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June 24, 2020

Alternative Lending and the Resilient Consumer

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June 24, 2020

Alternative Lending and the Resilient Consumer


Alternative Lending and the Resilient Consumer

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June 24, 2020


Please see important disclaimers at the end of this article.


The coronavirus pandemic has taken a devastating human toll, while wreaking havoc across economies and markets. Alternative lending has not been immune to these conditions, but we believe this fintech-driven asset class has exhibited fundamental resilience during the acute initial phase of the downturn. Recent data supports continued optimism.


For unsecured consumer alternative loans originated after the onset of COVID-induced economic shutdowns, the marketplace model that alternative lenders use for matching consumer borrowers with loan investors has driven rapid recalibration in underwriting standards, reflecting changed economic realities. Tighter credit conditions and higher interest rates on new alternative loans compensate investors for both heightened risk and heightened risk aversion. For unsecured consumer alternative loans underwritten before the economic shutdowns, three factors are critical: how much the loan impairment rate increases relative to the sharp change in the U.S. unemployment rate, how long the loan impairment rate remains elevated, and what percentage of impaired loans ultimately results in charge-offs—defaulted loans removed from the books or marked down to low expected recovery values. As discussed below, early impairment data is encouraging.

How Do Changes in the Unemployment Rate Affect Changes in the Consumer Loan Charge-Off Rate?

Before reviewing consumer alternative loan performance during the initial phase of the downturn, we present an intellectual framework that models the expected change in the alternative lending charge-off rate as a lagged function of unemployment rate change. This framework is informed by historical credit card data that tracks consumer charge-off trends over extended periods of time, including multiple prior recessions. Of course, behavior of the American consumer through prior recessions is no guarantee of how consumers will behave going forward—particularly given that this pandemic lacks recent historical precedent. Furthermore, while credit card lending is also a form of unsecured consumer lending, we recognize that it provides an imperfect proxy for consumer alternative lending. Credit card loans might sit higher in borrowers’ payment priority hierarchies than do loans facilitated by alternative lenders. Conversely, alternative loans generally repay via automated pulls directly from borrowers’ bank accounts, and they typically amortize rather than revolve like credit card loans.

With these caveats in mind, we have analyzed how alternative lending might perform as we move through the pandemic. Key variables include how high the unemployment rate rises, how long it remains elevated as the crisis abates, and how unemployment rate changes translate into lagged changes in the loan charge-off rate. Display 1 shows that, historically, changes in consumer credit card delinquencies have broadly tracked changes in the unemployment rate—both up and down. For example, both spiked during the Global Financial Crisis (GFC) but normalized soon thereafter. 

Display 1: Changes in Credit Card Delinquency Rate Historically Mirrored Changes in Unemployment Rate (1991-2019)

Source: Based on quarter-over-quarter absolute change in credit card delinquency rate from 3/31/1991 – 12/31/2019 per Federal Reserve data ( , as well as quarter-over-quarter absolute change in average quarterly unemployment rate from 3/31/1991 – 3/1/2020 per Federal Reserve data (  Derived from analysis by Upstart Network, Inc.



Similarly, while the explanatory power is limited, regression of historical credit card data demonstrates roughly a 1:1 relationship between unemployment rate change and credit card charge-off rate change on a three-month lag. The regression suggests that any expected increase in charge-off rate following a rise in the unemployment rate typically would only apply to the period immediately following the unemployment rate increase. Afterwards, we would expect the charge-off rate to stabilize. Likewise, we would expect the charge-off rate to fall following an unemployment rate decline, which is typical after a recession. With this framework, it is important to remember that changes in the charge-off rate are annualized, so the duration of unemployment rate increase is critical when thinking about the prospects for alternative loans underwritten pre-pandemic.

