Marketplace Lending & the 2016 Economy
At only 6 weeks in, 2016 is shaping up to be a very different year. Global markets are experiencing volatility, and investors of all stripes are wondering whether the past few months’ performance represents a temporary jitter or if it portends greater trouble ahead. Given that the past couple years of massive growth in marketplace lending have taken place in a highly favorable economy, it’s worth paying close attention to key indicators and exploring how the sector would perform in a more uncertain market.
Years of Growth
Over the past several years, the marketplace lending sector has experienced incredible growth, with annual origination volumes on LendingClub and Prosper – the 2 largest issuers – rising from $153MM in 2010 to over $12B in 2015.
As we can see in the graphs above, while marketplace lending was born amidst the storm of the Great Recession, it has grown up in a rising tide of overall economic prosperity. From 2010 to 2015, LendingClub and Prosper’s massive volume increase happened contemporaneously with a 78% increase in the value of the S+P, along with a U.S. GDP that rose from $14.5T to $18T over the same period.
Yet, despite the growth of the past several years, there is caution in the air. For the past several months, many have worried that 2016 would be different – that no economic cycle could last forever and that at some point, the turmoil felt in global markets would ultimately arrive on our shores.
Of course, while public markets owe their volatility to numerous factors, consumer loan performance is very much a function of the financial health of the American household.
In keeping tabs on the financial condition of American consumers, we find it useful to monitor several key economic indicators. The following charts paint an interesting picture of the country’s financial health.
As we can see, the unemployment rate is at a multi-year low, at half of its peak value of 10% near the height of the great recession. Unemployment has consistently fallen amidst the economic recovery and now appears to be at a generally acceptable level. While the direction of that chart is promising, the next one may be cause for concern, as the labor force participation rate has been consistently falling for some time. That indicates that part of the reason for the decrease in unemployment is not only due to an expanding job market, but also due to decreased participation in the labor force.
The above 2 charts paint a positive picture of financial health. Households’ financial obligations as a percent of their disposable personal income have decreased significantly since the over-leveraged days of the early-2000s. This means that consumers would conceivably have less trouble making debt service payments, a hypothesis seemingly confirmed by the very low charge-off rates on credit cards seen in the next graph.
Marketplace Loan Performance
With the backdrop of a booming economy, a growing market, and high returns, institutional investors have deployed significant capital into marketplace-funded consumer loans. On the whole, such investments have performed very well, besting the returns of many other fixed-income products and exhibiting relatively low volatility. While market performance has been strong, delinquency rates have inched up over the past few months, and overall market returns, as measured by the Orchard U.S. Consumer Marketplace Lending Index, while remaining solidly positive, have compressed to 32 bps for the month of December 2015.
Prosper is already reacting to changes in the market by making significant adjustments to the interest rates on their loans, increasing rates by up to 199 basis points (depending on grade) to ensure their loan products remain competitive for investors.
It is not yet clear whether the recent uptick in marketplace delinquencies will prove to be temporary, or if it will continue throughout the year. It will be important to also monitor what effect the increased volatility in global and domestic markets has on the U.S. consumer. Either way, the economy of the coming year is likely to be a lot more interesting than that of the last. Marketplace lending will now have both the need and the opportunity to prove its resilience as an investment class in changing and potentially difficult markets. If the industry proves it is up to the task, it will cement its position as an attractive investment and compelling component of the economy for years to come.