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A Patient Universe: Hello Digital

July 17th, 2020

Market Views

A few years ago, we wrote about A Galaxy Far, Far Away, noting that small-balance digital private credit operated in a distant corner of the white-hot universe of private debt. How things have changed.

While there may not be a discernible center to the Universe, it certainly seems that the appeal of our digital credit neighborhood has grown meaningfully as the tsunami of digital dependence has washed over the world. That distant corner is being drawn to the core of the private debt universe by the powerful gravitational pull of investors seeking strong absolute and relative performance.  We estimate that digital credit assets outstanding today amount to $100 billion compared to a private debt universe of over $800bn, a meaningful increase over the past few years.1

To the digirati investor, our distant corner always made perfect sense because it fit nicely into the narrative of a digital future. They evangelized the virtues of digital finance investing and, early on, made digital credit a core holding of their portfolios.  For many traditional fixed income allocators however, there was a reticence to get involved. They may have long recognized the potential benefits of small-balance, short duration digital private credit – massive diversification, uncorrelated returns, low volatility, high cash yields, and historically compelling risk-adjusted returns – but they failed to commit.   The rationale supporting the aversion ranged from “this is too esoteric and opaque” to “history is limited”, but ultimately, it converged on one principal – if not legitimate question: “how will it perform during a recession?”.  The universe is a patient place.

Based on data in the public domain and at HCG, we can now conclude that over the past few months, private digital credit has crossed the Rubicon of a difficult market cycle. As a proxy for performance, we look to the JP Morgan Consumer Loan ABS Index, roughly 50% of which consists of marketplace lenders: it is down -1.7% for the first half of the year, compared to declines of -4.8% and -3.9% for US High Yield and US Senior Loans, respectively, and gains of 4.8% for US Investment Grade Corporates.  LendingClub securitizations are trading above par for the A-tranche securities, in the mid-90s for the B-tranche, and around 90 for the C-tranche.2

This digital credit ecosystem demonstrated its resilience and effectiveness under the most stressful circumstances, underscoring its viability and critically, its necessity to the U.S. economy and society.  With these proof points, it seems the question about performance during a recession – some would argue a depression – has been answered. The positive financial performance and societal impact cannot be denied.

Economics aside, the digital private credit ecosystem has clearly contributed to our shared societal agenda. Fintech firms at the heart of digital credit like Kabbage, Square, and CrossRiver Bank played critical roles in the transmission of government stimulus to America’s small and micro businesses that needed life support urgently. The numbers are astounding, with Kabbage, ranking as the nation’s third-largest PPP lender by application volume. Further, the average size of a Fintech-originated loan was below $30,000 compared to over $100,000 for all lending institutions.3


Marketplace lenders like LendingClub and Upstart who originate and service personal installment loans to consumers were able to mobilize sizable payment relief efforts that helped consumers navigate and survive hardship.  For example, LendingClub was able to mobilize payment relief to over 130,000 borrowers starting April 1 seamlessly and proactively, weeks if not months ahead of most traditional banks. Testimonials from borrowers have been resoundingly positive.

Digital helped Main Street when help was most needed by allowing speed, agility, transparency, simplicity, and reach.  As we work our way through today’s challenging economic and public health crises, it is gratifying to see the performance of both the digital finance ecosystem and private digital credit. Just as the digital economy has proven itself during this crisis, so too has digital credit: we believe it has earned the status of a core “buy and hold” position in a fixed income portfolio.


[1] Preqin 2020 Global Private Debt Report, Statista, HCG Calculations
[2] J.P. Morgan ABS Index Monitor, Bloomberg Barclays Indices, Bloomberg
[3] SBA
[4] SBA, Kabbage
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