Charge-Off Rate Change Expectations Based on History May Not Reflect Positive Factors at Work Today

Historical credit card data stems from prior recessionary periods that lacked the truly unprecedented fiscal and monetary stimulus measures in place today. We expect these stimulus efforts will reduce the pass-through from unemployment rate changes to lagged changes in the loan charge-off rate. Furthermore, U.S. households significantly reduced their aggregate debt relative to GDP in the aftermath of the GFC. They also entered the current crisis with debt service ratios at low levels not seen in decades.1

Industry-level data from the lending analytics firm dv01 highlights the U.S. consumer’s resilience during this challenging time. Encouragingly, Display 2 shows that from the beginning of March to the end of May, change in the rate of unsecured consumer alternative loan impairment (including both delinquent and modified loans) was in line with change in the official U.S. unemployment rate. The impairment rate change also was well below change in Morgan Stanley Research’s estimate of the adjusted unemployment rate, after correcting for undercounting in the official rate.2 Furthermore, both the unemployment rate and the loan impairment rate trended down in May as the economy began to recover.

Of note, we expect a significant percentage of impaired loans to be repaid as the economy recovers and borrowers transition out of short-term loan forbearance programs. This suggests that the lagged increase in charge-off rate might prove well below what historical credit data would suggest following the massive increase seen in the unemployment rate. According to dv01, “These are very positive trends for investors and indicators of the strength, proactive responses, resiliency, and long-term sustainability of online lending as a steady and established product and asset class.3

Display 2: Post-COVID Increase in Alternative Loan Impairment Rate and Unemployment Rate

Source:  dv01 - Loans in the dv01 dataset have weighted average FICO score of 715, weighted average coupon of 13.6%, and weighted average balance of approximately $11,400; , and Morgan Stanley Research, US Economics | North America, “May Payroll: The Beginning of the Reopening Bounce,” June 5, 2020. 



In addition to the positive impact of current government stimulus programs, historical data does not take into account the large percentage of recently jobless describing themselves as temporarily unemployed, which suggests continued attachment to prior employers. This is very different than the period following the GFC and may be akin to the “Volcker Recession” of the early 1980s.4 Like the COVID economic shutdown, the Volcker Recession effectively was exogenous. Importantly, that recession was followed by rapid hiring; suggesting that a V- or swoosh-shaped recovery might be more likely than the U-shaped recovery experienced post-GFC—assuming the health crisis continues to abate. Indeed, Wall Street research departments project a relatively rapid snap back in economic activity with a commensurate drop in unemployment (Display 3). However, both downturn and recovery dynamics will depend on progression of the virus and on countercyclical government stimulus, and we expect the slope of recovery will be more gradual than the slope of deterioration.

Display 3: Investment Banks Expect the Dramatic COVID-Induced Spike in Unemployment to Normalize Fairly Rapidly

Source: Bloomberg as of June 12, 2020. Data via most recent economic forecast from the research departments of the above referenced financial institutions. Data includes projections through June 12, 2020, that had been updated following the May unemployment report released on June 5, 2020.



What Does This Mean for Investing in Alternative Loans Going Forward?

We believe that alternative lending performance will be influenced by the pace of employment recovery, with divergent outcomes across different groups of consumers. Consumers’ willingness and ability to service debts will be influenced by their financial histories, balance sheets, incomes, types of employment and states of residence—with COVID-19 amplifying the effects of all these variables. Alternative lending’s differentiated underwriting takes these factors, and many more, into consideration when determining whether a loan should be extended and at what risk-adjusted pricing.

We also expect performance to differ across loan vintages. Seasoned, partially amortized loans may prove less sensitive to acute changes in the economic backdrop than similar but less seasoned loans underwritten just before the downturn. This is because contractual monthly principal amortization may naturally reduce a borrower’s propensity to default as the loan progressively pays down. Furthermore, newly originated alternative loans underwritten after the onset of the downturn should reflect changed economic circumstances through tightened credit standards and higher borrower interest rates.

