Given recent events, it seems the marketplace lending (MPL) business model that is more ‘sustainable’ is the one where originators are using equity plus warehouse lines to initially fund loans and consequently, partially/fully selling off these loans through Asset Backed Securities. This business model (Avant) does not charge an origination fee to the borrower (the main source of revenue for LC and Prosper) and income is generated through net interest margin on loans partially/ fully held on balance sheet.
Delving a little deeper into the economics of loan origination for pure ‘originate to sell’ (OTS) marketplace lenders (LC, Prosper and Marlette among others) shows that there is not much room for an upside in revenues in its current state.
For instance, an MPL loan originator earns approximately $675 (assuming an average loan amount of say 15,000 and origination fee of 4.5%) per loan from the borrower on the revenue side (servicing fees tend to mostly be a wash with servicing expenses). This is used to pay for acquisition marketing costs of approximately $350 per funded loan, about $100 for variable production expenses, about another $50 for direct origination expenses. The MPL originator is left with a ‘marginal contribution’ of $175 per funded loan for paying for fixed costs:
It may be worth noting that the higher the average loan amounts, the higher the marginal contribution and vice versa. Furthermore and typically, lower FICO borrowers tend to be eligible for lower loan amounts and higher FICO borrowers for higher loan amounts, although this is also a function of disposable income. And FICO and income need not always be highly correlated.
Breaking Even
Fixed expenses for MPL lenders can vary depending on investment in technology, product development and general administrative expenses and can be as low as a few hundred thousand dollars a month for smaller originators to over $10 million per month for large platforms. Just for the sake of illustration, assuming a fixed cost of $10 million a month and net revenue (marginal contribution) of $175 per loan, means that the lender has to fund 171,430 loans ($2.6 BN) per quarter just to break even. So the larger the lender’s fixed costs base, the greater the pressure to keep the wheels spinning to achieve profitability.
Investor Returns
As a comparison, assuming investors are targeting to earn 7% annualized returns (net of charge-offs and assuming a normal payment rate), the net present value of such returns (discounted at say 10%) for an investor holding to maturity (HTM) vs. marginal contribution for an originator by different loan amounts is as below:
*Using a discount rate of 10%
This observation begs the question: Is the MPL business model skewed in favor of investors vs. originators?
Yet, recently, there have been concerns from investors that loss rates have been escalating and that they are falling short on their expected return from investing in these loans.
Given the above profitability examples it is quite obvious that originators are under pressure for keeping origination costs within budget. Among the major expense items, marketing cost is the biggest expense line item for originators. Increasing competition tends to drive marketing costs higher and offering competitive interest rates definitely helps to reduce the same.
What are the ways and means that originators can increase their revenues and marginal contribution so as not be pressurized to lower interest rates? While targeting higher loan amounts should help to boost origination fee/ marginal contribution, will keeping loans with smaller loan sizes on balance sheet additionally help to shore up finances?
Disclaimer: The views and opinions expressed in this article are solely those of the author. Examples of analysis performed within this article are only examples. They should not be utilized in real-world analytic products as they are based only on very limited and dated open source information.
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