What new features will be announced at Prosper Days 2008?

Last year, at Prosper Days 2007, CEO Chris Larsen announced several major changes in the Prosper platform. Lenders and bloggers have been speculating about the changes and new features which will be announced next week at Prosper Days 2008.

In January, HollowOak posted a poll thread at Prospers.org with 21 possible options. (Numbers in parentheses are the percentage of members who selected that feature.)

* The secondary market for loans (20%)
* Increase in the minimum credit grade that may create a listing (4.4%)
* Publication of legal actions against defaulting borrowers (8.3%)
* Increase in loans servicing fees (7.2%)
* Increase in state rate caps (2.2%)
* A national Prosper license (3.9%)
* Increased options on the search loans feature (4.4%)
* More granular credit data (1.7%)
* Credit report from more than one credit reporting agency (8.3%)
* Reduced minimum bid size (3.9%)
* Lenders can create their own portfolios (7.8%)
* Lenders can publicize their portfolios for other lenders to follow (6.1%)
* Stock options for long-time lenders (1.1%)
* 3rd loans for borrowers (3.3%)
* Borrower refinancing their loans directly (2.2%)
* Revolving credit loans (1.7%)
* The entry of corporate lenders (4.4%)
* Changes (unspecified) to loan verification (2.8%)
* Streamlined borrowing for AA-B credit grades (1.1%)
* Enhancements to the Friends and Endorsements program (0%)
* Complete elimination of groups (5%)

Mike at Prosperousland recently offered his wish list of four items, two of which were on HollowOak’s list: a secondary market and a national license. The other two may appeal to those of a more technical bent:

* AJAX: Prosper will AJAX-ify their website, bringing eye candy to the otherwise drab world of banking. Think of it as an upgrade to Web-2.5. The buzzwords will fly.

* Search API: I'm hoping for an upgrade to Prosper's developer API to let me run performance search queries on their performance engine without all that pesky web browser getting in the way.

And, of course, lenders are expecting announcements (or at least explanations) regarding two collections-related issues which, while well-intentioned, have been the subject of a series of embarrassing blunders and delays over the past month or so: switching loans from Penncro to AmSher, and initiating litigation against 66 California borrowers whose loans are at least 4 months late. (Fred93's blog is the best source for tracking collections issues.)

Without further ado, here are my predictions for Prosper Days 2008. Be sure to check back next week and tell me how wrong I was.

Secondary market. Prosper Marketplace Inc. has been promising to create a secondary market for quite a while, and on October 31, it filed a registration statement for a Resale Platform with the U.S. Securities and Exchange Commission. If Chris Larsen does not announce at Prosper Days 2008 that the secondary market is ready to go, it will be a major embarrassment for Prosper.

On the other hand, actually launching the secondary market may result in greater embarrassment down the road, or worse.

While the secondary market, like the advent of second loans for borrowers, will likely create a brief flurry of activity on the Prosper site – and generate a bit of extra income – it’s unlikely to generate a significant sustained cash flow. But if disgruntled lenders take advantage of the new platform to dump their portfolios en masse, at a discount, the results will reflect badly on Prosper loans as an investment class, and likely reduce demand for newly originated loans. Who wants to invest in a Prosper loan today, knowing that it will be worth less than face value tomorrow?

But that’s not the worst case scenario.

As readers of this blog already know, lenders have expressed numerous concerns about Prosper Marketplace Inc.’s compliance with its contractual, fiduciary, and other legal obligations. I’ve caught Prosper violating its own legal agreements on several occasions, and quite a few of us have pointed out their repeated failures to act in the best interests of the lenders whose loans they are servicing. As I documented in another post this week (and others have pointed out before me), Prosper’s advertising regarding lender ROI is seriously misleading. And there are more issues that I have yet to mention here.

In my opinion, once these concerns began to surface with some regularity, Prosper should have commissioned a comprehensive compliance audit – conducted by an independent party, not in-house counsel - to ensure that its practices conform to its legal agreements and comply fully with applicable laws, and that its marketing claims can be fully substantiated. After watching Prosper bungle the collections issues over the past month, I’m pretty sure that this hasn’t happened; the legal agreements still don’t match what Prosper is actually doing.

For Prosper to launch a secondary market platform subject to SEC scrutiny without first identifying and correcting the obvious legal problems in the existing platform is, in my opinion, damn foolish. State regulators, for the most part, are only interested in how Prosper treats its borrowers. The Securities and Exchange Commission will be interested in how Prosper treats the lenders who purchase registered securities on its platform, in the quality of those securities, and in the marketing claims which are made regarding them.

