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Credit Analysis and Valuation Methods for Marketplace Lending Loan Portfolios

We dig in to the complex topic of valuation with this Q&A piece conducted with Houlihan Lokey

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[Editor’s note: Many of us have questions on marketplace lending loan valuation so when we were approached to see if we would be interested in a Q&A post on the subject we jumped at the chance. The Lend Academy team created the list of questions and Gunes Kulaligil, Director in Houlihan Lokey’s Financial Advisory Services business provided his answers.]

As Marketplace lenders continue to lend at a fast pace, there has been a significant increase in the past several years in non-bank consumer, student and small business lending. Although these platforms operate in a similar fashion, there is a wide variety of underwriting guidelines thereby producing loans with notably different credit profiles and terms. As a result, prepayment and default performance vary significantly based on the platform originating the loan and the credit grade of the loan as determined by the platform. Additionally, loan performance and platform performance have been mixed, with losses sometimes coming in higher than expected and governance issues shaking investor confidence in the sector.

Despite these challenges, origination rates have climbed back towards their prior highs, and funding sources have been expanded with increased interest from whole loan buyers in flow agreements as well as investors seeking to acquire tranches from securitizations. The recalibration of performance expectations has hit many platforms and continues to be an ongoing process, thus highlighting the need to determine the relevant default and prepayment drivers necessary for accurate fair value analyses. While a robust and liquid secondary whole loan trading market has not emerged as some market participants had hoped, secondary transactions are occurring, especially as loans are aggregated into securitizations. Many of these transactions occur at a premium to par and can provide meaningful insight into pricing and relative credit performance of one platform versus others over time.

1. What are the most prevalent methods of valuing loan portfolios today?

Discounted cashflow (DCF) methodology at the loan or cohort level is the most prevalent valuation methodology used today to value marketplace loan portfolios and related assets, including tranches in securitizations and servicing rights, regardless of the lending vertical. I emphasize “today” because marketplace lending is an evolving corner of consumer & business lending that is small and fragmented in general, with over a hundred lenders, both small and large, with a handful of large lenders accounting for the lion’s share of the issuance. Despite its still nascent nature, marketplace lending has caught the eye of nimble credit-focused alternative investment managers and the relatively risk averse large bond funds alike. Credit investors usually acquire whole loan portfolios or subordinate bonds off of securitizations on a levered basis, whereas many of the larger bond funds focus on the senior bonds in securitizations.

The investment thesis from the credit funds’ perspective is the opportunity to achieve mid single to double digit returns on a levered basis with a short duration versus the bond funds’ thesis which could essentially be described as a yield pickup strategy where the buyers expect to achieve unlevered single digit returns with shorter duration than whole loans and ample structural credit support present in securitizations in the form of subordination and excess spread. Non-bank lending owes its ability to attract the attention of such a diverse group of investors not only due to the sector’s capacity to offer a wide range of credit exposures and duration, but also due to its future growth potential with a confluence of support from increasingly tech-savvy borrower demographics, a de-regulatory environment and innovative partnerships in the Fintech ecosystem.

2. Are valuation methods standardized? If not, why not? How does this lack of a valuation standard affect investors?

[Read more…]

Peer IQ Releases Q4 2017 Marketplace Lending Securitization Tracker

Cumulative issuance for marketplace lending securitization now totals $28.2 billion across 106 deals.

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The easiest way to get insight into the marketplace lending securitization market is through PeerIQ’s quarterly reports. It feels like every quarter brings more good news for originators and the fourth quarter of 2017 was no exception.

Issuance in the quarter totaled $4.4 billion, which is another record and represents a 100% increase over Q4 2016. Total issuance is now $28.2 billion and PeerIQ expects issuance to grow by 30% annually to $18 billion in 2018. PeerIQ shares that investor appetite for these securitizations continues to grow.

All deals for the quarter were rated by at least one rating agency. Kroll Bond Rating Agency leads in rating consumer deals while DBRS leads in rating the student lending deals. SoFi continues to impress as they issued the largest consumer and student lending deals ever in marketplace lending. Upstart issued their second securitization and is expected to be an annual issuer. Besides their standard securitizations, LendingClub also completed a whole loan pass through security to a single investor which is listed at the bottom of the below table.

