Topics 72-79 Flashcards
Identify reasons for the failures of funds in the past
Following is a concise list of reasons past funds have failed.
- Poor investment decisions.
- Fraud.
- Extreme events.
- Excess leverage.
- Lack of liquidity.
- Poor controls.
- Insufficient questioning. Often in a committee-style decision-making process, there may be a dominant member who sways the decision and/or members who are afraid to voice any valid concerns over information they have discovered that would question the merits of the investment manager and/or investment. Ideally, all due diligence team members should be encouraged to play the role of “devil’s advocate” when appropriate and raise reasonable concerns as early as possible, especially before they reach the committee stage.
- Insufficient attention to returns. Investment funds attempting to reduce operational risk sometimes overcompensate by implementing excessive controls and may end up bearing too many expenses and not generating enough returns. Ideally, there is a healthy balance between generating strong returns while taking on a reasonable level of risk.
Explain elements of the due diligence process used to assess investment managers
- Prior to investing, an investor performs due diligence on a potential investment manager, which involves assessing the manager, the fund, and the investment strategy. Information such as the investment background, manager’s reputation (e.g., education, employers), and past performance have always been key considerations but are insufficient on their own.
- An additional element of due diligence involves assessing the investment process and risk controls. The starting point is a review of the fund’s prospectus or offering memorandum.
- Additionally, an attribution analysis could be performed to determine how the returns were generated. Were they generated through the skill and control of the manager, luck, and/or factors beyond the manager’s control? In addition, was the amount of return in line with the amount of risk taken?
- Another related element is assessing the fund’s operations and business model. In general, are there internal controls and policies in place to preserve the investors’ funds? Specifically, are the controls in place sufficiently robust to detect and prevent fraudulent activities or are limits imposed on managers to seek higher level approval for transactions exceeding a certain dollar amount or frequency? Is there appropriate segregation of duties between the front office and the back office? What is the process and frequency of asset valuations? What is the fee structure and are there any additional fees after a specific threshold? Are there any limitations or blackout periods on redemptions?
- In the end, investors should assess potential managers and their investment strategies with an objective and unbiased mind. They should not get caught up with a manager’s past successes.
Identify themes and questions investors can consider when evaluating a manager
Manager evaluation is not a task that should be taken lightly by potential investors. This process can be broken down into four areas including strategy, ownership, track record, and investment management.
Strategy
General questions regarding a managers strategy may include:
- Does the manager follow a particular investment style (e.g., growth, value)?
- Are there any current “trends” in the fund or specializations in specific securities, industries, or sectors?
- How has the fund changed its investment style or rebalanced its holdings over the past year? What changes are contemplated in light of anticipated market conditions?
- What is the extent of turnover and liquidity in the fund? What market signals are used to determine whether to exit or enter a position?
- What mechanisms are in place to limit any potential losses in the fund?
- To what extent is quantitative analysis and modeling utilized in the investment process? Have any models been developed or tested to date?
- Are short sales used to generate excess profits or to hedge? How successful or detrimental have they been so far?
- Are derivatives used in the portfolio? If so, are they used for hedging or speculative purposes?
- How does the trade execution process work? Does a central trading desk exist for maximum efficiency?
- What is the extent of any investment in private company securities and their role in the overall investment strategy?
- What is the tradeoff between maximizing current returns versus long-term fund growth?
- Has the fund ever been closed or provided investors with a return of capital?
Ownership
Ownership interests often help align the interests of the investment team and the investors.
They can be useful in attracting and maintaining quality staff, thereby enhancing and/or continuing to generate strong investment returns for investors. Therefore, potential investors should inquire as to whether any members of the investment team (e.g., traders, portfolio managers, research analysts) have ownership interests in the firm.
Track Record
Specific questions about the manager’s and fund’s track records may include:
- How does the past performance of the manager and/or fund compare to its peers and/or funds that follow the same or similar investment philosophy?
- Has past performance been audited or verified by a third party?
- Is there sufficient performance history to perform trend and/or attribution analysis? How did the manager or fund perform during market downturns?
- What were the investment returns relative to the size of the investment assets?
- Are most or all of the staff on the investment team that generated those past results still employed by the firm?
Investment Management
Inquiries during manager interviews may include:
- What is/was the manager’s investment strategy for generating excess returns?
- How did the manager cope with tough market periods? Reference checks on managers could include the following individuals:
- Former employers: Was the manager a leader or follower? Proactive or reactive? A team player or individualist?
