Author Topic: Idea: LC but with partially secured consumer loans  (Read 7360 times)

bdonovan

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Idea: LC but with partially secured consumer loans
« on: July 28, 2016, 03:15:19 AM »
According to the average returns showed by LC, there is a delta between the interest rate for the borrower and the actual return.  Wide Delta.  Instead of receiving 17% on D's, we get 8%.  Half the return is lost to defaults.  What if you could marketplace consumer loans, but in this case, compel the borrower to provide proof ownership of a vehicle, home ownership, or partial ownership.  If you look at the detailed borrower stats, they show if they own home (Own) or mortgage (partially own).  This may work because at the outset of the loan, everything thinks it will work; the borrower is not thinking about defaulting so it may not seem significant to use his assets as collateral (because he doe snot think they will beneeded to repay the principal anyhow).  But now, consider, that many of the marketplace loans are backed either fully or partially by these assets.  A $3.5K loan request can be backed by a $7K used car.  A $40K loan for a large purchase may be backed by a mortgage in which he's bough 50% of 400K house. 

Could such a model improve yields?  The overall interest rate would have to be lower (but perhaps not by much).  But most importantly, the Surrender $ from Default will go down.  I mean look at how ominous the numbers look like the MINUTE a loan payment is late.  That won't be the same if we knew there's real collateral.  One may ask- well if they have a car and wanted to consolidate debt, why wouldn't they just sell the car if it was that important.  But that's not how debtos think.  They are optimists assuming both. 

I think it might be interesting for a closer look.

rawraw

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Idea: LC but with partially secured consumer loans
« Reply #1 on: July 28, 2016, 05:49:24 AM »
Are you new to lending? Not sure how much I need to explain vs. assume you know. So I'll bullet point

1) This would bring net returns lower, not higher
2) This would likely increase the servicing fee you pay for lower yielding notes
3) This wouldn't work well with a market place lender structure.
4) collateral you describe is far from an assurance of reduced losses. It could actually increase the credit costs.







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bdonovan

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Re: Idea: LC but with partially secured consumer loans
« Reply #2 on: July 28, 2016, 11:29:55 AM »
Are you new to lending? Not sure how much I need to explain vs. assume you know. So I'll bullet point

1) This would bring net returns lower, not higher
2) This would likely increase the servicing fee you pay for lower yielding notes
3) This wouldn't work well with a market place lender structure.
4) collateral you describe is far from an assurance of reduced losses. It could actually increase the credit costs.

Just an idea.  You say it would bring 'net returns' lower; I see how it would bring interest rates lower on loan that is partially secured.  The net returns would be a combination of the interest rate and the delinquencies/defaults.  RE: within a marketplace lender structure- there is really nothing else the marketplace would need to do; the business of originating and scoring loans, along with collection would still be the responsibility of the company involved, in this case Lending Club.  Yes, collateral is no assurance of reduced losses; however, presumably the reason why partially secured loans elsewhere have lower interest rates than unsecured loans is because there is some advantage to the lender in terms of recouping the principal loaned. 

I'm sure there are pros/cons with the idea; just thought it would be interesting to discuss.


rawraw

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Re: Idea: LC but with partially secured consumer loans
« Reply #3 on: July 28, 2016, 11:59:10 AM »
Are you new to lending? Not sure how much I need to explain vs. assume you know. So I'll bullet point

1) This would bring net returns lower, not higher
2) This would likely increase the servicing fee you pay for lower yielding notes
3) This wouldn't work well with a market place lender structure.
4) collateral you describe is far from an assurance of reduced losses. It could actually increase the credit costs.

Just an idea.  You say it would bring 'net returns' lower; I see how it would bring interest rates lower on loan that is partially secured.  The net returns would be a combination of the interest rate and the delinquencies/defaults.  RE: within a marketplace lender structure- there is really nothing else the marketplace would need to do; the business of originating and scoring loans, along with collection would still be the responsibility of the company involved, in this case Lending Club.  Yes, collateral is no assurance of reduced losses; however, presumably the reason why partially secured loans elsewhere have lower interest rates than unsecured loans is because there is some advantage to the lender in terms of recouping the principal loaned. 

I'm sure there are pros/cons with the idea; just thought it would be interesting to discuss.
I love discussions that challenge perceptions, so don't take the bullets as dismissive. I'll have to type up an explanation on some of those points when I'm at a computer.