Lenders have invested real money in the loans that are originated and serviced by Prosper, and will invest real money in the loans which are re-sold – now in the form of securities – on its secondary market platform. When we discover Prosper's lapses, many of us have a tendency to make federal cases out of them, figuratively speaking. Launching the secondary market on a platform regulated by the SEC creates the opportunity for disgruntled lenders to convert those figurative federal cases into literal ones.

Increase in state rate caps. At the end of October, Prosper Marketplace Inc. increased the maximum borrower interest rate to 36% (except where state law imposes a lower cap), with the maximum lender rate capped at 35% (or one percentage point below the state cap). The difference between the borrower and lender caps, historically speaking, is that borrowers who opted to pay by bank draft paid 1% above the lender rate to cover the costs of processing the drafts.

Now that the bank draft “surcharge” (technically, it was a discount for not using bank drafts, rather than a surcharge) has been eliminated, there is no reason for Prosper not to raise the rate caps by 1% across the board (other than an overabundance of caution, which, in light of Prosper’s history, seems wise but unlikely). In fact, I suspect that the only reason Prosper hasn’t already done this is that it has been saving the announcement for Prosper Days 2008.

I don’t expect to hear an announcement that Propser has obtained a so-called “national license,” however. (Technically, a “national license” is not a license but an alliance with a bank or credit union, which serves as the lender of record for the loans. Under federal law, banks and credit unions are exempt from state rate caps, except those imposed by their home states. Lending Club and Zopa USA have partnered with banks or credit unions, so they can offer the same interest rates in all 50 states.)

I’ve speculated elsewhere (and let me emphasize that this is pure speculation) that the regulations governing banks and credit unions may require that interest rates for borrowers be based on objective criteria bearing a rational relationship to credit risk. (Or, at least, that banks and credit unions are sufficiently fearful of discrimination suits – and value their licenses sufficiently – that they are unwilling to do otherwise.)

LendingClub and Zopa USA set the interest rates for all loans originated on their sites, using credit scores and other objective criteria, while Prosper loan rates are set by a bunch of oddballs (yeah, us) whose criteria are anything but rational. Of course, when the platform – rather than the lenders - sets the interest rate, part of the fun – and much of the P2P appeal of the site - is lost.

If my speculation is accurate, Prosper may simply be unwilling to make such a dramatic change in its business model and sacrifice its P2P appeal in exchange for a “national license.”

Lender-created portfolios. When Prosper created portfolio plans at the end of October, Prosper_Andrew said: “In the future, you'll be able to build your own plans based on your standing orders.” So I think it is quite likely that this feature will be announced at Propser Days 2008.

I thought there had also been discussion of enabling lenders to share their portfolio plans, but I couldn’t find it in the announcement thread. Perhaps that was just something that lenders thought would be a good idea, not a feature that Prosper had on the drawing board.

More credit data. Experian is most likely the bottleneck here; I suspect that its contract with Prosper limits the amount of data which can be disclosed to lenders. On the other hand, I doubt that negotiating for lenders’ right to see more data is high on Prosper’s priority list.

In my opinion, the biggest weakness in the Prosper credit scorebox is the lack of chronological data. LendingClub’s borrower listings, which are based on TransUnion data, include two chronological fields not available on Prosper: “months since last delinquency” and “months since last public record.” At best, lenders can hope that Prosper Days 2008 will include an announcement that Prosper will announce that it has persuaded Experian to allow it to add these two fields.

(In my opinion, addition of these two fields would help “red flag” some loans, but will still not give lenders enough information to understand the trends in the borrower’s credit history over time. When I was an active lender and group leader, analyzing these trends – I called it “Trajectory Analysis” – was central to my loan-picking methodology; I learned from my early lending mistakes that it is almost impossible to do this effectively without access to a full credit report.)

I wouldn’t expect to see announcements of credit data from more than one credit reporting agency, full (albeit sanitized) credit reports, replacement of ScoreX with FICO, or any other major improvement in the character or granularity of credit data.

Elimination of HR loans. At Prosper Days 2007, Prosper announced that HR borrowers with ScoreX credit scores below 520 and NC (no credit history) borrowers would no longer be eligible to borrow on Prosper. I won’t be surprised if Prosper goes a step further this year and eliminates the HR category altogether.

