Tag Archives: Morgan Stanley

Peer-to-peer Lending Update.

It’s time for an update on peer-to-peer lending and social finance.

Years ago, clipping coupons from bonds was the province and passion of people in retirement. Today, a tidal wave of aging boomers want income, but traditional sources basically suck. Ten-year ­Treasury’s yield 1.6%. Safe-money bank CDs? 0.5%. Investment-grade corporate bonds are delivering 3.2%.

So retiring boomers are seeking alternatives. That’s why dividend stocks and annuities are very popular. But, there’s another cool source of high yield investments that are rapidly growing in popularity. Peer-to-peer lending, or making personal loans via the Internet, using websites like LendingClub.com and Prosper.com, have proven to represent a new and attractive asset class for a broad range of investors.


They have been around for 6 years and have had some bumps, including weathering a financial crisis and the current recession, peer-to-peer (P2P) lending has earned its place on an income investor’s menu.

The basic premise of these bank disintermediaries is that they harness the networking power of the Web to match people who have excess cash, with people in need of it, or those who simply want to do things like refinance credit card debt.

The key to its success has been how the sites have managed the inherent riskiness of unsecured personal loans. Believe it or not, it is now possible to earn yields of 6% or more, making relatively safe loans to complete strangers.

Los Angeles financial advisor Brendan Ross committed $300,000 of his own money to Lending Club in early 2011. Based on his quarterly interest payments he claims he has accrued about $40,000 in income to date. Annual yield: 10.2%.

“I’d been tracking the P2P space pretty much since the inception,” Ross says. “I was waiting to feel like its loan underwriting model had matured.”

San Francisco’s Lending Club is the largest P2P lender, followed by its crosstown rival Prosper. And, there are several other, specialized sites (like iPeopleFINANCE) who offer a lending model that is different than the securitized model of Lending Club and Prosper. These offer a direct lending model where an investor chooses one individual borrower based on an affinity profile and makes a small, short term loan where the investor can earn higher interest rates, yet still be able to enjoy mitigated risk.  Lending Club and Prosper have loaned a total of more than $1 billion since inception, in 112,000 loans.

Lending Club currently issues about $45 million in loans a month versus Prosper’s $13 million per month. Prosper ran afoul of the SEC in 2008 and temporarily shut down to “revamp its risk-assessment model” which is corporate code for getting into SEC compliance.

At Lending Club, after a quick registration you can sort through hundreds of potential loans. Each loan has its own risk rating, term (either 36 or 60 months) and rate of return.

Loans with the highest rating—based on the borrower’s FICO score and some additional analysis—pay in the 5% to 9% range—about the same as junk bonds. Interest rates on riskier loans range as high as 31%. Both companies also offer diversified funds of aggregated loans and IRA options.

Lending Club and Prosper vet thousands of loan applications, whittling down the pool to only those borrowers the company deems least likely to default. Renaud Laplanche, cofounder and CEO of Lending Club says his firm declines about 90% of all borrower applications, focusing on the 10% of borrowers with the best credit. Which makes them essentially, banks.

Of course, defaults do happen. Lending Club’s top-rated three-year loans expect a default rate of around 1.4%, and the riskiest loans, offering rates as high as 25%, have a 9.8% default rate. By contrast junk bonds have an average default rate of 1.9%.

It’s prudent to opt for the pools of hundreds of P2P loans both sites offer. That’s how advisor Ross is earning 10%, despite a handful of defaults on direct loans he made, because his defaults were offset by his performing loans. With the emerging market lenders like iPeopleFINANCE, the investor cannot hedge his risk in the same way, but due to iPeople’s proprietary credit scoring algorithm, an additional 20% of applicants get funded, and get a higher credit rating than their FICO scores would yield from the big-3 credit bureaus.

Additionally, iPeople insures that each borrower has in place a free, pre-paid, re-loadable debit card that receives a direct deposit with each paycheck that guarantees the loan payment, so the risk of default is very low. iPeople is targeted to young Gen-Yers and to returning Vets from Iraq and Afghanistan. Both of these groups have had little opportunity to establish credit, prefer a more cash-oriented lifestyle, and seek relationships with non-traditional banks. iPeople offers a suite of mobile cash applications tied to the debit card, that can be downloaded to smart phones, and can efficiently deliver banking services to customers 24 hours a day, 7 days a week, wherever they may be.

