Peer-to-Peer Lending for Banks, Too?

Prosper, a pioneer in connecting little lenders with little borrowers, will start auctioning off bank-originated loans, too

By Amy Feldman

Prosper, the largest "peer-to-peer" lending site, is opening itself up to financial entities that want to list their performing loans and auction them off to average-Joe investors in miniature increments.

The first financial firm to participate is Consumer Portfolio Services(CPSS), an Irvine (Calif.)-based specialist in auto financing for consumers with past credit problems, low incomes, or limited credit histories. CPS began posting the first of a few hundred loans on what Prosper calls its "open market" on Apr. 28. Chief Executive Chris Larsen hopes this will make more loans available for autos, small businesses, and the like—at least in Prosper's own little way. "These markets are still completely shut down," Larsen says. "This solves the key problem of securitization in that you will have that direct line of sight to the loan itself."

Prosper and other peer-to-peer lenders specialize in connecting borrowers who need up to $25,000 in cash to fund small businesses or refinance their credit cards with individual investors who bid on those loans in amounts as small as $50. Prosper has originated $179 million of loans that way since its founding in 2006.

Waiting on SEC Approval

But the recession has brought stunningly high default rates to some peer-to-peer loans. And Prosper has been on regulatory hiatus since October while it worked to get approval from the U.S. Securities & Exchange Commission for its existing market as well as the new market for institutional loans. It still hasn't received SEC approval. Instead, it is moving forward under an obscure loophole that permits companies to seek a one-state exemption; Prosper received the go-ahead from California state regulators to reopen in that state only.

The overall marketplace, as of Apr. 28, will be open for California lenders only, and only California financial companies will be permitted to post their loans on Prosper. A secondary marketplace for all of Prosper's loans, which has been in the works for some time, will follow soon after, although again only in California to start.

How will peer-to-peer lending work for financial institutions? Just as in any regular loan, the financial institutions—banks, car dealerships, community lending organizations, and the like—will lend to people buying a car or running a business. The loan must then gestate for three months. After those first three payments have been received, the financial institution can post the loan for bids on Prosper. This is not meant to be a place to unload toxic bank loans (there are other places for that), and only loans up to $25,000 that are current on payments may be posted.

Extending the Terms

The bidding will work similarly to the site's typical small-timer loans: Borrowers post for money and lenders bid eBay-style (EBAY) for pieces of each loan. After there are enough bidders to fill the entire loan (for example, 100 bidders of $50 for a $5,000 loan), increased bidding lowers the interest rate. That allows the financial institutions that posted the loans to make money off the spread between what they're charging the original borrower and what they owe Prosper's lender/investors.

Unlike Prosper's historical business—which is entirely three-year, unsecured loans—these new institutional loans can have terms from three months to seven years, and they can be secured or unsecured. Investors will see the details of each specific loan and its payment history, as well as the credit-rating report details that are on all Prosper loans.

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