Marketplace lending securitization remains a bright spot in the ABS market. Total issuance topped $2.4 billion this quarter—a record—and is up 41.1% from Q2, with cumulative issuance now totaling $12.7 billion. YTD issuance of the sector stands at $5.4 billion as compared to $3.0 billion from prior year, an 86% increase as compared to a 10% decrease in non-MPL ABS issuance.
Although MPL origination volumes have declined at some platforms, ABS issuance is increasing as is the proportion of loans funded by ABS. The percentage of loans funded by ABS is over 50%.
The movement towards rated securitizations at larger transaction sizes continues. All the deals issued in the third quarter were rated, with the exception of LCIT 2016-NP1. Further, the growth in average deal size continued, growing to $267 million in 2016 as compared to $64 million in 2013.
New issuance spreads continued to tighten in—a friendly environment for securitization. Across all segments in MPL, Q3 2016 saw spread compression across each part of the capital structure, indicating strong investor appetite for MPL ABS paper in the market.
We estimate $6.0 to $10.3 billion MPL ABS issuance for 2017.
Goldman Sachs, Morgan Stanley, and Citi take top positions on the league tables.
Differences in execution and losses are emerging across issuers.
SoFi maintains a significant execution advantage over peer student lending originators, and remains the largest issuer in the category. PeerIQ expects 3 additional deals to breach loss triggers in the unsecured consumer installment category in the coming months.
In the U.S., the Federal Reserve left rates unchanged, but signaled an increasingly hawkish stance due to an improving growth outlook and inflation risks. Outside of the U.S., central bankers continue to combat disinflationary pressure in a negative-interest-rate world.
For 3Q16, implied volatility on 3-month CDX HY options stayed at their historical low of 37%. On-the-run CDX HY traded in a range bound between 375 to 420 basis points. With reduced volatility and an expanding universe of participating MPL ABS investors, new issuance spreads in MPL securitizations tightened across all parts of capital structure.
Marketplace Lending ABS Trends
Further, the third quarter continued the steady growth in MPL securitization. Nine deals priced, totaling $2.4 billion, representing steady growth of 41.1% from the previous quarter. YTD issuance stands at $5.4 billion, as compared to $3.0 billion for the first three quarters of 2015. This growth now brings the total size of MPL securitization issuance volume to date to $12.7 billion.
The market continued to move towards larger deals with repeat issuers. New issuance pricing spreads continue to tighten as do other securitized products more generally, although MPL bonds continue to offer attractive relative value for comparable duration and rated products.
All variations of originators—balance-sheet, pure marketplace lenders, and hybrids—have established programs to tap into the ABS markets. In July, Marlette issued its first unsecured consumer loan MPL ABS deal from its new shelf (MFT). In August, Lending Club introduced the first deal on its branded shelf (LCIT), suggesting a pattern of repeat standardized issuance. Upstart reportedly intends to have a rated securitization in the fourth quarter.
Further, SoFi has emerged as a model for successful execution, enjoying 70-110 bps of funding cost advantage versus its peers in the student lending category, and remains the largest MPL issuer by a significant margin.
Continued Regulatory Uncertainty
Regulatory uncertainty remains high for marketplace lenders that rely on partner funding bank model. The consensus view is that the risk is low that loans originated via the partner bank model may be found to be unenforceable, although the remote probability is paired with high severity.
In July, Colorado state regulators sent letters to several originators saying state law would apply to loans offered to state residents, according to Kroll. Platforms responded by removing loans made to Colorado borrowers in their offerings.
On August 31st, courts sided with the CFPB in CashCall v. CFPB, a ruling that Moody’s determined was credit negative for MPL assets as the court relied on a “pre-dominant economic interest” to test for “True Lender’” status.
In a positive finding for originators relying on the “rent-a-charter” model, on September 20th, the US District Court of California rejected the plaintiff’s arguments in Beechum v. Navient and determined that an exemption to state usury laws “must look solely to the face of the transaction” and expressly rejected the position that a subjective inquiry into the intent of the parties or an economic interest test must apply.