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Larry321

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Re: Idea: LC but with partially secured consumer loans
« Reply #4 on: July 28, 2016, 01:48:24 PM »
bdonovan's questions which started this thread are terribly interesting!

The implied question in his post is how to increase the probability that a borrower will pay back a loans.
Another way to put it is, how to reduce defaults.

The better you can predict default rate, the better returns.
I do not know how interest rates are determined for an individual. I suppose that FICO is a primary variable used in that formula. I assume that FICO is a good predcitor of financial reliability-risk.

I suppose if you did a deep interview, a full psychological assessment, and took one of the borrower's children as a hostage, you could increase probability of repayment. I suppose that more in depth data collection would cost more.  There has got to be some set of data which are the best predictors of probability of default. I guess those variables could be determined using factor analysis.

Since any statistical prediction only has a particular margin of error, the more loans the less the variance.
This all and bdonovan's question, makes me want to learn more about the science and math of making loans.
I had taken stats in grad school, but I just don't remember enough to solve this problem, now.
I do wonder if LC gathers enough data and provides the data to us for us to be able to improve the prediction of default rates.





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LonghornSF

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Re: Idea: LC but with partially secured consumer loans
« Reply #5 on: July 28, 2016, 02:52:07 PM »
The idea has been considered especially on the small business side of things, but there are several hurdles:

1) Collecting and monetizing collateral increases servicing costs dramatically. You need a large ticket loan for the economics to work. Collecting is also a scummy business which the (formerly) reputable marketplace lenders didn't want to get into.
2) Assessing the value of collateral during the underwriting stage is also difficult and again increases costs.
3) Collection laws vary widely state to state. From a compliance standpoint, its difficult to administer.

Moreover, most collateralized loans such as auto and HELOCs are already low cost, so its not clear that investor demand would be there.



rawraw

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Re: Idea: LC but with partially secured consumer loans
« Reply #6 on: July 28, 2016, 05:54:51 PM »
The other problem is that this lending works because the product is homogenous.  It doesn't make sense to assemble pools of unlike consumer credit into a portfolio.  The marketplace model relies on homogenous loans to make this stuff work.   When you add variation, it makes it impractical to do it.  Market place lenders are already at a cost disadvantage, since their cost of funding is so high.  Layering on additional costs and segmenting loans by weird collaterals just doesn't make sense when trying to optimize a cost structure to compete against banks and other lenders.  Automating all that stuff you've described is much more difficult than you'd think.  Credit score cards are very complex generally, but not so much on just homogenous consumer credit.  This is a reason most successful market place guys do some form of consumer lending.

bdonovan

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Re: Idea: LC but with partially secured consumer loans
« Reply #7 on: July 29, 2016, 02:03:25 AM »
Interesting comments all.  Just a random thought I had.  I get that there would be different costs in collecting on the collateral but bear in mind that LC already has steep costs for collection; it's 18% as it is, and 30% of litigation is involved.  But some customers simply don't have cash, and if unsecured, perhaps think the law doesn't require them to 'liquidate' and get rid of the car  to pay it back.  It seems unfair- but less so if you explicitly agreed to it in the first place.  Generally, partially secured loans seem to be more economical for the lender - I presume they wouldn't lower their interest rates if the overall cost (including cost to collect on the collateral would be higher); simple example:

"One way to reduce your interest rate (and maybe increase the amount you can borrow) is to turn a personal loan into a, “partially secured,” loan by pledging collateral (like a paid off vehicle) that is worth more than 10% of the value of the loan. Ask your loan officer if you’d like to pursue this option."
https://cuonlineuhs.org/loans/loan-types/

So I think the real question would be- is the (reduction in default loss - variance in cost of collection) >  Lower Return from Lower Interest Rate.  Regulatory hurdles- agreed; although many many other companies seem to be doing partially secured loans- I would think the model is understood.  Assessing value is work- but I can't see how it's less complicated than taking a person with a bunch of data points and assessing a risk profile.  Cars have titles that can be verified and paired with the Blue Book, and public websites like Trulia have at least a ballpark on just about every home out there.

