US online lending model is unproven, Eisman of The Big Short fame says in Hong Kong

Steven Eisman, famous for successfully shorting the US subprime market before the onset of the 2008 financial crisis, has said the online lending business model used in the United States is unsustainable, and that losses from Canadian mortgages could widen.

Eisman, who is profiled in Michael Lewis’ The Big Short: Inside the Doomsday Machine, on which the 2015 Hollywood film The Big Short is based, also said he did not see any systemic risks on the horizon, and that credit quality related to consumer credit in the US “keeps getting better”. He was speaking on the sidelines of the CFA Institute’s annual conference in Hong Kong on Monday.

Market volatility has not quelled the appetite for risk, with subprime mortgages back in demand

The one pocket of financial market anomaly in the US was online lending, where, he said, the underwriting of peer-to-peer credit was unproven, as selling a loan to investors such as hedge funds and other financial institutions was an unsustainable business model.

“The problem [with P2P lending] is that selling a loan [online] is not the same as selling a book. You buy a book on Amazon and that’s the end of the transaction. When you make a loan, that’s the beginning of a relationship. The question is how you manage that relationship,” said Eisman.

Specifically, unlike a bank, a P2P lender typically does not want to keep the loan on its own balance sheet. Hence, after extending a loan to a borrower, it sells the loan off to investors such as insurance companies and hedge funds, whom Eisman described as a “fickle audience”, as such sources of capital that invest in and hold these loans will disappear once they see any signs of the loan performance deteriorating.

Another global financial crisis is imminent, and here are four reasons why

The good news, he said, was that online lending in the US remained small relative to the entire US lending market. He did not cite any data, but a Federal Reserve Bank of Boston report from 2017 shows that marketplace loans, another name for P2P lending often used in the US, represented a tiny share of the US consumer loan market in 2015 at just 0.75 per cent, but it was growing.

Eisman, currently a managing director and senior portfolio manager at Neuberger Berman in New York, stood out for his contrarian views about the US subprime market, when mortgage lenders and banks were originating and packaging ill-afforded retail mortgage loans into collateralised debt obligations, which contributed to the global financial crisis in 2008. He started shorting in 2006 when he was working for the now defunct hedge fund FrontPoint Partners.

Subprime crisis to hit Hong Kong banks

At Neuberger Berman, an asset manager with US$299 billion under management, he oversees a separately managed account that takes a long/short strategy on stocks, spanning listed equities in the US, Canadian and European markets.

Today, he said, the US mortgage market was in a much healthier state, given the general shortage of new homes in the US market, which has led to increases in the prices of new homes. He also said the mortgage lending sector was “better at managing risk”.

However, he said he was shorting “several Canadian financial institutions”, and said Canadian banks active in the mortgage market were likely to see lower earnings because of credit losses from their mortgage business, and this would affect their equity performance too.

“With house prices beginning to come down, and [home sales] volumes coming down, you would likely begin to see some losses in the mortgage market,” he said, but added that the magnitude of these losses was likely to be contained, and that they would not be of a magnitude that causes systemic concerns.