Marketplace Lending – A High-Risk Investment? Too Soon to Tell

13 Jan

09/12/15

Where banks must make full disclosures of their capital adequacy ratios (under Basel 3) – and, in their annual report, the current market value of all their assets and liabilities including derivatives, – marketplace lenders have far less transparency obligations.

Key names such as Borrowize, Accion, Fundera, Multifunding and others are seemingly not financially significant enough to be required to publish annual reports on the SEC’s electronic filing system EDGAR. The information is not readily available on their websites. And they do not willingly give such information to journalists or inquisitive citizens.

For those of whom the majority of their investors are private institutional clients, they admittedly have no real public obligation. But those marketplace lenders whose primary stakeholders are retail investors arguably do have a duty to give some detail on how they manage the key risks of conducting their conducting their business.

Market Risk

This we will broadly define as the risk that an asset will decline in value due either to macro conditions, e.g. change in interest rates; or some underlying change in the asset class, e.g. a certain number of loans defaulting on payments.

Lending Club is typical of many marketplace lenders, in that it offsets its exposure to the loan pool by selling notes, equivalent at the time of issuance to the value of the loan, to its institutional partner. Lending Club collaborates with Utah-registered WebBank, partly to take advantage of Utah’s lax stance towards interest rate-capping. But many lenders have a wider range of institutional partners.

In its 2014 annual report, Lending Club explains away its market risk thus:

“Because balances, interest rates and maturities of loans are matched and offset by an equal balance of notes and certificates with the exact same interest rates and maturities, we believe that we do not have any material exposure to changes in the net fair value of the combined loan, note and certificate portfolios as a result of changes in interest rates. We do not hold or issue financial instruments for trading purposes.

 The fair values of loans and the related notes and certificates are determined using a discounted cash flow methodology. The fair value adjustments for loans are largely offset by the fair value adjustments of the notes and certificates due to the borrower payment dependent design of the notes and certificates and due to the total principal balances of the loans being very close to the combined principal balances of the notes and certificates.”

In order for the loans’ value to continue to equal that of the notes and certificates, the debt trading forum must ensure prompt resolution of any delinquent debts. But they do not generally have the right to forcible repossession of goods to the sum of what is owed. Fixed charges placed over assets owned by the debtor would make up part of the money owed.

But how many actively are the loan issuers ensuring collateral is posted?

Collateral Posted – A Mixed Bag

Intersect Fund and Copperline, in response to our inquiry, volunteered information about their policy on collateral, and on their credit checks. The contrasting policies of these two respondents clearly demonstrate that there is no fixed industry standard on either point.

When asked under what circumstances they would require an applicant to post collateral, Intersect Fund explained: “We use collateral as a compensatory factor for recent credit blemishes and overdrafts. We don’t have a LTV (loan to value) minimum and it depends on how strong the applicant is in other areas.”

Intersect Fund makes a policy of taking four character reference numbers, in addition to running a personal credit check through TransUnion. For Copperline, “Personal credit reports (from Experian) serve as character references”.

The ‘insurance policy’ of Copperline is also more relaxed, and typifies the more liberal end of the lending market. A spokesperson summarised, “We only require collateral if the client is purchasing equipment in which case we take the said equipment as collateral. We never take additional collateral.”

In sum

While all marketplace lenders take measures to counter the risk of delinquency and default, there are limits to the measures they can take to recover missed interest payments. Fortunately there is an ever-expanding supply of fresh loan applicants to keep their portfolios at full value.

Furthermore, the actual sums at stake seem to indicate this risk is for now fully under control. To draw again on Lending Club’s 2014 annual report – this time a detail from the auditor’s notes – we can see that its ‘loan loss contingency fund’ of $1,824,739 is more than sufficient to cover the losses in its three main portfolios over the preceding two years. In fact, the maximum sum deficient, in 2012, was $512,395.

So the management has just cause to consider the loan loss contingency fund “sufficient” to cover all potential future losses from its portfolios.

 

 

 

 

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