PeerIQ also shares the breakdown of issuance by company across 2016 and 2017. Not surprisingly, we’ve also seen the average deal size increase over the years.

Conclusion

What’s fascinating to me is to think about how far the securitization market has come since the early days of the industry. I still remember back in 2014 when Eaglewood was awarded LendIt’s Innovator of the Year Award for putting together the first securitization in the marketplace lending space the previous year. It’s impressive how robust the market is now and how it has grown in such a short amount of time.

If you’re looking for more details of the securitization market you can download the full report for free on PeerIQ’s website. We also recently interviewed Rosemary Kelley from Kroll Bond Rating Agency on the Lend Academy podcast who shared her perspective on the securitization market.

Bills Being Introduced to “Fix” Decision in Madden v. Midland

We report on the updates to the Madden v. Midland case and get perspectives from a top law firm and the Marketplace Lending Association.

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The Madden v. Midland case has been a topic many lenders have been following closely for over two years. Our last update was in June 2016 when the Supreme Court denied a petition to hear the case which left the case unresolved. Now bills are being introduced in hopes to fix the ambiguity around this case.

For a historical perspective you can read our coverage of the case at the below links:

An article in American Banker this week from Adam Levitin, professor of law at Georgetown University, provides his perspective on what the bills mean for the case. Levitin expresses concern over the bills, believing that the bills being introduced are overly broad and will facilitate predatory lending.

Nat Hoopes, Executive Director of the Marketplace Lending Association disagreed with Levitin’s assessment. Here is what he had to say:

These bills are strongly pro-consumer. They will help ensure that consumers can continue to refinance their higher interest rate debts, saving consumers significant amounts of money through lower interest costs.  Furthermore, these bills clearly cannot facilitate predatory lending because they do not change the rate or terms on which any entity in this country (regulated at the state or federal level) can lawfully lend money.  The language of the bills simply reaffirms one of the fundamental principles of contract law — that valid loan contracts can be sold on the secondary market.

[Read more…]

Lending Club Q2 2017 Earnings – Back to Growth

Lending Club grew originations 10% for the quarter, originating $2.15 billion in loans.

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Lending Club’s second quarter earnings marked an important milestone for the company – a return to growth. It seemed as though there was a general consensus that this was a make or break quarter for the company. Originations have been hovering around $1.9 billion since Q2 of last year. This quarter Lending Club announced originations of $2.15 billion for the quarter, up 10% from the prior quarter of $1.96 billion. While this is still down from their previous highs, it shows that the company is back on a growth trajectory.

Also of significance was net revenue of $139 million, up 35% year over year. The second quarter marked the second highest revenue generating quarter for the company. Lending Club anticipates that the third quarter will be their best quarter yet from a revenue perspective. Below are the other financial highlights for the company.

The earnings call focused on a couple of initiatives for the quarter. One was Lending Club’s first sponsored securitization of near prime loans. This brought in 20 new investors and is an additional revenue source for the company. Many of the analysts on the earnings call were interested in learning more about the financial impact of the securitization program. Lending Club anticipates they will do one securitization per quarter with the next one being a prime securitization.

The other initiative was focused on borrower take rates. Lending Club redesigned their website and developed testing infrastructure to better understand what prompts borrowers to say ‘yes’ to a loan. This included analysis on many different factors including testing pricing sensitivity as well as experience tests.

Bank participation has been an important part of the turnaround story for Lending Club. Last quarter the company announced banks were funding 40% of loans, but that reached higher in the second quarter to 44%. Lending Club was able to land new banks in the quarter and cited that the asset class continues to be attractive in the low interest rate environment. With bank funding stable, Sanborn stated that they would be increasing their efforts on the retail investor.

On loan performance the company continues to be vigilant due to high debt levels of consumers. However, early signs of delinquencies on recent vintages are in line with expectations which has resulted in no significant changes to pricing. With respect to auto loan refinancing, Lending Club is still working on ramping that business up and it is not making up a meaningful part of originations.

Given that Lending Club beat expectations the company adjusted their earnings outlook upwards.

