Last week it was OnDeck’s turn to see its shares take a tumble - the hybrid lender’s shares are down 28% over the month.
The bottom line? Public investors are now openly questioning the business model of these platforms.
Not so fast, or at least that’s what the London stockmarket seems to be saying about the asset class that is ‘alternative’ or ‘direct’ lending. The table below is from the end of yesterday (May 9th 2016) and shows the share price of a gaggle of lending funds listed on the UK stock market. If investors had really stopped believing in the alternative lending revolution, these funds’ would be struggling.
But take a look at the column Mid Close % from open. It shows the intra day pricing for these funds – barely any movement at all! Does this suggests that London investors are relaxed about the alternative lending asset class – or is it that they’ve not really woken up to the threats?
P2PGI is the one fund that has the most potential exposure directly to any future issues at LendingClub – about 55% of its loan book is to US consumer lending platforms although that will also include other outfits such as Prosper and Avant. Its share price has hardly moved today. In fact, looking at the one month performance, P2PGI’s shares – as well as many of its peers – have actually staged something of a revival, rising by 6.36% over the last month.
Price change %
% from open
Funding Circle SME Income Fund Ltd
GLI Alternative Finance PLC
P2P Global Investments PLC
Ranger Direct Lending Fund PLC
VPC Specialty Lending Investments PLC
But I’d suggest that danger still lurks.
Just as I suspect that the panic over LendingClub will subside, equally I think that UK investors might be a little too complacent. Outfits such as VPC and P2PGI deliberately diversify their loan books between platforms, so any issue at an individual holding needn’t be life threatening.
Equally, the vast majority of the value in these funds sits in actual loans – not equity. Questions at the moment relate to the viability of the market place lending business model rather than the quality of the underlying loans that are being originated. As such, whilst the small equity exposures to platforms that a fund like P2PGI holds may have reduced in value, the loans that make up the vast majority of their portfolio have not. At this stage there is certainly no question as to the viability of Lending Club – the company has as much as $600m of cash on their balance sheet! So just as there is no danger that the loan assets that funds hold are at threat, nor is there any danger that Lending Club will not continue to service them.
But lurking beneath this debate are two issues that could eventually impact on the share price of the UK funds – and hints of both emerge in a recent quarterly detailed update from VPC, reported on by the funds team at Numis yesterday. The note observes that Q1 net asset value returns for the fund has been “somewhat muted”.
Some of this negativity is run of the mill stuff and associated with VPC securitising its loans – thus pushing down returns as it receives cash in from investors. Currency hedges also help to drag down returns. Zig zagging equity market valuations might play a small part – both VPC and P2PGI have some small equity holdings, usually in platforms where they have exposure via their loan book. In VPC’s case this has had most impact via zipMoney, an Australian lending company. According to Numis, zipMoney’s share price was down c.20% over January/February (in Sterling), but recovered in March to end Q1 up 16.6%. Since the end of March, zipMoney’s share price is up a further 50%. We can only guess what will happen to the Oz outfits’ share price tomorrow, but the net overall impact on VPC isn’t likely to be huge.
The key issue that this highlights is the challenges that trusts have faced in deploying their capital. This has resulted in a hunt for access to loan origination that may have forced the trusts to seek out riskier sources of lending. For VPC that’s meant an intense hunt for new platforms and a big shift towards (riskier) SME lending platforms. OnDeck has also reported that it’s not finding it a walk in the park to source credit worthy new business customers.
The challenge here is well known. Platforms need to find new lending opportunities via credible borrowers to satisfy investor requirements. This origination issue might also feed through into the bigger short term challenge – returns are dropping. Logic suggests that if the platforms can’t generate enough new demand for loans to satisfy huge institutional interest, the narrower pool of existing borrowers will play lender off against lender. This has the potential to lower returns.
Here’s the simple equation as I see it.
Too much institutional Capital + Too little borrower origination = lower cost of capital and lower investor returns.
My hunch is that some of this problem can be seen in the following observation from Numis analysts about VPC’s current yield. They observe that “recent monthly returns have been c.0.4% which compares to a required monthly run-rate of 0.64%, implied by the target dividend of 8%pa.” i.e. for now VPC are not finding enough high yielding opportunities to achieve their target dividend yield.
My worry is that platforms need huge amounts of money to ramp up their origination machines. But LendingClub’s troubles might scare off public market investors sitting on pools of growth capital. That could lead to a nasty spiral where the big lending platforms scale back customer acquisition spend and then chase the same pool of borrowers, pushing down yields even further. With many traditional junk bonds now sitting on much, much higher yields, why should the broader institutional money managers bother with less liquid, and lower returning, alternative credit and loans?
My concern is that this negative feedback loop could eventually impact the share price of listed funds in this space especially as confidence in these funds is still a tad fragile after the recent sell off. The good news is that I would guess in a months’ time many of the worries about LendingClub and OnDeck will have abated. The bad news is that if these funds are to combat their stubborn discounts – the discount at VPC is running at 7.5% – they need to prove that the alternative lending asset class is resilient. Investors have been worrying for far too long about rising defaults but oddly enough the bigger near term concern is actually finding credit worthy borrowers. Forget the default rate, for now, focus on the risk adjusted yield.