- Current and former colleagues, clients, and other independent parties: Ensure consistency but if there are mixed reviews, follow up for explanations and/or obtain clarification from the manager.
- Current and former investors: What good and bad investment experiences did they have with the manager?
Background checks on managers may include the following questions/activities:
- Obtaining comprehensive background check reports on the manager.
- Review the Form ADV filed by the manager with the SEC and state securities authorities. It contains general information about the business as well as more detailed information such as fees, services provided, conflicts of interest, and background of key personnel.
- Has the manager consistently demonstrated herself to be a person of integrity? This could be verified by examining public databases and the SEC website to look for any past or current instances of litigation or criminal behavior.
- Has the manager demonstrated strong personal financial responsibility? This could be verified by examining personal credit reports and bankruptcy reports.
- Are the manager’s stated representations accurate? This could be verified by inquiring with auditors and brokers who are currently working with the manager or have worked with the manager in the past.
- What is the extent of the manager’s involvement in any related party transactions?
Describe criteria that can be evaluated in assessing a fund’s risk
management process
A proper risk management process should contain an assessment of the following areas: risk, security valuation, portfolio leverage and liquidity, tail risk exposure, risk reports, and consistency of the fund terms with the investment strategy.
Risk
- Assess the applicable systematic risk factors (i.e., regular market risks common to most or all funds) and unsystematic risk factors (i.e., risks specific to the manager, fund, or strategy).
- Determine whether written policies and procedures exist regarding measuring and monitoring risk.
- Determine whether a risk committee exists that would receive such measurements. If so, how often are they reported?
- Evaluate the extent of the risk management culture among the various types of employees. For example, how actively involved are employees with managing and mitigating the firm’s risks on a day-to-day basis?
- Assess the information technology resources used to quantify the risks. For example, are they reliable and do they measure items consistently between traders and portfolio managers?
- Identify the existence and structure of any risk models. What are their inputs and assumptions? Have the models been tested and are they robust?
Security Valuation
- Identify the proportion of fund assets that are objectively valued through reliable market prices versus those that are more subjectively valued by the broker or through simulation.
- Examine the independence of valuations. Is valuation performed by the fund administrator (generally more independent) or by the fund manager (generally less independent)?
- Determine if prices may be overridden for valuation purposes. If so, by whom? Is there documentation or an approval process?
Portfolio Leverage and Liquidity
- Assess the sources of leverage as well as the current and historical levels of leverage.
- Calculate the current level of liquidity and observe how it has changed over time. The current level is especially relevant because of the impact on portfolio investment capacity and whether it can take on more investment capital.
- Within a stated investment strategy, excessive leverage and/or illiquidity could generate actual returns that are significantly different than expected (i.e., no longer comparing apples to apples), thereby requiring an adjustment in expected returns.
Exposure to Tail Risk
- Analyze information about the fund to conclude whether the fund’s return distribution possesses skewness or kurtosis.
- Discuss the possibility of tail risk with the manager and determine whether the manager has sufficiently mitigated the risk or whether further action is required by the investor.
Risk Reports
- Review risk reports prior to investing in the fund. Investors should receive these risk reports on a regular basis (e.g., monthly, quarterly, annually) whether they are prepared in-house or by a third party.
- Analyze key risk metrics and compare them to other similar funds for benchmarking purposes and for determining if any unusual risks exist in the fund.
Consistency of the Fund Terms with the Investment Strategy
- Examine the general fee structure of the fund and determine whether it is consistent with similar funds.
- Identify the existence of any additional fees after a specific threshold (e.g., high-water mark, hurdle rate).
- Evaluate whether high fees are being paid to managers in search of market alpha (fair) as opposed to beta (unfair).
- Identify the existence of any limitations or blackout periods on redemptions.
Explain how due diligence can be performed on a funds operational
environment
Investors should focus on several key areas when performing operational due diligence on a fund. The focus areas are internal control assessment, documents and disclosure, and service provider evaluation.
Internal Control Assessment
- A starting point in due diligence is examining the qualifications and attitudes of the personnel.
- An analyst must also assess whether the internal control staff have sufficient technical and work experience to perform their compliance duties properly.
- Finally, background checks on critical internal control staff members might be required.