Nevertheless, platforms relying on rate exportation have publicly reported they seek to align the on-going economics of loan performance with their partner funding banks. To mitigate regulatory risks, originators and warehouse lenders also curtailed extension of credit to impacted rates and geographies.
Warehouse financing costs remain elevated versus last year; yet, aggregators see lower funding costs in ABS market, which offers a non-recourse permanent financing solution.
Data & Standardization
Ratings agencies continued to raise the quality and history of data as key factors in their rating assessments, as seen in the case of Kabbage, Zopa, and Funding Circle.
Also, the paucity of historical data increases the error on cumulative loss estimates which can makes ratings assessment difficult. Rated bonds have a much broader investor market and improved new issuance pricing as compared to unrated bonds.
Finally, we note that the Structured Finance Industry Group (SFIG) has recently established committees encouraging the adoption of consistent data reporting standards and consistent representations & warranties across originators, a welcome development for the sector.
Definitions and Inclusion Rules
Our Tracker includes all issuances connected to assets originated by marketplace lending platforms, which we define as including both:
(i) Online and other novel technologies to increase operational efficiency, risk accuracy, and borrower experience, and
(ii) Non-deposit funding for lending capital.
We recognize there is rapid innovation in lending channels, and welcome all comments and consideration on inclusion rules.
This past quarter saw nine (8) securitization deals, adding $2.4 billion in new issuance, a record for quarterly issuance. This represents 86.0% YoY growth in total issuance year-to-date and 41.1% growth from Q2, further underscoring the ABS market’s interest in MPL securities. Indeed, MPL securitization remains a bright spot in the ABS world, with its 86% YoY growth contrasting with a 10% YoY slowdown in non-MPL ABS issuance, according to SIFMA.
Total securitization issuance to date now stands at $12.7 billion, with 62 deals issued to date (38 Consumer, 16 Student, and 8 SME) since September 2013 (Exhibit 1).
Examining issuance by underlying collateral segment, we see that Consumer and Student have similar volumes, with Consumer continuing to lead with $6.0 billion issued to date, as compared to Student at $5.0 billion (Exhibit 2). Issuance activities in the Small-Medium Enterprise (SME) space was muted for the quarter. SME remains the smallest segment with $1.7 billion total issuance.
There were eight new deals in Q3 2016 (Exhibit 3):
- SoFi: SOFI 2016-C, SCLP 2016-2, SCLP 2016-4, SOFI 2016-D
- Marlette: MFT 2016-1A
- Avant: AVNT 2016-C
- Earnest: EARN 2016-C
- Lending Club: LCIT 2016-NP1
- LoanDepot: CILO 2016-LD1
Of note, this quarter marks the first securitization of Lending Club near-prime loans with a new shelf Lending Club Issuance Trust (LCIT), potentially signaling Lending Club’s desire to establish standards and to tap into the ABS markets for non-recourse term financing.
LCIT 2016-NP1 is sponsored by Jefferies and backed by about $135 million of Lending Club (LC) near-prime loans. The pricing indication was favorable as compared to guidance; the pricing indication was 25 basis points tighter for the A-tranche and 50 bps tighter for the B-tranche.
All deals issued in 3Q16 were rated by at least one rating agency (Exhibit 3), except for LCIT 2016-NP1. As of today, we track 91 MPL ABS rated by rating agencies, of which, 25% were rated in 3Q16, representing a significant uptick in rating agency participation (Exhibit 4). We expect that the vast majority of MPL ABS to be rated as issuers seek to broaden the base of eligible investors.
There was no SME issuance this past quarter. Also, notably there was no securitization from Citi’s CHAI shelf following the mutual termination of the Citi loan purchasing program from Prosper.
