Prosper Marketplace – 21st Century E-Peer-to-Peer and Institutional E-Lending

Prosper Marketplace is a modern peer-to-peer and e-institutional lending marketplace, efficiently matching borrower and lender supply and demand.

Introduction & Context

Prosper [1] is a highly effective global e-business. Prosper is a virtual marketplace where lenders and borrowers can meet each other’s lending and borrowing needs, bypassing the need for a bank. Prosper self-advertises as “cut[ting] out the middleman”, or the bank in the lending process. In reality, the e-business serves as a middleman, albeit taking a smaller commission on the borrowing and lending transactions and providing superior product efficiency and usability (See Figure 1). A key difference between banks and Prosper is that loans are not made by the business itself, but rather by 3rd party individuals or institutions.

Figure 1: Prosper loaner view: prospective borrower marketplace listing, risk & return projections [7]

fig1

As of April 2015, Prosper is valued at $1.9B USD [3].

Prosper borrower default rate remains at 5.2%, in line with that of major banks [8]. Figure 2 shows a detailed Prosper rating breakdown.

Figure 2: Prosper Rating Estimated Average Annual Loss Rate

fig2

Business Model

Prosper is critically dependent on attracting prospective borrowers and lenders onto its’ platform. Prosper enables 5.99% – 36% APR $2000 to $35000 loans, and provides returns in line with borrower’s credit risk. Lenders assume borrower risk of default, which increases with a decreasing credit rating – Prosper does not carry federal insurance (FDIC).

Investors can select to invest as little as $25 and thus diversify risk among multiple individuals of similar or differing credit risk ratings. By allowing investments in smaller increments, Prosper is enabling loan investing to individuals with limited financial capabilities, who perhaps would not be otherwise able to invest in loans.

The online marketplace interface allows for expedient and easy-to-use interface in seeking funds or making loans.

Prosper advertises to those in need of credit card debt replacement and refinancing options [9].

Rate calculation formulas for borrowers, like any other lending institution are typically not public information. However, it is known that credit history, such as number of inquiries, payment delinquency, available credit etc. and borrower supplied information, is taken into account when formulating a Prosper Rating [2][7]. Loan candidates applications are verified through Prosper. Based on empirical data, Prosper notes 100% positive returns for diversified lenders (i.e. defined as a Prosper investor that has invested in more than 100 notes – a minimum of $2500).

Figure 3: “Competitive Returns” Prosper Rating Graphic [10]

fig3

Two channels exist for investment. First, individuals can purchase notes, from Prosper Funding LLC, 100% owned by Prosper Marketplace. This framework is known as peer-to-peer (P2P lending. Second, wholesale investors (i.e. accredited institutions, investors such as banks, finance professionals) can purchase entire loans (similar to mortgage traded securities). While Prosper originated as P2P marketplace, Figure 3 shows a dramatic change of direction towards wholesale in recent years.

The Prosper prospectus states that individual ‘notes’ investors are protected by default risk of Prosper Marketplace.

Prosper marketplace offers, on average, more competitive loan terms, more transparency and quicker decisions than traditional institutions.

Operating Model

Prosper has a non-traditional loan model with several key advantages over traditional banks. The E-business commerce setup reduces fixed costs borne by physical infrastructure (e.g. bank branches) and automation, databases, software and technology improve and expedite the borrowing and loaning experience.

Prosper has set audacious goals, based on listening and repurposing offerings to customers’ needs, fitting and redacting the senior management team to goals accordingly, and enabling a culture of constantly seeking feedback. [13]

Seeking growth, Prosper has been searching for new potential customers, which could benefit from an alternative loan marketplace. In 2Q15, Prosper acquired American Healthcare Landing, a software firm that connects healthcare system users who may require additional funds for surgeries. In addition, Prosper is also collaborating with smaller community banks. [4]

Prosper is further looking to expand into incremental financial services, in order to better compete with banks. The acquisition of Billguard, an app that helps consumers monitor finance activity, signals that Prosper is serious about expanding consumer offerings [5][11].

