DEFAULT RATES ON THE RISE
Default rates have also begun to tick up. The S&P/Experian Consumer Credit Default Composite index, for example, has risen from 0.81 in May 2016 to 0.92 in January 2017 (although over three and five years they are down from 1.34 in January 2014 and 2.16 in January 2012).
While the marketplace lending sector has not yet been though a full economic cycle, the financial crisis gives some insight into what might happen if another shock were to occur.
In 2009, when US default rates spiked to roughly 11%, net returns remained close to 4% and recovered quickly, climbing back to 7% by mid-2010 and breaking through 10% again in 2013.
As the market changes, platforms are able to dynamically adjust their rates, which feeds into the market’s resilience. Rates have already gone up by 100 to 200 basis points in the US, for example, not just in response to Federal Reserve tightening, but also to attract more investors after some turbulence at large platforms last year saw levels of origination fall slightly.
Jullia predicts that default rates would have to rise to around 10% and stay that way for a year in the US for investors to lose money.
“There would need to be a sustained shock over a long period,” he says. “Investors may lose money for a few months, but we would need very tough conditions to lose money over a year.”
Durations in consumer loans are also short. Loans typically cover three or five years with average durations for investors of 1.5 years on three-year loans and 2.5 years on five-year loans. A portfolio tilted 80% to three-year loans would therefore have average duration of 1.7 years. This “self-liquidating” characteristic works to limit the impact of the change in the interest rate cycle, for example.
“There are not many asset classes that offer the yield, transparency and self-liquidating factors that are on offer in consumer loans,” Rajguru says.
