Prosper, the online lending company that began the peer-to-peer lending revolution in the U.S., will mark its second year of lending Feb. 21. Prosper’s unique take on lending was followed by Lending Club, CommunityLend, Smava and iGrin, among others. Like any new company, Prosper’s first year has seen significant changes to the business model and a lot of small tweaks to the system.
One of the most notable aspects of Prosper’s business model is its groups feature. Borrowers may join a single group based on a common interest such as nationality, local community, religious affiliation or an affinity for PCs over Macs. Groups have reputations based on how well their members’ loans have done and each member borrower can help or hurt that group’s reputation.
Originally, groups were created to allow borrowers to leverage their group’s reputation to get better bids and lower interest rates from lenders. Lenders, theoretically, would prefer to lend to those in groups because peer pressure would lower the default rate for borrowers.
“I think it is an interesting concept that simply did not work out as Prosper had originally intended,” Eric Petroelje, owner of Eric’s Credit Community, a website dedicated to statistics about Prosper, said in an e-mail interview.
Groups are managed by group leaders who, in addition to developing a home page for the group, also have the option to review the loan requests of borrowers who belong to their groups. If a borrower’s loan was accepted, the loan request listing would go live. If not, the loan request would be cancelled, and borrowers would have to rewrite the request. This was intended to help borrowers submit listings that would attract lenders and get funded.
Until recently, group leaders received compensation for new loans created through their groups. That practice has been discontinued, leaving group leaders with little incentive to help borrowers.
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“In practice, groups became more like an affiliate program where group leaders simply brought in anybody they could find, whether they actually knew them or not, in hopes of making a quick buck off the group leader rewards,” Petroelje said.
Now the only financial incentive from Prosper at all is a referral reward that is available to all members, not just group leaders. The referral rewards give referrers a $25 reward for referring a lender, and 0.5 percent of a referred borrower’s loan amount once the loan is funded.
“Most of the bad groups on Prosper simply poach their members from the flow of new users coming in on their own, while the better groups generally bring in their own borrowers,” Petroelje said.
“The better groups can continue to get some compensation via the referral program, while the bad groups still receive nothing since they are not usually bringing in their own borrowers…[assuming] that the referrer and the group leader would actually be the same person for most of the better groups out there,” he said.
Beyond the struggles many groups now have with their leaders lacking incentive to check in on group members, a number of groups that were highly rated during Prosper’s first months have fallen significantly in the rankings because of defaults that drove down the groups’ reputations.
“Because of this, the track record of most groups is no better than the track record of the average non-group borrower on Prosper,” Petroelje said.
However, borrowers are still able to profit from affiliation with a group, as seen in this graph from Eric’s Credit Community.
“Although group listings do not seem to perform any better than non-group listings in general, they are much more likely to be funded than non-group listings,” Petroelje said.
“It could be because group leaders are helping their borrowers write more attractive listings,” he said. “Or it could be a self-selection thing—more sophisticated borrowers tend to join groups, while less sophisticated ones don’t—or it could be that lenders still have a false confidence that group membership in general will reduce default rates.”
No matter what the reason for the success of borrowers who are group members is, it is still wise for borrowers to look into joining a group so they may benefit from the possibility of getting their loan fully funded. As for lenders and investors, it may be best to watch Prosper’s groups closely over the next few months to see what effects the removal of compensation has on the groups and their leaders. At this point, however, investors should probably put little weight on whether or not a potential borrower is a member of a group.