John Mack, former chairman of Morgan Stanley, is a convert to P2P lending. After committing several million of his own capital to such loans, he joined Lending Club’s board in April, lending a strong measure of credibility to the space.

Of course, a couple of former Wells Fargo executives have joined iPeople’s board as well, sending strong messages to the markets that peer-to-peer lending is here to stay.


Crowdfunding Needs To Go On The Warpath!

I cannot believe the opposition to the Crowdfunding component of the JOBS act. This is a classic case of government lifers protecting their turf.  

President Obama sent a strong message by signing the JOBS Act: This administration wants to actively participate in job creation, revive the American entrepreneurial spirit, and maximize the opportunities that modern technology can offer small business owners.

And the best part: It doesn’t cost taxpayers a dime. Just by cutting regulations, the JOBS Act energizes and modernizes an age-old formula. It’s simple: More funding for start-ups = more jobs. Kauffman Foundation’s research is clear:  All net new jobs in the last 30 years come from businesses fewer than five years old. Stimulating and enabling start-ups is the key to stimulating the job market.

The Crowdfunding opponents’ main objections? Fraud.

The SEC, along with several state securities regulators are “worried” that innocent, unsophisticated investors will be bilked by unscrupulous system gamers and scam artists. They actually equate this new frontier to the Wild West. Nothing could be further from the truth. And, by the way, this is the same SEC and state securities regulators that somehow missed Bernie Madoff, JPMorgan Chase, Lehman, AIG and Goldman-Sax, to name but a few. Are these the agencies that we want “protecting” us from predatory investors and scam artists? I think not.

Here’s a few reasons why their “concerns” are poorly grounded:

First, the SEC has another nine months in which to establish all sorts of regulations that will surely protect investors from fraudulent schemes. But, the best protection is baked right into the essence of Crowdfunding itself. That is, the crowds will ferret out any semblance of fraud and broadly report it before any investors have an opportunity to participate. The best example of this behavior can be seen by examining the recent Facebook IPO.

Within hours of the offering, millions of bloggers and reporters took to the airwaves reporting on the botched IPO, and this was “carefully” managed by people like JPMorgan, Morgan Stanley and the like. Imagine how quickly that information would have been disseminated were an actual crowd participating online.

Second, we have a lot of actual Crowdfunding history to dispel the notion of fraud. Indiegogo, for example, has been around for over a year and has distributed millions of dollars every month – losing less than 1% to fraud.

Third, that tiny fraud rate is not mere coincidence. Rather, it’s based on very specific efforts. From the very start of a campaign, today’s Crowdfunding sites capture relevant information from both campaign owners and campaign funders. Online tools constantly screen funding campaigns using a fraud algorithm built on hundreds of thousands of transactions (similar to PayPal, MasterCard, and eBay).

Finally, the realities of Crowdfunding limit fraud as well – as typically the first 30-40% of funds contributed are from friends and family, providing social proof before new investors come on board. Quite understandably, strangers are reticent to fund empty campaigns. And beyond fraud, there are additional information rights and investor protections written into the JOBS Act.

Setting the fraud concerns aside, the benefits associated with Crowdfunding are unique, and in addition to creating lots of jobs and potential wealth, the upside is huge:

1. Projects that begin through online Crowdfunding have built-in risk mitigation. That’s because the public nature of the solicitations forces transparency regarding demand for the product or service.

2. The Crowdfunding process facilitates marketing efforts even before a new company is operational. It provides an opportunity to test the message – after all, the whole process of securing funding involves social media networking, marketing, and brand-positioning.

3. The very nature of starting a business through an online platform provides exposure to potential customers that a bank loan doesn’t. It provides open access to anyone, anywhere, and is shared with like-minded friends through social media.

4. The data-collection inherent in online interactive activity provides new businesses with critical information. Brick and mortar businesses struggle to obtain data about existing customers – let alone prospects. The Crowdfunding world provides that data instantly and in volumes large enough to draw statistical conclusions.

