By Jerome Camblain on Thursday 1 August 2019
Jerome Camblain, partner at SmartLenders, makes the case for an emerging asset class brought about by "de-banking".
An asset manager is no different than any other business. It aims at solving clients pain points. In the current situation, one of them is finding a fixed income investment product with a positive yield compared to inflation, low volatility, a short duration not to be caught exposed at the all-time low for interest rates... and possibly a low correlation to financial markets price movements. If, as an extra, that investment could also have a positive impact on society, such as financial inclusion or job creation, it would be a great solution.
One of the areas of positive carry for years has been credit card lending. But private and institutional investors could not lend directly and could therefore only get exposure through credit card debt securitisation, a strong activity that unfortunately is leaving too much money on the table, shared between investment banks, lawyers and rating agencies.
Online marketplace lending not only offers this direct access to financing consumers and small businesses who relied on their credit cards balance to meet month ends, it also improved the financial health of the borrowers with amortising loan products, taking borrowers out of the debt spiral, whereas revolving credit card balances can be pushed to the next month endlessly.
This article could end here if it was that easy to invest through platforms directly, with a rock-solid fiduciary duty approach. An asset manager, in this field, performs three very important tasks for its investors as the market is maturing and larger investments are made possible by institutional investors:
Three points are very important to analyse and understand (among others):
The legal and tax framework, supported by the right lawyers to get their legal and tax opinion regarding the circuit of origination such as who issues the loans? Are they kept separate from the platform’s assets? From other investors? What happens to the loans if the platform (a low capital tech outfit) goes bankrupt? Who is the back-up servicer? Etc;
The historical returns by grades;
The operating processes such as origination channels, data collection tools, credit scoring tools, cashflow monitoring and debt collection policy, etc.
The selection of the platforms and the loans: a source of alpha and independence
On the platforms, it is often possible to pick and choose each loan by accessing all its data points, analyse and execute through the platforms’ API. The asset manager developed a technical ability to score loans and execute transactions. An independent selection guarantees that, should the quality of borrowers offered were to decline, the quality of loans purchased in the fund would remain constant. The asset manager also developed a risk management tool to monitor risks and cashflows, as such tools do not exist over the counter. A large people & time investment.
When an individual selection of loans is not permitted, it is essential to follow the platform performance over at least a couple of years to evaluate the scoring processes and/or the amount of “skin in the game” of the platform itself.
New very attractive platforms can emerge on a vertical that makes sense. The asset manager would then work upstream to help the development of their scoring tool and find innovative structures that could help them deploy capital early while protecting the investors’ money.
The structuring part
Last, but not least, it is already complicated for a local investor to open an account with each platform and monitor all cashflows. It is even more cumbersome and costly for a foreign investor wishing to diversify geographically. Investing through a fund makes it so much simpler in processes and cost-effective, but also includes currency hedging, centralised reporting, liquidity monitoring, etc.
Apart from simplicity, come three other great advantages:
The pool of loans of a fund is much larger than the one a single investor could assemble; therefore, the sample is statistically more relevant and safer;
The larger pool also induces lower fees from service providers;
Finally, it offers a multi-vintage exposure to the economic cycle as the fund keeps investing its inflows and continually re-invests the cashflows from loans regular repayments. Alternatively, an independent investor would deploy capital during a concentrated period of time and would only be exposed to, let’s say, the production of the 2nd quarter 2019, not the whole cycle. A key element often overlooked by investors willing to gain exposure to this asset class
A lot of asset classes will be changed by the “de-banking” or bank disintermediation. Online lending platforms will thankfully accelerate that trend. Asset managers in this field add professionalism, safety and processes to the recent access to this asset class through their fiduciary duty. A natural evolution of this industry.