In the past couple of year, Prosper has partnered with Wall Street heavy-weight banking institutions, experiencing dramatic growth in whole loans, relative to fractional loans.

Figure 4: Prosper loans by type [12]

fig4

Recent tragedy may instigate governmental inquiries in evaluating whether online lending goes through the identical screening as traditional lending mechanisms [6].

 

 

 

Sources:

Note: All resources accessed on December 9 2015.

[1] https://www.prosper.com/

[2] https://investorjunkie.com/9328/lending-club-vs-prosper/

[3] http://www.wsj.com/articles/prosper-marketplace-completes-funding-round-1428533267

[4] http://www.wsj.com/articles/prosper-marketplace-completes-funding-round-1428533267

[5] http://blogs.wsj.com/moneybeat/2015/09/24/online-lender-prosper-diversifies-with-purchase-of-personal-finance-app/

[6] http://www.wsj.com/articles/san-bernardino-shooter-took-out-28-500-loan-prior-to-terror-attack-source-says-1449608166

[7] https://www.prosper.com/Downloads/Legal/prosper10k12312014.pdf

[8] https://www.youtube.com/watch?v=WF4Fsnu7wgM

[9] https://vimeo.com/74938659

[10] https://www.prosper.com/invest/

[11] http://venturebeat.com/2015/09/24/peer-to-peer-lender-prosper-marketplace-acquires-personal-finance-tracking-startup-billguard/

[12] http://qz.com/379710/wall-street-heavyweights-are-pouncing-on-peer-to-peer-lending/

[13] http://www.inc.com/peter-cohan/5-turnaround-strategies-from-prosper-s-new-ceo.html

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11 thoughts on “Prosper Marketplace – 21st Century E-Peer-to-Peer and Institutional E-Lending

  1. Fascinating. How easily are they managing to solve trust issues?

    1. Michael, refer to https://www.prosper.com/loans/how-to-get-a-loan/loan-verification-process-(old)/.

      Per Prosper’s prospectus, Prosper relies heavily on an automated verification process to reduce the amount of time required to make a decision on loan. Applicants are accordingly screened for against anti-laundering and other regulations.

      On how Prosper gained trust, that’s a good question, maybe not unique to Prosper. How did Paypal, Venmo, Amazon, and other e-businesses/applications gain trust? I would speculate through a good design, a highly efficient website, and response to customer feedback.

  2. Since this is definitely the type of business that seems like it would benefit from network effects (my hypothesis is that more users = more capital available = more competition among lenders = lower interest rates), I wonder how the company managed initially to acquire the “threshold” level of users that allowed it to really be economically viable. It would be interesting to understand what a loan on this platform would have looked like when there were 100 users vs. a loan made when there are 100,000 users.

    1. Good questions Sudip. I am a bit skeptical about more capital available leading to lower interest rates. My reaction would be that that Prosper’s proprietary risk rating mechanism does not provide lower rates, as a function of how much capital is available. I do not have the history of how capital supplied and demanded has balanced out over Prosper’s short existence. I don’t think it has mattered too much with a significant amount of users present, as there are a finite level of risk rankings, and nothing else that significantly differentiates loan-seekers in the lenders view.

      I agree that the search of users in the beginning must have been interesting and what kept the founders and investors awake at night. Not being able to gather a critical mass user base would have spelled an early end to this business.

      From sources, I gathered that initially direct mail was used to gather customers (likely targeting those with revolving credit card debt) and now Prosper is trying to secure partnerships, which generate leads. http://www.lendingmemo.com/prosper-ceo-aaron-vermut-on-growing-350/

  3. Very cool post! Love the detail and the analysis… Sudip asks a great question! The threshold issues with this kind of business is particularly interesting because you need to avoid taking on excessive risk in the beginning, when you are new at the business and probably don’t have access to the best loan prospects.

    1. Agreed – coming up with and testing a new risk rating mechanism, in light of the financial crisis generated a few interesting conversations, I’m sure.

  4. Great post! It would be interesting to see how the business model evolves to include other financial products. Many of the large competitors such as LendingClub in the US and RateSetter or Zopa in the UK have gradually increased their product offering to include not only consumer loans but also property, and SME financing.