Conclusion

What struck me the most in the earnings call was that this was the second highest revenue generating quarter. To close out 2017 the company expects to generate between $585 and $600 million. That is substantial revenue. Now, the company is not profitable yet, they generated a GAAP net loss of $25.4 million but they are making progress and they have come a long way since last year. Lending Club CFO, Tom Casey and CEO Scott Sanborn believe Lending Club will be able to deliver on margins while also investing in the business for further growth. It seems as though the new securitization program could be a big driver of additional revenue in quarters to come.

Disclosure: Peter Renton, the founder and CEO of Lend Academy, and Ryan Lichtenwald, the author of this article both own LC stock.

PeerIQ Reports on Q2 2017 Marketplace Lending Securitizations

Nine securitizations took place in Q2 2017 totaling $3 billion with each deal rated by at least one agency.

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Every quarter PeerIQ releases a Marketplace Lending Securitization Tracker and every quarter there are new developments on the securitization front. Q2 2017 was no exception with nine securitizations taking place totaling $3 billion, a 76% growth over the second quarter of 2016. This is in line with Q1 2017 where issuance was the same, but there were only seven deals. Total issuance is now $21.9 billion across 92 deals.

Other highlights provided by PeerIQ include:

  • Multi-seller club deals and self-sponsored deals have emerged at several leading platforms.  All deals were rated in this quarter, including record-sized consumer deals from SoFi, large multi-seller deals from Marlette and Prosper, and the first self-sponsored, near-prime deals from Lending Club and Upstart.
  • Dealer and rating agency participation continues to intensify. Fitch rated its first Consumer MPL ever, Prosper’s PMIT 2017-1, indicating broadening acceptance across ratings agencies. Goldman Sachs, Morgan Stanley, and Deutsche Bank lead over 47% of MPL ABS transaction volume. Noteworthy is the rising presence of BNP Paribas, which co-managed CLUB 2017-NP1. DBRS leads the rating agency league table, and Kroll dominates the unsecured consumer sub-segment.
  • New issuance spreads continued to tighten and flatten—a credit friendly environment for securitization.  In Q2 2017, we saw spreads tighten in riskier tranches of consumer ABS, indicating strong investor appetite for MPL ABS paper in the market.
  • Delinquency rates have continued to increase across several verticals—such as subprime auto, student, and personal loans—due to exposure to riskier borrowers, a re-leveraging of consumer balance sheets, “loan stacking,” and shifting payment priority trends.
  • Initial pricing is near record tight levels. Lending Club’s inaugural deal priced at Libor + 110, second only to Marlette’s MFT 2017-1 (L+100) in execution on the Class A bond. Overall, spreads have tightened with greater investor acceptance in an overall “risk on” environment.

[Read more…]

The Current State of Marketplace Lending in Japan

In this guest post we get an overview of the Japanese marketplace lending market.

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Editor’s note: This is a guest post from Yo Shibata, a serial entrepreneur that has sold three businesses. In 2016, he co-founded Crowdport, a “Bloomberg for marketplace lending in Japan”. He is also a partner at an angel investment fund, Tokyo Founders Fund. His previous service Smapo, later acquired by Rakuten, provides users with loyalty points as they enter participating stores by pairing a mobile application with his proprietary ultrasonic based micro-location technology. Prior to founding startups, he worked for McKinsey & Company as a consultant.

Growing market

Marketplace lending growth in Japan has been slow compared to the U.S., Europe and China but that has started to change in the past three years. The market has been almost doubling each year and we expect this trend to continue through 2017. Investment volume was $140 million in 2014, $310 million in 2015 and $530 million in 2016. We estimate it to reach $1 billion this year.

Marketplace lending, also commonly referred as “social lending” in Japan, started as p2p lending around 2008 but struggled due to high default rates, which sometimes reached 30%. Since Japanese lending law prohibits interest rates above 15% in most cases, a 30% default rate was not sustainable for those businesses.

Around 2011, marketplace lending players, which at the time was just three or four companies, started to shift their focus to business loans, specifically in real estate and clean energy where there is valuable collateral behind the loan. As those players started to prove the new model was working, new companies entered the market. The number of crowdfunding platforms increased from less than 10 to 21 in two years. There are now many more companies looking to enter the market.

