VPC Specialty Lending fund shifts strategy to greater balance sheet exposure after difficult Q2

The VPC Specialty Lending Investment trust is looking to up its stake in balance sheet lending with profits from its marketplace loan holdings and move away from Funding Circle US’ exposure.

More spare cash will be moved into balance sheet loans rather than marketplace loans in the VPC Specialty Lending investment trust, according to an update by the closed-ended fund’s management team.

The UK’s vote to leave the European Union negatively impacted performance, VPC says, with currency hedges hampering performance and the loans from Funding Circle’s US book underperforming. The fund stopped buying loans from Funding Circle's US book in late 2015. 

A spokeswoman for Funding Circle says the historic performance of US loans have performed in line with expectations from a historical perspective. 

"Funding Circle USA continues to deliver attractive returns. The overall portfolio has delivered more than 8 per cent per annum in the US for our whole loan marketplace, and we continue to target net yields of over 8 per cent," she said.

The VPC Speciality Lending trust saw growth in its net asset value of just 0.33 per cent during the second quarter of 2016 on a total return basis, reflecting a 0.62 per cent loss in May.

According to AltFi Data, VPC Specialty Lending had outerperformed the broader UK marketplace lending space, as measured by the Liberum AltFi Returns index (the LARI) since its launch back in March 2015 until recently.

Performance of VPC Specilaity Lending NAV since launch vs LARI

Source: AltFi Data

The key drivers of the recent shortfall, VPC says, was a cash drag from holding cash to cover currency hedges, and a peak in defaults, reflecting the life cycle of loans.

While the fund’s Q2 numbers are “below expectations”, VPC says long-term returns should be in their target range. The higher than expected losses, they add, came from the Funding Circle US loans which substantially underperformed expectations while the balance sheet loans in the portfolio experienced no setbacks and are generating coupons of between 12-16 per cent, with a weighted average coupon of 12.96  per cent

The management team is planning a shift into greater exposure to balance sheet loans t in the future. They plan to redeploy amortisation from marketplace lending loans into balance sheet loans.

The portfolio is a combination of ‘marketplace’ and ‘balance sheet’ loans. Marketplace loans are originated by a platform, which earn an origination fee, with the fund lending directly to underlying borrowers targeting unlevered returns of 6 to 10 per cent, or 11 to 18 per cent on a levered basis. Balance sheet loans on the other hand are made to platforms with target returns of 11 to 16 per cent on an unlevered basis. The balance sheet loans are made through a special purpose vehicle [SPV] with the platform using the cash to originate loans.

At launch back in March 2015 balance sheet Loans were expected to be around  half of the portfolio, and currently represent 43 per cent of the invested portfolio. However, according to analysts at Numis Securities the management team at VPC believe that industry illiquidity has created attractive opportunities for balance sheet lending.

As a result they have recently made investments in West Creek Financial ( a point-of-sale lease-to-own US consumer durable goods) and Fundbox (a short-term US SME loans platform), as well as a new tranche of senior secured debt to Elevate Credit (a US consumer lender).

“The move to focus on Balance Sheet Loans will differentiate the fund, given that most of its peers focus on Marketplace loans. However, we believe the key issue for the fund is its disappointing performance record, with an NAV total return of just 1.5 per cent in H1 2016, and 7.3 per cent since IPO in March 2015,” said Numis’ analysts.

“This is well below the target dividend of 8 per cent per annum, and NAV total return target of 10 per cent per annum. Furthermore, the share price has suffered from a derating, and is currently trading at a discount,” they added. 

The trust is currently trading on a discount of 16.9 per cent. At launch in March 2015 it moves rapidly to a premium likes its peers in the space such P2P Global Investments. But, like its peers, it has also seen a substantial period at a double digit discount in 2016.

However, VPC, which manages the trust, recently announced that it will now use 20 per cent of its monthly management fee of 1 per cent of gross assets to buy back its own shares at market prices. However, this will only occur when the shares are trading at a discount and the manager does not holds less than 10 per cent of total voting rights. 

Numis said however, than investors should not expect a quick snap back to a premium.

“We believe there is little scope for this discount to narrow until the fund consistently delivers monthly returns in line with its target. In addition, we believe the fund’s fees are high at 1 per cent of gross assets with a 15 per cent performance fee on net asset value [NAV] returns  [with] no hurdle."

This, they say, is especially pertinent given that the P2P Global Investments trust -  VPC Specilaity Lending's largest peer -  recently reduced fees from 1 per cent to 0.5 per cent of gross assets, and Funding Circle SME Income - another peer - has no fees at the fund level.

Currently, the fund’s exposure across platforms is: 22.8 per cent in Avant; 11.6 per cent in Funding Circle UK; 10.6 per cent in Borro; 10 per cent in Prosper; and 9.8 per cent in Funding Circle US loans. The overall portfolio has a weighted average coupon of 16.25 per cent (18.64 per cent marketplace and 12.96 per cent  balance sheet) and life of 20 months. It provides exposure to 567,466 loans with an average size of $3,943.