    Secondly, as more online lenders pop up it would be interesting to see how Propser approaches customer acquisition and retention since customers are purely searching for best price.

    1. Thanks Stevon, looks like we both agree that it will be interesting to track Prosper’s acquisitions that will expand financial service offerings.

      From the customer acquisition perspective, a lower interest rate and timeliness of loan receipt would be my two criteria, given that credibility and usability are not an issue. I think Prosper is seeking ways of expanding past the revolving credit card debt market.

  5. Great post. While I do love the efficiency this concept creates, I am somewhat concerned that the subsidization benefits the existing lending model provides for lower income/higher risk borrows will be eliminated. An analogy is in healthcare — pre-Obamacare, insurers were better able to stratify risky pools of people and charge different fees — which eventually led to those who needed insurance the most also having to pay the most. Post-Obamacare (as far as I know), the healthy pools of people subsidize those that are more “risky”/costly to insure. Do you have an opinion on this subsidization effect as it relates to lending?

    1. Very interesting questions Patrick.

      From the perspective of the low credit score, high risk prospective borrower, Prosper’s lending rates generate value to these consumers, as they are lower than the rates offered by credit cards. In effect, for the customers who pass the most coarse applicant screen, the eligible consumer saves on interest payments.

      I am not too familiar with the traditional lending model and subsidization. How/does this still exist? Could you describe more? Is this not what caused the financial system collapse a few years ago – excessive risk taking by industry, and a systematic turning of blind eye by industry to credit-worthiness of individuals?

      As an aside, as my family originates from the Eastern side of the Iron Curtain. I therefore have a strong distrust of subsidies, socialist overreach, which in the case of Bulgaria are tied to oligarch cronyism. The majority of industrial outfits which were subsidized by government during socialism practically collapsed after the fall of the communist system, leaving a handful of well-connected oligarchs scooping up industrial companies in rough shape for pennies on the dollar, optimizing a bit and selling/liquidating or operating for a profit.

      As another anecdote, subsidies caused a half billion dollar loss for the US government’s sponsoring of an inefficient and economically unsustainable outfit – Solyndra.

      Jack’s post mentions a solid write-up of the disaster of AMTRAK for a business/finance perspective, at an annual taxpayer cost of $1B. Is there social utility beyond financial metrics – of course! How much a subsidy worth and are there better ways to achieve the desired impacts of the subsidy should be the question being asked.

      I agree that from a temporary perspective, subsidies may make sense in certain situations. For example, the case of transition of centrally planned economies (e.g. former Eastern Bloc) to free market economies. For example, European Union aids newer EU members by providing in effect subsidies or payments, in exchange for structural reforms in judicial, financial areas etc.

      Regarding the Affordable Care Act, my personal position is that right to healthcare access is a fundamental human right. That being said, the aforementioned group of patients who you mentioned were not able to afford healthcare prior to the passing of the ACA, did receive healthcare, albeit at the latest and costliest stage of treatment – the emergency room. This bill was likely not collectible, and was ultimately passed to all paying insurers, at a cost far more significant, had these patients received ACA/similar subsidies in the first place.

      Regarding your question of subsidies in the private loan industry, I think it is an excellent question to which I do not have the answer.

      I am not sure what the root cause of the problem of individual credit is, and whether addressing the issue in the private marketplace is the most efficient idea.

      I would argue that this question is bigger than government taking a socialist functions and providing for ‘cheaper money’ to borrowers with poor credit ratings. I would hypothesize that a government subsidy for loans without any requirements (e.g. take a financial course, obtain education/job training etc.) is not a meaningful and/or long-term solution to individuals credit issues. I see a net negative here.

      I would argue that financial literacy education, investment in and reform of the education system towards producing jobs that are in high demand and make a nation more competitive and steering a significant amount of college graduates towards vocation schools that are needed (e.g. any degree or certification less than a bachelor’s – e.g. associates degree for professions such as mechanic, heavy equipment operator, web developer) would be a better way to reduce Americans indebtedness.

      1. Please excuse the poor grammar :]

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