Prosper - Case Study 2
March 5, 2009 – 7:50 am | by ChristianWho are they?
Prosper’s CEO and co-founder, Chris Larsen, was formerly the CEO, Chairman and Founder of E-LOAN, an online consumer lender “dedicated to providing consumers with a fast, transparent, and low cost way to obtain mortgage, auto and home equity loans.” Prosper is backed by Accel Partners, Benchmark Capital, DAG Ventures, Fidelity Ventures, Meritech Capital Partners, and Omidyar Network, and in 2008 it aligned with Web Bank.
What do they do?
Prosper bills itself as the ‘eBay of personal finance’. With emphasis placed on personal interactions and community lending, potential borrowers set a maximum interest rate they will be willing to pay on a loan, then other people ‘bid down’ for the privilege of lending it. Prosper aims to make sure everything is safe, fair and easy.
How does it work?
Borrowers
Prospective borrowers register with the site and allow the company to review their credit history. Then they post a loan request of up to $25,000, along with an upper limit for the amount of interest they are willing to pay. Loans are not secured by collateral and are paid off over three years at a fixed rate, with no prepayment penalty. Once the bidding is complete, and if enough lenders bid enough money to finance the loan at a single rate acceptable to the borrower, Prosper transfers the money to the borrower’s account and establishes a monthly repayment system that withdraws money from the borrower’s checking account. Should a borrower default, Prosper hires a collection company on the lender’s behalf and alerts credit bureaus.
Lenders
All of Prosper’s loans are 3-year fully amortised, unsecured loans. People who want to lend set the minimum interest rate they are willing to earn and bid in increments of $50 to $25,000 on loan listings they select. People who lend can easily diversify using ‘standing orders’, which automatically make many small loans to different borrowers. Lenders essentially deposit their money with Prosper, which holds it in an interest-bearing account with Wells Fargo, and either review the loan requests individually or fill out a form permitting Prosper to allocate money to borrowers who meet certain criteria. Chief among those criteria is the borrower’s rating from the credit reporting bureau Experian, but borrowers can also join or create groups with defined interests or characteristics that, they hope, will make them more attractive to some lenders.
Community
Unlike Zopa, there is a greater emphasis on personally selecting and lending to particular borrowers. Loans can be fully funded by one person, so it is possible to lend an individual up to $25,000 (in Zopa the limit is just £200.) As a result there is much more interaction between lenders and borrowers. Members can join an appropriate ‘group’, based on various social and cultural lines. These are ‘a way for tightly affiliated communities to help their members through person to person lending.’
Prosper’s group leaders receive a commission on the group’s lending and borrowing activities, which they sometimes share among the group. When you join a responsible group with a good payment history, you get a good reputation by association, and lenders are more likely to offer good interest rates. But, belonging to a good group puts some pressure on you, too. If you stop making your loan payments, you not only tarnish your own reputation, but the group’s as well. If you’re part of a group, the theory is that you’ll perform better as a borrower than if it was an impersonal bank or credit card company.
Business model
Prosper generates revenue by collecting from borrowers a one-time closing fee on funded loans (either 2-3% depending on credit grade, or $75 – whichever is the greater). Lenders pay a 1% annual servicing fee. In addition, borrowers pay a $15 failed payment fee as well as a late payment fee, while lenders pay a collection agency recovery fee.
Establishing trust
Prosper obtains the borrower’s Experian credit score, and assigns one of seven credit grades, from AA to HR (high risk). Borrower credit grades are posted with their listing to help lenders plan their bidding. Further information is also provided, such as delinquencies, number of credit lines, debt-to-income ratio and debit or credit card utilisation. Additional data, which is self-reported by most borrowers when registering, includes occupation and income. This information combines with the personal and group interactions that Prosper enables, to give lenders and borrowers a credible sense of risk and trust in other people, and to make the service seem less like just another financial instrument. In addition, Prosper publishes its performance statistics on the website, helping users to make informed decisions.
Performance
Prosper has over 830,000 members and $178 million in loans to date. Their open API has spawned dozens of websites focused on Prosper users, and these communities and Prosper groups are very active. Prosper has raised approximately $40 million in investment for further expansion.
However, as of August 2008, approximately 18.5% of all money loaned on Prosper from its inception through to June 2008 is in some form of delinquency. Also, more than 35% of all loans that originated in February 2007 are in some form of delinquency.
Prosper is currently registering promissory notes with securities authorities and has entered a ‘quiet period’ in which it is not accepting new lender registrations or new commitments from existing lenders.
After a peak in May 2008 of nearly $10 million in new monthly loan originations, business has dropped significantly.
Problems or limitations
Like Zopa, Prosper’s contractual and enforcement structure is founded on specific territorial laws. Growing the network transnationally is impracticable due to regulatory considerations. Given the size of the US banking market this is not a fundamental problem, but it is necessarily a brake on growth, especially given the geographically dispersed nature of many online communities and affinity groups.
A more pressing problem concerns Prosper’s run-in with the regulator, which highlights the inherent risks involved in uninhibited peer-to-peer financing.
