The Arrival of Tech-Enabled Loan Origination in Emerging Markets
In a little over a decade, the tech-enabled lending sector originally championed by the likes of Lending Club and Zopa has become a force in providing capital to consumers and small companies in EM. The recent Series C funding of Tala and Series B for Funding Societies/Modalku further underscore the viability of this lending model in the emerging markets, where in many countries growth is hampered by inadequate and inefficient modes of lending. The two announcements also follow on what has been a slew of early stage investment rounds in the region, while highlighting a differentiated investment thesis from their developed market counterparts.
A Rising Asset Class In A Rising Region
The recent growth in EM-based originators such as Credissimo in Bulgaria, UangTeman in Indonesia, and Mr. Presta in Mexico is reminiscent of Lending Club, the market leader in the US that crossed over $1 billion in total origination volume in the first five years since its founding in 2006. Aided by lending constraining regulations enacted after the global financial crisis and growing appetite from institutional investors, Lending Club’s origination has since grown to nearly $9 billion per year, and there are multiple competitors originating over a billion in the US alone.
While EM adoption relative to the US is still low, global peer-to-peer lending (P2P) in 2016 reached an estimated $30bn in gross origination. Not surprisingly, much of this global issuance has and continues to be concentrated in developed markets like the US and Europe. However most of the opportunity is within emerging markets. With the exception of China, the expansion of the asset class to the emerging markets has been limited to local niche and micro-loan players even though the underbanked market is arguably much larger. One reason is investors assign a higher risk to EM borrowers and in EM assets in general, even though approximately half of EM countries hold an investment grade credit rating and the majority of the top rated global banks are in EM, not in the US or Europe. Additionally, there is also the higher perceived risk of marketplace loans as an asset class, even though marketplace lending is often more transparent than the balance sheet of a traditional bank.
While the early days of EM marketplace lending has seen its share of failed originators, additional capital support, firm institutional polices and scale have given investors fewer reasons to pause. The enormity of the opportunity should also continue to drive improvements in risk controls, models and capital allocation. The market for the entire marketplace lending asset class remains a tiny fraction of the multi-trillion dollar markets found in both consumer credit and liquid fixed income products. However, we believe the relative proportionality will change markedly in the coming years given the growth of platforms like Tala and Modalku.
Importantly, investors can now access this digital lending revolution in numerous ways. As exhibited by the story tagged here, one manner is via venture funds that sponsor loan originators; another is to invest directly in the originators themselves or in the few existing debt securities issued by the lenders. A far larger and more diverse approach is to invest in a fund that acquires the loans themselves from the originators. While in its nascent stages, these new funds will be able to target a high level of current income, assume little duration, as well as diversity by sector, geography and originator.
Case Studies: The Marriage Between A Local Approach and Tech-Enabled Lending
Tala and Modalku are real-time case studies in taking a local and systematic approach in deconstructing and mitigating the risks inherent in the borrower. Leveraging relationships with local supply chain businesses and consistent communication with the regulator, Modalku became the only marketplace lending operator with government issued licenses in three markets: Singapore, Indonesia, and Malaysia. Meanwhile, Tala, which makes loans in Kenya, Tanzania, the Philippines, Mexico, and India customized their distribution network to each region to optimize the borrower experience. This has resulted in multi-functional teams that are able to monitor and control every aspect from data collection to debt servicing and risk management.
In an earlier post on navigating marketplace lending in Asia, we mentioned the need to be wary of platforms touting quantitative models and “big data” as their key differentiator. That said, it is impossible to downplay the role a robust technology infrastructure plays in determining the viability and scalability of a lending platform. This is particularly important in emerging markets where the average loan size is typically less than $500, compared to $10-20k for Lending Club or Prosper. A robust infrastructure is also necessary to leverage machine intelligence to combat both internal and external fraud.
Tala and Modalku are among a handful of companies like the US-based Kabbage at the forefront of leveraging data and building world-class technology franchises staffed by elite talent to inform their entire underwriting process. Tala is flanked by their CTO and ex tech entrepreneur, Johnny Lee, who left Apple two years ago to join Tala. The Head of Engineering, Eric Lee, is a data architecture expert who has held engineering leadership roles at Oracle, Cisco, and EMC. Meanwhile both of Modalku’s CTO and Chief Product Officers, Mao Ching Foo and Pramodh Rai, have led development for products leveraging data-analytics and fraud detection tools serving millions of users. Mao and Pramodh also held quant and data-driven positions in the capital markets before moving to Modalku to serve SMEs in Southeast Asia.
An important and necessary technical advantage for Tala is the ability to scale and iterate quickly, both to support its growth within a given locale, and across countries. Architecting the right infrastructure to support offline analysis and model building, and online origination processing, enabled Tala to its continual growth. Similarly, Modalku has been able to scale its technology stack from a monolithic architecture serving one customer segment to a microservice structure serving multiple loan verticals. Pramodh notes this required flexible systems that accommodated multiple programming languages and frameworks across a growing team of engineers in multiple countries.
The analytical foundation enabled by each company’s technology infrastructure along with an understanding of local customer and regulatory needs drives the ability to parse out the mass majority of borrowers that will honor their debts. Repayment rates in Tala have remained over 90% since inception while for Funding Societies/Modalku it has been over 95%. The short duration of the loans (<60 days for Tala, <18 months for Funding Societies) combined with APRs north of 25% provide further significance to the repayment figures within an investment thesis.
The resulting loan growth and VC interest supports this. Tala’s total origination recently passed $300 million while Funding Societies passed $100 million last quarter. Each company has hit 100% CAGR in each year of operation and shows little sign of slowing down. The business risks and revenue model may differ between the two companies: Tala keeps its loans on balance sheet while Modalku is almost entirely marketplace. However, both share the same local approach and technology foundations that allow them to locate and empower the EM borrower to operate in the local economy.