5. Crowdfunding provides young businesses and ideas with money to launch those ideas.

6. Crowdfunding allows average Joes and Janes access to startups and opportunity to invest and become part of the next Facebook, Google or cool Indie film debuting at Sundance.

These guys (Pebble) raised $7 million in two weeks before they shut down the fundraising on KickStarter and are now making these cool smart-watches that work with iPhones and Androids. Now, of course, the very Venture Capitalists who turned them down and dying to throw money at them. In addition, they have created a development platform for smart-watch applications, which guess what, creates lots of new jobs. If this had happened after Crowdfunding for equity was lawful (next February) the investors would each own a piece of this company – now they just get a watch instead.

We are not the same society that we were in the 1930s when the Securities Act of 1933 was written into law. That act prohibited anyone worth less than $1,000,000 from investing in privately held companies. 

This is 2012. We have the Internet. We have news on a 24/7 cycle. We all use Facebook, Twitter and many of us Blog and Pin and send Instagrams. We are social networking junkies. We insist on authenticity and we love to share. The JOBS act acknowledges the changing world and is an attempt to reflect today’s realities in the world of investing and business creation.

The JOBS Act is a natural evolution of President Obama’s Startup America agenda. And perhaps nothing speaks to the value of Crowdfunding better than the successful businesses – and jobs they created – that owe their existence to the short history of Crowdfunding. Let’s all get behind this and make sure that the law, as passed is what we are going to get next February and not some crazy, restricted version that defeats the whole purpose.

The End of the Euro Nears.

As we watch the growing deterioration of the Greek and Spanish banking systems, I thought it might be interesting to take a closer look at the major U.S. banks’ overseas positions and exposures.

Citigroup has the largest net exposure to non-U.S. sovereign governments, with a little more than €14 billion ($17.5 billion) on their balance sheet.  JPMorgan Chase comes in second, with about €8 billion ($10 billion), while Morgan Stanley is third with €5 billion ($6.2 billion), and Goldman Sachs holding the smallest position of the four big banks with €4 billion ($5 billion) in non-U.S. sovereign debt. Remember how Wall Street reacted when JPMorgan lost $2 billon in derivative exposure a couple of weeks ago? Now, imagine a $39 billion loss. As Senator Everett Dirksen famously declared, “A billion here, a billion there, pretty soon it adds up to real money.”

This is an important data point because the U.S. banks are completely exposed to the growing European banking disaster. Europe’s entire banking sector has the potential to collapse completely if the contagion catches and runs completely amok. With the current run on Greek and Spanish banks, the possibility is slowly becoming a probability. Without an EU-wide deposit guarantee, depositors will withdraw all of their funds and move them to their mattresses.

In addition, the bigger of the PIIGS, Spain and Italy, have their debt spread out across Europe, putting them in the unenviable position of causing systemic ignition to just such a contagion.  As one example, French banks (Credit Agricole and Societe Generale) hold a substantial portion of their credit portfolio in Italian sovereign debt. Which we know is worthless.

Europe as a whole is in deep trouble as this latest iteration of the never-ending sovereign debt crisis could finally result in at least a partial breakup of the EU.  The actual likelihood is that Greece, then Spain, followed by Portugal, Italy and Ireland will drop out of the EU.

If that happens, Germany’s most rational choice would be to withdraw as well. After all, why should they continue their exposure to more poorly managed countries who will only default on what remains of their sovereign debt?  France, Sweden, Belgium, the Netherlands and the U.K. would be quick to follow in Germany’s footsteps, leaving behind, a handful of countries like Cyprus, Estonia, and Latvia to sort out the remaining arguments for remaining in the Union and supporting a single currency.

It doesn’t take much of a mental stretch to imagine what would happen next.

$2 Billion? Chump Change. Jamie Dimon Has Real Problems Now.

The US Federal Reserve has just released data that shows mind-boggling trade positions that JP Morgan has taken in synthetic credit indices, an extremely haphazard class of derivative, also known as Credit Default Swaps (CDS).

Um, try $100 Billion worth; an increase from a net long notional of $10 Billion at the end of 4Q11, to $84 Billion by the end of 1Q12.

