidated financial statements, which PMI has prepared in accordance with U.S. generally accepted accounting principles. The preparation of consolidated financial statements requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and the related disclosures. PMI bases its estimates on historical experience and on various other assumptions that PMI believes to be reasonable under the circumstances. Actual results could differ from those estimates. PMI’s significant accounting policies which include repurchase obligation, revenue recognition, stock-based compensation, and income taxes are more fully described in Note 2 to its consolidated financial statements included elsewhere in this Annual Report.

Critical accounting policies are those policies that PMI believes present the most complex or subjective measurements and have the most potential to impact its financial position and operating results. While all decisions regarding accounting policies are important, PMI believes that the following policies could be considered critical.

Fair Value Measurement

Following the Accounting Standards Codification (“ASC”) Topic 820 Fair Value Measurements and Disclosures, PMI determines the fair values of its financial instruments based on the fair value hierarchy established in that standard, which requires an entity to maximize the use of quoted prices and observable inputs and to minimize the use of unobservable inputs when measuring fair value. PMI uses various valuation techniques depending on the nature of the financial instrument, including the use of market prices for identical or similar instruments, or discounted cash flow models. When possible, active and observable market data for identical or similar financial instruments are utilized. Alternatively, PMI determines fair value using assumptions that it believes a market participant would use in pricing the asset or liability.

PMI’s financial instruments consist principally of cash and cash equivalents, restricted cash, short term investments, receivables, loans held for investment, Borrower Loans and corresponding Notes, accounts payable and accrued liabilities.

The estimated fair values of cash, cash equivalents, restricted cash, accounts payable, and accrued liabilities approximate their carrying values because of their short-term nature. Short term investments, loans held for investment, Borrower Loans, and Notes are accounted for on a fair value basis. For additional information and discussion regarding PMI’s significant accounting policies surrounding fair value measurement, see Note 2, Note 5 and Note 6 to the consolidated financial statements included elsewhere in this Annual Report.

Borrower Loans and Notes

On July 13, 2009, PMI implemented the operating structure it employed through January 31, 2013 and began issuing Notes. That operating structure resulted in PMI purchasing loans from WebBank and holding the loans until maturity. PMI also issued new securities, the Notes, to the winning lender members in connection with that operating structure. PMI’s obligation to repay the Notes was conditioned upon the repayment of the associated Borrower Loan owned by PMI. As a result of those changes, PMI carried the Borrower Loans and the Notes on its balance sheet as assets and liabilities, respectively.

In conjunction with that operating structure, PMI adopted the provisions of ASC Topic 825, Financial Instruments. ASC Topic 825 permits companies to choose to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. PMI applies the provisions of ASC Topic 825 to Borrower Loans and Notes. The aggregate fair value of the Borrower Loans and Notes were reported as separate line items in the assets and liabilities sections of the balance sheet using the methods described in ASC Topic 820.

PMI determines the fair value of the Borrower Loans and Notes in accordance with the fair value hierarchy established in ASC Topic 820, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. As observable market prices are not available for the  Borrower Loans and Notes PMI held or for similar assets and liabilities, PMI believes the Borrower Loans and Notes should be considered Level 3 financial instruments under ASC Topic 820. ASC Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

Overall, if the fair value of the Borrower Loans held by PMI that were funded through the Note Channel decrease or increase due to any changes in PMI’s assumptions, there will also be a corresponding decrease or increase in the fair value of the linked Notes. As a result, the effect on PMIs earnings of adverse changes in key assumptions would be mitigated.

As PMI receives scheduled payments of principal and interest on the Borrower Loans it holds that were funded through the Note Chanel, PMI in turn makes principal and interest payments on the corresponding and Notes. These principal payments reduce the carrying value of those Borrower Loans and Notes. If PMI does not receive payments on any such Borrower Loan, PMI is not obligated to and does not make payments on the corresponding Notes. The aggregate fair value of a group of Notes corresponding to a particular Borrower Loan is approximately equal to the fair value of that Borrower Loan, less the service fee. If the fair value of the Borrower Loan decreases due to changes in PMI’s expectations regarding the likelihood of default or the amount of loss in the event of default, there will also be a corresponding decrease in the aggregate fair value of the related Notes (an unrealized aggregate gain related to the Notes and an unrealized loss related to the Borrower Loan).
Key economic assumptions and the sensitivity of the current fair value to immediate adverse changes in those assumptions at December 31, 2013 for Borrower Loans and Notes are presented in the following table:
 
 
 
Borrower Loans
   
Notes
 
Discount rate assumption:
   
9.77
%*
   
9.77
%*
Resulting fair value from:
               
