victory park capital: altus conference …...selectively participate in minority equity positions...

UNDERSTANDING RISK OF ONLINE DIRECT LENDING AS AN ASSET CLASS

NOVEMBER 2016

VICTORY PARK CAPITAL:

ALTUS CONFERENCE ONLINE DIRECT LENDING SECTOR DISCUSSION

▪ Recently joined Victory Park Capital Advisors, LLC (VPC) as a Principal –alternative credit focused investment firm1,2

▪ Past 3 years: Co-founder and Director of Liberum Alternative Finance. Focused on the online direct lending P2P sector

› Involved in raising £1bn+ capital for some of the leading platforms and several direct lending investment trusts

▪ Large cap Financials/ Banks analyst for over decade

▪ Presentation covers:

› VPC overview

› Advantages of Balance Sheet lending vs. buying whole loans

› Current Online Direct Lending (ODL) volumes, returns

› Historical returns from ODL sector and proxies

› Key Risks and Risk mitigation for Investors in ODL

1. Sector Views presented here are those of presenter individually rather than necessarily VPC.2. Services provided through a consultancy relationship with Vital Concept U.K. Ltd., registration with U.K. Financial Conduct Authority pending.

BACKGROUND / AGENDA FOR ALTUS PRESENTATION

VPC Introduction

Broader Online Direct Lending Sector Overview

Conclusion

UNDERSTANDING RISK OF ONLINE LENDING AS AN ASSET CLASS

Founded in 2007 by Richard Levy and Brendan Carroll

▪ Senior management team has worked together since 2005 with proven performance through multiple credit cycles

▪ Based in Chicago with additional resources in London, Los Angeles and New York, with over 40 employees

▪ Top-tier Executive Board comprised of prominent investment and industry professionals1

An Experienced Investor in Non-Bank Financial Services Companies

▪ VPC has made approximately $4.6 billion of commitments across various non-bank financial services platforms2

▪ Wide range of experience lending to small and medium-sized business, subprime, near-prime and prime consumers, secured and unsecured debt, legal finance and other miscellaneous types of capital providers

▪ Extensive knowledge of sector participants as well as the complex regulatory requirements needed to operate within the industry

▪ Experience in both direct lending and purchasing whole loans

▪ Proven ability to add value across its platforms given history and network in the space

Extensive Sourcing Network

▪ VPC has executed transactions partnering with more than 35 leading financial sponsors in the sector3

▪ In 2015, VPC reviewed 925 new opportunities, issued 55 term sheets, executed 34 term sheets and closed 24 transactions across the Firm

Page 3

1. Please refer to Appendix F for more information.2. As of June 30, 2016.3. List of identified managers is not exhaustive.

OVERVIEW OF VICTORY PARK CAPITAL

United States U.K., Mainland Europe and Australia

40%

61%50%

33%

11% 6%

1995 2000 2005 2010 Sep-15

Housing Business

Personal

Australia Bank Credit by Sector(Share of Total)4

47%40% 31%

$0.5

$0.8

$1.0$1.2

2000 2005 2010 3Q15

Commerical Loans ($ Trillions)

% Small Business

U.S. Commercial Loans Outstanding,And % Small Business3

Yes36%

Probably Could22%

Probably Not

16%

Definitely Not

26%

▪ Since the credit crisis, the supply of consumer credit for non-prime borrowers remains constrained

▪ 40% of Americans cite they would not be able to come up with $2,000 in thirty days

▪ Lending to small businesses continues to compress and accounts for only 24% of all commercial loans outstanding

▪ Loans below $1 million are uneconomical for banks to underwrite from a cost and capital efficiency standpoint

▪ The number of loan facilities approved by banks for U.K. small businesses was 61 thousand in 4Q15, down 49% since 3Q11

▪ The aggregate amount of loan facilities approved has decreased 31% from £9.0 billion in 3Q11 to £6.2 billion in 4Q15

▪ Over the past twenty years, the portion of bank credit extended to businesses and consumers in Australia has consistently declined

▪ Credit to businesses, which accounted for half of bank credit in 1995, now accounts for only 33%, while the share to consumers has compressed to just 6%

U.S. Consumers Ability to Come Up with $2,000 within 30 Days1

1. FINRA, Barclays Research (November 2013).2. British Bankers Association Statistics (September 2015). 3. FDIC Quarterly Banking Profile (September 2015).4. Reserve Bank of Australia (September 2015).

