For Part 1 of this series on what happens if Lending Club goes bankrupt, check it out here.
Since we looked into what happens if Lending Club goes bankrupt, it's natural to now look at Prosper and see what happens if they go bankrupt. Again, like with Lending Club, the investments in Prosper, especially in 2013 by Sequoia and BlackRock have lessened the likelihood of a platform bankruptcy happening but it's still a topic worth exploring. With this in mind, let's address the questions of what can happen versus what will happen. First, retail investors like you and me.
Are Retail Investors Protected?
In a word, yes they are. Unlike Lending Club, Prosper has set up a separate entity for the issuance and servicing of loans, known as Prosper Funding LLC versus the lending platform itself, which is owned by Prosper Marketplace, Inc. The platform going bankrupt would mean a bankruptcy filing by Prosper Marketplace (PMI) and Prosper Funding would be unaffected as a separate entity.
Prosper themselves describes what protection they have in place right here on their own blog. You can see that they are specifically accounting for the issue of the lending platform itself going into BK. This creates a very different environment of the what can happen versus what will happen as you will see below.
What Will Happen: Prosper Funding continues to service existing loans.
The whole purpose of the separate entities is to have a separate entity for the servicing of loans. Where LC has it all under the same entity with a backup service agreement with PFSC, this separate entity is specifically set up and approved with the SEC for the purpose of continuing the servicing of existing loans in the event of a platform bankruptcy.
What Can Happen: PMI's assets are purchased by another company
Since Prosper Funding has the loans, the only assets PMI owns are technology and intellectual property based. These are the things that allow for this user friendly lending platform to do its thing and so we can invest. Even with the loans not included, there is very clear and obvious value; whether it's in licensing to others, continued operation or the prevention of competitors getting access to it. The lending platform itself would be of value to many different people and companies and its sale would help to facilitate a smoother faster bankruptcy for PMI and would benefit us as investors as well.
What Will Happen: The issuance of new loans will stop.
Since PMI is the platform that generates new loans, which are then assigned to Prosper Funding, a PMI bankruptcy means that the issuance of new loans stops until a Federal Bankruptcy judge allows them to start issuing again OR (see above) that PMI's assets are purchased.
What Will Happen: WebBank's role continues as before
Per 2012 S-1, WebBank's role as the distributor of proceeds, seller of notes to Prosper Funding, issuance of promissory notes continues since they are not exposed at all to PMI, only to Prosper Funding (S-1, page 7). This another area that differs from LC where WebBank's role would have to cease since it deals directly with LC, which is the bankrupt entity in their case.
Are Institutional Investors Protected?
Just as with retail investors, the separation of servicing entity from loan origination entity means that Institutional investors have exactly the same protections. Their loans are in the same pool that are serviced by Prosper Funding as the retail loans.
2013 was the year that the US discovered peer to peer lending. Big institutional investments by Google Ventures, Sequoia and BlackRock into the 2 largest retail based peer to peer lending platforms made this a big year, as well as a year where the likelihood of the lending platforms going bankrupt has come down significantly.
The risk is still there, after all, Lehman Brothers was a very old established investment bank and it went under. It can happen. The chances that it will happen are significantly lesser than they were even a year or two ago. That being said, if you believe that there is a very real risk of platform bankruptcy, then your money is much safer at Prosper than at Lending Club. Prosper has protections in place while at Lending Club we are relying on an asset purchase or the decision of a federal bankruptcy judge.
Correction: The January SEC Prospectus filing update shows that the backup servicer is now First Associates Loan Servicing.
Thanks to Larry Chiavaro at First Associates for the correction