Imagine a world where making a loan or borrowing money is as simple as clicking your mouse.
Thanks to the advent of the peer-to-peer, Internet-based lending, that scenario is now a reality. Lending Club, which has already received an investment from Google and is pondering an IPO in the near future, is the biggest player in the space in the U.S. At roughly a fourth of Lending Club's size, Prosper is the second largest online peer-to-peer lending marketplace.
In the video below, Matt Koppenheffer and David Hanson from The Motley Fool's financials-focused show, Where the Money Is, catch up with Ron Suber. Ron is the Head of Global Institutional Sales at Prosper.
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The full transcript can be found below.
Matt Koppenheffer: Ron, thanks again for joining us. Why don't you start with giving us a high-level overview on what Prosper is?
Ron Suber: Thank you. At a very high level, Prosper is our country's first marketplace and exchange where prime borrowers and lenders can meet. It's a new asset class, and it's really changing how people interact to borrow and lend.
A few years ago, if you wanted to borrow money, you were limited to going to a physical bank, a high interest rate credit card, your parents, or perhaps your own circle of friends. What Prosper is doing, and peer-to-peer finance, is changing the way that capital is borrowed and lent in our country.
Koppenheffer: So it's on both sides of the coin there, for both the borrowing and the lending. That's pretty interesting. Who's the competition out there? I know Prosper isn't the only company doing this. Who else is out there doing this?
Suber: In our country, there are two major players in the peer-to-peer finance space, or the online direct consumer space. It's Prosper and Lending Club. We're roughly one quarter Lending Club's size.
In the United Kingdom, there are three major players, and then there are 15 other marketplaces or exchanges around the world -- in Asia and Latin America, and other parts of Europe -- that are helping borrowers and lenders meet and exchange credit.
David Hanson: Great. What are the hurdles to starting a peer-to-peer facilitation site -- whether it's you guys, Lending Club -- what is the hurdle, that someone else can't just come in and say, "Well, we're going to do it too?"
Suber: I've said a few times before that the moat is very large, and the hurdles are very high in starting a peer-to-peer platform. It's really like marriage and yoga -- it's much harder than it actually looks.
Koppenheffer: Unfortunately, I have experience -- well, I shouldn't say "unfortunately" -- I have experience on both. I'd say that they are both pretty difficult!
Ron, a lot of our viewers and listeners here are individual investors that are curious about the idea of peer-to-peer lending, and whether that's an appropriate vehicle for them to invest in. In your experience, what type of investor is a peer-to-peer loan appropriate for?
Suber: That's a great question. We have two types of lenders; retail and institutional. The peer-to-peer finance marketplace is really not a competitive product to equities. It's a fixed income alternative for a retail lender -- an individual or a high net worth person -- who would like to build a minimum $10,000 per account, a diversified pool of consumer credit.
The minimum dollar bid per loan is $25, so you can see that an individual can work with a peer-to-peer platform like Prosper and invest in numerous, diversified borrowers to get access to short-duration, short-term, fixed-rate loans that accrue daily and pay monthly.
Koppenheffer: Now, you kind of already answered this for us, so we can just do this quickly. Is this an alternative to an individual bond, a bond fund, or a dividend-paying stock, or is the right way to think about this as a new, separate asset class?
Suber: That's a great question. We're hearing from many financial planners and wealth managers that they are putting a portion of their clients' assets in the fixed income category into peer-to-peer finance loans -- and I can tell you why in two quick numbers.
If you look at the aggregate U.S. bond market, and the index of it, the one-year performance is -2.02%, as of today. If they had invested the portion in peer-to-peer finance, and done a diversified index portfolio, the yield would be roughly 8% for that same one-year period.
If we look at the one-month period, the aggregate U.S. bond market index was down, -0.57%, but if you had indexed the peer-to-peer platform, Prosper, in a diversified index portfolio, the yield for that one-month period would be positive 0.60%, so up more than one half of one percent for the one-month period.
Koppenheffer: Just to clarify for our listeners, those returns would include the charge-offs in the portfolio, as well as any fees associated with the loans?
Suber: That's correct. That would be a net performance number, after expenses and defaults.