All banks are required to report quarterly on these things and JP Morgan’s position in CDS has jumped eight-fold in under 6 months. This may raise additional concerns about JP Morgan’s investment strategy in synthetic products.

In investment-grade CDS with a maturity of one-year or less, JPMorgan‘s net short position exploded  from $3.6 billion notional at the end of September 2011 to $54 billion at the end of the first quarter.

Over the same period, JPMorgan’s long position in investment grade CDS with a maturity of more than five years leapt five times from $24 billion to $102 billion (see chart). They are either really, really smart, or really, really, stupid. If it’s the latter, guess who bails them out?

“I don’t care how big a bank you are, that’s still a big move,” said one seasoned credit analyst.

JPMorgan’s chief executive Jamie Dimon said his firm began closely examining the CIO’s (Chief Investment Officer) controversial trading strategy in closer detail when large mark-to-market losses – put at $2 billion by Dimon during an analyst call on May 10 – started appearing in the second quarter.

Dimon has since tried to balance his exposures by flipping positions in long, high-yield CDS and short positions in investment-grade CDS, but the crazed selling of these CDS positions is eerily reminiscent of the final hours of Lehman Brothers.

People will question senior JP Morgan management signing off on a trading strategy that vastly increased the banks’ exposure to a worsening credit environment at a time when other banks were battening down the hatches. In dramatic contrast to JPMorgan, the Fed data show ALL other major US banks (GSax, Citi, B of A, Morgan Stanley) maintaining large short positions in investment-grade credit in expectation of a continuation of the rocky credit environment persisting throughout the second half of 2011.

The figures underscore JPMorgan’s failure to act at an earlier stage, given the large concentrations of risk it was accumulating, as well as the inability of regulators to discern abnormal trading patterns among the piles of data banks already reported to them. Shame on the SEC … again.

On the day (May 10th) that the $2 Billion loss story broke, that morning’s The Gartman Letter, market commentator Dennis Gartman wrote:

“The press conference… caught everyone a bit off guard and does raise all sorts of flags and does indeed cause us to remind ourselves that “there is never just one cockroach;”          however, if the losses sustained are held to what was reported yesterday afternoon, then we must remember that this is isolated; that it shall be a loss of only 30 cents/share; that Jamie Dimon’s pristine reputation has been irreparably sullied; that the Left shall use this as an excuse for even more onerous over-sight of the banking/broking businesses of the nation, but the nation is not in jeopardy and we shall all go on.”

IF … “the losses sustained are held to what was reported … .”.

Should be an interesting couple of weeks on Wall Street.

Mad As Hell! And, See You In Court.

That didn’t take long.

Facebook Inc and Morgan Stanley, the lead underwriter of social networking company’s IPO, were sued by shareholders who claimed the defendants hid Facebook’s weakened growth forecasts ahead of its $16 billion initial public offering.

The lawsuit also names underwriters JPMorgan Chase and Goldman Sachs among others, and follows quickly on the heels of Facebook’s May 18 stock market debut, which was plagued by technical glitches.

Facebook shares fell 18.4 percent from their $38 IPO price in the first three trading days. In early afternoon trade today, Facebook shares were up 2.1 percent at $29.51.

Hey, I just lost $2 Billion. Don’t bug me with your problems!

The legal action accused the defendants, including Facebook Chief Executive Mark Zuckerberg, of concealing “a severe and pronounced reduction” in revenue growth forecasts resulting from increased use of Facebook’s app or website through mobile devices.

Facebook was also accused in the lawsuit of telling its bank underwriters to “materially lower” forecasts for the company.

“The main underwriters in the middle of the road show reduced their estimates and didn’t tell everyone,” said Samuel Rudman, a partner at Robbins Geller Rudman & Dowd, which brought the lawsuit. “I don’t think any investor in Facebook wouldn’t have wanted to know that information.”

Regulators including the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and Massachusetts Secretary of the Commonwealth William Galvin have begun looking into how the IPO was handled. The U.S. Senate Banking Committee is also reviewing the matter. Busy, busy, busy. Let no self-respecting agency appear as though they aren’t busy looking into things. Problem: Horses are already gone. 

