I sit down with the President of Prosper to talk about peer to peer lending and the future of peer loans
Today’s post is an interview with Ron Suber, President of Prosper Marketplace. Ron joined Prosper in 2013 to develop and execute on the company’s business development strategy. Since then he has seen some big changes in peer to peer lending and has some ideas on where peer loans are going in the future.
The interview provided a ton of insight into p2p lending for borrowers and investors. For a review of the two peer to peer lending sites, Prosper and Lending Club, click through to my previous post, Peer Lending Sites Reviewed.
I have included my own comments in italics so as not to be confused with Ron’s.
Thank you for your time Ron, I’ve been impressed with what you have done with Prosper just in the last year.
Thank you, always glad to talk with the peer to peer lending community.
First, tell us a little about yourself and how you got into peer to peer lending.
I’ve spent twenty-five years on Wall Street. And I left a Wall Street brokerage business to become an entrepreneur in 2006. A friend of mine introduced me to the concept of peer to peer lending in late 2010 and I started investing for my own family office in early 2011. I really became enthralled with this new investable asset class. This was a new opportunity — for the first time, to invest in consumer credit directly via an online marketplace, enabling individuals like myself to get a yield on their money, and a return on your money that you could see accruing daily.
And so I literally started telling my friends and people about this opportunity, with firms like Prosper and Lending Club. In January of 2013, my partners Aaron Vermut, Steve Vermut and I, along with Sequoia Capital, were able to invest in and take over the management and leadership of Prosper, which was America’s first peer to peer lending platform. Since then we’ve grown Prosper from seventy employees to over two hundred employees, from $9 million a month in loan originations on the Prosper platform in February 2013 to $177 million dollars in loan originations on the Prosper platform in October 2014.
The growth has been explosive. I think one of the major reasons for this growth is because there’s such a mutual benefit to the retail and institutional investors in the loans, and clearly a benefit to the many borrowers. If we look at one of the big things that changed, it’s the type of borrower. In early 2013, most of the borrowers that came to peer to peer marketplace lending platforms were for debt consolidation. These were people who had income and a job, but were stuck in a death spiral of credit card debt with a very high interest rate, no term and the minimum payment problem. So, in the earlier days, these borrowers were debt consolidations and we helped many people in the U.S. eliminate their debt and improve their credit scores.
What we’re seeing now is the evolution of marketplace lending, where people who want to buy something —a large purchase, an example could be: home improvement, special occasion, a second car or medical procedure – are coming to the marketplace lending platforms. They are realizing credit cards are good point of sale transaction device but a terrible place to borrow money. They’re coming now to us, at Prosper, to borrow money for these large purchases and life events.
And the third type of borrower, which is relatively new and growing very rapidly, are entrepreneurs in our country who run businesses who need to borrow money for their businesses. They’re finding that these marketplace lending platforms, like Prosper, are a place where they can borrow, on their personal credit, for the purpose of their business. And they can do it quickly and easily and online 24 hours a day. We’re finding so many borrowers now doing second and third loans because they understand now this is the new way and the smarter way to borrow.
It took Prosper 8 years to originate a billion dollars in loans through the platform. This year, the second billion were originated through the platform within six months. To say that growth has been explosive is an understatement. Ron’s point to the increase in loan types, from debt consolidation to other loans and as a means of small business funding is an important one. It means that peer to peer lending is becoming more mainstream and an accepted form of lending rather than as simply a means to consolidate existing debt.
What about the market for small business peer loans?
We’ve decided at this time to stay 100% laser focused on consumer credit and not enter in the small business arena for lending today. We’re really confident that helping consumer with debt consolidation, with large purchase and consumers, based on their personal credit for their business, is the way that we can best help the consumer here in America.
There is plenty of growth ahead for Prosper in the consumer market. The Federal Reserve reports the consumer debt market has grown to $3.2 trillion dollars in the second quarter of 2014. Banks have yet to start lending in earnest because of heavy regulatory fees and high capital requirements. Financial institutions are sitting on $2.6 trillion in cash above the amount needed to meet federal requirements.