Hanson: With more institutional money coming into the space, whether it be insurance, hedge funds, BDCs -- we saw Prospect Capital just yesterday say that they're moving more into the peer-to-peer lending space -- are we moving toward a point where this isn't really peer-to-peer anymore, and more institution-to-peer? Will that be changing more?
Suber: Prosper will always have a very solid commitment to the retail and high net worth and peer-to-peer concept of the exchange and the platform. But you're right, there's no doubt that institutions -- business development companies, credit hedge funds, insurance companies, and banks -- are very interested in yield products, and we're seeing them come to us, looking for more inventory.
But we are committed to, and assure our members, that we will always be a peer-to-peer platform.
Koppenheffer: Now, Ron, when I go on the Prosper site, I notice that there's a table that shows the returns for 2005-09 vintage loans, and I appreciate that Prosper puts that up there. To me, it seemed like a way to get a perspective on what happened during the credit downturn.
The performance wasn't all that good -- it was in the negative -- so, looking ahead to when we do eventually have the next downturn of the credit cycle, what assurance do investors have that they will have performance through the cycle? Obviously it will go down, but what should they be expecting, realistically?
Suber: That's a great question, and one we get often. There are really three different versions of Prosper, and the one you just mentioned -- that 2005-09 period -- is a different firm. It's nothing like what Prosper looks like today. Then the second version of Prosper is that '09 to December of 2012 period. Then my partners and I, along with Sequoia Capital, purchased Prosper in January of 2013.
The answer to your question is, we have put in new pricing, credit, and risk policies, new servicing and new collections, to ensure that the returns from January of 2013, all the way through the future, all the way through the next potential credit crisis, will not look like what Prosper 1.0 was.
That old version included lenders negotiating rates with borrowers, and many other auction-type systems, which is not how Prosper operates at all, today.
Koppenheffer: Today it's a tiered system, right, and the pricing is set by Prosper for each credit tier?
Suber: That's right. We work with three types of borrowers; people who want to do debt consolidation, people who want to purchase something, and small businesses who want to borrow on their personal credit.
We look at 500 variables for each and every single type of borrower, and we assign not only a letter grade, but an interest rate -- and we're working to make sure that that borrower not only has the willingness, but the ability, to pay back the lender.
Koppenheffer: When I think about an investor investing in a Prosper loan, how does the investment typically take place? Are they investing small amounts across a lot of loans?
I would think that there would be a risk of -- if I go in there and I invest in just a couple of loans -- that my returns will look much different than what the overall Prosper experience has been, because I might have one of the loans that goes bad, and that could be an overwhelming part of my experience.
Suber: That's absolutely right. We think that diversification is key for all lenders, and we work very closely with lenders. If we see somebody come on with too small of an account to get diversified -- if they can't purchase more than 100 loans, we don't think they're diversified, and we're really working with them to ensure they understand the need for diversification -- and we're really making sure that people understand the need to invest over time to have a balanced, diversified portfolio.
Koppenheffer: Got you. That makes a lot of sense. Jumping back to the pricing system, now that I think about it, it seems like it was a really savvy move on Prosper's part to move to the fixed pricing system, but when you think forward, you've got a lot of institutional money in, maybe you get a lot more individuals also joining the system.
As you get a more liquid market into the Prosper universe, do you see going back to an auction market pricing system at some point?
Suber: I don't see the auction market pricing system returning. I think that history has shown us that lenders aren't the best judges of what rate a borrower should borrow at, and we think that our technology and our very experienced veteran group of pricing risk, credit, and actuarial people -- who come from the credit card, banking, rating agency, and technology industries -- really have the best credit models for the peer-to-peer platform today.
That's really shown in the net performance of the loans from Prosper, for the last 14 months since we've been here at Propser.
Hanson: Yes. You talked about lenders historically not being the best at pricing risk all the time, and we're seeing data from the OCC, the Fed's survey of some loan officers, saying that they're starting to see standards across the board ease a little bit, especially when it comes to consumer credit cards, auto loans, etcetera.
Do you see credit card banks and lenders moving more aggressively into the space, and maybe challenging the customers that would be Prosper customers?