119

61

0

25

50

75

100

125

Number of Loan Facilities Approved for U.K. SMB Businesses2

(in Thousands)

Page 4

24%

UNDERSERVED MARKETS CREATE UNIQUE OPPORTUNITY

Bo

rrow

ers

Consumer

Small / Medium Business

Le

nd

ers

/ I

nve

sto

rs

Originators

Other

VPC NON-BANK FINANCIAL SERVICES INVESTMENTS

Structured Credit OpportunitiesWarehouse Loan Model

▪ Loans originated and retained by Platform

▪ Platforms access capital through a combination of equity, mostly from venture investors, and credit facilities

Lender

Product Offering

Unit Economics

Credit Risks / Mitigants

▪ Loans originated by platforms

▪ Loans are sold, generally at par, to peers or institutional investors, in whole or in part

▪ Generally not model dependent (i.e. consumer loans can be offered through either balance sheet or P2P models)

▪ Platform makes loan and is entitled to all principal and interest payments

▪ Targets unlevered returns of 11% to 16%

▪ Although platform does not directly experience losses on defaulted loans, if underwriting is perceived to be inaccurate, investors will no longer purchase

▪ Credit enhancement or incentive-based fee structure to align interest with platforms

▪ Platform is subject to loss of principal on defaulted loans

▪ Lender has exposure if losses increase over historical trends

▪ Marketplace earns origination fee with principal and interest flowing to individual investors

▪ Targets unlevered returns of 6% to 10% and levered returns of 11% to 18%

Examples

StructureEquity

Platform VPCBorrowers

SPV

Cash

Notes + Origination Fee

Assigned Loans/ Participation

Interests

Cash

Guarantee/Blanket Lien

Senior Secured Loan

Platform VPCBorrowers

SPV

Cash

Notes + Origination

Fee EquityCash + Servicing Fee

Notes (Principal + Interest Payments)

Page 6

Comparison of Lending Models

A PROVEN INVESTMENT MODEL

Strategy

Overview

▪ VPC provides financing to non-bank consumer and small business lenders

▪ Generally structured as debt, with seniority within a vehicle

▪ Selectively participate in minority equity positions where the upside might be significant

Diversity of Assets

▪ Investments in multiple platforms provided across diverse geographies (U.S., U.K., Europe, Australia and Latin America), products (SME loans, prime, near-prime and sub-prime consumer loans, legal settlement finance and other types of capital providers) and structures (whole loans, senior credit facilities and equity)

▪ Underlying pool of tens of thousands of borrowers with loans ranging from $200 to more than $1,000,000 and terms from one week to 60 months

Risk Control

▪ The majority of VPC’s investments are structured as loans to a SPV, with a guarantee and lien, transparency and control

▪ Typically, VPC does not fund the platform’s working capital

▪ VPC retains funding discretion with dynamic LTV ratios based on loss ratio and a typical cushion of 2x to 3x

▪ VPC puts in place control agreements and can restrict the platform’s access to cash in the event of a default

Page 7

RISK MANAGEMENT – BALANCE SHEET MODEL ADVANTAGES

VPC Introduction


Conclusion


$bn

0

50

100

150

200

250

300

350

2013 2014 2015 2016E

Europe ex-UK UK US China

▪ China dominates globally: 90% of 2016e annual P2P volumes

Annual Online Lending Volumes by Geography, USD billions

Source: WDZJ , AltFi Data, Company reports

CAGR:

151%

ANNUAL ONLINE LENDING VOLUMES OVER $300BN IN 2016E

Page 9

-

20

40

60

80

100

120

140

1H14 2H14 1H15 2H15 1H16

China Volume

0.0

0.5

1.0

1.5

2.0

2.5

1H14 2H14 1H15 2H15 1H16

Funding Circle Zopa RateSetter

LendInvest Market Invoice Others

Source: AltFi Data

1H15 o 1H14

2H15 o 2H14

1H16 o 1H15

43%

73%

75%

xx

xx

xx

Year on Year growth ratesChina historical volumes $bn

Source: WDZJ

UK historical volumes $bn

180%

305%

255%

-

0.1

0.2

0.3

0.4

0.5

1H14 2H14 1H15 2H15 1H16Younited Credit Auxmoney*Mintos F. Circle EUTwino Others

Continental Europe historical volumes $bn

Source: AltFi Data

115%

130%

107%

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

1H14 2H14 1H15 2H15 1H16

Lending Club Prosper

US historical volumes $bn

Source: Company reports

13%

92%

111%

Page 10

RECENT HALF ON HALF GROWTH SLOWDOWN MOST

PRONOUNCED IN U.S.