- Examining the fund’s policies and procedures may also be useful. One drawback is that these documents tend to be general and only demonstrate the intention to have a strong control environment. It is usually a good sign if a fund has been proactive and obtained an audit report and opinion on the effectiveness of its controls. If this report is available, it Should be reviewed.
- The due diligence process should include an examination of the in-house or outsourced compliance system that is in place.
- There should be an investigation into how the funds deal with counterparty risk arising from OTC derivatives and other counterparties. Is such risk mitigated by dealing with more than one counterparty? Are the counterparties monitored for risk on a daily basis?
- Finally, there should be an assessment as to the effectiveness of corporate governance.
Documents and Disclosure
- As part of the due diligence process, investors must confirm with the fund’s legal counsel its involvement in preparing the original version of the fund documents as well as any subsequent revisions.
- Conflicts of interest that are disclosed in the offering memorandum should be scrutinized carefully. Lack of clarity in the disclosure may be a red flag and warrant further discussion with the manager and/or require independent information.
- Similarly, lack of clarity or sufficiency in the disclosure of risks may warrant further investigation. The discussion of very general or irrelevant risk factors may be cause for concern.
- The focus of any due diligence should be on the manager. As a starting point, the potential investor should determine the extent of the manager’s authority.
- In analyzing the financial statements, the investor should begin by ensuring the audit opinion is unqualified (i.e., the auditor believes the financial statements contain no material misstatements). The balance sheet and income statement should be examined for consistency with the fund’s investment strategy.
- In addition, the footnotes (which are also audited) should be examined carefully since they provide more detailed information on key items (e.g., contingent liabilities, related-party transactions) than the corresponding financial statements.
- Fees paid to the manager by the fund should be scrutinized and recalculated. They should be corroborated with the offering memorandum. Specifically, there should be a check of any incentive fees paid in loss years.
- Finally, there should be a check for the level of net contributions to the fund by the general partner. .Any fund withdrawals should be questioned.
Service Provider Evaluation
- Third-party service providers may be hired by a fund for trade execution, information technology, valuation, verification, and asset safeguarding purposes.
- A starting point for assessing the actual service providers is to examine the internal control letters issued by its auditors and its audited financial statements. Further due diligence could be performed through in-person discussions regarding the service provider’s role.
Explain how a fund’s business model risk and its fraud risk can be
assessed
In addition to the previous due diligence, potential investors need to closely examine the fund to ensure that the risks associated with its business model and potential fraud are not excessive.
Business Model Risk
Evaluating business model risk requires assessing whether managers know how to operate the business as well as generate high returns. Typical risks, potentially leading to failure and closure of the fund, include a lack of cash and working capital, a lack of a succession plan, and excessive redemptions in a short period of time.
A fund’s business model risk can be assessed by performing the following tasks:
- Examining the nature of the revenues and expenses. Calculating the percentage of revenues derived from variable incentive or performance fees (that may not materialize in market downturns).
- Assessing the significance of the gap between management fees (revenue) and operating expenses.
- Considering the sufficiency of the amount of working capital (especially cash) in place to cover revenue shortfalls and/or expense overages for a reasonable period of time.
- Determining how frequently budgets are created and for what period of time.
- Determining the fund’s breakeven points in terms of assets under management and required performance level. Comparing those amounts to current (actual) and future (projected) amounts.
- Ascertaining if there is sufficient personnel or capacity to increase the fund’s investment asset base.
- Ascertaining the existence of key person insurance on relevant individuals and the existence of a succession plan.
Fraud Risk
Fraud risk can always exist even though extensive due diligence has been performed on the manager and fund prior to investing.
Fraud risk may be mitigated by performing the following actions:
- Check the SEC website for any prior regulatory infractions.
- Check court records for any prior litigation and bankruptcy records for examples of financial irresponsibility.
- Inquire with service providers for assurance over their competence and independence from the manager.
- Perform extensive background checks on the manager.
Describe elements that can be included as part of a due diligence questionnaire
The questionnaire should make the following inquiries:
- Inquiry into general inform ation on the manager provides a starting point in the due diligence process. Examples of such information include:
- Confirmation of proper registration with regulatory authorities.
- Determination of ownership form (e.g., corporation) and structure.
- Identification of key shareholders.
- Reference checks.
- Information on past performance.
- Business contact information.
- Inquiry into general information on the fund also is critical. Examples of general information that should be collected include:
- Fees.
- Lockup periods.
- Redemption policies.
- Primary broker.