This is driving a lot of consumers, especially for larger purchases where they need loans, to peer lending. Once they see that the risks to peer lending are no different than for any type of loan, they return to the lending platforms for other loans.
Could P2P lending ever get into the market for home loans and auto loans?
We see the marketplace lending arena and the industry expand beyond the consumer. You have a couple firms, we could take for example SoFi. SoFi is doing student loan refinancing and now they’re doing a very large business in mortgages. And you see some platforms doing consumer and business and you see lots of new platforms doing real estate with Realty Mogul and Patch of Land and numerous other real estate firms. I think you’re going to see other areas expand into marketplace lending in addition to small business consumers, real estate, student loans, mortgages are going forward. Exciting new things in 2016 will be announced from the industry.
SoFi could become a big player in the online lending space though it is not a peer to peer lender where investors can participate. The site offers student loan refinancing with fixed rates between 3.6% and 7.5%, personal loans and mortgage loans with fixed and interest-only options. Click through this link to learn more about the loans and rates available.
What do you think every borrower should know about peer to peer lending?
I think the first thing borrowers should know is the importance of the platform validating and verifying: identity, income, and employment. The faster the borrower submits the documentation required, the faster the platform can do its job to verify the information they have submitted so that their loan can be listed. This is critical for the success and speed of the platform to deliver the capital back to the borrower.
Even peer to peer loans can get expensive if you have bad credit. Check out these three credit score hacks to raise your FICO before getting a loan.
Any risks that borrowers should understand about peer lending?
I think the borrowers should focus on prepayment penalty, if any. Some platforms have them and some don’t. Prosper does not have a pre-payment penalty. They should also consider the rate they are quoted, make sure they understand all the fees, and also be comfortable with the speed and ease of use of the platform.
Fees are always the hidden trap of credit and loans. That 0% teaser rate may sound great on your new credit card until you find out there is a $100 annual fee and the rate you’re going to pay after the first year. And that’s not even considering where your rate will go if you miss a payment.
Origination fees for peer lending are relatively small. Prosper and Lending Club both charge a 2% to 5% origination fee on your loan, which they take out before disbursing the money to your bank account. Both peer lending platforms charge a 15% late fee if your payment is more than 15 days overdue but your rate will never increase.
One of the most common complaints I hear about peer to peer lenders is the strict credit score requirements. You’ll need a credit score of 640 or higher to get a loan on either Prosper or Lending Club, which basically locks out a quarter of the population with bad credit. Check out this earlier post on the Top 10 List of Bad Credit Peer Loan Websites if you have less-than-excellent credit but need money.
Now, shifting gears to the investor side. What three things should people know about peer lending investing?
It’s been written by almost every platform that one critical components of being an investor in a marketplace lending platform and a peer-to-peer platform is investment diversification. Ensuring that you have at least a hundred loans and, also preferable, more than two hundred loans spread across different loan grades and different time periods and vintages, to ensure diversification. And another key is to not just to be on one platform but to have the opportunity to invest in more than one platform to continue the diversity of their investment.
And the third thing I would encourage investors is to look at the IRA account. The tax deferred account, as a vehicle when investing in these loans given the high interest and the ability in tax deferred accounts to defer the interest in the IRA account. Those are three points I encourage the investors to consider.
I have talked about investment diversification in peer loans on the blog as being a double-edged sword. It is absolutely critical, as with all investments, that you invest in enough loans so a few defaults do not significantly affect your portfolio return. On the other hand, a lot of sites recommend investing in thousands of loans which means you’ll need to relax your loan criteria and basically invest in any loan that comes down the pike.
Interested in peer lending investing? One peer loan investor shared his steps in another article for making 12% annual returns and consistent cash flow. See how this investor makes money in peer lending.
That kind of ‘dartboard’ investing is similar to index investing in stocks. You may earn the market return or a little worse but you’ve diversified away any chance at better returns. A chart of portfolio returns by the number of loans held, based on Lending Club data, shows that diversification benefits level off quickly around 150 to 200 loans.
