US unemployment fell to 4.4%—the lowest level in a decade—matching the low-point in the last economic expansion. The FOMC maintained interest rates in their target zone of 75 to 100 bps.
On the regulatory front, Thomas Curry stepped down this past Friday as Acting Comptroller of the Currency. Congressional Republicans have urged the OCC to pause the FinTech charter until a Trump appointee can re-evaluate.
In capital markets news, China Rapid Finance followed Elevate Credit in becoming the second consumer lender to go public this year. (We refer readers to this Lend Academy post for further analysis).
Last week, PeerIQ noted the pattern of double-digit reserve increases among non-bank lenders. This week, OneMain (NYSE: OMF) bucked the industry trend by announcing that charge-offs remain in-line with expectations.
We note that OneMain buttressed the ramparts early in response to incoming data. OneMain boosted loan-loss reserves 69% from 2014 to 2015, nearly a full year ahead of other non-bank lenders, who only experienced a single digit increase in reserves over the same period. Investors rewarded vigilant, forward-looking risk management—OneMain shares jumped 5.5% on their earnings release date.
Lending Club also released earnings. Although results exceeded guidance shares of LC dropped 5.6% due to flat origination growth and higher expenses. We believe a key statistic to monitor is Lending Club’s share of loans funded by banks. That metric now stands at 41%—a record high—and up from 31% last quarter. A higher share of bank loan purchasing decreases Lending Club’s “effective” cost-of-capital (e.g., the funding costs borne by LC’s whole loan aggregators). A higher bank mix also lessens dependence on relative value oriented asset managers in a rising rate environment.
Finally, Bloomberg reports that Prosper notified its retail investors about a system error for return calculation. Many investors affected saw their annualized net returns on the “account overview” page lower than what they were before. The errors do not impact bonds linked to Prosper loans. Also, cash activity and loan balances were correctly reported.
This week we introduce “Cash-on-Cash Return” an observable and easy to calculate metric.
Cash-on-Cash Return (CoCR) Approach
As evidenced from Prosper’s annualized return calculation methodology, the return calculation can be complicated, involving several moving parts. Marketplace institutional investors appreciate the complexity and diversity of return calculations. At PeerIQ, we have had numerous conversations in the past with our clients and developed the “Cash-on-Cash Return” metric as one of several tools to monitor portfolio performance.
Cash-on-Cash Return (CoCR), expressed as a percentage, is defined as Interest Received ($) plus Fees Received ($) and plus Gross Recoveries ($) minus Servicing Fee ($) minus Charge Off ($), then divide by Outstanding Principal BOP ($) on as of valuation date. BOP stands for “Beginning of Period”. Exhibit 1 illustrates the calculation of monthly cash-on-cash return (CoCR).
It varies from Prosper’s Estimated IRR by only considering realized cashflow information. Unlike Annualized Return, it eliminates complication springing from annualizing simple returns. In short, CoCR utilizes few readily available loan and pool level data points and summarizes the historical return of the investment on monthly basis.
Exhibit 1 Example of Cash-on-Cash Calculation
The CoCR metric is a useful, simple model-free tool for benchmarking and monitoring pool-performance based on realized cashflows.
Here we illustrate how Cash-on-Cash Return evolves as portfolios season by looking at Prosper’s vintage performance for Q1 2014, Q1 2015, and Q1 2016:
Cash on Cash Return
The cash-on-cash return profile above follows a familiar pattern. Interest income is strong in the early periods. As pools season, charge-offs increase and compete with interest income in driving return performance.
The disadvantage of the CoCR metric is that returns are not forward-looking. Also, the declining cash-on-cash return performance (a typical characteristic of installment loan portfolios) can create confusion or frustration for retail investors. Retail investors experience strong net annualized returns in the early periods, only to experience returns consistently decline as loans season.
Investors need to evaluate investment returns through various lenses. We urge investors to obtain multiple viewpoints and analyses to gauge the risk and return of lending products. We also strongly encourage the use of 3rd party fair value to provide a forward-looking measure of risk that fully accounts for prevailing and expected rates, expected charge-offs, and loan status. PeerIQ’s analytical tools offer investors an independent perspective on risk and return and enables institutions to critically examine return guidance from various originators.
- What’s Next in Fintech Lending? – PeerIQ Breakfast and Panel Discussion
- PeerIQ will host a panel on May 9th at 9AM featuring a roundtable discussion led by Peter Rudegair of WSJ and joined by thought leaders including: Zhengyuan Lu, principal at Victory Park Capital, Greg Nowak, partner at Pepper Hamilton and Ram Ahluwalia, CEO of PeerIQ.
- Space is limited to 20 slots, so please RSVP to confirm attendance.
- FRALLC’s Bank/Alternative Lender Strategic Partnership Summit on May 10-11 in New York. Ram will speak on the “Tapping Secondary Markets: Securitization & Liquidity” panel on Tuesday May 11 at 2:00PM.
- Use our discount code to get 15% off your registration: FSM409.
PeerIQ in the News:
- Online Lenders Feel the Pinch (Bloomberg, 5/5/17)
- Avant’s First 2017 ABS (PeerIQ), Rated: AAA (LendingTimes, 5/2/17)
- Fintech Charter in Limbo with Changing of the Guard at OCC (Bloomberg, 5/4/17) The federal initiative to issue national bank charters to financial technology companies looks to be stuck in neutral with the departure of Thomas Curry as Comptroller of the Currency.
- Lending IPOs Find Cautious Investors Amid Consumer Credit Fears (Bloomberg, 5/5/17) China Rapid Finance follows Elevate Credit in becoming the second consumer lender to go public this year.
- Goldman Embraces Banking’s Bland Side: Lending Money (WSJ, 5/1/17) Goldman Sachs is moving to a range of new lending businesses—financing corporate takeovers, lending against mansions and making personal loans for things such as kitchen remodels.
- Online Lender Prosper Says System Error Overstated Loan Returns (Bloomberg, 5/4/17) Glitch affected majority of loan investors, spokeswoman says, error has been fixed and didn’t affect tax documents or cash.
- Funding Drought Threatens Business Lenders (AB Alert, 5/5/17) A potential liquidity squeeze for online small-business lenders incites nervousness.
- Banks Pull Back on Car Loans as Used-Auto Prices Plummet (WSJ, 5/3/17) After years of revving up auto loans, the banking industry is sounding a more cautious tone due to declining re-sale values.
- Artificial Intelligence Geared to Erase Capital Markets Jobs: Study (WSJ, 5/3/17) Capital markets firms could spend $1.5 Bn on AI technologies this year, growing to $2.8 Bn by 2021.
- Milken Institute: A Conversation with Treasury Secretary Steve Mnuchin (Milken) Mnuchin seeks to simply the “black box” of bank capital & liquidity rules, and pursue corporate tax reform.
- Warren Buffet 2017 Annual Investor Letter (Berkshire Hathway) The Oracle of Omaha is optimistic on the outlook for American innovation, productivity gains, and entrepreneurial spirit.