Rising APRs

The industry average APR increased to 8.4% from 5.7% in two years, mainly due to newer entrants that were charging higher APRs. Default rates in the past three years have been close to zero due to platforms being more selective on who they lend money to. As a result, marketplace lending as an asset class became very attractive to investors.

From a macroeconomic point of view, Japan is famous for zero or negative interest rates. Yields for Japan’s 10-year government bond are a mere 0.06% and the 5-year bond yield is -0.07%. Average APRs for savings accounts at banks is 0.4%. Average consumers are pessimistic on Japan’s economy in the long term, due to an aging and decreasing population which is a hard trend to reverse.

Financial literacy

So why aren’t Japanese people rushing into marketplace lending where APRs are 200 times better than savings account? Are they conservative? No they are not.

When you look at the bitcoin prices and the hype around bitcoin in the past three months (March 2017 – May 2017), it’s mainly been driven by the Japanese. JPY-based bitcoin transaction volume often exceeds USD-based transaction volume, which may be surprising. It is well known that Japan has the biggest ForEx trading volume in the world. A portion of the Japanese population do like trading and we estimate there are about 100 million active ForEx investors in Japan.

However the rest of the population are conservative investors. Despite the effort by the government to convince the population to financially prepare for their retirement, financial literacy among the Japanese population has been low for many years.

Current investors in marketplace lending are early adopters but are also cautious. There has been almost no loss of principal for three years across all crowdfunding platforms, and an 8% APR is very high. We predict that some funds will have principal losses in the coming months and some investors will react emotionally to the loss of principal since this isn’t something they are used to.

Crowdfunding platforms can do better at managing expectations, customer support, information disclosure and publicity as the platforms mature. We believe our service, Crowdport can add value to maintain transparency in the market. [Read more…]

An Investor’s Due Diligence Lessons in Marketplace Lending

This investor shares what he has learned doing due diligence on 40 origination platforms and 50 investment vehicles.

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[Editor’s Note: This is a guest post from James R. (“Jim”) Hedges, IV. He was one of the early leaders in the hedge fund and alternative investments industry, and is the author of Hedges on Hedge Funds. He was the Founder and Chief Investment Officer of LJH Global Investments, LLC, an alternative investment advisory firm which advised on over $5 billion of alternative investment allocations.  In 2017, Mr. Hedges founded HEDGES COMPANY (www.hedges.company) to provide insights on alternative investments to entrepreneurs, investors and fund managers.  The firm is especially focused on specialty finance and co-investment opportunities.  Mr. Hedges is also a partner in LJH Financial Marketing Strategies, LLC (www.ljhfm.com). He lives in Los Angeles, California.]

When I began working in the family office and hedge fund worlds in 1992, private investors were looking, foremost, for return enhancement and, secondarily, for diversification. Fast forward 25 years, investors are still looking for return enhancement, but less on the equity side, and rather more for current income. In the early 1990’s, hedge funds were a secretive, largely unregulated landscape with virtually no disclosure and very little educational information available for those looking to allocate capital to the space. As a result, investors often did not know how to differentiate fund managers and tell the difference between an A- player and a C- player. There was a profound lack of thought leadership, and those charged with advising new entrants in the market had to do a great deal of educational missionary work and lay out a thoughtful path of insights.

In today’s marketplace lending sector, it is a similar story. There is a proliferation of funds in the space, and assets are flowing in to funds to the tune of hundreds of millions of dollars per quarter. There are ample industry-focused conferences and e-publications, but there remains precious little in the way of independent research and insight for private investors, institutions and the consultants who serve both groups. Product differentiation is difficult, and there is still not a robust set of data analytic tools or benchmarking indices.

