Please ensure Javascript is enabled for purposes of website accessibility

Prospect Capital Corporation's Plan to Earn 23% Per Year

By Jordan Wathen - Feb 5, 2014 at 9:27PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Will peer-to-peer lending become a big earnings driver for Prospect Capital? Don't bank on it.

Source: www.planetofsuccess.com.

I have to tip my hat to Prospect Capital (PSEC 0.85%) -- it always has some unique, out-of-the-ordinary way to make a buck.

Recently it's been apartments. Now, it's a plan to get into the peer-to-peer lending space to earn as much as 23% per year.

Loans by individuals, for individuals
Peer-to-peer lending companies launched as a way for consumers to skip the bank. You can go online to one of many peer-to-peer sites (the biggest being Prosper and Lending Club) and ask for a loan. Then, investors, most of whom are individual investors, look at your loan request and decide whether they want to make you a deal.

From start to finish, hundreds of investors may make up just one loan. Once the loan is fully funded, Prosper and LendingClub send the cash to the borrower and process all the back-end stuff like making sure you pay on time and that the investors get their portion of the payments when each amortizing payment comes in.

The potential
Returns from LendingClub and Prosper vary greatly by credit quality. On the conference call, Grier Elisak said Prospect is getting a weighted average yield of roughly 13%. After expected losses, which Prospect believes will come in at 5% of the loan portfolio, the net return is 8%.

Obviously, for a double-digit yielder like Prospect Capital, an 8% return is much too low. Prospect Capital thinks it can leverage this portfolio up to 3-to-1 with secured funding.

We can run the numbers on what this portfolio might return based on its own projections. We can estimate that Prospect Capital would fund this with a line of credit with a rate consistent with its funding for its corporate line of credit as well as its funding for First Tower, another consumer loan company. Prospect can currently borrow at LIBOR plus 2.75%.

That puts Prospect Capital's funding costs at roughly 2.90% per year. That's cheap. Levered at 3-to-1, Prospect would earn 8% on assets and pay total funding costs equal to 2.175% of assets, for a total return on equity of 23.3% per year.

That's good for 18.2% annually after accounting for management fees.

That's the expectation. What about reality?
Everything in the conference call is consistent with data from one P2P lending site, Prosper.com. Prospect said it was looking at borrowers with FICOs of 700 or better scores and expected 13% returns with losses in the 5% range.

I did my digging. Prosper.com has a page outlining returns for various loans by credit quality. The B-range borrowers have a 700-plus credit score, tend to yield about 14% per year, and have losses at around 5% per year.

There is one important caveat: This is looking at Prosper's historical returns since the middle of 2009. As we know, that's when the economy started improving.

Prosper has changed its pricing model and leadership team since the pre-crisis era, but the company discloses that loans between November 2005 and June 2009 produced a negative-5.29% return. LendingClub reveals that loans issued in 2007 and 2008 to B-credit borrowers returned roughly 3.2% per year.

The Foolish bottom line
Prospect Capital's P2P lending is interesting, but it's not exactly compelling. Prospect Capital earns huge returns in its other consumer lending businesses because it adds value by finding the customers. That's the hard part of consumer lending. The easy part is providing the capital to do it. P2P lending sites take out the component that adds value (finding borrowers), and the investors provide the commodity -- money.

If Prospect Capital proves to be profitable in P2P loans, other financiers, who have much lower-cost capital, can do exactly the same thing. Investors should probably look at this as a niche, and potentially temporary, place for Prospect to earn a return.

Jordan Wathen and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Prospect Capital Corporation Stock Quote
Prospect Capital Corporation
PSEC
$8.09 (0.85%) $0.07

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
390%
 
S&P 500 Returns
125%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/11/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.