I normally recommend investors aim for between 150 and 200 loans in their portfolio but you could go up to 250 loans if you are able to find them within your loan criteria. If you find you are relaxing your loan criteria just to get more loans, you put yourself at risk of lower returns.
The Individual Retirement Account (IRA) option is a great choice for investors. Interest from loans is taxed at the same rate as your income so can be pretty high for those in the top tax brackets. Putting your money in an IRA account means you won’t pay any taxes until you withdraw the money. You will also be able to deduct the money you put into the account from the income you earn each year. There is a limit to how much you can put in an IRA account each year and you cannot withdraw it until you are 59 years old, so there are some limitations.
The money you lose on charged-off loans can be deducted from your other investment gains, if you hold your peer loans in a regular, taxable account. This can help to offset gains in other investments like stocks but the taxes you pay on peer loans interest may make it a better choice to put your peer loans in an IRA account.
That brings us to the growth in the investor base. It’s really taking off, especially on the institutional side. I’ve heard a lot about the interest from family offices and advisors and it seems like it’s making it difficult to find peer loans to fund for retail investors.
Does Prosper have a plan for attracting more borrowers to fill this demand? How could they do that?
Prosper is very committed to the balance between retail and institutional investors. To do that we are very focused on borrowers. We’re using many new avenues to find borrowers that fit. Traditionally, these platforms use a lot of direct mail to find borrowers, and to educate borrowers and to pre-screen offers. Now, we’re using digital marketing and social media and partnerships and affiliates and lots of new ways to find new borrowers and educate them about the opportunity to borrow for less, easily and quickly, with a fixed rate and a fixed term to get out of debt and improve their credit.
The fact that Prosper doubled loan originations though the platform to $2 billion in just six months this year speaks to the growth in the industry. There will be some growing pains, as we’ve seen in the faster growth of investor loan demand, but I think the issue gets worked out in the coming year. As more borrowers begin to see peer loans as an alternative to traditional bank financing, the increase in loans will help clear the market for investors.
How about the future of peer lending? Where do you see peer loans in, let’s say, three to five years?
I see peer lending really integrating itself with the banking industry. There are initiatives happening today where banks are introducing their borrowers to us, the peer-to-peer marketplace lending platform. At the same time, as we are able to help their borrowers get a loan, those banks are buying those loans from us.
We’re starting to see the banks realize that we are part of the solution to help them take care of their clients, to improve customers’ satisfaction, to get loans to their clients, and at the same time, own customer credit without having to do the loan. I think that a critical piece for people to understand today is that the banking community is really embracing what we’re doing and seeing as how we can help the banks and their clients.
The second thing I think that’s going to happen is a continued integration of these peer-to-peer platforms into the social network and the social community. If you look at Facebook today and go to the Prosper page on Facebook, you see thousands, tens of thousands of people telling their stories, sending in videos about how we helped them, and sending in photographs about the benefits of using Prosper. And you’ll start to see more and more of these technology firms embracing peer to peer finance and payment. I think that will be a major driver in the next year or two ahead.
Integration with the traditional banking industry will be very interesting over the next few years, especially as more regulation from Dodd-Frank comes into effect. These, and other banking rules, have increased capital requirements and regulatory fees on banks and limited the ability of smaller banks to profitably survive. The fact that banks are choosing to be an investor in peer loans rather than originate themselves give you a clue to the difficulty in their industry.
It’s interesting that you brought up Facebook. You probably heard the rumors that Facebook wants to be more involved in peer loans. Everyone is curious whether that means its own platform or maybe a platform on the site run by another company.
Any idea where Facebook might want to be involved in peer loans?
No, I wouldn’t want to speculate about that.
Another question that I really didn’t expect Ron to be able to answer but it was worth a try. The social network reaches more than a billion people and would bring a huge global reach to peer loans. While the Lending Club IPO is a positive for the industry, investors in Lending Club shares should be worried that Facebook could enter the market in some way as a competitor.
What speed bumps do you see for peer lending companies, whether government regulations or economic that could come into play?
