Marketplace lending ABS: The next big short

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Marketplace lending ABS is following a worryingly familiar path.

Having largely failed to predict the last financial crisis, financial journalists are always eager to make sure that they are early for the next one. And despite years of regulation and restructuring since 2007, the story could end up sounding rather familiar.

Take the peer-to-peer lending industry, which is often anything but. As the size and number of participants has grown, it has morphed into marketplace lending with banks originating the loans, selling them to marketplace intermediaries who subsequently sell to institutional investors. If that doesn’t sound a million miles away from originate-to-distribute, it is because it isn’t. 

There are now more than 100 marketplace lenders in the US, the largest of which are Lending Club and Prosper Marketplace. Both of these firms have relied on a small, Salt Lake City-based lender, WebBank, for much of their business. Lending Club disbursed more than $4 billion in 2014, most of which was originated by WebBank and Prosper Marketplace used WebBank to source $1.6 billion of lending last year. 

The bank, which has an ROE of 44%, originates the loan but immediately sells the risk on to the marketplace lender. It all sounds eerily reminiscent of banks originating sub-prime mortgages and selling them to third party vehicles to securitise.

Marketplace loans are securitized too. According to PeerIQ Research, the marketplace loan ABS sector had reached $8.4 billion via 41 deals by the end of 2015. And growth is accelerating: the $2.7 billion securitized via nine deals in the fourth quarter last year represents over 30% of cumulative issuance to date and is five times larger than the volume issued in the fourth quarter of 2014. 

Citi securitized a pool of unsecured consumer instalment loans originated by WebBank via a $376.7 million deal last July. The loans had been purchased from Prosper Marketplace. The $227.28 million senior notes of Citi Held for Asset Issuance (CHAI) were rated A3 by Moody’s. Six months later on February 11, however, Moody’s placed the Class C notes of three CHAI deals on review for downgrade, prompted by "a faster build-up of delinquencies and charge-offs than expected". The net losses on the original pool balances had risen to 12% from 8% at closing. Moody’s had modelled base case losses at 8.5%, while rival Fitch had modelled losses of 11%.

In the same month this deal was put on watch for downgrade Prosper Marketplace announced it would be raising its lending rates by an average 140bp. This followed two rate hikes by Lending Club, in December and January. 

If unexpectedly large delinquencies building up in securitizations of consumer lending issued by entities that did not originate those loans doesn’t remind the regulators of unexpectedly large delinquencies building up in pools of sub-prime mortgages originated by banks with no skin in the game, it certainly reminds us.

This is a movie we have all seen before.