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Why this subprime lender funds loans through the Cayman Islands
Kadhim Shubber Author alerts

Jan 19 10:18 5 comments

Elevate Credit calls its customers in the US and the UK the New Middle Class, selling them
loans in the latter at a representative APR of 1295 per cent. It is gearing up to float in New York
this week and, if successful, the Texas-based business will be the first tech IPO of 2016.
The company claims that unlike payday lenders, it has transparent fees in order to help our
customers facing financial hardships. But while its front-end might be simple, the funding for
one of its loans is a complex web of financial engineering involving a Chicago-based privateequity firm and a special purpose vehicle in an offshore tax haven.
The documents filed for Elevates IPO not only show a company trying to raise as much as $80
million while admitting it may not be completely legal, as MarketWatch put it last week, they
also provide an insight into the mechanics of modern finance, describing a flow of money from
stressed borrowers* in the US to the Cayman Islands and then seemingly back again.
Its a demonstration of how fintech companies are more financial wizardry than technological
innovation.
Elevate has three products, all with happy sounding names that disguise the fact that they are
high interest loans for people with few other options. Rise and Elastic in the US, and Sunny
in the UK. The company itself used to go by a different name. In 2014, it was spun out of Think
Finance, itself a sky high-interest lender that changed its name from ThinkCash in 2010. Its
chairman and chief executive Ken Rees was previously the chief executive of Think Finance and
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the company is 27 per cent owned by Sequoia Capital.

The source of capital for two of its loans, Rise and Sunny, is Victory Park Capital, a Chicagobased private-equity fund and one of the most active buyers of high interest, online-originated
loans. Victory Park gives an Elevate subsidiary access to up $335m in funds and the subsidiary
uses that money to lend to its customers. Pretty straightforward.
But the third product, Elastic, technically a line of credit, is funded in a more complicated
manner. Heres how it works.
Instead of having a direct agreement with Victory Park, this time it is a bank in Kentucky that
does the lending and a company thousands of miles away in the Cayman Islands through which
funding for the loans flows. Its called Elastic SPV and is a special purpose vehicle named after
the product.
Republic Bank and Trust Company, the Kentucky bank, lends to the public and pays Elevate a fee
for its underwriting and branding. These partnerships are not uncommon for the simple reason
that while nonbank lenders have to obey state usury laws in the US, banks are granted the right
to avoid local interest rate caps and instead abide by the rules of their home state. The average
APR for Elastic loans is 88 per cent, meaning Elevate would struggle to make the loan itself in
many states.
The Cayman Islands SPV then has the right, but not the obligation, to buy a 90 per cent
participation interest in those loans, paying a premium on the loan and a fee to the bank. The
bank retains the loan documents and the relationship with the borrower, while the majority of
the interest payments flow offshore to the Cayman Islands and into the SPV.
So where does the SPV get the money to buy the participations? It has funding from Victory
Park, the aforementioned Chicago-based fund. When the SPV was created in July last year,
Victory Park agreed to lend it up to $50m, later upped to $100m. For the first $50m Victory Park
charges a base rate of 3-month LIBOR or 1 per cent, which ever is higher, plus 13 per cent. For
the next $50m, it charges the same base rate plus 12 per cent. Elevates assets are pledged as
collateral for the facility.
The reason thats important is the margin. Victory Park is charging around 14 per cent and the
Elastic loans pay an average APR of 88 per cent. The difference between those two numbers,
when you account for loan losses, is effectively profit that is collecting offshore. Essentially, the
margin earned by that SPV would escape US taxation, said Andrey Krahmal, a US tax lawyer at
Temple Tax Chambers, via email.
According to Elevates prospectus, the SPV had $48m worth of loans receivables on its balance
sheet as of September 30 last year. Assuming these are the Elastic loans at an average APR of 88
per cent, that suggests $42m of interest income a year. Elevate had net charge-offs, or
unrecoverable debts, of about 50 per cent in 2014, so lets halve the $42m to $21m. At the time
the Victory Park line of credit was just $50m, which would come at a cost of $6.5m a year. So
thats a yearly profit of about $14.5m as of September 2015, at which time the SPV had around
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$5m in cash on its books.

But at least some of that money comes back onshore, and heres where it gets even more
interesting. Elevate has not only pledged its assets as collateral for the Victory Park loan to the
SPV, it also has a credit default swap agreement with the SPV, under which Elevate receives
payments in return for promising to protect the SPV against loan losses from the Elastic product.
Elevate is acting as an insurer to the SPV, or in other words, Elevate is being paid to take the hit
on the riskiest loans, while Victory Park is being paid a bit less, presumably, to fund the safer
stuff.
Finance experts will have deduced by this point that the Elastic SPV looks like a securitisation
vehicle. The SPV, which Elevate includes in its financials for accounting purposes but does not
own, appears to be a way for Elevate and Victory Park to divide up, or tranche, the Elastic loans
and receive a different return for taking on different risks.
So why do it in the Cayman Islands?
Well, one reason, and the reason why lots of securitisation vehicles are based there, is that the
Cayman Islands has next to no taxes. Heres an excerpt from a 2013 Conyers Dill & Perman
document comparing the advantages and disadvantages of various small island groups for
financiers wishing to do a securitisation (emphasis ours):
No taxes are imposed in the Cayman Islands upon an SPV or its shareholders. An SPV
is entitled to receive an undertaking from the Cayman government such that no law
enacted in Cayman imposing any tax to be levied on profits, gains or
appreciation or which is in the nature of estate duty or inheritance tax
shall apply to an exempted company, or its shares or by withholding for a
period of up to twenty years, which is usually renewable for a further ten years upon
expiry. Stamp duty applies in the Cayman Islands where original
documents are brought to the jurisdiction although the liability of exempted
companies is capped in most cases.
Not only is the Elastic SPV an exempted company, according to the IPO documents, its
agreement with Republic Bank states that the loan documents are retained by the bank and not,
you know, brought to the Cayman Islands.
The aim of all this engineering, says Jeremiah Wagner, a partner in the capital markets group at
Cadwalader, Wickersham & Taft, appears to be to provide Elevate a lower cost of financing in the
most tax efficient way possible. Youre not changing the economics of the company, rather
[you're] giving it a better rate of financing, and then you need to structure it so you dont trigger
extra taxes, he said via email.
A key question here is the size of the CDS payments from the SPV to Elevate. They may be large
enough that the SPV is effectively routing interest payments back onshore to Elevate. Or they
may be small, accumulating interest payments offshore. Another important question is the
owner of the SPV, which is not public (its possible to have an orphaned SPV, meaning its
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owned by a trustee). Andrew Dean of Maples Fiduciary, who is listed as the SPVs director,
declined to answer questions when contacted by phone. Victory Park Capital declined to
comment, as did Elevate, which cited its quiet period ahead of the IPO. Republic Bank did not
return a request for comment.
Its also worth noting that Elevate is running at a loss ($4m in the nine months to September last
year) and has deferred tax assets of $20m as of end of 2014.
If nothing else, it would be interesting if the income flowing into the Elastic SPV is securitised in
the classic sense divided up into a series of risk categories and then sold off to other investors
in the form of bonds. Particularly in light of this line from the Elevate IPO documents.
If Elevate products were required to receive and review additional documentation
from consumers such as bank statements, photo identification or pay stubs, this
added inconvenience may result in lower consumer applications and loans, which
would adversely affect our growth.
*Update: A previous version of this post described Elastic borrowers as poor. The average
borrower salary is $60,000.
This entry was posted by Kadhim Shubber on Tuesday January 19th, 2016 10:18. Tagged with
Elevate, Securitisations.

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