Best of both worlds: the composite loan business model



Alternative loans have become an important part of the financial landscape. The two main lending business models in this industry are market loans and balance sheet loans, which differ mainly in the spread of risk and the amount of return. Composite loans link these models together and bring the benefits of market lending to balance sheet loan originators.

In the world of alternative lending, two important lending business models are market lending and balance sheet lending.

Market loans for less risk

In the market lending model, loan companies sell loan portfolios to third party investors in exchange for collecting a service charge over the life of the loan, and possibly an upfront origination fee. This transfers the associated risk of default to investors, but reduces the overall return by sacrificing the portfolio’s interest rate spread. These sales bring in new capital, allowing lending companies to make more loans without being constrained by capital adequacy and leverage ratios.

Lending companies in the market typically focus on long-term loans, such as unsecured consumer loans close to the premium, loans to small and medium-sized enterprises (SMEs), and real estate finance. These are usually low-margin, long-term deals, so these companies often require long and substantial capital investments from venture capital firms to keep their business going.

Balance sheet loan for a higher return

In the on-balance sheet loan business model, loan originators keep the portfolio and thus receive the interest rate spread over the life of the loans. This increases yield and provides cash flow, but lenders retain the risk of possible defaults.

Balance sheet lenders tend to focus on specialty loans, such as short-term subprime loans, cash payments, POS loans, cash advances to merchants, and factoring. Loans of this type are generally short term and focus on current profitability.

Maintaining the interest rate spread means that the cash flows expected from a single loan for these companies are generally higher than those for market loan companies, allowing them to access the profits for the growth of the market. company rather than relying on venture capital commitments. Nonetheless, balance sheet lenders must adhere to certain capital adequacy and profitability covenants when raising new capital to spur set-ups, as all risk is concentrated on their balance sheet.

Which model do investors prefer?

While on-balance sheet lenders may earn a higher initial return, the market lending model has proven to be more attractive to investors. Market loan portfolios more easily attract traditional investors for a number of reasons:

  • Lending in the market tends to be more transparent and the main risk investors need to assess is that of the underlying, rather than the overall business, as is the case with on-balance sheet lenders. .
  • Direct loans to balance sheet lenders are risky for third party investors and highly illiquid.
  • Investors are generally unaware of the specialized assets in these portfolios, leading them to compare the lender to a bank and draw the wrong conclusions.
  • Subprime and subprime short-term short-term loans typically found in the portfolios of on-balance sheet lenders are difficult for investors to value using a traditional approach, while loans from the model Market loan loans are more easily valued using traditional models.

However, the scalability of the business is a bigger issue facing balance sheet credit companies. Both the market and on-balance sheet loan models need to generate capital to fund ever-increasing market demands for loans and to grow their businesses. Companies in each lending model need historical lending statistics to demonstrate proven results – a track record – to potential new institutional investors, but to create these statistics they need up-front investors. To reach this point, market lenders must spend early investor money, while balance sheet lenders can use their own funds for this purpose. Once a business collects enough statistics and attracts institutional money, it will experience tremendous mount growth.

Investors prefer transparency and scale to high return with unknown risk. Therefore, the loan companies in the market were literally founded to acquire new investors in order to accelerate their growth. Balance sheet lenders retain profits, allowing expansion into new segments and markets; however, few balance sheet lenders have extended their operations sufficiently to take on debt through securitization or off-balance sheet transactions. This is mainly due to an expensive set-up and the lack of specialist investors.

Presentation of the composite loan model

The composite loan model combines the advantages of both on-balance sheet and market loans. In this model, part of the portfolio is kept on the balance sheet financed by the company’s capital, while the other part is financed by external investors on the principles of market lending.

Switching from a balance sheet to a composite loan model is advantageous for the originator. The company benefits from the same high return on the current portfolio while receiving additional set-up and management costs from the newly created portfolio. As newly issued loans are sold to investors, the lender reduces the risk and leverage of the business, measured by volume of origination. This allows for the virtually infinite scalability inherent with loans in the market.

Composite loans give companies the ability to add new products and enter new markets by using their own portfolio to expand their track record and then open that part of the portfolio to market investors. By citing its existing balance sheet statistics as its track record of success, balance sheet lenders can present a strong case study for onboarding new investors to the lending portion of the portfolio market.

Another advantage of composite loans is the increase in the valuation multiples of the business. Indeed, markets tend to have price-to-earnings ratios that are up to 2.7 times higher than other balance sheet lenders, and 7.2 times higher than traditional lenders.

However, developing a marketplace lending business requires substantial investment in IT, legal, and marketing as this is not the core business of a balance sheet lender. Additionally, investors might be concerned about the perceived conflict of interest for the originator dividing the origins between kept potions and selling portfolios as well as setting fees.

Traditional banks use market loans to build their consumer loan portfolios using a process called loan as a service (LaaS). Likewise, balance sheet lenders outsource the integration of institutional investors through the market-to-third-party lending model using Market Lending as a Service (MPLaas).

Market Loans as a Service

An example of such a third party is Blackmoon Financial Group, which provides a platform used by institutional investors to invest in loans issued by balance sheet lenders.

Balance sheet lenders partner with Blackmoon to grow their business and sell loans at the time of origination. The integration is performed through the API (Application Programming Interface) and is designed to be easy to deploy for IT staff at lenders. Using the API, the entire data exchange between the originator and the investor takes less than a second, with no effect on the customer experience.

In order to guarantee the absence of conflicts of interest, each loan is priced independently and receives set-up and management costs according to its risk and expected cash flows. This helps to avoid selective selection on behalf of investors and selection bias on behalf of originators.

Investors have independent analysis of originators, flexible loan selection criteria and the opportunity to diversify into different geographies and currencies. All of this ensures that the pure market lending approach is executed on the basis of full transparency and informed decisions.


The composite loan model brings the benefits of market loans to companies operating under the balance sheet loan model. These benefits include scalability, reduced risk and an improved cash cycle while maintaining high return and discretion over the portfolio held. Balance sheet lenders are seen as more beneficial by institutional investors because they see not only a strong track record of origination in the portfolio, but also a transparent and skin-in-the-game approach.

For more information on Blackmoon Financial Group, please visit us online at or contact us at [email protected]

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