“A horse is here to stay, but the automobile is

only a novelty — a fad.” This was what

the president of Michigan Savings Bank said

to Henry Ford’s lawyer, Horace Rackham, in

1903, discouraging him to invest $5,000 in

the new car company. Sixteen years later,

Rackham sold his Ford shares for more than

$12.5 million, earning IRR of more than 150

percent per annum.

one of the biggest industries, is

currently undergoing a transformation. As it was with the automobile industry

transformation, a number of modern innovators will probably face serious difficulties,

some will merge with competitors and some will just disappear.

Of course, the emergence of a new huge and rapidly growing industry has always

attracted the attention of journalists. At the same time, as all the changes happen

very quickly and there are few experts who really understand the issues, news

headlines are often absolutely misleading in respect of the developments.

One of the news items that have received considerable attention recently is the

possible downgrading of Moody’s rating on the CHAI securitization bonds

(securitization of loans issued through the Prosper platform implemented by


Such statements create an impression that something has gone wrong with the

alternative lending market in general, and P2P loans in particular. Without trying to

understand the actual nature of P2P loans and not having the necessary statistics,

many investors tend to believe publications of that kind.

Reading the news makes one feel that the situation around P2P lending reminds us of

the subprime crisis in the U.S. in 2008 — but if you look at the facts, you can see that

is simply not the case. I suggest looking at the facts and trying to understand the

reason for the possible downgrading of CHAI securitization rating by Moody’s.

The graph below shows cumulative delinquency on Prosper loans, issued by the

platform itself, on a quarterly basis. It is easy to notice that since the introduction of

the Prosper 2.0 scoring system, the delinquency curves are almost identical from

quarter to quarter. The graph clearly shows the stability of credit quality of loans

issued by Prosper; 2015 is no exception.

On this chart, you can once again see very clearly that delinquencies on loans behave

the same way as in the previous years.

Next, look at the figure below, provided by MonJa, which shows delinquencies on

loans issued by P2P platforms in general — we can clearly see that delinquencies do

not grow and have remained at average levels for the past few years.

If the overall situation with delinquency is stable, can there be something wrong only

with the loans that are the security in CHAI securitization? Let’s examine in more

detail what is the underlying of CHAI. The average FICO score of the borrowers in

CHAI underlying is 703, which means that the loans are granted to mostly prime

borrowers. The average rate on the loans is 13.2 percent, 63 percent are loans with 36

months maturity and 37 percent are loans for 60 months. Let’s look more closely at

the cumulative delinquency on securitization of various alternative lending platforms

as of this writing.

The chart above (the source chart is here) suggests that the delinquency on most

securitizations are at their planned level, and the spread between the actual

cumulative loss value and trigger value at which the cash flows received on loans

begin to be withdrawn from the holders of junior classes of bonds in favor of the

holders of the senior classes remains unchanged (except for a few securitizations).

Prosper’s securitizations, which include CCOLT, as well as CHAI PM1, CHAI PM2 and

CHAI PM3, all demonstrate a predictable and stable performance. The only

securitization that fails to go as planned is the one undertaken by Jeffries for

CircleBack Lending (marked in red in the lower left corner of the chart), but CircleBack

issue loans to borrowers with lower FICO scores.

And yet, if everything is going as planned, why did Moody’s place the rating of bonds

on CHAI securitization on review with the possibility of its downgrading after only a

few months upon its assignment?

Moody’s explains that this is due to the increase of expectations from 8.5 percent to

12 percent in respect of the level of defaults on the portfolio of loans that serve as

underlying for bonds. It looks very strange if we take into account that the initial

forecast of Prosper on defaults on this portfolio was 9.5 percent to 11 percent.

Why did Moody’s assign the rating based on the default rate of 8.5 percent if the

platform itself considered that the level of defaults will be higher? MonJa believes that

Moody’s simply made a mistake in their initial assessment; this seems very convincing

if we analyze the data presented in the charts above.

The fact that rating agencies and investors still do not completely grasp the issues

involved in pricing and rating assignment for securitization ratings in alternative

lending is also illustrated in the chart below (prepared by PeerIQ; link to the full

report here):

As regards P2P loans, this chart takes into account two securitizations: CCOLT and

CHAI, both with loans issued by Prosper as the underlying asset. Despite the fact that

the average FICO score for CCOLT is 706 and 703 for CHAI (FICO scores for credit

cards range from 679 to 710, and for Auto Subprime Loans the value is from 650 to

678), the ratings assigned by Moody’s for securitization on P2P lending are

significantly lower compared to the ratings on other asset classes with weaker FICO

scores of the borrowers. In case of car loans, this can be explained by the fact that the

car is used as collateral, but it should only have an impact on lower tranches, not the

senior classes of securitization.

I believe the difference in the rankings is because rating agencies do not have an

opportunity to calculate the risks of P2P lending, as this sector has not completed a

full loan cycle with sufficiently large amounts. I think this is also largely because rating

agencies were miles out in their calculations back in 2008 when they assigned high

ratings to some securities, which became almost worthless afterwards, and now they

are skeptical about anything new.

It is a negative factor for P2P lending platforms such as the LendingClub and Prosper

(as the funding of loans is becoming more expensive), whereas those who invest in

loans may benefit from lower ratings as the rate of return is greater than the actual

risk of the instrument.

As a result, we again have a situation where we need to thoroughly analyze the details

to make a conclusion that everything is going exactly as planned — but reading the

headlines can make one sure that alternative lending is heading to a collapse.

There is no collapse, and no signs of deterioration of loan quality or increasing loan

delinquency, and I think those who will understand the mechanisms of operation of

alternative lending and the real risks involved — instead of just relying on the data

presented in the press — will get an opportunity to achieve superior returns on their


Fintech and alternative lending are now in a situation similar to that of the automobile

industry at the beginning of the 20th century.