With regard to the online consumer loan market, it was a natural assumption when the pandemic broke upon us that this market, itself young and fragile, could be destroyed by the nastier new business climate.
That hasn’t happened. According to data and research from dv01, the end-to-end data management hub for lenders and the capital markets, online consumer loans have proven very resilient.
The mid-month reports from dv01 have provided a fascinating account of the development of this market under stress. The firm’s mid-September report stresses the importance of the fact that the U.S. Congress has not continued stimulus assistance.
Why is that important? Because in the face of evidence that the market was showing unexpected resilience in the early summer, one obvious hypothesis might be: government stimulus payments were having their desired effect, letting people who would otherwise have defaulted continue their loan payments. But that hypothesis may now be rejected.
The stimulus has come and gone, yet the recovery of the alternative loan market continues. Specifically, as of September 9, 58% of borrowers had faced a September payment, but there was no evidence of a renewed faltering of borrower performance.
The critical metric
Impairments are a, perhaps the, critical metric here of this resilience. By definition an “impairment” is a combination of two distinct loan statuses. It is any loan that is either delinquent or that has an active modification status.
Impairments shot up dramatically as the economy closed down last spring. But impairments have dropped steadily and impressively since then, continuing that decline through mid-September. The total impairment level as indicated by the latest available figures is 8.7%, still well above pre-pandemic levels of approximately 6%, but only about 30% of the pandemic-created peak.
Since most online lenders have allowed their borrowers to skip payments during this period, the impairments that have taken place are classified as active modifications rather than delinquencies. Actual delinquencies are well below historical averages.
Who invests? Who downloads?
Alternative lending generally involves getting money to borrowers who are underserved by traditional lending institutions. It grew out of small balance, P2P unsecured consumer loans financed by retail investors. The investors, loan buyers, have generally been institutions. Hedge funds were among the earliest buyers. In the words of a Morgan Stanley report, the hedge funds and alternative credit funds pursued alpha by “actively selecting individual loans that they expected would outperform the platforms’ average underwriting.”
As the market matured, and as one might expect, inefficiencies grew more difficult to find and a new wave of institutional buyers moved in, making (in the words of Morgan Stanley again) “passive pro rata purchases of loans within each buyer’s defined credit box.” These more beta-driven institutions included endowments and foundations and bulge bracket banks.
There is, nonetheless, room for high-net-worth (HNW) and family office investors.
Vadim Verkhoglyad, principal data analyst at dv01, said: “Yes, it’s very possible for HNW and family offices to get direct exposure to marketplace loans. For family offices that buy loans in institutional investor sizes – all platforms offer the ability to purchase loans directly. For HNW or smaller non-institutional buyers — some of the online platforms, like LendingClub and Prosper also have a retail origination channel allowing smaller investors to purchase loans directly as well.”
Who is downloading the dv01 data? The series of reports began in March of this year as the scale of the problem became clear. There is no specific audience data, but there is certainly an audience. The reports have been downloaded a total of 7,000 times. What is more, they are broadly quoted and discussed, for example by KBRA, Morgan Stanley, and Diamond Hill. Diamond Hill has praised the dv01 reports for the “unparalleled access and transparency” they provide for more than 530 securitizations “totaling more than $104 billion across consumer-unsecured, mortgage, small business and student loans.”
Why the resilience?
But let us get back to the mystery of this unexpected resilience. Why hasn’t the pandemic, which has done so much harm to so many areas in the economy, blown a lasting hole in the online consumer loan market? Certainly, anyone making calls on analogy to the slow recovery from the world financial crisis of 2008 would have been very wide of the mark.
If the stimulus payments as a matter of fiscal policy aren’t the answer, what can we say about monetary policy? Hasn’t the Fed deliberately kept interest rates very low, and isn’t its policy getting more inflationary over time? Asked about this, Verkhoglyad replied that the reports don’t go into speculative matters. But as to the data, he said, “Everything here is relatively shorter term. If you look at the trends, they haven’t been tied to the rate changes one has seen from the Federal Reserve.”
This leaves the question open. Why the resilience? The September report of dv01 suggests two related answers. First, even before the pandemic hit the players in the market had done a good job of establishing the credit worthiness of their borrowers. Second, since it hit, they have done another good job.
In the words of Wei Wu, dv01’s principal data scientist, “Originators got ahead of the problem really quickly,” working with their borrowers in need. In both respects, then, the market has proven resilient, and remains a good bet for investors, because the risk management systems were in place and have been employed.
But this suggests another possible route to pessimism. Couldn’t the trade become crowded? Couldn’t new originators enter the castle, which seems unprotected by any obvious moat?
To this thought Verkhoglyad replied, “It is feasible that a lot of entrants will want to come into this space. But it isn’t that simple to build a reliable and trusted platform in the way the incumbents have.”