100 basis point increase
 
$
222,989
   
$
220,362
 
200 basis point increase
   
220,363
     
217,756
 
 
               
Resulting fair value from:
               
100 basis point decrease
 
$
228,465
   
$
225,784
 
200 basis point decrease
   
231,282
     
228,560
 
 
               
Default rate assumption:
   
7.2
%*
   
7.2
%*
Resulting fair value from:
               
10% higher default rates
 
$
223,233
   
$
220,620
 
20% higher default rates
   
220,039
     
217,439
 
 
               
Resulting fair value from:
               
10% lower default rates
 
$
228,151
   
$
225,477
 
20% lower default rates
   
230,554
     
227,866
 

* Represents weighted average assumptions considering all Prosper Ratings.
 
Overall, if the fair value of the Borrower Loans decrease or increase due to any changes in PMI’s assumptions, there will also be a corresponding decrease or increase in the fair value of the linked Notes. As a result, the effect on PMI’s earnings of adverse changes in key assumptions is mitigated.

As PMI receives scheduled payments of principal and interest on Borrower Loans originated through the Note Channel, it in turn makes principal and interest payments on the corresponding Notes. These principal payments reduced the carrying value of the Borrower Loans and Notes. If PMI does not receive payments on any such Borrower Loan, it is not obligated to and does not make payments on the related Notes. The aggregate fair value of a group of Notes corresponding to a particular Borrower Loan is approximately equal to the fair value of that Borrower Loan, less the service fee. If the fair value of the Borrower Loan decreases due to changes in PMI’s expectation regarding the likelihood of default of the loan or the amount of loss in the event of default, there is also a corresponding decrease in the aggregate fair value of the Notes (an unrealized aggregate gain related to the Notes and an unrealized loss related to the corresponding Borrower Loan).

For additional information and discussion, see Note 2 and Note 6 to the consolidated financial statements included elsewhere in this Annual Report.

Results of Operations

Revenues

Origination Fees

WebBank charges borrowers an origination fee equal to a specified percentage of the aggregate principal balance of each Borrower Loan based on Prosper Rating and loan term. WebBank, in turn, pays PMI amounts equal to those fees as compensation for its marketing and underwriting activities.

Prior to April 2012, there was an origination fee of 0.50% for Borrower Loans with a Prosper Rating of AA, 3.95% for Borrower Loans with a Prosper Rating of A or B and 4.95% for Borrower Loans with a Prosper Rating of C through HR. In April 2012, this fee schedule was updated as follows to consider the term of a loan:
 
   
Jan – Apr 2012
   
Apr 2012 – May 2013
   
 
Prosper Rating
   
All Loans
   
1 Year Loan
*
   
3 Year Loan
   
5 Year Loan
 
AA
     
0.50
%
   
0.50
%
   
1.95
%
   
4.95
%
A
   
3.95
%
   
1.95
%
   
3.95
%
   
4.95
%
B
   
3.95
%
   
2.95
%
   
4.95
%
   
4.95
%
C – HR
     
4.95
%
   
3.95
%
   
4.95
%
   
4.95
%
 
* In April 2013,  1 year loans were discontinued.
 
In May 2013, the origination fee schedule was updated as follows:

   
May 2013 – December 2013
 
Prosper Rating
   
3 Year Loan
   
5 Year Loan
 
AA
     
1.00% - 1.95
%
   
1.95% - 4.95
%
A
   
3.95
%
   
4.95
%
B
   
4.95
%
   
4.95
%
C – HR
     
4.95
%
   
4.95
%
 
Origination fees for the years ended December 31, 2013 and 2012 were $16,471 and $6,918, respectively, representing an increase of $9,553, or 138%, which was primarily due to higher origination volume through the platform during 2013.

Origination Volume

From inception through December 31, 2013, a total of 1,908 Borrower Loans, totaling $800,715, were originated through the platform.

During the fourth quarter ended December 31, 2013, 14,054 Borrower Loans totaling $155,844 were originated through the platform, compared to 4,425 Borrower Loans totaling $37,027 originated during the fourth quarter of 2012. This represented a “unit” or loan, increase of 217.6% and a dollar increase of 320.9% . 33,912 Borrower Loans totaling $357,438 were originated through the platform during 2013 as compared to 19,553 Borrower Loans totaling $153,175 originated during 2012, which represented a unit increase of 73.4% and a dollar increase of 133.4%.

For the year ended December 31, 2013, month over month unit origination through the platform grew by an average of approximately 6%, and month over month dollar origination grew by an average of approximately 11%, as compared to 6% and 9%, respectively, for the year ended December 31, 2012.