Suber: I think we're going to see a change in the landscape. I don't know exactly what's going to happen, but given the growth of Prosper and Lending Club -- now doing in excess of $300 million per month in new loan originations -- it's clear that the understanding and awareness of who we are is spreading to the different banks and incumbent credit card companies.
We don't know what the changes will be. Hopefully, there will be lower interest rates to benefit the borrowers, across the board.
Hanson: Matt hinted at this a little bit earlier, in terms of the tiered pricing system. You guys have something that you call the Prosper Rating. Can you talk a little bit about what that is, and what the thinking behind that is?
Suber: I sure can. There are seven different Prosper Ratings. AA is assigned to the best credit, lowest interest rate borrower. Then there's A, B, C, D, E, and then our HR, that higher-rate, smaller loan size.
Every borrower who comes to us, we are verifying their identity, employment, occupation; all the data about them. We're pulling social media data, data from the agencies, lifecycle and experience, and really studying each individual and assigning a letter and a number -- and an interest rate -- to that person.
We might find a borrower who wants to borrow $20,000, but our analysis might come back that that person actually only is able to borrow $10,000 from us, and it may be a three-year loan request, and we may suggest a five-year, based on the amortization and the lower payments, helping that borrower get the right amount of money at the right terms to help them rebuild, or build, or improve their personal financial credit.
Hanson: Right. Just thinking about the model of a lending club, of a Prosper; it's not a bank, so can you walk us through what kind of banks you work with? What do you need from a bank in order to operate your model successfully?
Suber: We use banks for the origination of loans for a very short amount of time, and we hold the cash, on behalf of our lenders, at large banks. We're working very closely with the banking community around the country. In fact, we have banks sending us borrowers, and some banks are actually buying AA loans to hold on their balance sheet.
We really think that the banking community has understood we can be a great customer and actually help them facilitate what they're looking for, as well. The way it works is, we link to the borrower's bank account. We process their request for money. In an average of four days, we will have found the lenders to fulfill the loan.
We will originate the loan, and then we will work with the bank to put the money in the borrower's account. Then every month, we will work with the borrower's bank to take their payments electronically from the borrower's bank, then we will give back each month to the different lenders who have invested in that borrower's loan.
Koppenheffer: That's interesting. The banks, then, don't necessarily need to see Prosper as the enemy, moving in to disintermediate, but more as a partner that is opening up a new opportunity?
Suber: We think the banks are not our competition. We actually think that our competition is education and awareness for borrowers and lenders. I had breakfast with the president of one of the country's biggest banks on Saturday in Chicago, and there's a lot that the banks can do and want to do with the peer-to-peer platforms.
Koppenheffer: Great. Looking ahead, I heard you talk about this at a conference you were at; I saw the video online. You were talking about the idea that this could be paired with a social network, down the road.
To me, Facebook and LinkedIn came immediately to mind. I was curious if you could spill the beans for us on any discussions or any plans going on, that could link up Prosper with one of these social networks.
Suber: There's no answer to the question, and even if I knew it, I probably wouldn't tell you what the answer was.
Koppenheffer: I know!
Suber: But I think it's a great question, and one we talk about often. If you look -- just for example; I'm not foreshadowing anything specific -- look how Priceline has moved in between the airlines and the hotels. Look how some of the other FinTech -- financial tech -- firms have moved in between the recruiting agencies and some of the other old-line businesses.
It wouldn't surprise anyone to see Amazon, eBay, Yahoo!, Apple, Google, better-integrate this peer-to-peer solution -- borrowing and lending -- into their networks.
Koppenheffer: That's interesting. Would Prosper ever move in the direction of becoming more like a social network itself, in terms of connecting people with other people?
Suber: That's a great question. It's not something we're going to be doing this quarter or next. We do have two million members who have visited and done business with Prosper as borrowers or lenders, but you're right. We are a big data, financial technology firm, and we do connect people with money.
Koppenheffer: Two million is not a bad starting point. Well, Ron, we really appreciate your time. We really appreciate you joining us and explaining a little bit more about Prosper and the peer-to-peer lending opportunity in general.
Suber: Thank you both.