What a difference a year makes! Around this time in 2016, some were penning the obituary for digital finance investing, given the challenging fund-raising environment for FinTech and an aggressive widening of credit spreads on the sector’s asset-backed bonds. Combined with other negative headlines during the year, a perception emerged that this sector may not have the muscle to continue to exist.

Fast forward to the reality of an active first few months of 2017 that saw four transactions alone attract $1.7 billion into the sector: SoFi’s and FundingCircle’s equity raises of $500 million¹ and $100 million², respectively, and two record-setting marketplace asset-backed bond issuances for $1.1 billion³…

…and Prosper secured a $5 billion financing program⁴ from a host of high profile investors, providing further validation for the marketplace model.

For an industry that has been battling negative perception, the reality is that there is strong financial commitment to both the digital loan originators’ capital structure – debt and equity – and to the loans being originated on those platforms. We believe the sector has the muscle to thrive.

Lendit 2017, SFIG Vegas, and Context Marketplace Summit. Three recent conferences featured digital finance investing. We moderated two interesting panels, one on allocation to alternative lending and one on credit underwriting. At Lendit 2017, HCG was nominated for “Fund Manager of the Year – 2016”⁵. The reality we saw at the conferences is one of a maturing sector that is attracting the attention of investors of all profiles.

The U.S. banking sectors’ management teams offer insights into the overall U.S. credit cycle⁶. While the Partnership operates in the digital loan space, the traditional U.S. banking sector is still the heart of today’s U.S. credit economy, and we monitor it closely. Our takeaways from the banking sectors’ recent quarterly earnings events, 2017 guidance and outlooks on the credit cycle, especially with respect to future pricing (i.e., loan coupons and APRs) and loss expectations, are:

• Revolving consumer credit continues to grow. The trillion-dollar revolving unsecured consumer credit market grew 6.2% yoy⁷ with the fourth quarter showing the highest year-on-year growth rate of 2016. Based on bank commentaries and Federal Reserve surveys on lending, we believe some banks have started to tighten underwriting and credit availability, particularly on the new loan marketing front, as we may have just seen the peak in competitive loosening.
• Losses, or net charge-offs, should increase. Losses should increase towards the long term historical average loss rates for consumer credit. Banks generally have been slow to tighten the credit funnel arguing that loans are still accretive despite higher expected loss rates. Note that digital loan platforms saw the deterioration in loss rates occur earlier and many reacted faster by tightening underwriting in 2016. For example, LendingClub revised its credit underwriting policy several times over the past 9 months to exclude approximately 15% of prime borrowers that had qualified pre-revisions⁸.
• Stated coupons on consumer credit should rise. Credit card rates, which are the consumer credit pricing baseline, are floating rate. As the Fed raises rates, consumer credit pricing naturally follows in lockstep. We expect digital loan platforms to raise fixed rate coupons in due course.
• Small-business optimism and business confidence is rising in their outlook for the economy. In a recent survey by Wells Fargo and Gallup, small business owners’ confidence reached highs not seen since 2007, with 45% reporting increased revenues yoy, and 79% expecting better financing performance in 2017.⁹
• Home buyer demand is holding steady in the face of rising mortgage rates. Several bank executives commentary was relatively sanguine, noting that activity had slowed down but was still positive. Recent data from the National Association of Realtors and the Mortgage Bankers Association reinforce this view that the market should continue to grow, albeit at a more moderate pace in 2017 vs 2016.¹⁰

The OCC’s proposed FinTech SPNB, or Special Purpose National Bank, charter: comments from industry participants…and rocks from the States. While FinTech players offered constructive feedback, several states¹¹ and members of Congress were vocal about their differences with the OCC’s approach. Our view is that legislation with broader sponsorship and buy-in will need to be introduced. Stay tuned.

LendingClub and Square reported fourth quarter earnings. The two publicly-listed digital loan platforms in our ecosystem underscored real improvements in financial health manifested by improved operating cash flow¹², strong available cash balances¹³, and healthier loan origination volumes¹⁴. Notably, at LendingClub, banks purchased 31% of total platform originations (second-highest level during the past 8 quarters)¹⁵, and 2017 guidance is $40-55 million in Adjusted EBITDA. Square guided to $30 million of 2017 Adjusted EBITDA and implied a $1 billion origination run-rate for Square Capital. For more details, please see each company’s release (click here for LendingClub, here for Square).

DISCLAIMERS AND OTHER IMPORTANT INFORMATION

Confidentiality and Non-solicitation: No information herein constitutes an offer or a solicitation to buy or sell any securities or any interests in any product or investment strategy managed by HCG Fund Management LP (“HCG”).  Any offer or solicitation relating to any such investment will be made only by means of confidential offering documents relating to a particular fund  or investment contract and only in those jurisdictions where permitted by law.

Reliance: This information may not be relied upon for investment decision-making purposes. It does not contain all the information necessary to make an investment decision, including the risks, fees, and investment strategies of investment products advised by HCG. Eligible investors are described in official offering documents, all of which must be read in their entirety and will supersede the information contained herein.  No offer to purchase any securities or interests by a prospective investor will be made prior to receipt of all official documents, and no offer to purchase any securities or interests will be accepted without receipt of all official documentation that has been completed to HCG’s satisfaction.

Opinions — No obligation to update:  The information contained herein represents the views and opinions of HCG.  It is intended solely for informational purposes and is not intended to constitute investment, legal, tax or accounting advice.  The views about digital finance investing and estimated future investment opportunities expressed herein reflect those of HCG management as of the date herein and are a reflection of our best judgment at the time.  They are subject to change based on market and other conditions, and we have no obligation to update.  Actual results, however, may prove to be different from our expectations.  No warranty is given to the completeness or the accuracy of the information contained herein.

Suitability and Risks:  Any investment in products managed by HCG is appropriate only for financially sophisticated investors capable of analyzing and assessing the associated risks fully disclosed in the Private Placement and/or Information Memoranda. Investors should consider the investment objectives, risks, and charges and expenses of the investment carefully before investing. The Private Placement and/or Information Memoranda contain this and other information about the investment. A prospective investor should have no need for liquidity with respect to its investment and should view it as long-term and not a trading vehicle.  Additional risks are disclosed in the Private Placement and/or Information Memorandum including, including, limited liquidity and restrictions on transfer of the securities, dependence on HCG’s principals, and short operating history of certain products. As with all private investment funds, investments are deemed speculative and involve risk of loss.

Third Party Data: We do not verify third party data used in certain calculated metrics shown here.