NEWS

Pair of online companies make person-to-person lending easier

Silicon Valley/San Jose Business Journal
June 2, 2006
by Raksha Varma

As the Federal Reserve continues to raise interest rates, consumers looking for a good deal on a loan may begin considering a new alternative -- Internet-based person-to-person lending sites.

One, named Prosper, set up shop in the Bay Area in April and a year-old British service -- called Zopa -- is coming to California this summer.

Both promise consumers better rates than they can get from traditional lenders and, for investors, higher yields than those products offered by brick and mortar banks. Financial experts say Internet-based lenders don't pose a large threat to bigger banks right now, but they are gaining traction.

"The Bay Area seemed like a natural place for us to launch," says Richard Duvall, Zopa's chief executive officer. He intends to set up the office in San Francisco and market Zopa to California only. "It's an entrepreneurial society. People are looking for better places they can put their money."

The start-up recently secured $15 million in funding from Bessemer Venture Partners, which has an office in Menlo Park, the same firm that funded global Internet telephone company Skype. Existing investors Benchmark Capital, which has an office in Menlo Park, and Kitchner, Ontario-based Wellington Partners also joined in the latest round.

"Consumer lending markets amount to tens of billions of dollars," says Rob Stavis, a partner at BVP's New York office. "There's a real opportunity here to bring the best deal to consumers."

At social lending sites, consumers can "shop" rates posted by individuals looking to make loans. At the same time, those looking to loan out their money can peruse through loan requests posted by members.

For example, here's what Prosper could do for a potential San Jose couple looking to buy a new car. Instead of heading to a bank -- the typical rate at Wells Fargo Bank is about 9.63 percent for a 36-month new-car loan, according to Bankrate.com -- they log onto Prosper's site to surf for better rates. They input the amount requested and the maximum interest rate they want to pay.

Then, lenders bid on the couple's listing by inputting the amount they want to lend at a rate they think is fair. After the listing ends (it's a 10-day maximum), the bids with the lowest rates are combined into a single 36-month loan for the couple. Each month, the couple's payment is deducted from their bank account and deposited into their lenders' accounts until the loan is repaid. The couple can also mail in a check, but Prosper charges a fee for processing.

Zopa employs a similar process. For a 36-month loan request at 4,000 pounds (about $8,000 in the United States), a typical interest rate is about 5 percent, depending on a consumer's credit rating and the rates lenders are offering at a specific time.

"The lowest rate is about 4.3 percent," Mr. Duvall says. "Usually, it's between 4 and 7 percent."

With Zopa, lenders make money even if their funds are sitting idle. Lenders deposit money into accounts that they plan on making loans from. While they're looking for a potential loan to fund, their money earns interest at 3.25 percent.

"Like anything, to make money there needs to be an investment," says Tiffany Fox, a spokeswoman for Prosper. "Lending one time may not yield a lot of money. But if a lender makes a lot of small, little loans, there's going to be a payout in that."

At social lending sites, interest rates aren't affected by the prime rate because both the lender and the couple barter together, until a mutual rate is agreed upon, Mr. Duvall points out.

Prosper, transparent for most of the process, earns money by charging lenders a 0.5 percent annual loan fee and a 1 percent closing fee to borrowers. There are no other fees attached to the process, except delinquency fees if a payment isn't made. Similarly, Zopa charges lenders and borrowers a 0.5 percent fee each.

"The risk is managed," Mr. Duvall says. The Federal Deposit Insurance Corp. does not regulate online lenders, such as Zopa and Prosper, but does insure deposits at Internet banks like ING Direct and HSBCdirect.com, which offer consumers high-yield savings accounts and also make loans.

In order to cut risk, there are legally-binding contracts, and Zopa manages the collection of monthly repayments. Both companies perform all of the checks a bigger bank does, including credit checks, on lenders and borrowers.

To manage their risk, lenders typically make a lot of small loans. That way, if one or two borrowers default on their payments, the lender still has other loans to count on.

There's also an informal honor system. There are community user groups (for example, San Jose firefighters) that can vouch for another group member's reputation -- a la
Friendster -- but not guarantee his loan at Prosper. If a group member defaults, his entire group's rating plummets, making the group less attractive to others scouting for loans. Lastly, if a loan is not paid, the site informs the online lenders, sends late notices, notifies the three major credit bureaus and a collection agency in less than 30 days.

"Lenders aren't in the business of losing money," Mr. Duvall says. Less than a fraction of 1 percent of money that's been loaned out in Zopa's one-year history has not been paid back.

Both Prosper and Zopa appear to be gaining traction. Though Zopa has not officially launched in California, it has a member base of 68,000 -- 60 percent of them, lenders. Mr. Duvall declined to discuss the company's sales, but he says that Zopa employs 38.

"Person-to-person lending makes for a stronger sense of accountability because people are connected to each other, not banks," says Chris Larsen, Prosper's chief executive officer. Backed by Palo Alto-based Accel Partners, Benchmark Capital, Boston-based Fidelity Ventures, and Omidyar Network, Prosper has raised approximately $20 million.

Started just a month ago, Prosper already has 800 user groups and 1,300 loan listings. Mr. Larsen, a San Jose native, is also the co-founder and prior chairman and CEO of E-Loan, a Pleasanton company.

Despite their appeal, niche Internet-based lenders may not be as successful as bigger banks that offer more "traditional" lending routes, industry sources say.

"It's not really a threat to the brick and mortar lenders," says Kurt Vandenberg, a financial consultant at New York-based firm Capco. "But it does make microfinance more of a possibility. Financing automobiles and home lending becomes easier, because there are more choices."