Analysis

Blue Elephant – How smart capital invests in p2p lending

Brian Weinstein, the Chief Investment officer of Blue Elephant, once managed more than 300 billion dollars in assets as a managing director at Blackrock’s fixed income division. In 2013 he co-founded Blue Elephant Capital Management (BECM), an investment manager specializing in consumer loans issued on various direct lending platforms. Lending-Times.com recently had the chance to speak with Brian to understand more on the direct lending marketplace (also known as peer-to-peer) and his firm’s approach.

By investing in high-quality paper from the marketplace lenders and using just the right amount of leverage, the company was able to generate annual returns of 9.68% net of fees for the original fund in 2015. The firm has two funds: the original Blue Elephant Consumer Fund (launched in 2013) and an offshore fund (launched in December 2015).  The new offshore fund is similar in strategy to the onshore, with the main difference being no use of leverage and increased seasoning of the loans it buys. The offshore fund is presently using a 90-day seasoning period for tax reasons, which is to our knowledge the longest such period employed by a fund in the space. The second fund’s target returns are in the 6% to 8% range, versus 10% for the original (levered) fund. The first fund has assets under management of 40 million dollars and total gross assets of the firm currently stand at 103 million dollars.

The consumer fund which started in July 2013 was able to execute one of the first securitization deals in the space in May 2015.  What’s remarkable was their nearly 70-million dollar securitization by Citigroup was priced similarly to a securitization Blackrock had undergone in the same period, except BE’s collateral was even higher in quality.  According to BECM’s Chief Investment Officer, the market was very hot at that time for securitization and they ceased opportunity which is not present today anymore.

The fund was one of the first backers of Prosper debt back in 2013, with it holding almost 10% of the loans that Prosper originated at one point in time. Prosper originated loans still account as the largest allocation for the fund. As new marketplace lenders have entered the space, BECM has taken a hard look at more than 100 originators and counting, yet BECM has only approved 5 of those originators.  The company’s approach to the space has been to only invest in and then leverage the highest quality paper they can find.  The majority of investors in marketplace lending must invest in a cross section of all loans issued (the index of a platform), but BECM works hard to control the quality of the loans they source. In addition to the US secured and unsecured consumer debt they buy from three platforms, the fund also buys secured small business loans from the US entity Funding Circle focussed on small business lending. BECM’s one non-US platform relationship is with Harmoney, a New Zealand based unsecured consumer lender.

Based in Irvington, New York, BECM describes itself as “among the first to offer investors institutional quality access to the high and stable yields of the developing platform lending market.” The investment manager has an all-star founding team. The CEO is J.P. Marra, an expert in fixed income with more than 22 years of experience in Nomura, Banc of America and Lehman Brothers. The COO is Ashees Jain, a portfolio manager with more than a decade of experience in trading structured products at Nomura and Barclays Capital. As explained above Brian Weinstein is the Chief Investment officer; he was a managing director at Blackrock’s fixed income division for over 17 years. Kent Macwilliams and Brooke Long joined the team in 2015, heading credit and marketing & investor relations respectively.  The company is investing in prime secured and unsecured US and New Zealand consumer debt, along with secured small business debt. The investment manager is constantly scouting for opportunities to expand its investment portfolio at home and abroad.

The founders of the company look at their business as not a pure play on Fintech, but believe that “bank disintermediation” is the real theme. Though the marketplace lending model has caught on fire due to the emergence of online P2P lenders like Lending Club and Prosper, BECM believes that bank contraction (moving out of its traditional role as lender to the masses) has created many new types of investment opportunities. Banks are exiting niche markets like consumer lending, boat lending or small business funding due to increased capital requirements and regulation. This has created a gap in the market that is being filled by direct lenders – some online, some not.

BECM’s most interesting bet has been the 25 million dollar debt capital commitment to Boat Finance, a specialty lender in the marine-lending space. Boat Finance will focus on the used boat market. Every loan will be secured by boats which have already mostly depreciated. They are thus able to secure double-digit returns with secured collateral.  The marine lending market had been shuttered due to the financial crisis and BECM management found it as a niche disintermediation play which provided high returns with tangible security and excellent LTV ratios.

In an interview with Lending-Times.com, Brian Weinstein reaffirmed the funds’ commitment to only prime and near-prime unsecured debt at this point in the credit cycle.  BECM has been deleveraging over the last 6 months and will continue to source different loan types and securitize debt opportunistically, with respect to the management’s views on credit and business cycles.