In terms of the landscape, on one side of the field, we have a universe of loan originator platforms. Best known names like Lending Club, Prosper and SoFi have dominated the press, but there are, in my estimation, well over 100 unique specialty finance loan origination platforms, and within that group, loans are being originated in an ever-increasingly diverse set of sectors, such as:

  • Unsecured consumer credit for debt consolidation and emergency expenditures
  • Real estate lending (often secured by real property)
  • Small business credit
    • Merchant Cash Advance
    • Equipment Financing
    • Factoring
  • Retail installment contracts (RIC’s)
  • Solar equipment financing
  • Education financing
  • Automotive repair financing

Each of these segments has unique drivers impacting customer acquisition costs, underwriting procedures, and borrower behavior. Consequently, many of the segments offer differing yields, default rates and durations.

On the other side of the marketplace lending landscape, once the loans are originated, there are many different asset management structures through which capital inflows are being allocated, including:

  • Managed Accounts for institutional investors
  • Hedge Fund Vehicles (i.e. private partnerships: funded all at once with shorter lock-ups)
  • Private Equity Vehicles (i.e. private partnerships with investment drawdown periods and long-term lock-ups)
  • Fund of Funds investing across a spectrum of originator strategies
  • UK-listed Funds (i.e. closed end funds, most of which trade at meaningful discounts to their NAV)
  • Luxembourg SICAV’s
  • 40 Act Funds (interval funds which mostly have staggeringly high fee burdens)
  • Notes and Variable Life Insurance wrappers for tax efficiency

[Read more…]

Lending Club and Marketplace Lending – One Year On from Renaud Laplanche’s Ouster

We take a look back at lessons learned on the one year anniversary of the ouster of Renaud Laplanche at Lending Club.

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It came as a complete shock to everyone. When I woke up on May 9th last year I could not believe the news I was reading. Renaud Laplanche had been forced to resign from Lending Club, a company that he had founded and where he was the public face.

Back then everyone wondered about the impact this would have on the industry. No one knew what was going to happen but we all expected both Lending Club and the whole industry was going to be in for a rough time. This came at a time when the industry was already experiencing a downturn. Just the week before Prosper had announced layoffs and many other platforms were also struggling to attract investors.

Five Lessons from the Past Year

Today, I thought it would be useful to take a step back and reflect on what we have learned in the past year.

  1. The industry is bigger than one person

While it is true that Renaud Laplanche was an imposing figure in the marketplace lending industry with Lending Club the dominant player, the industry did not fall apart because of his departure. While it made headlines around the world and many industry players saw their struggles increase it did not trigger an industry collapse as many at the time predicted. In fact, we have seen only a handful of small platforms go out of business in the past year and several platforms have continued to grow.

  1. Investors still need yield and borrowers still like installment loans

[Read more…]

Ten Marketplace Lending Options for Accredited Investors

We review ten different investment choices across real estate, small business and consumer loans for accredited investors.

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Last month Ryan provided this great rundown of marketplace lending investment options for non-accredited investors. Today, we will do the same thing but provide some options for accredited investors.

Before we get started let’s get clear on the definition of an accredited investor. This is from the SEC’s investor website:

An accredited investor includes anyone who:

  • earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, OR
  • has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).

If you fit that description then you have many more investment options available to you. In this article I am going to run through ten different options across the three asset classes of real estate, small business loans and consumer loans. I am excluding Lending Club and Prosper from this review even though as an accredited investor you also have access to these platforms. They were covered in Ryan’s post mentioned above. Also, I am not covering any funds or aggregator sites – these are all platforms that originate their own loans.

I should also point out that this article is for information purposes only. I am not providing investment advice here nor am I recommending any of these investments.

Real Estate

There are more real estate options than any other category. Real estate is the largest asset class by far and one that has attracted a wide range of individual investors for many decades. So, it is not surprising that when it comes to marketplace lending it is leading the way as far as investor options go.

  1. LendingHome (https://www.lendinghome.com/)

[Read more…]

About Lend Academy

Lend Academy has been bringing you all the news and information about peer to peer lending since 2010. Founded by Peter Renton, Lend Academy not only has the most active news site, but also the largest online forum and the first and most popular podcast in the industry.

The Lend Academy team loves peer to peer lending and our staff have all invested their own personal money in one or more of the platforms. Lend Academy Media is part of Cardinal Rose Group which also owns LendIt, the leading industry conference, and has a majority interest in NSR Invest.

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