Why can’t banks do what Prosper does? And why can’t investors do what MonJa does?

Last week we were honored to be part of a very special event, organized by Vijay Rao, who has been MonJa’s Principal Consultant since the inception of the company. Vijay is also a CFA, FRM, the COO and Founder of Just Invest, Inc., and the chair of the FinTech Commitee at San Francisco CFA Society. The event took place at Prosper Marketplace office in San Francisco, hosted for the Asian bank investors considering FinTech expansions. Event included presentations on topics including marketplace lending, marketplace lending analytics, crowdfunding, digital payments, BitCoin and BlockChain, digital wealth and robo advisor.

Event started with the presentation of David Kimball, Prosper’s CEO, who gave the audience an overview of Prosper, online lending platform, his perspective on the changes happening in the industry, challenges they face as a marketplace lender and ways of overcoming them.

Prosper, founded in 2005, was the first Peer-to-peer platform in the US. Since then it originated over 800,000 loans of over 10 billion in total. David highlighted the advantage of having employees with finance and FinTech background at Prosper. Not only that lets the platform have things done fast but also the right way, and in compliance with regulation.

At the very beginning of David’s career at Prosper, he asked: “Why can’t banks do what Prosper does?” And this question is still often asked. Banks have depositors and have borrowers  – can’t they do what Prosper does? In US, borrowers have the choice to go to individual bank branches to get a loan. They even have the option of submitting the application online. But, that’s when the differences between a bank and marketplace lender, like Prosper, start. Borrower may have to call afterwards, fax extra paperwork, wait 2-3 weeks after the application in order to find out whether their loan was approved or not. With Prosper – borrowers get the instant decision. Prosper has credit team just like any bank does and is controlled just like any bank, meaning it has to be transparent. The two main differences, compared to a bank, as David said, are the speed and willingness to adapt technology. That gives Prosper key competitive advantage, compared to a bank. Now banks technically can do what Prosper does – they just choose not too. If they offer their clients loans on rates lower than their credit card rates – they lose their margins. Not to mention that banks have other priorities to focus on. According to David, the main goal of Prosper for the next few years is to become ahead in technology so that when banks will want to do it – they cannot do it.

Who are Prosper’s borrowers? Prosper competes with banks for same segment of borrowers: prime- and  subprime, whose FICO scores are over 700, most with the goal to eliminate their credit card debt. But there is an obstacle for a bank  – it cannot offer loans at the same rate as credit card interest rate their clients pay. So what happens is that these clients go to online lenders, such as Prosper.  There are clear advantages to borrowers who decide to consolidate their debt with the help of Prosper. Having a fixed rate and term (3 or 5 years) allows borrowers to save money and pay off their debt faster. The rates don’t evolve or change as at the bank. All loans offered by Prosper are unsecured loans starting at the size of $2,000 and up to $35,000. There are no prepayment penalties and no fees. Borrower can get money as fast as in 2 days. Prosper’s goal, according to Mr. Kimball, is to increase borrower’s financial security so that they can pay off their debt and don’t come back. There is an incentive to the borrower whose credit card interest rate can be up to 20-25%, while at Prosper he can get a loan for 14% (on average).

What are the advantages to investors? Retail, high net worth investors have the option of picking the loans they want to fund or letting Prosper pick loans according to their risk appetite. Individual investors can invest at increments of as little as $25. But Prosper recommends to invest in at least 1000 loans in order to replicate the platform diversification. Retail investors represent about 10% of the platform’s invested money, majority is institutional investors, including banks. It is interesting that when Prosper just started in 2005, investors had the option of choosing the person whose loan they want to fund, based on individual characteristics of the certain borrower. The way things are now is very different – the borrower and investor do not know each other. Borrower only knows that the loan was funded, and Prosper facilitates it. Investors have a choice: to earn 1% on the deposit in the bank or earn 6-7% by investing in whole loans. At Prosper, borrowers pay the initial origination fee, investors pay ongoing servicing fee, profit goes to investors.

