Gaby Lapera: One of the things that you have to realize is that people vary in their risk
when you're giving them a loan, and if you give people who are high risk a loan, they're
probably going to default. That's why banks are so careful.
Jay Jenkins: Absolutely. That's why they charge higher interest rates, too.
Lapera: Exactly. Jenkins: The theory is they'll have more loan
losses on those riskier loans, so they should charge more to cover those losses and still,
hopefully, make a profit. Lapera: Right. Just to be clear, they charge
higher interest rates for people who are riskier. One of the easiest metrics to see is your
FICO score, which says if it's above 750 these people are prime borrowers, or above 800,
super prime borrowers. They're going to have the lowest interest rates. People below that
are going to have much higher interest rates, which means that they're going to pay more
over the life of the loan. But the banks do a really, really good job of checking and
making sure that you are who you say you are, and that you make as much as you say you do,
and getting all these factors about your life and making decisions, especially if you're
applying for a business loan, making a decision about whether or not the business sounds feasible.
Jenkins: Absolutely. It always makes me think back to the financial crisis on the mortgage
side. Subprime mortgages, no documentation loans, no income verification loans, and we
all know what happened. Those loans were not repaid with any sort of regularity and it
caused these tremendous losses at the banks that almost tipped the entire global economy
over. Then you read, some of these online marketplaces, that what they're verifying
is a lot of times even less than what was being verified for those subprime mortgage
loans. I've got a number here for you. In Prosper's S1, currently it's privately owned,
but it's an online marketplace lender just like Lending Club or On Deck.
Lapera: Just so you know, an S1 is what a company has to file with the SEC before they
go public. Jenkins: Correct. Thank you. According to
their S1, which they filed earlier this year, Prosper verified employment and/or income
only on 59% of the loans on their marketplace. Just 59%. In theory, that means 41% of these
loans, these individuals could have just popped on the website, made up a bunch of stuff,
and then walked away with a pile of cash. Lapera: Yeah.
Jenkins: That's fraudulent, of course, but from an investor perspective, that's a lot
of risk that these companies are taking on, lending out huge amounts of capital. The thing
about lending money is not only do you have to sell the loan, you also have to get it
back. That's fundamentally different when you sell a widget or some other kind of service.
If a bank or lender doesn't get their loan money back, that lender's going to fail pretty
doggone quick. Lapera: I think even more horrifying than
the fact that they only checked 59% of the loans, is of those 59% they checked, they
pulled 15% of the listings, saying 15% weren't real or weren't good listings.
Jenkins: That's right. Of the ones they checked, one in six was wrong or fraudulent or just
fabricated. Lapera: That's a lot. The chances of that
happening at a bank are so, so much lower. Jenkins: Especially in today's environment.
With Dodd-Frank and all these regulations, know your customer regulations, it's a real
serious thing. Lapera: Yeah.
Jenkins: It's one that banks have perfected. Banks have been doing this for literally thousands
of years and there's value in that institutional and kind of cultural knowledge in the industry.
I don't want to be too negative. I really like the concept of using the internet and
using peer-to-peer as a channel to enhance. People who need credit and are maybe a subprime
but are still willing and able to pay, improving the access to credit can go a long way to
helping these individuals' lives. And an investor who's in a company that's doing that effectively
and taking the proper risk management steps ... There's a lot of money to be made. I was
reading a PricewaterhouseCoopers report last week, as all this news was breaking that predicted
that the online lending marketplace industry could reach $150 billion in originations per
year by 2025. That's a huge number, but that huge number only represents 10% of the current
revolving consumer debt market, plus 5% of the non-revolving market.
This is a gigantic ocean where these guys are playing. It's the kind of market that
if disrupted properly, there's a lot of money to be made. It's just at this point I think
they're failing on the risk management front, so we're just not quite there yet.