Prosper Pays Dearly For Growth

Second-quarter results show the lifeline that digital lender Prosper Marketplace Inc. took earlier in 2017 is starting to pay off.

A year-over-year jump in origination volumes accompanied by healthy fee revenue growth signal a rebound in personal loan-focused Prosper’s core business. Management reported a cash-flow positive quarter based on adjusted EBITDA of $6.7 million, compared to negative $11.6 million a year earlier.

Despite the positive signs, questions remain about the ability for Prosper to become profitable on a GAAP basis, especially in light of continued costs related to an agreement with investors entered earlier this year.

Origination growth boosted by consortium

Marketplace lenders like Prosper rely on demand from investors to fund new loans, which generate revenue for the company in the form of transaction and servicing fees. Prosper reported strong growth in origination volumes, with a 74% year-over-year increase to $744.7 million in the second quarter of 2017.

The second quarter of 2016 was a particularly hard quarter for Prosper. In April of that year, the company lost a stable source of funding as Citigroup Inc. exited a partnership in which it had purchased Prosper loans for securitization. Subsequently, originations fell to a multiyear low of $311.8 million in the third quarter of 2016, far from a record high of $1.1 billion a year earlier.

Without Citi, Prosper faced a reduction in available capital and its ability to fund new loans. To remedy this situation, Prosper entered into an agreement with a consortium of institutional investors in February 2017 that would see the investors purchase up to $5 billion in platform loans over the following 24-month period. The commitment was not guaranteed, and the consortium could choose not to purchase any loans during a given period.

In exchange, the consortium received warrants for the purchase of up to 177.7 million shares of series F preferred stock at an exercise price of one cent apiece. Warrants in the arrangement vest based on a monthly schedule depending on the volume of loans purchased by the consortium in each month.

While this deal is clearly advantageous to the investors, it was much needed by Prosper in order to continue to generate revenue.

Lifeline weighs heavily on earnings

Although the company reported positive EBITDA on an adjusted basis, that adjustment removes the value of warrants issued to the consortium purchasing loans from the platform. Because this is inherently a cost of capital, it is more appropriate to look at net income when assessing how growth in originations has helped the bottom line.

On a GAAP basis, the company reported a second-quarter net loss of $41.4 million, compared to a year-ago loss of $35.6 million. Net income was weighed down primarily by charges related to vesting and valuation of warrants granted to consortium investors.

The vesting of warrants in connection with loans purchased during the quarter reduced operating revenues by $16.9 million. Fee revenues, including transaction and servicing fees, grew by an impressive 57% year-over-year to $42.2 million while operating revenues increased only 13% to $30.5 million. Had Prosper grown its capital base without the involvement of consortium investors, operating revenues would have grown by 75%.

Growth in originations and fee-based revenue is a promising sign for Prosper, but the company is paying for its lifeline. Issuing shares in return for loan purchases helped the company reignite growth, but could create a hangover for years to come. With a year and a half left in the agreement, it is important that Prosper work to diversify its investor base through finding new funding partners and continuing to produce new securitizations.

Competitors in the industry like LendingClub Corp. are nearing stable profitability, and while Prosper is behind the curve, it is clear management is working hard to catch up.