David mentioned that, despite everyone talking about FinTech disrupting the way banks work and representing a threat to them, he sees more opportunity in rather partnering with banks, helping them become more efficient. Relying on technology is the opportunity to lend less expensively. FinTech is obsessed with growth, and so was Prosper until last year. Now they focus on sustainable growth. There has been a lot of changes within the company to achieve the goal. It decreased volume and decreased cost to be more efficient. Last quarter (Q2) was the first to generate cash, with the new CFO who joined the team in February this year – Usama Ashraf. Continuing with the help of people from finance and technology, Prosper plans to generate cash in Q3 and Q4.

Prosper’s competitive advantages. Speed and ability to embrace technology let the platform make the borrower’s application process as simple as possible, so that less information is required. At the same time, it spends a lot of resources on verification. Prosper verifies identity and bank account information of 100% of its borrowers. This results in fraud rate of just 0.1%. Online lender utilizes technology to validate employment, phone number and identity. It also tries to make it easy for their clients to access the information in their account: to make sure they know when to pay and can be better borrowers overall.

Since marketplace lending is a fairly new asset class, for institutional investors, it is crucial to understand the risks associated with it. What are the average loss and default rates for this type of investments? What is the bad debt rate? What are the trends in the regulation environment? What happens when a platform, as Prosper, uses certain risk borrower assessment model and then changes it? How does it impact the performance of the investor’s portfolio? How do the platforms ensure the adequate risk/reward balance for their investors? How is risk assessment on default probabilities done and how is it priced? What’s the motivation for region banks to buy from Prosper?

To be able to not only answer questions like the ones above, but also navigate within endless marketplace lending investment opportunities, requires a lot of time and resources. Some investors choose to have a team of analysts and data scientists. Others  – to partner with a company, like MonJa, and outsource the heavy data analytics work.

James Wu, Co-founder & CEO of MonJa, presented to investors with an overview of US-based marketplace lending platforms and the analytics side of marketplace lending, explaining the advantages for a bank to invest in marketplace loans and how MonJa’s solutions can help them achieve their investment goals. Needs to be mentioned that, to the advantage of the audience, Mr. Wu, was presenting in Mandarin and investors were able to understand and ask question directly.

With the growing number of platforms, grows the complexity of understanding the Peer-to-Peer lending investment opportunities. And grows the amount of due diligence and pre-purchase analysis required for investors. There is over 30 consumer online lending platforms, over 70 small business lenders and over 10 real estate in US. Three different asset classes of loans (consumer, business and real estate) require different analytic tools and different investment strategies. As the market grows, matures and continues to evolve, so does MonJa’s services offered. Previously, most of company’s work was done for investors (hedge funds, asset managers, family offices) purchasing consumer loans. Now we see investors showing more interest in diversifying their portfolio holdings with loans of all three asset classes, combining platforms and constantly looking for new investment opportunities. There is also more interest from the banks, insurance companies and international investors. What stays same and actually even more important for investors is making data-driven decisions.

MonJa builds the investment support tools for the marketplace lending industry. Investors have to analyze massive datasets on a daily basis across multiple originators. That is why portfolio management software are crucial to serve this market. With the right software, investors can lower default rates, reduce delinquencies, and enhance returns. If you are interested to know what are the tools MonJa offers investors and how they can make your investment process more efficient, please read here: how MonJa helps investors optimize their loan portfolio.

This week there is another event we are very much looking forward to: FinTech Series: Marketplace Lending holding by CFA SF Society on Thursday, September 28th at Lending Club San Francisco office. This would be panel of industry practitioners to discuss the current state of marketplace lending: Peter Renton, Chairman & Co-Founder, LendIt (moderator), Usama Ashraf, Chief Financial Officer, Prosper Marketplace, James Wu, Founder & CEO, MonJa, Philip Bartow, Portfolio Manager, RiverNorth, Patrick Dunne, Chief Capital Officer, Lending Club and Paul Stockamore, VP, Capital Markets, LendingHome. Use discount code “CFA-Fintech” for a free ticket to this event! We hope to see you there!