- Fund director.
- Administrator.
- Compliance: auditor and legal advisor.
- Financial: assets under administration, investment capacity, and historical performance (also see financial statements).
- Historical drawdown levels.
- Inquiry into execution and trading as well as service providers may provide some insight on the speed and accuracy of transaction processing and the existence of related-party service providers, the latter of which may raise red flags with potential investors as discussed earlier.
- Inquiry regarding the firm’s third-party research policy may be useful to determine a fund’s sources of research information, thereby allowing the assessment of the extent and quality of the due diligence performed by the fund in its investment process.
- Inquiry regarding compliance processes, the existence and degree of involvement of inhouse legal counsel, and the existence of anti-money laundering policy and procedures may help provide comfort that the fund and its managers have a desire to operate in an ethical manner and/or within the boundaries of the law.
- Inquiry into the existence of information regarding disaster recovery and business continuity plans as well as insurance coverage and key person provisions may provide some assurance regarding the stability of the firm and, therefore, the safety of any invested funds.
- Inquiry into the investment process and portfolio construction provides the potential investor with information required to make an informed decision whether the overall risk and return profile of the fund is consistent with the investor’s investment objectives.
- Inquiry into risk controls such as leverage, liquidity, asset concentrations, portfolio diversification, and market risk factors give the investor a more complete picture of the investment risks and how the managers attempt to manage and mitigate them.
Describe the reasons to provision for expected credit losses
- The requirement for banks to set aside funds as capital reserves is unlikely to reduce a banks lending activities during strong economic periods. The result may be excessive lending by banks. Therefore, by provisioning for expected credit losses (ECL), a more accurate cost of lending may be determined (which may ultimately control the amount of lending).
- The concept of procyclicality refers to being positively correlated with the overall state of the economy. Reducing the procyclicality of bank lending is likely to occur with earlier provisioning for loan losses. Increased (decreased) regulatory requirements pertaining to provisions tend to reduce (increase) the level of bank lending.
- The use of forward-looking provisions essentially results in the earlier recording of loan losses, which may be beneficial to financial statement users from the perspective of conservatism in a bank’s reporting of earnings.
Compare and contrast the key aspects of the IASB (IFRS 9) and FASB (CECL) standards
The IASB and FASB standards are similar in that ECL must be initially recorded at the outset of all loans and updated at the end of each reporting period, taking into account any changes in credit risks of their loan assets. In addition, the standards do not require any specific catalyst to occur in order to report a credit loss. Finally, the standards mandate the use of reliable historical, current, and forecast information (including macroeconomic factors) in computing ECL. For example, both standards measure probability of default (PD) at a point in time (rather than in context of the economic cycle) and measure loss given default (LGD) and exposure at default (EAD) as neutral estimates (rather than downturn estimates).
There are two main differences between the IASB and FASB standards:
- FASB requires ECL to be computed over the term of a loan commencing right from the start while IASB requires a series of three stages.
- IASB permits the recording of accrued interest income on delinquent loans, regardless of whether loan payments are being received. FASB requires the use of the cash basis (no interest income accrual), cost recovery method (payments applied to principal first, and once principal is repaid, the excess is recorded as interest income), or a combination of both in order to provide a more conservative and reliable method for income recognition on delinquent loans.
International Accounting Standards Board (IASB)
Under IFRS 9, ECL is reported in three stages to represent the deterioration of assets: stage 1 (performing), stage 2 (underperforming), and stage 3 (impaired).
Upon loan purchase or origination, stage 1 begins and the 12-month ECL is recorded (expense on income statement and contra-asset on balance sheet). However, interest revenue is computed on the original loan amount, not the amount net of the ECL. The 12-month ECL is computed as the expected lifetime credit loss on the loan asset multiplied by the probability of default within the upcoming 12-months after the end of the reporting date.
- Stage 2* for a loan asset occurs upon severe deterioration of credit quality to require classification into a high credit risk category. That would be presumed to occur after the loan is 30 days past due according to IFRS 9. Interest revenue computation in stage 2 remains the same as in stage 1.
- Stage 3* involves loan assets that are credit-impaired or generating credit losses. The entire lifetime ECL continues to be recorded but the interest revenue is now computed on the original loan amount less the loss allowance.