From an investor’s perspective, reinvesting cash flows from alternative loans already in a portfolio into new alternative loans could facilitate vintage diversification that could in turn reduce recession sensitivity. Over time vintage diversification could allow the portfolio to reflect changing economic conditions in terms of varying credit standards and borrower rates across portfolio vintages (Display 4). In our view, loan vintage diversification provides a powerful risk management tool for investors in alternative loans that may not be as available to investors in traditional corporate credit portfolios which repay principal only at maturity.

Display 4: Reinvesting Cash Flows from Alternative Loans Facilitates Vintage Diversification

Diversification does not eliminate the risk of loss.

Source: AIP Alternative Lending Group. The chart assumes a simplified illustrative $100MM portfolio of loans with a 7% coupon rate. The chart also assumes no losses or prepayments, and $20 million of additional investments each month. It further assumes that the first investment was made on 12/31/19 and that all interest and principal payments from the loans were re-invested into new vintages on a monthly basis. 




While the unemployment rate remains staggeringly high, the official rate decreased from 14.7% in April to 13.3% in May.5 This suggests that light may be flickering at the end of the tunnel. We cannot yet determine how long the unemployment rate will remain elevated, how much government stimulus will moderate the pass-through from unemployment rate changes to charge-off rate changes, how much consumer balance sheet repair following the GFC will insulate consumers as they deal with the lingering effects of the downturn, how likely employers will be to rehire as the economy reopens, or how the virus will progress from here. However, as GDP troughs and the unemployment rate declines, we grow increasingly optimistic about the forward-looking opportunity set for alternative lending. In the primary market for new alternative loans, those already unemployed are not typically eligible to borrow, meaning the benefits of tightened credit and higher borrower interest rates become more apparent as the magnitude of new jobless claims declines. We also have seen compelling alternative lending secondary market opportunities across both whole loans and asset backed securities.

Importantly, we are encouraged by unsecured consumer alternative lending’s fundamental resilience during the acute phase of this downturn, as reflected in early impairment data. In these uncertain times, as in more normal times, we believe that diversified exposure to alternative loans across regions, sectors, platforms and vintages remains the best way to access the asset class. Alternative lending may diversify both traditional fixed income and private credit allocations.



1 Kenneth Michlitsch, “Alternative Lending: Why Today and Through the Credit Cycle?,” December 2, 2019,

2 Morgan Stanley Research, US Economics | North America, “May Payroll: The Beginning of the Reopening Bounce,” June 5, 2020.

3 dv01 COVID-19 Performance Report, Volume 5, “Bending the Impairment Curve.” Wei Wu, Vadim Verkhoglyad and Alex Kale, May 28, 2020.

4 Goldman Sachs Economics Research, “US Daily: Parallels with the Volcker Recession: Policy-Induced Downturns, Temporary Layoffs, and V-Shaped Recoveries (Hill),” April 8, 2020.

5 Employment Situation Summary, U.S. Bureau of Labor Statistics, accessed June 12, 2020,

Managing Director
AIP Alternative Lending Group

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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. Persons considering an alternative investment should refer to the specific fund’s offering documentation, which will fully describe the specific risks and considerations associated with a specific alternative investment.

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Alternative investments are speculative, involve a high degree of risk, are highly illiquid, typically have higher fees than other investments, and may engage in the use of leverage, short sales, and derivatives, which may increase the risk of investment loss. These investments are designed for investors who understand and are willing to accept these risks. Performance may be volatile, and an investor could lose all or a substantial portion of its investment.

Global Pandemics. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (such as natural disasters, epidemics and pandemics, terrorism, conflicts and social unrest) that affect markets generally, as well as those that affect particular regions, countries, industries, companies or governments. It is difficult to predict when events may occur, the effects they may have (e.g. adversely affect the liquidity of the portfolio), and the duration of those effects.

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. Leverage Risk: The Fund is permitted to use any form or combination of financial leverage instruments, and such use of leverage may expose the Fund to greater risk and increased costs; there is no assurance that the Fund’s leveraging strategy will be successful.


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