How Do Marketplace Loans Perform in Downturns? Q&A

Below are excerpts from our webinar: Marketplace Loans: How Might They Perform During A Downturn?

Here are 6 common questions about marketplace loans answered by experts.

1. What are you seeing in credit markets, and where we are in the cycle?

We’re leaning a little bit bearish on the markets, but in terms of the economic outlook we feel the coast is clear for the balance of 2019. Most economists and strategists we follow aren’t predicting a recession before 2020. But risks are on the rise. Employers are more cautious in adding to the labor force, commodities are showing signs of demand weakness, oil prices have entered a bear market, and low inflation is a concern.

On a positive note, the Federal Reserve has opened the door to potential interest rate cuts. From what we can see now, consumers seem to be in a pretty good position, so we think the likelihood of a consumer-led recession is pretty low. The high level of corporate debt leverage, three times higher than before the last recession, does concern us. On top of that, financial markets are navigating new waters from trade tariffs to regulatory concerns around the big tech stocks.

2. What are some characteristics that may make marketplace loans advantageous in a recession?

There are really three factors. First, their return drivers differ from those of more traditional investable asset classes. Second, marketplace loans typically show less price sensitivity to interest rate changes compared to other fixed income assets. That’s because of their relatively short maturities and because they fully amortize, unlike a typical bond; a marketplace loan’s regular interest payments bring down their effective duration. Finally, consumer demand for credit has been consistently strong—even with high credit card interest rates. Strong demand, plus an unmet need for credit are features, not bugs, underpinning the consumer credit market’s durability across cycles.

3. In a downturn how do you see LendingClub performing relative to other participants, or new entrants?

We believe we’re at an advantage thanks to the strength of the credit model and our brand. We have over 40,000 people filling out applications every day. We fill an unmet need for credit, and we’ve accumulated a critical mass of consumer data.

But to assess potential impacts of a recession, we looked at loan charge-off rates to see when they might peak. We found the biggest impact¹ would occur if a recession started within two quarters of a loan’s origination date. Next, we looked at returns. There, our data suggest that loan performance would still compare favorably to what happened in equity markets during the last recession. In a severe recession we believe we could expect vintage level returns to fall into negative single digits.

We also looked at external data on how banks’ unsecured personal loans fared during recessions and saw the biggest negative impacts were on near prime and large loans. Their performance showed the greatest sensitivity to changes in the unemployment rate.

4. What are some of the controls you have in place on the servicing side to manage a downturn? How do you see servicing evolving during a downturn?

As we see it, successful recovery strategy involves:

• Finding those members most receptive to a conversation about their finances

• Ensuring we have the most well-trained representatives on the other end of that call

• Helping borrowers understand the risks of defaulting

• Making sure those representatives have a variety of options that meet the immediate financial difficulties borrowers are facing—it doesn’t matter if you can get a borrower on the phone if you don’t have options, like payment plans, to offer them.

We’re investing in programs to address all four of those areas. We’re also trying to lower the cost of loan servicing without losing any collections capability.

5. How will LendingClub’s approach to facilitating loans change in a downturn?

The straightforward approach is to tighten in a downturn. But the fact is that borrower demand is likely to increase, not decrease, in a downturn. We’re different from traditional lenders from that standpoint. We look at FICO bands and how relative increases in delinquency could play out. We expect to have more pricing power, and to be able to raise interest rates. With that said, there are likely to be segments we won’t be able to price so some tightening might still be in order.

Overall, you want to take advantage of a recession, because sometimes competitors will pull back and open the door for you to help great borrowers stay on track. We are preparing by building in extra liquidity and continuing to broaden our investor base. When the next recession hits, we want to work with investors who will be opportunistic, and with 3 million borrowers we have the scale to do that. We’ll look to gain market share but in a prudent way.

Valerie Kay is the Chief Capital Officer at LendingClub, responsible for overseeing the Investor Group. Valerie brings more than 25 years of capital markets experience across a broad range of consumer asset classes. She previously served as LendingClub’s Senior Vice President, Head of Institutional Investors, and launched the company’s securitization and Club Certificate programs. Prior to that, she spent 20 years at Morgan Stanley, including 12 years as a Managing Director, holding several leadership roles within Global Capital Markets, including Deputy Head of Asset Finance, Head of Structured Asset Monetization, and Head of Mortgage Finance.

Ronnie Momen is LendingClub’s Chief Lending Officer, overseeing LendingClub’s credit strategy including using credit data, analytics, and innovative products to drive responsible growth. Ronnie brings more than 28 years of experience developing innovative, forward-looking and collaborative credit organizations. Prior to LendingClub, he served as Chief Credit Officer for GreenSky, and held leadership positions at Wells Fargo and HSBC.

John Steward is Vice President for Institutional Sales at LendingClub. Prior to LendingClub, John held senior sales roles at Builder’s Bank, Action Investment Real Estate, and Marcus ＆ Millichap.

Andrew Jensen is a Senior Director of Business Operations at LendingClub and a former Senior Director of Payment Solutions. Andrew manages third party recovery agencies and distressed debt buyers, and leads a variety of projects to improve LendingClub’s recovery capabilities.

1. Looking at vintage level loan losses across all grades during the 2001 and 2009 recession.