The things that we think about at Prosper include the risk-free rate of returns and the Fed funds rate and what are the investment alternatives that retail and institutions have to ensure that we become an attractive place for people to invest in a loan. We also think a lot about the economy and unemployment to make sure that our pricing, credit and risk continues to iterate and stay very up to speed on what’s happening with consumers.
And the other thing we think about is the institutionalization of these platforms as they grow. We need to continue to invest in infrastructure, people, mobile and new products to make sure that we can continue to be able to grow with quality and with the great service our borrowers and investors are used to and require.
The risk-free rate is the interest rate paid on U.S. government treasuries, usually the 10-year bond. It is called the ‘risk-free rate’ because payments are backed by the full faith and credit of the United States. It is on this interest rate that all other bonds and loans trade because all of these have marginally higher risks than the treasury bond. They have to do this to attract investors to buy the debt.
The highest-rated bonds of corporations might pay rates just a little above treasuries, after all you wouldn’t expect Disney to ever default on its loans. At the other end of the spectrum is bonds of risky companies and unsecured loans to individuals, i.e. peer loans, that would need to offer higher rates of return to investors.
The Federal Reserve, which sets the rate on government bonds through its federal funds rate, has given clues that it will start raising rates in 2015. While it will mean different things for different types of loans, I think it is going to be a good thing for peer loans. Rates on peer loans may increase a little as the interest rate increases while defaults will probably not increase since missed payments are more closely tied with employment and the economy. Even if there is higher competition from other bond investments from an increase in interest rates, peer loans offer extremely high returns compared to even junk-rated debt and I still see a lot of investor interest in the year ahead.
You gave a great presentation about the Necessary Nine for Global Success of the Marketplace Lending Industry (Youtube) at the Alternative Finance Conference in November.
What does peer lending need to do to stop being an alternative form of finance and become really mainstream?
I think in 2015 peer-to-peer lending will become the best way, the most efficient way to borrow money. It won’t be something that’s new and it won’t be that only just a few people use it. I think it will eventually become an application and use in people’s daily life and not just for a first loan, but for a second and third loan and a place that the millennials and Gen X use as a solution for their personal financial needs, both for investment and for borrowing.
At present twenty-three states prohibit investing on Prosper, similar numbers prohibit investing on Lending Club. I think there are three states prohibiting borrowing on Prosper and five that prohibit borrowing on Lending Club.
Can you talk a little bit about why that is? And how Prosper or the industry in general can go towards making it a more democratized system across the country?
Absolutely. We are working very closely with the regulators, both on a federal level and state level, to educate them on the benefits, to the investors and the borrowers of the transparency of the platform. And how we’re really helping people and how the industry has grown and changed since perhaps their earlier introduction to it over the last eight years.
Many of these states are starting to realize that these platforms are extremely well capitalized. Run by experienced professionals with pricing and credit and risk models that are very different than the earlier days of peer loans. And that these platforms are going to be accepted by many more states. We’re hoping to have more states looking to approve us going forward especially in 2015.
I think, as the Lending Club IPO starts to gain media attention, the pressure is really going to be on states to open their regulation to investing and borrowing in peer loans. After nearly a decade of lending in the industry with no real smoking gun or fraud, there is little reason to keep half the country from being able to invest in peer loans.
What are the three biggest area of growth for peer lending?
I think for growth, Prosper is looking to grow its employee base. We are hiring people every week and we are expanding in California and Arizona. In 2015, we are focused on our products – rolling out new features and functionality that attract more borrowers, including a major focus on mobile. We’re also focused on partnerships that help us reach new borrowers.
Growth has just been amazing in the peer lending space and there is still a ton of room to go before the platforms have to really start thinking about competition. I think it will be interesting to see how that competition evolves in the online lending space, whether through financial institutions moving online or through social networks developing lending platforms. Growth in other loan types is probably the biggest opportunity in the near-term as people go to the platforms to fund their large purchases instead of just for debt consolidation.
Thank you Ron Suber and I want to thank you, the reader, for joining us. I hope you will join us for more interviews and follow the blog on Facebook and Twitter. Please consider sharing this article with your friends using the social share buttons on the left.