In Brian’s eyes, one has to have a view on the market. The firm began with a strong focus on sourcing the highest quality paper they could find.  As the credit cycle has begun to turn, Brian has observed an increase in defaults Sept 2015, something he had predicted and expected particularly for the mid to lower-grade debt in the marketplace.

One question for this market is if the present cost of acquisition of loans is sustainable. In Brian’s eyes, the problem is a cycle of cost of operations vs revenue. And while there will be hiccups on the way, originators are fundamentally viable as long as they cut costs and may choose to reduce growth speed in anticipation of downtrends in the credit economic cycle by not chasing constant growth in volume.

In Brian’s view we are in the late credit cycle, approaching higher defaults. They have therefore chosen to focus on sourcing high quality paper much more than chasing high yields. In their eyes security trumps temporary yield, especially in space where the majority of new lenders are yet unproven through a major downturn.

In an overall view of the origination space FED intervention skews prices (real estate, cars) and especially in real estate marketplace originators are picking rejects from other places. BECM has avoided certain lending types: anything that appears predatory is avoided.  BECM does not buy payday loans, merchant cash advance, and will not do business where there is a hint of moral hazard.   In addition, the firm has so far steered clear of lending where the data files are too thin, or there is not enough data.  For now this equates to Blue Elephant avoiding most subprime loans, and certain points of the lending landscape such as autos and student debt. Brian says BECM has contemplated point of sales models like Affirm or Bread, but is still evaluating those opportunities.  The loans from Prosper have been given an Investment grade by Moody’s, further enhancing their value as collateral for investment funds.

As international markets go Brian’s view is that there is no need to chase 15% yields in riskier places when one can get 12% yields in the US with an appropriate and clear risk-reward ratio. He also expects that by underwriting using new types of payment data (particularly in places where there is no traditional FICO-like scoring system), personal lending will show enormous growth but it will probably take five or more years to achieve that.

Colchis Capital, Evolution, Disruption Credit, Eaglewood Capital, Victory Park and many others are using innovative financing structures and the evident gap in the market to finance the industry and generate positive alpha in a yield hungry market.

Peer-to-peer or direct lending has changed how the consumer finance market works. Investment managers like Blue Elephant are the pioneers who are providing precious capital to the space, and what sets BECM apart is its institutional approach. But with the Federal Reserve chairman Janet Yellen signaling a hardening in interest rates and increased competition for high quality paper, it will be interesting to see how Blue Elephant and other asset managers in the space (such as Colchis Capital, Nexlend Capital, Eaglewood Capital, Evolution, Disruption Credit, Evolution etc.) deal with an increase in consumer loan defaults, a byproduct of the type of softening economy we are experiencing today.

Author : George Popescu and Heena Dhir

 

About the author

George Popescu

Serial entrepreneur.

George sold and exited his most successful company, Boston Technologies (BT) group, in 2014. BT was a technology, market maker, high-frequency trading and inter-broker broker-dealer in the FX Spot, precious metals and CFDs space company. George was the Founder and CEO and he boot-strapped from $0 to a $20+ million in revenue without any equity investment. BT has been #1 fastest growing company in Boston in 2011 according to the Boston Business Journal and the only company being in top 10 fastest in 2012-13 as it was #5 in 2012. BT has been on the Inc. 500/5000 list of fastest growing companies in the US for 4 years in a row ( #143, #373, #897 and #1270). After the company sale in July 2014 until February 2015 George was Head-of-Strategy for Currency Mountain ( www.currencymountain.com ), a USD 100 million+ holding company focused on retail and medium institutional currencies, precious metals, stocks, fixed income and commodities businesses.

• Over the last 10 years, George founded 10 companies in online lending, craft beer brewery, exotic sports car rental space, hedge funds, peer-reviewed scientific journal ( Journal of Cellular and Molecular medicine…) and more. George advised 30+ early stage start-ups in different fields. George was also a mentor at MIT’s Venture Mentoring Services and Techstar Fintech in NY.

• Previously George obtained 3 Master's Degrees: a Master's of Science from MIT working on 3D printing, a Master’s in Electrical Engineering and Computer Science from Supelec, France and a Master's in Nanosciences from Paris XI University. Previously he worked as a visiting scientist at MIT in Bio-engineering for 2 years. George had 3 undergrad majors: Maths, Physics and Chemistry. His scientific career led to about 10 publications and patents.

• On the business side, Boston Business Journal has named me in the top 40 under 40 in 2012 in recognition of his business achievements.

• George is originally from Romania and grew up in Paris, France.

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