Growing pains of marketplace lenders

By:
Louise Bowman
Published on:

The fintech darlings of online lending are becoming victims of their own success. Questions over loan performance and industry structure have put the young sector firmly in the regulators’ sights. What started out as a market known for its transparency is becoming increasingly complex, not least through the growing use of securitization and involvement of the biggest banks and asset managers. Marketplace lending needs to grow up fast.

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Just before Christmas last year Moody’s issued a rating on the securitization of a pool of marketplace lending (MPL) loans from a Citi-run shelf known, in the clunky parlance of the industry, as Citi Held for Asset Issuance (Chai). The $265 million deal was the third from the platform and was backed by consumer loans originated by online lender Prosper Marketplace. All the notes were privately placed.

As the industry returned from the Christmas break in January, however, the analysts at the rating agency were clearly having second thoughts. On February 11, a mere 36 working days after issuing the rating, Moody’s declared that it was placing the $43 million Class C notes of this deal, which it had rated Ba3, on watch for downgrade along with the Class C notes from the two prior Chai securitizations, both of which had taken place since August 2015. The Class C notes in the December deal had 15% credit enhancement and had been offered at 6% over swaps.

That is a remarkably short period of time for the dynamics of the pool to have changed so dramatically. By the end of the first quarter of this year there had only been 29 securitizations of consumer MPL loans, totalling $3.9 billion, so for three of them to be put on rating watch is a big deal.

It isn’t just Chai. In June 2015 Florida-based marketplace lender CircleBack Lending securitized $126 million of loans through Jefferies, with which it has a $500 million forward-purchase agreement. By March this year, however, cumulative losses on the deal had already caused it to breach its triggers, according to Morgan Stanley. 

Anyone who lived through the financial crisis – or even saw the film 'The big short’ – should have a nasty sense of déjà vu about the evolution of the MPL ABS market. This is a market that was launched on the back of a simple idea: two peers lending to and borrowing from each other. 

It has, however, developed into a complicated network of risk transfer, with the original loan application often travelling from online platform to agent bank where the loan is made but then transferred back again to the online platform in as little as 24 hours. It is then matched with an investor and is often sold again – this time to a securitization platform. It will then be packaged up and sold on to ABS investors – a process that by any measure has become horribly complicated. Complexity is not what this industry, which is supposed to live and breathe on transparency, needs.

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Uncomfortable

Are concerns about this complexity an over reaction? The marketplace lending sector remains tiny in global financial market terms. These are private placements sold to institutional investors and hedge funds, so the systemic implications are minimal. 

There is, however, much to feel uncomfortable about if marketplace lending grows to become as big as many expect. That is because securitization will fuel much of that growth. "No regulator is looking to make the banks bigger," muses Gyan Sinha, founding partner at Godolphin Capital Management, a New Jersey-based investor specializing in MPL asset-backed securities. "Credit has to come from the non-banks." 

Sinha has first-hand experience of ABS deals going wrong: immediately before the 2008 crisis he was the lead analyst covering the sector at Bear Stearns where he attracted criticism for his bullish calls on sub-prime residential mortgage-backed securities right up until mid 2007. 

After Bear, Sinha joined KLS Diversified, where he worked with Samir Desai, who went on to found UK marketplace lender Funding Circle. "Securitization will be absolutely essential to the growth of the MPL market," he says. "It will require a huge investment of time and effort on the part of securitizers and issuers." 

If non-bank lending is the future, then the securitization industry had better figure out how pools of these loans perform over time – and fast. Because, despite its fintech swagger, marketplace lending is not new. 

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Ram Ahluwalia,
PeerIQ

"This is not a new asset class, it is a new business model," explains Ram Ahluwalia, chief executive officer at research firm PeerIQ in New York. "Consumer-lending ABS has been going on since the 1990s." So investors, issuers and rating agencies need to take a hard look at exactly what is different about MPL platforms to unpick exactly how risky this brave new world of consumer finance really is.

Marketplace lending accounts for only 0.08% of the $96 trillion global corporate and household debt outstanding. However, the sector is accelerating fast, growing an average 123% a year since 2010. Some $24 billion of marketplace loans were originated globally in 2014; Morgan Stanley forecasts that this will reach $290 billion by 2020. It’s also attracting big names in finance, most recently ex-Deutsche Bank CEO Anshu Jain, who joined the board of marketplace lender SoFi this year.