Innovation at the
Intersection of Finance
and Technology

We believe alternative lending represents a secular shift in the way small businesses and consumers seek access to capital.

Fintech has disrupted the traditional banking model

Banks may struggle with high cost structures, outdated technology and regulatory capital pressures that limit their ability to lend.

Under the traditional banking model, banks draw on debt and equity to augment customer savings deposits to make loans. Consumer credit decisions are often based on credit scores, backward-looking measures of consumer credit worthiness, which may be augmented with data such as income and employment status.

Alternative lending can benefit borrowers and lenders

Alternative lending platforms use a broad set of data, not just credit scores, that can help predict a borrower’s willingness and ability to repay a loan in the future.

For borrowers, alternative lending may provide access to credit on terms more attractive than would be offered by credit card companies.

With alternative lending, technology-enabled models rapidly underwrite borrower credit risk to determine appropriate loan pricing, terms and amounts. Through these platforms, loan investors, which are predominantly large institutions, provide capital for loans directly.

Platforms may use partner banks to formally originate the loans that they underwrite. The partner banks typically conduct oversight on the platforms’ underwriting models and ensure that underwritten loans and servicing procedures comply with applicable laws. In some cases, the partner banks or the platforms may maintain a continuing economic interest in loans sold to investors.

What’s in it for investors?

  1. Exposure to investments in unsecured consumer and small business loans, investments historically dominated by banks
  2. Yield and relatively low duration because of the typically short-term, amortizing nature of the individual loans
  3. Diversification versus other types of fixed income—notably versus corporate credit

Looking Ahead

Borrowers are turning to fintech lenders in record numbers, reflecting demographic shifts and an increasing preference for conducting business online.

Source: TransUnion consumer credit database as of 12/31/2018

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DISCLAIMERS
The views and opinions are those of the author as of the date of publication and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. The views expressed do not reflect the opinions of all investment personnel at Morgan Stanley Investment Management (MSIM) or the views of the firm as a whole, and may not be reflected in all the strategies and products that the Firm offers.

This general communication, which is not impartial, is for informational and educational purposes only and not a recommendation. Information does not address financial objectives, situation or specific needs of individual investors.

Any charts and graphs provided are for illustrative purposes only. Any performance quoted represents past performance. Past performance does not guarantee future results. All investments involve risks, including the possible loss of principal.

Additional Risks
REITs. A security that is usually traded like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. The risks of investing in Real Estate Investment Trusts (REITs) are similar to those associated with direct investments in real estate: lack of liquidity, limited diversification, ad sensitivity to economic factors such as interest rate changes and market recessions.

Loans May Carry Risk and be Speculative. Loans are risky and speculative investments. If a borrower fails to make any payments, the amount of interest payments received by the alternative lending platform will be reduced. Many of the loans in which the alternative lending platform will invest will be unsecured personal loans. However, the alternative lending platform may invest in business and specialty finance, including secured loans. If borrowers do not make timely payments of the interest due on their loans, the yield on the alternative lending platform's investments will decrease. Uncertainty and negative trends in general economic conditions in the United States and abroad, including significant tightening of credit markets, historically have created a difficult environment for companies in the lending industry. Many factors may have a detrimental impact on the Platforms' operating performance and the ability of borrowers to pay principal and interest on loans. These factors include general economic conditions, unemployment levels, energy costs and interest rates, as well as events such as natural disasters, acts of war, terrorism and catastrophes.

Prepayment Risk. Borrowers may have the option to prepay all or a portion of the remaining principal amount due under a borrower loan at any time without penalty. In the event of a prepayment of all (or a portion of) the remaining unpaid principal amount of a borrower loan in which alternative lending platform invests, the alternative lending platform will receive such prepayment but further interest will not accrue on such loan (or the prepaid portion, as applicable) after the date of the prepayment. When interest rates fall, the rate of prepayments tends to increase (as does price fluctuation).

Default Risk. Loans have substantial vulnerability to default in payment of interest and/or repayment of principal. In addition, at times the repayment of principal or interest may be delayed. Certain of the loans in which the alternative lending platform may invest have large uncertainties or major risk exposures to adverse conditions, and should be considered to be predominantly speculative. Loan default rates may be significantly affected by economic downturns or general economic conditions beyond the alternative lending platform's control. Any future downturns in the economy may result in high or increased loan default rates, including with respect to consumer credit card debt. The default history for loans may differ from that of the alternative lending platform's investments. However, the default history for loans sourced via Platforms is limited, actual defaults may be greater than indicated by historical data and the timing of defaults may vary significantly from historical observations. The Platforms make payments ratably on an investor's investment only if they receive the borrower's payments on the corresponding loan. Further, investors may have to pay a Platform an additional servicing fee for any amount recovered on a delinquent loan and/or by the Platform's third-party collection agencies assigned to collect on the loan.

Credit Risk. Credit risk is the risk that a borrower or an issuer of a debt security or preferred stock, or the counterparty to a derivatives contract, will be unable to make interest, principal, dividend or other payments when due. In general, lower rated securities carry a greater degree of credit risk. If rating agencies lower their ratings of securities in the alternative lending platform's portfolio or if the credit standing of borrowers of loans in the alternative lending platform's portfolio decline, the value of those obligations could decline. In addition, the underlying revenue source for a debt security, a preferred stock or a derivatives contract may be insufficient to pay interest, principal, dividends or other required payments in a timely manner. Even if the borrower or issuer does not actually default, adverse changes in the borrower's or issuer's financial condition may negatively affect the borrower's or issuer's credit ratings or presumed creditworthiness.

Limited Secondary Market and Liquidity of Alternative Lending Securities. Alternative lending securities generally have a maturity between one to seven years. Investors acquiring alternative lending securities directly through Platforms and hoping to recoup their entire principal must generally hold their loans through maturity. There is also currently no active secondary trading market for loans, and there can be no assurance that such a market will develop in the future.

High-Yield Instruments and Unrated Debt Securities Risk. The loans purchased by the alternative lending platform are not rated by an NRSRO. In evaluating the creditworthiness of borrowers, the Adviser relies on the ratings ascribed to such borrowers by the relevant Platform or otherwise determined by the Adviser. The analysis of the creditworthiness of borrowers of loans may be a lot less reliable than for loans originated through more conventional means. The market for high-yield instruments may be smaller and less active than those that are higher rated, which may adversely affect the prices at which the alternative lending platform's investments can be sold.

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