A P-to-P Idea that Relies on Kinship Between Borrowers and Savers

Say this about StreetShares: the Reston, Va., firm is not following the rest of the online lending pack.

At a time when the emerging sector has largely abandoned its roots in peer-to-peer lending, StreetShares is embracing retail money. The company recently got approval from the Securities and Exchange Commission to open its platform to everyday investors.

Nor is StreetShares trying to compete for capital by promising high yields to savers who invest in its loans. The firm, which specializes in small-business lending, plans to offer modest but steady returns to its retail investors.

"The idea is, we can outperform what the banks are offering," Chief Executive Mark Rockefeller said. "We can give more certainty than what the stock market is offering."

The key to the company's strategy is to tap into the loyalties of particular borrowers and savers who already feel a sense of camaraderie with each other.

Military veterans offer the first test of the company's theory. Based on results from a small volume of lending, StreetShares says that veterans who take out loans are more likely to repay if other vets are backing those loans, and they have an opportunity to get to know the lenders through an online forum.

"It's a bit like if a bank allowed depositors to interact with borrowers, and you organized that interaction around social groups to create additional loyalty to the bank," said Rockefeller, who served in the Iraq War. (And, no, he's not backed by the famous industrialist and banking family — he said he's a "very, very distant relative" who didn't inherit any of the fortune.)

Over time, StreetShares plans to expand to include other groups of Americans who already have a strong affinity for each other. The idea is that the firm's website will serve as a hub that connects people who live in the same geographic area, or are members of the same organization.

The company is developing technology that it believes will foster these ties between borrowers and lenders. That is despite the fact that retail investors who invest in StreetShares loans will be promised a fixed return, and the repayment to investors will not be tied to the performance of a particular loan.

Affinity-based lending is not a novel concept. Social Finance was founded in 2011 on a similar premise – the notion that borrowers will be more likely to repay their student loans if they know that graduates of the same university are on the hook for any losses. More recently, SoFi has relied heavily on the securitization markets to fund its loans.

Rockefeller also pointed to USAA, which offers its banking and insurance products to members of the military and their families, as a forerunner.

"They actually started off with military officers insuring each other's automobiles," he said.

StreetShares is a long way from reaching the scale of USAA. Since the startup was founded in May 2014, it has originated about $8 million in loans to roughly 400 borrowers.

So far, StreetShares has funded its loans through a mix of institutional money and funds from accredited investors. The firm plans to add everyday retail investors to the mix next month.

In an interview Tuesday, Rockefeller discussed his company's against-the-grain strategy. Below are excerpts of the interview, edited for length and clarity.

Tell me about the terms of the loans that you offer.
MARK ROCKEFELLER: We're trying to create a loan product that ultimately helps small businesses, is not extractive, is not predatory, but actually adds value to them. So we think that occurs somewhere at or below the credit card rate.

What kind of returns will retail investors be able to expect?
It's going to look and feel a bit like a CD-type product, obviously not FDIC-insured. It's going to be 5% fixed returns. They'll be able to withdraw their money at any point for a 1% fee. The value proposition to investors here is very, very simple: to get a nice fixed return, but be able to back businesses that they believe in.

I'm wondering how you're able to set a fixed rate, and I guess guarantee a certain return, before you know exactly how the overall pool of loans will perform.
There's a couple of models for this in the U.K., but no one is really doing it here. The tool that you use is a provision fund. So in essence we're going to borrow from the public at 5%, and we're going to make loans at, let's call it, 15%, 12%, and have a provision fund to cover the losses. You can only do this if your credit models are very accurate, and if you're confident in your credit and your underwriting, which we are.

Do you have a process for verifying that the investors are indeed veterans, and that the borrowers are also veterans?
Yep. We have some databases that we can check, and so that's part of the onboarding.

SoFi was originally built on this concept, the idea being that borrowers will be less likely to default if they have a connection to the lender. My understanding is they've moved away from that as they've grown quickly.
The challenge for SoFi is their loans have such low margins – very, very low default rates, but there's not a whole lot of margin. So what SoFi started off doing, I think, was kind of a similar affinity concept to us. But as they grew, they realized that they were just acquiring really, really quality borrowers. And once they had that customer base, then they were able to cross sell and up-sell.

And then SoFi got very, very good at using the securitization markets to get extremely low-cost capital, which they had to do, because the margin on their loans was so small. Once they sort of worked that magic, then they were able to scale basically as a general, all-purpose lender with a low cost of capital. We are big fans of theirs.

Do you have any expectations about what the mix of your funding is going to be?
I think as a general rule, it's going to be something like two-thirds institutional, one-third retail. There's some problems with crowdfunding. One of them is reliability of capital.

It astounds me that folks will go on Kickstarter and give all this money because they believe in the social project or the art project, and get nothing in return but t-shirts or concert tickets. They do that because there's some affinity around that project. But that kind of capital really isn't reliable.

So we're trying to blend some of the social ethos of a retail investor component with the reliability of having institutional capital.