I do like the idea of taking the borrower's kids as hostage as well!   My former manager might be one of those who defaults as he often joked he wanted to 'downsize' by letting go of the kids and dog. 

rawraw

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Idea: LC but with partially secured consumer loans
« Reply #8 on: July 29, 2016, 06:24:33 AM »
Every bank on every street corner does the sort of lending you describe. But they have loan officers and back office staff devoted to the underwriting, collateral, filing uccs, doing collateral inspections, etc. But the difference is they are balance sheet lenders not trying to make every loan identical. But for an assembly line model, like mortgage or consumer credit, these sort of modifications make the efficiency ratio , price per loan produced, and defect rate all increase. At least that is what I'd suspect. Someone may figure it out

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jz451

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Re: Idea: LC but with partially secured consumer loans
« Reply #9 on: July 29, 2016, 11:41:21 AM »
Since I temporarily work at a loan company at a branch, I can say that the process is pretty easy for loans w/ collateral with only a few extra steps added. Basically pictures are taken of the car for proof of milage and condition and obtaining the title to transfer title of the vehicle. All underwriting is done at headquarters so cost is centralized. Filing this paperwork should not add any significant cost to the application process.
Every bank on every street corner does the sort of lending you describe. But they have loan officers and back office staff devoted to the underwriting, collateral, filing uccs, doing collateral inspections, etc. But the difference is they are balance sheet lenders not trying to make every loan identical. But for an assembly line model, like mortgage or consumer credit, these sort of modifications make the efficiency ratio , price per loan produced, and defect rate all increase. At least that is what I'd suspect. Someone may figure it out

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rawraw

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Re: Idea: LC but with partially secured consumer loans
« Reply #10 on: July 29, 2016, 01:03:11 PM »
Since I temporarily work at a loan company at a branch, I can say that the process is pretty easy for loans w/ collateral with only a few extra steps added. Basically pictures are taken of the car for proof of milage and condition and obtaining the title to transfer title of the vehicle. All underwriting is done at headquarters so cost is centralized. Filing this paperwork should not add any significant cost to the application process.
Every bank on every street corner does the sort of lending you describe. But they have loan officers and back office staff devoted to the underwriting, collateral, filing uccs, doing collateral inspections, etc. But the difference is they are balance sheet lenders not trying to make every loan identical. But for an assembly line model, like mortgage or consumer credit, these sort of modifications make the efficiency ratio , price per loan produced, and defect rate all increase. At least that is what I'd suspect. Someone may figure it out

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You're talking about cars. A peer lender could certainly be an indirect auto funder in theory. Again, if it's homogeneous it's easy. But indirect auto likely wouldn't work because dealers wouldn't put up with changing dollars available for funding based on sentiment. They want constant credit availability.  Collateral of a car vs a house is extremely different proposition. 

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jz451

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Re: Idea: LC but with partially secured consumer loans
« Reply #11 on: July 29, 2016, 07:59:11 PM »
When you say dealer do you mean an auto dealer? Basically any loan w/ collateral are with cars that are paid off or have value left over to cover the loan, or in LCs case at least a good portion.It would be in LCs interest to turn to collateralization to recoup some of the investor fees lost from loans charged off and keep investors happy.
Since I temporarily work at a loan company at a branch, I can say that the process is pretty easy for loans w/ collateral with only a few extra steps added. Basically pictures are taken of the car for proof of milage and condition and obtaining the title to transfer title of the vehicle. All underwriting is done at headquarters so cost is centralized. Filing this paperwork should not add any significant cost to the application process.
Every bank on every street corner does the sort of lending you describe. But they have loan officers and back office staff devoted to the underwriting, collateral, filing uccs, doing collateral inspections, etc. But the difference is they are balance sheet lenders not trying to make every loan identical. But for an assembly line model, like mortgage or consumer credit, these sort of modifications make the efficiency ratio , price per loan produced, and defect rate all increase. At least that is what I'd suspect. Someone may figure it out

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You're talking about cars. A peer lender could certainly be an indirect auto funder in theory. Again, if it's homogeneous it's easy. But indirect auto likely wouldn't work because dealers wouldn't put up with changing dollars available for funding based on sentiment. They want constant credit availability.  Collateral of a car vs a house is extremely different proposition. 