The graph below shows aggregate dollar originations through the platform dating back to July 2009:

 
In January 2013, PMI undertook an equity financing that recapitalized the company and brought in a new senior management team. In February 2013, PMI implemented a new public offering of Notes designed to provide the platform’s lender members with protection in the event of PMI’s bankruptcy. In addition, commencing in the second quarter of 2013, PMI introduced the Whole Loan Channel and also increased marketing campaigns to attract new borrowers. Lenders, liquidity and loan originations have all increased as a result of these changes. The decrease in loan originations that occurred between Q4 2012 and Q1 2013 was due to lack of liquidity.
 
Interest Income on Borrower Loans and Interest Expense on Notes
 
Loan servicing fees are accrued daily based on the current outstanding loan principal balance of Borrower Loan(s), but are not recognized until payment is received, due to uncertainty of collection of payments on Borrower Loans. PMI charges a servicing fee to holders of  Notes and Borrower Loans at an annualized rate of 1.0% of the outstanding principal balance of the applicable Borrower Loan, which PMI deducts from each payment on such Borrower Loan.
 
PMI’s procedures generally involve the automatic debiting of a borrower’s bank account by automated clearing house (“ACH”) transfer, although PMI also allows payment by check or bank draft. PMI charges a non-sufficient funds fee to a borrower to cover the cost PMI incurs if an automatic payment fails and is rejected by the borrower member’s bank, for example if there is an insufficient balance in the bank account or if the account has been closed or otherwise suspended. If an automatic payment fails, PMI makes up to two additional attempts to collect; however, there is no additional fee charged to the borrower if those attempts also fail. PMI retains the entire amount of the non-sufficient funds fee to cover its costs, and recognizes such fee immediately.

PMI recognizes interest income on Borrower Loans using the accrual method based on the stated interest rate to the extent PMI believes it to be collectable. PMI records interest expense on the corresponding Notes based on the contractual interest rates to the extent PMI believes they will be collectible.

The following table summarizes interest income on Borrower Loans and interest expense on Notes for the years ended December 31, 2013 and 2012.
 
 
December 31,
 
 
2013
   
2012
 
Interest income on borrower loans
$
35,526
 
$
23,101
 
Interest expense on notes
 
(33,072
)
   
(21,889
)
Net interest income
$
2,454
   
$
1,212
 
 
Overall, the increase in net interest income for the periods above was driven by the rise in the number of loans originated through the platform and serviced by PMI. As discussed above, the platform’s origination volume increased steadily during 2013 and 2012, which resulted in an increase to PMI's gross interest income and expense and ultimately PMI's net interest income for the aforementioned years.

Rebates and Promotions

PMI accounts for rebates and promotions in accordance with ASC Topic 605, Revenue Recognition. From time to time PMI offers rebates and promotions to its borrower and lender members. PMI records rebates and promotions as an offset to revenue if they are earned directly upon the origination of the loan. PMI’s rebates and promotions are generally in the form of cash back and other incentives paid to lender and borrower members.

For the years ended December 31, 2013 and 2012, PMI incurred expenses related to rebates and promotions extended to borrower and lender members of $1,534 and $1,322, respectively, which represented an increase of $212 or 16%. During 2013 and 2012, PMI increased the frequency and volume of its promotion and rebate programs as a way to incent more borrower and lender members to participate on the platform.

Cost of Revenues

Cost of Services

Cost of services consists primarily of credit bureau fees, payments which are due to strategic partners, collection expenses, and other expenses directly related to Borrower Loan funding and servicing. Cost of services expenses were $2,056 and $1,421 for the year ended December 31, 2013 and 2012, respectively, representing an increase of 45%. The primary driver for the increase was higher listing volume and an increase in strategic partnership fees under PMI’s contracts with WebBank.

Repurchase and Indemnification Obligations

Under the terms of the Notes, the Lender Registration Agreements between PMI and lender members who participate in the Note Channel, and the loan purchase agreements between PMI and lender members that participate in the Whole Loan Channel, PMI may, in certain circumstances, become obligated to repurchase a Note or Borrower Loan from a lender member or indemnify a lender member against loss on a Note. Generally, these circumstances include the occurrence of verifiable identity theft, the failure to properly follow loan listing or bidding protocols, or a violation of the applicable federal/state/local lending laws. These repurchase and indemnification obligations are evaluated at least once a quarter and represent an estimate based on the rate of historical loan losses as a percentage of originations (which generally occur within six to nine months of origination). The provision for the repurchase and indemnification obligations may include a judgmental management adjustment due to PMI’s limited operating history, changes in current economic conditions, the risk of new and as of yet undetected fraud schemes, changes in origination unit and dollar volumes and the lack of industry comparables. Based on the analysis of the historical provision, PMI increased the obligation by 356% to approximately $118 at December 31, 2013 from a previously recorded obligation of $26 at December 31, 2012. During 2013, PMI repurchased or provided indemnification with respect to $724 in Notes, collectively. PMI continues to devote a significant amount of attention to fraud prevention and will continue to enhance its fraud control procedures with the aim of maintaining a low level of repurchases and indemnifications.
Other Income and Expenses