▪ Average UK unlevered P2P returns to investors net of all fees, relatively stable in the 5-6% range

▪ P2P Liberum AltFi Returns Index Methodology: values are time-weighted, published as aggregate annualised returns, measuring what an equal time-weighted exposure to every loan made would have returned over a preceding 12 month period

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16

Market Invoice Zopa RateSetter Funding Circle Overall Sector Return

UNLEVERED NET RETURNS IN U.K. CURRENTLY: 5.4%

Liberum AltFi Returns Index (LARI): Annual Returns from U.K. P2P Loans

Source: AltFi Data

Page 11

Credit risk

1

Platform fraud risk

2

Cyber security risk

3

RISKS FOR LOAN INVESTORS: 3 SIGNIFICANT SPECIFIC RISKS FOR

P2P LENDERS THAT NEED TO BE ADDRESSED…

Page 12

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

2005 2006 2007 2008 2009 2010 2011 2012

Net yield Servicing cost

Loan losses Average net yield

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

2005 2006 2007 2008 2009 2010 2011 2012



0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

2006 2007 2008 2009 2010 2011 2012



0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

2005 2006 2007 2008 2009 2010 2011 2012



▪ ZOPA one of the few Online Direct Lenders to have operated through the financial crisis

▪ The worst annual cohort, 2008, had annualised loan losses of 2.3% and an average net yield of 5.9%; the worst credit grade (C1) had loan losses of 4.3% and a net yield of 5.6%

Zopa annual returns by cohort % all credit grades

Source: ZOPA data

Zopa annual returns by cohort % A* credit grade

Source: ZOPA data

Zopa annual returns by cohort % B credit grade

Source: ZOPA data

Zopa annual returns by cohort % C1 credit grade

Source: ZOPA data

1 2 3

ZOPA RETURNS: RESILIENT THROUGH GLOBAL FINANCIAL CRISIS

Page 13

U.S. credit cards:

▪ Solid returns: Average net yield achieved on U.S. credit cards net of loan losses: 8.2%

▪ Stable losses: Peak losses 1.9x average losses

▪ Consistently positive returns: No year with negative returns in at least 20 years

Similarly for U.K. credit cards:

▪ Average net yield achieved on U.K. credit cards net loan losses: 6.4%

▪ Peak losses 1.6x average

▪ No year with negative returns in at least 16 years

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Net yield Loan losses Avg net yield

U.S. Credit card effective yields net of loan losses

Source: Federal reserve data, Author seasoning adjustments

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

1999 2001 2003 2005 2007 2009 2011 2013 2015


U.K. Credit card effective yields net of loan losses

Source: Bank of England data, Author seasoning adjustments

Page 14

1 2 3

CREDIT CARDS RECEIVABLES: POSITIVE NET RETURNS FOR LAST

20+ YEARS

▪ Normalising loan losses to TTC levels suggests yields would decline c1%

▪ Even under fairly aggressive stress case assumptions U.K. consumer and SME net yields stay at/ above zero

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

Current TTC Stress

Net yield Loan losses

U.S. credit card return scenarios

Source: Author

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

Current TTC Stress


U.K. personal loan return scenarios

Source: Author

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

Current TTC Stress


U.K. SME loan return scenarios

Source: Author

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

Lending Club Funding Circle Zopa

Current Stress scenario

Estimated current and stress annual returns for selected platforms

Source: Author estimates

Page 15

ONLINE DIRECT LENDING ANNUAL RETURNS UNLIKELY TO GO

SIGNIFICANTLY NEGATIVE IN STRESSED CONDITIONS

1 2 3

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015


0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Net Yield Charge off Avg net yield

▪ Better Sharpe ratio for U.S. credit card assets and U.K. personal loans than for S&P

