Earlier this month, the Information Management Network (IMN) brought together online lending platforms, asset managers, senior lenders, regulators, fixed income investors, and others at the 2nd Annual Investors’ Conference on Marketplace Lending in New York. In addition to discussions on sustainable financing, composite lending, and risk management, as well as a year-end review of marketplace lending, MonJa’s own James Wu joined a panel on the topic of Liquidity Outlook: Establishing a Secondary Loan Market.
The panel sought to answer the questions: What’s happening with liquidity and secondary market trading of marketplace loans? and I know I can buy it, but what if I want to sell it? Michael McLaughlin, Senior Managing Director of Macquarie Group, moderated the discussion.
The discussion began with Matt Burton, Chief Executive Officer, Co-Founder of Orchard Platform, who provided insight on the structure of a developing secondary market; as Michael pointed out, Orchard’s periodically published index has the potential to be used as the basis for future trading.
“It’s been … one of my personal missions,” Matt said, “to get a secondary market off the ground.” For the past few years in fact, Orchard has been on the forefront of addressing the issue of a secondary trading platform.
A major hurdle to the secondary market is the overwhelming regulatory uncertainty in the industry, said Matt. Probably the largest barrier to the development of the secondary market is the SEC’s rumored plans to treat loans as securities, though he adds, “they have not said [it] publicly or taken any enforcement action.” According to Matt, this pending change affects the entire formation of the secondary market.
The fundamental lack of transparency in the market was a key issue for Joseph Besecker, Chairman, President and Chief Executive Officer of Emerald Asset Management.
“There was an earthquake in the sector,” said Joseph. “Now it’s incumbent on everybody to try to get a unified message as to the strengths and weaknesses in this area.” The challenges of the industry, he says, “exacerbated” those of the traditional asset managers.
“Platforms should not make the end buyer buy bundled product,” Joseph went on. “Platforms got a little full of themselves … additionally, they were competing with the distribution. Some of the platforms ran their own advisors. To me, that was an inherent conflict.”
The asset managers and the platforms, Joseph argued, should be separate. According to Joseph, there needs to be transparent, regulated “dividing, conquering, and delegating … comparable with the traditional asset class” in order for there to be success in the industry.
The sentiment of transparency in this asset class was further echoed by Rupert Taylor, Founder of AltFi Data. The problem at the heart of the pure marketplace model, he stated, can be solved through disclosure, because it aligns “the face of the platform with the face of the investor.”
“But the disclosure needs to be effective,” Rupert said. For that, disclosure needs to be independently verified by a third party. “The industry needs to find a way to allow [due diligence] to be done easily and efficiently.” According to Rupert, disclosure is the key to sustainability and profitability of the sector.
Another challenge to the secondary market, as Matt of Orchard stated, is in integrating standardized data sets with the new wave of digital lenders, who have begun to conduct their own servicing and create their own technology. Thus, investors have had difficulty analyzing the loan pool across the different platforms.
Further, Rupert of Altfi Data argued that transparency could be better addressed with static loanbook disclosure, which essentially “piece[s] together months of activity to get a picture of performance.”
While platforms may consider this data proprietary (an issue brought up by Joseph), Rupert believes that this method isn’t giving away any “secret sauce.” Rather, he argued, it could be helpful to look at the data from last ten years in order to best represent the investor. And as investor demand increases, originators can benefit, Rupert said.
Liquidity in the Secondary Market
Jason Jones, Co-Founder/Managing Member of NSR Invest (Lend Academy) is active in the secondary market, and was able to provide context of the market’s recent history.
“Both Prosper and Lending Club ran their own secondary markets until 2008,” said Jason. Until the SEC stepped in and asked the companies to switch to a securities-based issuance; whereas FOLIOfn became the custodian of those secondary markets.
While Prosper closed their secondary market (which was low volume to begin with) Lending Club adversely expanded their market. “There has been a total of 1.2 million loans issued at Lending Club to date,” said Jason. “[Meaning] about 10% of loans that have been issued on Lending Club have been listed on the secondary market.”
Numbers at a glance
- 600,000 fractional notes (approx 4:1) listed on FOLIOfn
- Current loans trade at an average of 3% premium
- Loans between 16 – 30 days-old trade at a 20% discount
- Loans over 31+ days-old trade at a 33% discount
The problem, said Jason, is that the market currently doesn’t provide trade or pricing transparency. According to Jason, while the market is still relatively small (Peercube estimates about 40 million dollars listed), it does spark interest for individual retail traders.
Market Determined Pricing
MonJa’s own James Wu offered his expertise on the subject of quantitative modeling in marketplace lending.
“There are many variables going into pricing,” said James. For example, understanding the first quarter variables, like vintages, grades and terms, as well as debt to income ratios, FICO scores, and credit utilization rates which also dictate pricing.
Platforms have evolved to create prices, said James, which is a relatively new thing. Originally, platforms let investors set prices, “but now prices are set at par or at origination, with quite a bit of detachment between primary and secondary origination,” James stated.
While there is no formal market that exists for institutional investors, bilateral transactions (typically between two investors) are commonplace. “Today there is no central registry,” said James. And with that, there is accompanying uncertainty. “It’s still more art than science,” he added.
Orchard’s future platform, James agreed, would be a huge step forward for MonJa and others in the industry.
According to Joseph Roth, Vice President of Prospect Capital Management, while securitization offers some of the parallels of a secondary market, “it lacks the price discovery and true transparency of a true secondary loan market.”
For companies like Prospect, which hold a prudent investment philosophy that is focused more on asset performance, securities are considered “an alternative form of financing.” While there is demand for securities, its lack of liquidity makes it less appealing for Prospect’s clients. Further, as mentioned by fellow panelists, the secondary market has taken more time to develop.
As James concurred, “The liquidity is there, but not sustainable in volume.”
Innovation & Looking Forward
Closing the panel discussion, Matt remained hopeful for index trading on the secondary market, saying: “It’s not a matter of if but when, as this asset class evolves over time …” Despite a decrease in volume, he sees high borrower demand for fixed income portfolios for both institutional and retail investors. The hard work for the industry players, Matt said, is in transforming these assets into usable products for a wide range of investors.
For Matt, the ‘winners’ of a secondary market include investors who can now access these new forms of capital, as well as participating banks.
“For everybody, there is a benefit,” Rupert added. “Alternative finance also has to mean: better than what came before.” He supports a singular secondary market and pool of liquidity, as well as price discovery, which he sees as the key to sector transparency.
The platforms also stand to benefit, added Joseph of Prospect, responding that “a number of large pools of capital will now participate in this asset class.” Further, he believes that diversifying funding sources and sources of capital would enable growth and stabilize platforms.
From the institutional side, Joseph of Emerald encouraged panelists not to think of the secondary market in a strictly linear fashion. “It’s still going to be a really nice, small, niche asset class … until we mature …” But he added, “it’s going to be a long-term play.”
“When I think of the future of marketplace lending, I definitely see securitization as a cornerstone to market,” said Jason, adding more equal distribution in the wealth management and retail sectors as a possibility with time. According to Jason, on the backend, more seamless technology would also benefit trading on the secondary market.
“I agree with the [idea] ‘don’t be the perfect, be the enemy of the good,” said James, in regards to pricing. “But right now … bilateral transactions are barely functioning. Having a true secondary market would facilitate these transactions.”
Listen to the full audio transcript of this panel on IMN’s website, and stay tuned for the accompanying written transcript on MonJa’s blog next month.