Weekly Industry Update: September 11, 2016
By Vy Phan
September 11, 2016
A number of headlines last week focused on student loans. Amazon and Wells Fargo announced that their short-lived partnership to promote private student loans has come to an end. This announcement marked the latest news to break concerning the controversy surrounding rates charged by private versus federal student loans.
Additionally, SoFi announced new fundraising plans as it eyes opportunities to expand its main student lending business. Reports indicate SoFi aims to raise $500 million in equity—one of the largest U.S. FinTech funding rounds this year.
Importance of Valuation to Unlocking Capital In this week’s deep-dive topic, we focus on valuation, which has been a key regulatory and investor fairness topic. ASC Topic 820 (formerly known as FAS 157) introduced fair value measurements and disclosure requirements for financial instruments.
Historically, the MPL industry has used a variety of informal valuation techniques; however, to grow as an institutional asset class, the industry needs to employ a sound and consistent valuation discipline. A consistent and reliable valuation approach will facilitate the sale of seasoned secondary pools and securitization deals, which, in turn, helps platforms and investors to unlock capital. Impact of Loss Timing & Seasoning on Valuation In this newsletter, we isolate the impact of loss timing on the valuation of a loan pool as the collateral seasons. We explore the price profile of a loan pool over its life for four distinct loss curve shapes: a flat, a front-loaded, a back-loaded, and an up-down CDR curve. Exhibit 1 shows that under a flat loss curve, price is constant over time. A front-loaded loss curve allows the loan pool to price above par as loans season; a back-loaded loss curve leads to a delayed price drop; and the price profile for an up-down loss curve is influenced by a combination of front and back-loaded curves. Exhibit 1 Summary of Seasoning Analysis Source: PeerIQ The Price of a Loan Depends on the Timing of Losses over Loan Age For the purpose of our analysis, we assume that recovery rate is zero for a defaulted loan. A loan pays interest and principal until it matures, is prepaid, or defaults. The price of a loan depends on the principal repayment and interest rate collected over the loan life. The level of prepayment and default, in addition to the timing of cashflow, determines loan pricing. As the loan pool experiences time-varying default or loss rates, the price changes over the loan life, even if the discount rates and collateral projections remain constant. PeerIQ has developed prepayment and default models to forecast cashflows at the loan-level for a number of platforms. We focus the follow discussion on default curve shapes in the context of loan pricing. Discounted Cashflow Approach for Loan Pricing Throughout this analysis, we assume a $100 million loan pool that is comprised of 36-month loans with a 15% fixed-rate coupon, a 16% CPR, and a 1% servicing rate. We carry out loan pricing according to the following steps: - We project the cash flows on the loan pool from the time of origination given CPR and CDR curves.
- We solve the yield at origination assuming the price is at par ($100).
- We apply this yield as the discount rate to arrive at the net-present value (NPV) of the remaining cashflow.
- We calculate the price of the loan pool as NPV divided by the beginning pool balance for each payment period.
- Single Month Mortality (SMM) measures the prepayment rate for a month. The SMM is the fraction of the beginning-month principal balance that prepays during the month. By convention, the scheduled principal is subtracted from the balance before calculating SMM.
- Conditional Prepayment Rate (CPR) is the annualized version of the SMM.
- Month Default Rate (MDR) measures to the charge-off or default rate for a month. The MDR is the fraction of the beginning-month principal balance that has been charged off during the month. By convention, the scheduled principal is subtracted from the balance before calculating MDR.
- Conditional Default Rate (CDR) is the annualized version of the MDR.
- IMN’s ABS East Conference in Miami on September 18-20.
- American Banker Marketplace Lending and Investing Conference on September 27-28 in New York.
- Context Summits 2016 Alternative Lending Summit on September 28 in Dana Point, CA—more coverage here.
- RiverNorth’s P2P Closed-End Fund Paves Way for Others: PeerIQ (Bloomberg, 8/30/16)
- Marketplace Lending News Roundup – August 27, 2016 (LendAcademy, 8/27/16)
Industry Update:
- SoFi Looks to Raise $500 Million in Latest Test for Fintech (WSJ, 9/7/16) A deal would be one of the largest U.S. fintech funding rounds of the year.
- Now Companies Are Getting Paid to Borrow (WSJ, 9/6/16) Europe’s Henkel and Sanofi sell bonds with negative yields as ECB buying drives down rates.
- Zopa Drops Rates, More Platforms to Follow? (AltFi, 9/1/16) Lenders decrease rates in response to increased investor demand.
- Online Marketplace Lending Partnerships Can Benefit Lenders and Small Businesses; Pitfalls Remain for A Nascent Industry (Moody’s, 8/31) Moody’s reinforces idea that bank partnerships can lower customer acquisition and funding costs.
- Lending Club Bolsters Investor Group with Two Senior Hires (PRNewswire, 8/24/16) LendingClub has brought in two heavyweights to bolster its push for more institutional and retail investors.
- Amazon-Wells Fargo Student-Loan Plan Ran Into Political Obstacles (WSJ, 9/6/16) Amazon-Wells Fargo skirmish marks the latest front in the controversy over private student loans.
- Ruling Boosts CFPB, Raises Marketplace Lending Questions (Bloomberg BNA, 9/6/16) True-lender and choice of law provisions emerge in CFPB vs. Cash Call.
- U.S. Regulators Allow Blackrock funds to lend to one another (Reuters, 9/7/16) SEC allows Blackrock funds to lend to one another as liquidity risk management is high on regulatory agenda.
Lighter Fare:
- Face of a Robot, Voice of an Angel? (MIT Technology Review, 9/9/16) DeepMind’s use of neural networks could finally make computers sound more human.