▪ S&P and commercial property had negative returns of -37% and -23% in 2008

▪ Direct lending no negative annual returns over last 20 years

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

S&P 500 total annual returns %

Source: Bloomberg

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

U.K. commercial property total annual returns %

Source: IPD

0.4x

1.8x

Sharpe

ratio*

0.5x

0.5x

U.S. Credit card loan effective annual returns net of servicing fees %

Source: Federal Reserve

U.K. personal loan effective annual returns net of servicing fees %

Source: Federal Reserve

*Sharpe ratio= (annual net return less 3m Libor) / (standard deviation of annual returns)

Page 16

1 2 3

ONLINE DIRECT LENDING ANNUAL RETURNS UNLIKELY TO GO

SIGNIFICANTLY NEGATIVE IN STRESSED CONDITIONS

▪ P2P returns (LARI) are 2.2% above the EU high yield index vs. historical average gap of -0.1%

▪ S&P Earnings yield* suggests equity market now richly priced vs. P2P sector

▪ *S&P 500 rolling earnings yield calculated as Bloomberg consensus for next 12 months EPS for S&P divided by current index and a rolling basis

Annual net returns from UK ODL platforms (LARI index) vs. to expected proxy returns from fixed income and equity alternatives

Source: Bloomberg, author calculations; AltFi Data

0%

2%

4%

6%

8%

10%

12%

Apr-10 Nov-10 Jun-11 Jan-12 Aug-12 Mar-13 Oct-13 May-14 Dec-14 Jul-15 Feb-16

SPX earnings yield LARI return index

EU High Yield 1-5y EU investment grade

Page 17

1 2 3

ONLINE LENDING OFFERS COMPELLING RELATIVE VALUE VS.

BONDS/EQUITIES

Nature of lending means that there a time delay between money invested and money returned. This creates an opportunity to temporarily misappropriate capital/ mislead investors on the investment details

1 2 3

Example Country Loan Investor Impact Going concern?

2016: Press reports that 880,000 investors collectively lost $7.6bn

NO

2015: Losses TBD but likely to be c$20-30mm

NO

2016: Some of date information that investors falsified. No directly related investor losses

YES

‘Robbing Peter to pay Paul’

Siphoning off cash

Misrepresenting data

PLATFORM FRAUD: 3 SHADES OF PLATFORM MISBEHAVIORS

Page 18

PLATFORM FRAUD RISK: MITIGATION STRATEGIES

1 2 3

Type of Action… …Provided by e.g.

Ensuring: access to clear information; segregation of client money; platform backup servicing plans

FCA (UK), SEC (US), CFPB (US), ASIC(Australia), FMA(New Zealand)

Professional fund managers perform detailed initial due diligence and then subsequently actively monitor the

P2P platformsAsset Managers e.g. Victory Park Capital

Forensic / v detailed due diligence at pre-deal phase for institutions

SIG, Altus, Baker Tilly

Standard periodic audits PwC, BDO etc

Not aware of anyone doing it yet, but scope for insurance companies to guarantee the absence of fraud

at platforms; premiums paid by platformsPotentially Lloyds of London etc...

Regulation

1

Institutional Scrutiny

2

Pre Investment Due Diligence

3

Financial / Process Audits

4

Fraud Insurance

5

Page 19

1 2 3

REALValidation

REALGrowth

REALTrust

TRUST BUT VERIFY – USING TECHNOLOGY

GDR Validates Data in the Market Place Lending Sector:

GDR’s Suite of Asset Certainty Products

▪ Loan Validation

› Borrower Validation – Confirming borrower is real – ID

› Credit Validation – Confirming reported credit representation

› Disbursement Verification – Confirming disbursement of funds to borrower from original creditor

› Document Validation – Confirming loan documents exist

▪ Rights/Pledge Validation – Ensuring that collateral not double pledged

▪ Compliance Validation – Usury rate, AML/KYC, etc.

▪ Provenance/Chain of Title Validation – Track from time application hits Platform

▪ Loan Verification – Same service verification agent/3rd party due diligence

Independent Data Repository (e.g. Global Debt Registry (GDR)) can essentially

eliminate PLATFORM FRAUD RISK

TRANSPARENCY BY ITSELF IS NOT SUFFICIENT

Page 20

▪ Fintech is vulnerable to cyber fraud: In Q1 2014 Cyber hackers stole $350m from Tokyo’s large bitcoin exchange Mt. Gox.