Change in Fair Value on Borrower Loans and Notes, net

Under the methods described in ASC Topic 820, Fair Value Measurements and Disclosures, PMI elected to account for unrealized gains or losses on the Borrower Loans and Notes on a fair value basis. PMI estimated the fair value of the Borrower Loans and Notes using discounted cash flow methodologies. The primary cash flow assumptions used to value the Borrower Loans and Notes include default rates derived from historical performance and discount rates applied to each Prosper Rating based on the perceived credit risk of each rating. Because PMI is obligated to pay principal and interest on any Note equal to the loan payments, if any, it received on the corresponding Borrower Loan, net of its 1.0% servicing fee, changes in the fair value of the Notes were approximately equal to changes to the fair value of the corresponding Borrower Loans, adjusted for the 1.0% servicing fee and the timing of borrower payments subsequently disbursed to holders of Notes. These amounts were included as a component of other income (expense) in PMI’s consolidated statements of operations. The total fair value adjustment was $(4,856) and $5,734 for Borrower loans and Notes, respectively, resulting in a net unrealized gain of $877 for the year ended December 31, 2013. The total fair value adjustment was $4,801 and $(3,844) for Borrower Loans and Notes, respectively, resulting in a net unrealized gain of $957 for the year ended December 31, 2012.

Insurance recoveries

PMI and certain of its executive officers and directors were the subject of a class action lawsuit brought on behalf of all promissory note purchasers on the platform from January 1, 2006 through October 14, 2008 that alleged that PMI offered and sold unqualified and unregistered securities in violation of the California and federal securities law. During the first quarter of 2011, the Superior Court of California issued a final statement of decision finding that Greenwich Insurance Company, PMI’s D&O insurance carrier at the time the events that gave rise to the class action lawsuit occurred, had a duty to defend the suit and requiring that Greenwich pay PMI's past and future defense costs in the suit up to $2,000. During 2011, Greenwich made aggregate payments to PMI in the amount of $2,000 to reimburse PMI for the defense costs it had incurred in the class action suit. On October 2, 2012, Greenwich made an additional payment of $143 to PMI for pre-judgment interest. Please see Note 12 “Commitments and Contingencies” in the notes to PMI’s consolidated financial statements contained elsewhere in this Annual Report.

Loss on impairment of fixed assets

During 2013, PMI’s management made the decision to discontinue the development of certain of its planned software development projects and to dispose of obsolete computer software and hardware. The assets previously capitalized in prior years were deemed to be impaired in accordance with ASC Topic 360, Property, Plant, and Equipment. An impairment charge for obsolete equipment of $62 is included in operating expenses in PMI's consolidated statement of operations for the year ended December 31, 2013.

During 2012, there were no asset disposals resulting in a loss or impairment of PMI’s fixed assets.

Other Income

Other income consists primarily of credit referral fees, where partner companies pay PMI an agreed upon amount for referrals of customers from the website. Other income was $1,151 at December 31, 2013 versus $369 at December 31, 2012, which represented an increase of 212% or $782. The increase in credit referrals during these periods was due to the addition of new partners as well as increased traffic to existing partners.

Expenses

All employees of the PMI Group are employed by PMI. Compensation and benefits expense was $13,079 and $10,334 for the years ended December 31, 2013 and 2012, respectively. The increase of $2,745 or 27% was largely due to PMI’s steadily increasing its employee headcount during 2013, which in turn resulted in increased payroll costs such as salary and wages, payroll taxes, and healthcare. PMI increased its headcount across its marketing and operations teams during 2013 to respond to increased volume demands. PMI intends to continue to increase headcount as the platform’s lender and borrower member bases grow and PMI carries out its business plan; however, PMI expects its current investment in the platform and website to improve operating expense efficiency going forward. In addition, spending increased related to the use of contract labor, bonus expense, variable pay expense and overtime during 2013 over the corresponding period in 2012.

As of December 31, 2013, PMI had 88 full-time employees compared to 74 full-time employees as of December 31, 2012.  The following table reflects full-time employees as of December 31, 2013 and 2012 by department.

 
 
December 31,
 
 
 
2013
   
2012
 
Sales, marketing and operations
   
53
     
37
 
Engineering
   
24
     
22