“The SEC has since the 1990s broadly condemned the trickling out of material non-public information, which would include that savvy, well-paid analysts are lowering estimates,” said Elizabeth Nowicki, an associate professor at Tulane University Law School and a former SEC lawyer. Condemned? Or, is it actually against the law?

Syndicate banks “are on the hook in terms of liability by not making accurate, complete disclosure,” she added. “Selective disclosure of analyst outlook changes is not acceptable.” Not acceptable? Or, against the law?

Andrew Noyes, a Facebook spokesman, said: “We believe the lawsuit is without merit and will defend ourselves vigorously.”

Andrew Noyse.

Morgan Stanley had no comment. It said on Tuesday that Facebook IPO procedures complied with all applicable regulations, and were the same as in any initial offering.

The shareholders said the disclosures about Facebook’s business risks were inadequate, and that the company should have told everyone, not just “preferred” investors, that analysts knew those risks and cut their business outlooks accordingly.

Should have? Or, were they bound under the law to disclose to everyone?


Mad As Hell!

I have been around the technology markets for a really long time, and I have never seen this happen before:

It appears that that Facebook‘s lead underwriters, Morgan Stanley, JP Morgan, and Goldman Sachs, all cut their earnings forecasts for the company in the middle of their IPO roadshow.

Worse, if possible, is the fact that the revised earnings forecasts were only passed along to a small group of major (important) investor clients, and not made public.

This is a huge problem.

As you might imagine, the lead underwriters are the most privileged insiders on any deal that is preparing to go public, and they have the best insight into the financial data and associated facts about the health of their client’s business. The earnings forecasts are material information and are prepared by these same analysts employed by the lead underwriters, and as such, are the foundational facts upon which the investing public places their trust. If it turns out that these analysts lied and their employers endorsed these lies, then what does that mean about the system upon which tens of millions of investors have depended for accuracy and integrity?

So, now the apparent truth about Facebook’s lackluster IPO would seem to suggest that news of these estimate cuts dampened interest in the IPO among those who heard about them. (Reuters reported exactly this—that some institutions were “freaked out” by the estimate cuts, as anyone would have been.)

During the road show that was selling (sorry, that’s what it is) the Facebook IPO, investors who didn’t hear about these estimate cuts were placed at a serious and critical information disadvantage. What they didn’t know cost them hundreds of millions of dollars.

Yes. This is a direct violation of securities laws. Privileged information selectively disseminated is a major league no-no. I assume the SEC is on this like, well you know.

What might have actually happened?

One possibility is that the underwriter analysts cut their estimates after a late amendment filing to Facebook’s IPO prospectus, in which a vaguely worded mention that indicated users were growing faster than revenue was a trend, and it appeared to be continuing into the company’s second quarter.

This language freaks out people who are used to reading filing documents, because it could easily have been taken to mean that Facebook’s revenue in the second quarter wasn’t coming in as strong as Facebook had hoped (why else would the language have suddenly been added at the 11th hour?)

Another possibility is that Facebook told the underwriters to cut their estimates—either by directly telling them to, or, more likely, by “suggesting” that the analysts might want to revisit their estimates in light of the new disclosures in the prospectus.

If there was any communication at all between Facebook and its underwriters regarding the analysts’ estimates, Facebook will have to answer for this.

Based on the actual language, it seems highly unlikely to me it would have prompted all three underwriter analysts to immediately cut estimates without some sort of nod and wink from someone who knew how Facebook’s second quarter was progressing. (To get this message from the language, you really have to read between the lines).

At the end of the day, privileged information was known to the lead underwriters and only disclosed to a few, important clients. As a direct result, Facebook’s IPO performed poorly and a lot of investors lost a lot of money, including Mark Zuckerberg, who is $2 Billion lighter today. This practice should be against the law and the lead underwriters should be severely punished. The SEC must regain control of this process and enforce strict oversight rules. The investment community should be outraged. Mary Schapiro should be fired!

Yes, Mary, it’s THAT big.

We’ll soon see how the SEC reacts, and what Congress has to say about all this. Maybe we’ll finally get to see who on Wall Street owns whom in Washington, and what the American people are actually made of.