Financial Accounting Standards Board (FASB)
In contrast to IASB, FASB requires the entire lifetime ECL to be recorded as a provision from the outset instead of dealing with stages. As a result, the FASB standard will result in earlier and larger recognition of losses (whereas there is some delay in IASB for loans classified in stage 1). The two standards are the same when dealing with loans that have considerable credit deterioration (i.e., IASB stages 2 and 3).
Assess the progress banks have made in the implementation of the
standards
- The IASB standard is effective as of January 1, 2018 (although early adoption is allowed) and the FASB standard as of January 1, 2020 for public companies and January 1, 2021 for all other applicable entities.
- The Enhanced Disclosure Task Force (EDTF) has recommended specific risk disclosure by banks in the transition period prior to implementation of IFRS 9. The disclosures are qualitative (i.e., differences from current approach, implementation strategy, capital planning impact), but also include quantitative assessments of the impact of using the ECL approach.
Examine the impact on the financial system posed by the standards
- The impact of the IASB standard would cause a dramatic rise in loss provisions at the start of an economic downturn, specifically the increase in amounts between stage 1 (12-month ECL) and stage 2 (lifetime ECL). One argument for a more proactive stance on recording losses is that it restates the balance sheet assets at more conservative levels to make way for possible future recoveries.
- In one sense, the standards would have no impact for banks that have established sufficiently large capital buffers that could withstand the impact of the increased loan provisions.
- The provisioning requirements of the standards could end up smoothing the issuance of loans throughout the economic cycle (i.e., slowing the growth of loans in a strong economy while preventing the slowing of growth of loans in a weak economy).
Describe the issues unique to big datasets
- Structured Query Language (SQL) databases are used for the smaller of the large datasets, but customized systems that expand upon SQL are needed for the largest pools of data.
- Another potential issue in dealing with a large dataset is known as the overfitting problem. This is encountered when a linear regression captures a solid relationship within the dataset, but has very poor out-of-sample predictive ability. Two common ways to address this problem are to use less complex models and to break the large dataset into small samples to test and validate if overfitting exists.
Explain and assess different tools and techniques for manipulating and analyzing big data.
- Using big data to make predictions is the focus of machine learning. This science may utilize regression if a linear relationship is present. Machine learning might deploy tools, such as classification and regression trees, cross-validation, conditional inference trees, random forests, and penalized regression, if a nonlinear relationship exists.
- Classification and regression trees can be very useful in explaining complex and nonlinear relationships.
- One concern with using this process is that trees tend to overfit the data, meaning that out-of-sample predictions are not as reliable as those that are in-sample. One potential solution for overfitting is cross-validation. In a k-fold cross validation, the larger dataset is broken up into “k” number of subsets (also called folds). A large dataset might be broken up into 10 smaller pools of data.
- This process starts with fold 1 being a testing set and folds 2-10 being training sets. Researchers would look for statistical relationships in all training sets and then use fold 1 to test the output to see if it has predictive use. They would then repeat this process k times such that each fold takes a turn being the testing set. The results are ultimately averaged from all tests to find a common relationship. In this way, researchers can test their predictions on an out-of-sample dataset that is actually a part of the larger dataset.
- Another step that could be taken is to “prune” the tree by incorporating a tuning parameter λ that reduces the complexity in the data and ultimately minimizes the out-of-sample errors. However, building a conditional inference tree (ctree) is an option that does not require pruning with tuning parameters. The ctree process involves the following steps:
- Test if any independent variables are correlated with the dependent (response) variable, and choose the variable with the strongest correlation.
- Split the variable (a binary split) into two data subsets.
- Repeat this process until you have isolated the variables into enough unique components (each one is called either a “node” or a “leaf” on the ctree) that correlations have fallen below pre-defined levels of statistical significance.
* The main idea of a ctree is to isolate predictors into the most specific terms possible.
Random forests and penalized regression
Constructing random forests is also a way to improve predictions from large datasets. This method uses bootstrapping to grow multiple trees from a large dataset. Using random forests to average many small models produces very good out-of-sample fits even when dealing with nonlinear data. Computers have made this method much more viable as sometimes thousands of trees can be grown in a random forest. There are four steps to creating random forests:
- Select a bootstrapped sample (with replacement) out of the full dataset and grow a tree.
- At each node on the tree, select a random sample of predictors for decision-making. No pruning is needed in this process.
- Repeat this process multiple times to grow a “forest” of trees.
- Use each tree to classify a new observation and choose the ultimate classification based on a majority vote from the forest.