The evolution of Prosper toward numbers-based people-to-credit-data lending, the increased emphasis on standing orders and portfolio plans, and the elimination of almost all vetting-based groups (which, in my opinion, were an essential element of any sub-prime lending strategy) have made it almost impossible for HR borrowers to fund, even at the new maximum interest rate of 36%. (The increase to 36% may actually have made sub-prime lending riskier for lenders; some of us believe that the very willingness of a borrower to pay 36% indicates a lack of financial competence.)

I have argued elsewhere that unsecured installment loans are primarily a sub-prime financial product, and that Prosper’s attempts to attract large numbers of prime borrowers (who are more interested in prime products such as low-interest credit cards and secured loans) are unlikely to succeed. In my opinion, Prosper should have focused on reducing default risk in the sub-prime categories – through mandatory vetting, stronger collections, etc. – rather than distancing itself from the sub-prime market altogether. But its management had other ideas.

Unless Prosper executes a sudden about-face (something which I regard as highly unlikely at this point), eliminating HR borrowers is the logical next step. There won’t be much of a revenue drop at this point; only 61 of the 1050 loans originated in January went to HR borrowers. The only downside for Prosper would be a dramatic reduction – by one-third - in the total number of active listings, generating the appearance of negative growth.

Groups, friends, and endorsements. An announcement of a major change in this area won't surprise me, but I'm not sure exactly what to expect.

When it eliminated compensation for group leaders in September, Prosper claimed that it was trying to return the group system to the original concept: small, tight-knit communities originating from real-life social networks. Since September, however, Prosper has put zero effort into promoting formation of social-network groups, so there has been no progress in that direction.

What the elimination of group leader compensation did accomplish was the neutralization of the parasitical groups which had become an embarrassment to Prosper (good), and the almost complete elimination of the vetting-based groups (including my own group) which were showing at least some success in reducing lender risk (bad). As things stand, the group system (with even fewer exceptions than before the elimination of compensation) is a vestigial organ with no apparent reason for its continued existence.

Rather than invest the effort required to promote the social-networking model or resurrect the vetting-based model, I expect that Prosper will eliminate groups altogether. I'm not confident that this will happen next week, as Prosper may want to enhance the friends and endorsements system first, but it will almost certainly happen eventually.

The other social networking aspect of Prosper - friends and endorsements - is now a year old (it was announced at Prosper Days 2007). I still find it difficult to take friends and endorsements seriously, particularly since verification of identity is optional, and many borrowers' endorsements are likely from their "imaginary friends." But, from Prosper's perspective, signing up a borrower's friends - even imaginary ones - pads the membership metrics and creates at least an illusion of growth and Web 2.0-ishness.

I'll go out on a limb and predict that Prosper's next step on the social networking front will be to enhance the friends and endorsements program so that it can eventually serve as a replacement for groups. A borrower's friends and endorsers - both real and imaginary - will be treated as an ad hoc group, and accompanied by some sort of borrower ratings system adapted from social networking websites. Experienced lenders have learned the perils of evaluating borrowers based on who their friends are, but perhaps newbies will find the enhanced friends and endorsements system appealing.

Collections. As noted above, lenders attending Propser Days 2008 can hope for new information regarding the litigation test and the transfer of collection responsibilities from Penncro to AmSher. (I assume that is what HollowOak was referring to by “publication of legal actions against defaulting borrowers.”)

Everything else. The rest of the possible announcements and features on HollowOak’s list strike me as either unlikely or unimportant (and I’m not techie enough to understand the two from Mike’s list), so I’ll just repeat a few additional comments from my post to the poll thread:

Increase in loans servicing fees -- Probably something best announced when lenders are on the opposite end of a modem, not in person

Reduced minimum bid size -- Nope.

Stock options for long-time lenders -- Yeah, right.

3rd loans for borrowers -- Probably not until they have statistics on performance of second loans; even then, it's something else that is best announced from the other end of a modem.

Borrower refinancing their loans directy -- Prosper will stick to their "regulatory issues" story on this.

Revolving credit loans -- Nope.

The entry of corporate lenders -- Corporate lenders could already be lending if they wanted to; I don't know what there is to announce.

Changes (unspecified) to loan verification -- Doubtful.

Streamlined borrowing for AA-B credit grades -- Maybe.

As I said, in a few days, you can come back and tell me how wrong I was.