▪ Online lending by its nature is vulnerable to cyber hacking. Some instances of hacking (e.g. DDOS attacks) for Chinese P2P lenders in 2014

▪ Twice yearly penetration tests commissioned from a third party security specialist

▪ Use of encrypted storage

▪ All public access via managed load balancers with firewall protection for the underlying servers

▪ Security policies in line with industry best practice

1 2 3

Cyber security risks

Ensuring Cyber security

Cybersecurity solution

provider example

CYBER SECURITY RISK: ROBUST SOLUTIONS; BUT NO ROOM FOR

COMPLACENCY

Page 21

VPC Introduction


Conclusion


Page 22

1 2 3

Once these are addressed: unlevered returns 5-7%; AND stressed annual returns likely to remain positive. Risk vs. Reward better with Balance Sheet Lending investment

structure

Credit risk controlled?

1

Platform fraud risk mitigated?

2

Cyber security mitigated?

3

✓

✓

✓

SOLUTIONS FOR ALL 3 KEY IDIOSYNCRATIC RISKS: INCOME

OPPORTUNITY IS ATTRACTIVE

Page 23

This confidential presentation (this “Presentation”) is for information purposes only. This Presentation does not constitute an offer to sell, or the solicitation of an offer to

buy, a security in any state or jurisdiction. This Presentation is not intended to be relied upon as the basis for an investment decision, and is not, and should not be

assumed to be, complete. The contents herein are not to be construed as legal, business, or tax advice and each recipient of this Presentation should consult its own

attorney, business advisor, and tax advisor as to legal, business and tax advice.

For the purposes herein, Victory Park Capital Advisors, LLC shall be referred to as “VPC.” Each recipient of this Presentation agrees that VPC, its affiliates and their

respective partners, members, managers, employees, officers, directors, agents, and representatives have not made any representation or warranty, express or implied, as

to the (a) accuracy or completeness of the information contained herein or (b) the opinions contained herein, and such persons shall have no liability for any misstatement

or omission of fact or any opinion expressed herein. Certain economic and market information contained herein has been obtained from published sources prepared by

third parties and while such sources are believed to be reliable, neither VPC nor any of its affiliates or employees has independently verified such information or assume

any responsibility for the accuracy or completeness of such information.

Except where otherwise indicated herein, statements in this Presentation are made as of the date hereof, and the delivery of this Presentation at any time shall not under

any circumstances create an implication that the information contained herein is correct as of any time after such date. Unless otherwise stated in this Presentation, the

information contained herein is based on information and estimates made by VPC.

Certain information contained in this Presentation constitutes “forward-looking statements” that can be identified by the use of forward-looking terminology such as “may,”

“will,” “should,” “expect,” “anticipate,” “target,” “project,” “estimate,” “intend,” “continue,” or “believe” or the negatives thereof or other variations thereon or comparable

terminology. Furthermore, any projections or other estimates in this Presentation, including estimates of returns or performance, are “forward-looking statements” and are

based upon certain assumptions that may change. Due to various risks and uncertainties, actual events or results or the actual performance may differ materially from

those reflected or contemplated in such forward-looking statements.

This Presentation and the information contained herein consist of confidential proprietary information and are the sole property of VPC. The Presentation is not intended for

any general distribution or publication and is strictly confidential. Each recipient of this Presentation further agrees that it will (a) not copy, reproduce, or distribute this

Presentation, in whole or in part, to any person or party without the prior written consent of VPC; (b) keep permanently confidential all information contained herein that is

not already public; and (c) return this Presentation to VPC upon its request. Except as otherwise provided in a written agreement between the recipient of this Presentation

and VPC or its affiliates, if the recipient receives a request under any applicable public disclosure law to provide, copy or allow inspection of this Presentation or other

information regarding or otherwise relating to VPC, the recipient agrees to (a) provide prompt notice of the request to VPC, (b) assert all applicable exemptions available

under law and (c) cooperate with VPC and its affiliates to seek to prevent disclosure or to obtain a protective order or other assurance that the information regarding or

otherwise relating to VPC will be accorded confidential treatment.

Page 24

DISCLAIMER

victory park capital: altus conference …...selectively participate in minority equity positions...

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