Examine the areas for collaboration between econometrics and machine learning
- Most machine learning assumes that data is independently and identically distributed and most datasets are cross-sectional data. In practice, time series analysis may be more useful. Econometrics can use tools like Bayesian Structural Times Series models to forecast time series data.
- Correlation does not always indicate causation. Traditionally, machine learning has been most concerned with pure prediction, but econometricians have developed numerous tools to reveal cause and effect relationships. Combining these tools with machine learning could prove to be a very meaningful collaboration.
CCP Loss Sequence
A CCP has the following liquidity resources to cover potential losses should a clearing member default (in the following sequence):
- Initial margin: The initial margin paid to the CCP by each clearing member is used to cover only the direct losses incurred from the member’s default.
- Default contribution of defaulting member: Losses greater than the initial margin may be covered by the defaulting member’s default fund contribution.
- Mutualization of large losses: Losses greater than #1 and #2 combined are first covered by a maximum contribution by the CCP (“skin-in-the-game”) to cover the remaining loss. If the skin-in-the-game is not enough, then the remaining losses are covered by other members’ default contributions.
- Recovery: Should the entire default fund be insufficient to cover the losses, the CCP could request additional default fund contributions by non-defaulting members, usually limited to the amount of the initial contribution to the default fund. Another source of funds for CCPs is variation margin haircutting (VMGH), which involves CCPs collecting variation margin payments from members with negative balances but keeping a specified percentage to boost its liquidity resources and transferring only the remaining amount to the counterparties.
- Failure resolution: May occur if the CCP is unable to recover sufficient funds or if the CCP or its members do not attempt to go through the recovery provisions.
The loss allocation process (or loss waterfall) is illustrated in Figure 2.
Traditional P2P Lending Model
There are three basic methods in establishing loan interest rates— in general, borrowers establish the maximum rate and lenders establish the minimum rate. The platform operator uses the information together with the loan amounts to match borrowers and lenders.
- Potential lenders make interest rate bids on loans within a range (i.e., minimum stated by platform operator based on risk assessment and maximum stated by borrower).
- The platforms provide the rate consistent with the credit risk assessment for the loan (that may be flexible depending on supply and demand).
- Borrowers are given a representative rate for an online loan based on a risk assessment and can seek out appropriate lending alternatives based on the rate.
The majority of platforms allow for partial or full prepayment of loans on a penaltyfree basis. On the assumption that payments are made as scheduled, there is no further monitoring of the loan and the borrowers could use the funds for any purpose.
In contrast, should a borrower be potentially delinquent on a loan, they should contact the platform as soon as possible to avoid the platforms contacting debt collection agencies to begin the loan recovery process. At the point of delinquency, the platform may start charging additional fees to the lender. Some platforms have methods to deal with credit losses, which could be in the form of insurance or guarantee/provision funds that provide partial or full coverage of the loan portfolio (i.e., there could be exclusions for higher credit risks). As for the percentage of loss covered, there is a wide range from 2.5% to 70% of the principal amount. An alternative method has the objective to pay out, at a minimum, the expected lifetime default rate for covered loans.
Should lenders wish to exit their loan investments, some jurisdictions allow those creditors to do so by paying fees to the platform and on the condition that other lenders will take over those loans. There also may be no exit guarantee if there are an excessive number of exit requests on the platform at the same time.
Notary Model
- The notary model is used frequently in Germany, Korea, and the United States. There is a partnership agreement between a fronting bank and the lending platform because the fronting bank actually originates the loans. The loans are then sold or assigned by the fronting bank directly to interested lenders or through a platform subsidiary (securitization) to institutional investors. The following diagram presents the basic model; some differences exist in its application in some jurisdictions.
- This is the approach used in Germany because only authorized institutions (i.e., not lending platforms) are permitted to provide loans.
- In the United States, regulatory restrictions sometimes cause FinTech lenders to work with a lending institution. The lending institution issues the loans to borrowers from the lending platform. The lending institution may either retain the loans or hold them for a very short period of time and then sell them to the platform lender. The platform lender may then either hold the loans or sell them directly to investors.
Guaranteed Return Model
With the guaranteed return model, the lending platform guarantees the principal and/or interest on the loans.
Balance Sheet Model
The balance sheet model involves the lending platform operating much the same way as a non-bank lender; it requires capital (i.e., debt, equity, securitization) to originate loans but it also retains the loan receivables as assets.