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rawraw

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Re: Idea: LC but with partially secured consumer loans
« Reply #12 on: July 29, 2016, 08:08:50 PM »
When you say dealer do you mean an auto dealer? Basically any loan w/ collateral are with cars that are paid off or have value left over to cover the loan, or in LCs case at least a good portion.It would be in LCs interest to turn to collateralization to recoup some of the investor fees lost from loans charged off and keep investors happy.
Since I temporarily work at a loan company at a branch, I can say that the process is pretty easy for loans w/ collateral with only a few extra steps added. Basically pictures are taken of the car for proof of milage and condition and obtaining the title to transfer title of the vehicle. All underwriting is done at headquarters so cost is centralized. Filing this paperwork should not add any significant cost to the application process.
Every bank on every street corner does the sort of lending you describe. But they have loan officers and back office staff devoted to the underwriting, collateral, filing uccs, doing collateral inspections, etc. But the difference is they are balance sheet lenders not trying to make every loan identical. But for an assembly line model, like mortgage or consumer credit, these sort of modifications make the efficiency ratio , price per loan produced, and defect rate all increase. At least that is what I'd suspect. Someone may figure it out

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You're talking about cars. A peer lender could certainly be an indirect auto funder in theory. Again, if it's homogeneous it's easy. But indirect auto likely wouldn't work because dealers wouldn't put up with changing dollars available for funding based on sentiment. They want constant credit availability.  Collateral of a car vs a house is extremely different proposition. 

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Yeah the dealer. Most people get their financing at dealership. The dealers aren't actually lending, they have a network of banks and other lenders that have automated process and offer rate. The dealer then can choose one he makes the most money on.  I don't see a peer lender getting scale in auto direct unless they do unsecured like lightstream. So to have an auto model, you'd need those dealership relationships to source the paper

If you mean loans for something else secured by auto, that's seems like it wouldn't be easy to scale. I'm not saying it's hard to make the loans but hard to make it fit a peer lending mass production model

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« Last Edit: July 29, 2016, 08:10:23 PM by rawraw »

HalfABubbleOff

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Re: Idea: LC but with partially secured consumer loans
« Reply #13 on: July 30, 2016, 06:25:12 PM »
According to the average returns showed by LC, there is a delta between the interest rate for the borrower and the actual return.  Wide Delta.  Instead of receiving 17% on D's, we get 8%.  Half the return is lost to defaults.  What if you could marketplace consumer loans, but in this case, compel the borrower to provide proof ownership of a vehicle, home ownership, or partial ownership.  If you look at the detailed borrower stats, they show if they own home (Own) or mortgage (partially own).  This may work because at the outset of the loan, everything thinks it will work; the borrower is not thinking about defaulting so it may not seem significant to use his assets as collateral (because he doe snot think they will beneeded to repay the principal anyhow).  But now, consider, that many of the marketplace loans are backed either fully or partially by these assets.  A $3.5K loan request can be backed by a $7K used car.  A $40K loan for a large purchase may be backed by a mortgage in which he's bough 50% of 400K house. 

Could such a model improve yields?  The overall interest rate would have to be lower (but perhaps not by much).  But most importantly, the Surrender $ from Default will go down.  I mean look at how ominous the numbers look like the MINUTE a loan payment is late.  That won't be the same if we knew there's real collateral.  One may ask- well if they have a car and wanted to consolidate debt, why wouldn't they just sell the car if it was that important.  But that's not how debtos think.  They are optimists assuming both. 

I think it might be interesting for a closer look.

Something along the same line of thinking... for the "debt consolidation" loans, it would be nice to see that the borrower has listed who exactly is going to get a check and for how much.  As well, that check goes directly from LC to that debt holder, without passing through the borrower's bank account.  It's been frustrating to see a loan with the purpose of "credit card payoff" and see the amount requested far in excess of the revolving balance (example below):
https://www.lendingclub.com/browse/loanDetail.action?loan_id=84135735&previous=browse
Just who's getting the extra 8k?

Fred93

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Re: Idea: LC but with partially secured consumer loans
« Reply #14 on: July 30, 2016, 06:48:33 PM »
It's been frustrating to see a loan with the purpose of "credit card payoff" and see the amount requested far in excess of the revolving balance (example below):
https://www.lendingclub.com/browse/loanDetail.action?loan_id=84135735&previous=browse
Just who's getting the extra 8k?

I understand your line of thinking, however...  Every revolving loan is not reported to every credit reporting agency.  Therefore, there may well be loans which don't show up on the particular credit report that LC pulls.  There is therefore no certainty to this sort of calculation.

On the other hand, you are free to choose which loans to invest in, and some investors do use the criteria of loan amount matching up with revolving balance shown. 

As long as you are free to choose, why is this "frustrating"?