Still, a number of new issuers entering the MPL ABS space that continued to drive growth. In addition to Lending Club, Marlette joins the club as a repeat issuer using the shelf Marlette Funding Trust (MFT). Marlette is a balance sheet lender that originates unsecured consumer loans via the Marlette Best Egg Platform. Loans issued through the Marlette platform are originated by Cross River Bank (CRB). CRB and Marlette retain a share of loans issued through their online platform addressing potential “skin in the game” and true lender concerns. This deal was oversubscribed and a PeerIQ analysis shows the deal generated a ~20% improvement in IRR for residual tranche holders, which suggests that many US credit asset managers remain eager to secure attractively priced alternative credits.
Finally, deals continue to increase in average deal size over time, led primarily by SoFi’s large placements. The average securitization deal now stands at $267Mnfor 2016 (Exh. 5).
MPL Securitization League Tables
Goldman Sachs took over the leadership position with $2.5Bn in total volume, an 85% growth from 2Q16. Goldman Sachs worked with SoFi, Marlette, and Earnest to capture about 20% of the market share in MPL ABS by issuance volume. Further, Morgan Stanley took the second position with $2.0Bn in total volume, a 28% growth from 2Q16. Deutsche Bank experienced the 2nd highest quarterly growth at 50%. JP Morgan has broader institutional relationships with Avant, OnDeck, and Prosper and has increased their participation by 34% quarter-over-quarter.
We continue to expect dealers to display heightened interest in MPL ABS securitization, driven by the demand for financing from originators and a reach for yield from global investors.
We also saw new leverage providers enter the market in 3Q16 as others slowed pace following the May 9th Lending Club disclosures. For instance, it was publicly reported that Macquarie closed a warehouse debt facility with MoneyLion, a mobile personal finance platform, to finance a relatively large volume of consumer loans over time.
While some banks have pulled back from financing business due to recent headlines, regulatory risks, or firm-specific consideration, we do observe new dealers and regional banks ramping up capabilities to extend financing solutions to this category.
We expect Dodd-Frank risk retention rules, effective on December 24, 2016, to lead to changes in issuance activity. The risk retention rule slows down the capital velocity for thinly-capitalized issuers whose primary strategy is to purchase whole loans, securitize loan pools, book gains on sale, distribute residual interests, and recycle sales proceeds.
Further, the combination of risk retention and regulatory capital charges reduces the willingness of banks to purchase and sponsor securitizations.
Turning to the issuer league table, we see that SoFi has strengthened its lead as the largest MPL ABS issuer by volume. We expect that SoFi may bring an additional 4 additional deals to the market, for a total of 11 deals this year, and is on pace to be one of the largest issuers globally for student and unsecured consumer loan segments. SoFi is the co-manager for almost all of its deals, capturing roughly a third of total new issuance (Exhibit 7).
JP Morgan experienced the most significant linked-quarter growth across its peer group participating both as a book runner and as a co-manager. Independent investment banks such as Greensledge are also increasing their interest and activity in MPL
As aforementioned, we currently observe 91 rated MPL ABS bonds in the market. As of 3Q16, DBRS leads Moody’s, Kroll, S&P and Fitch in the amount of rated bonds. DBRS rated $5 billion Student MPL ABS, or roughly 50% of sub-segment, competing primarily against Moody’s within the student sector. Kroll dominates the Consumer MPL ABS category with about 50% of market share.
New Issuance Spreads
New issuance spreads in 3Q16 continued to tighten across capital structures, as compared to the prior quarter, reflecting a healthy risk appetite in the capital markets. Moreover, we saw a continued preference for senior tranches over riskier subordinated bonds. As reflected in Exhibit 9, this overall senior preference leads to a steepening of the overall term structure, with investors demanding higher premiums for riskier tranches—and this remains true across all loan segments. Credit spread curves shifted downward in parallel, suggesting an overall yield compression and favorable credit environment in 3Q16.
Commentary on Collateral Performance
In January, PeerIQ observed approximately a 30 to 50 basis points YoY increase in delinquency rate, a leading indicator of charge-offs, on unsecured consumer loans across a composite of marketplace lending platforms.
In early February, Moody’s placed the mezzanine bonds of Citi’s CHAI shelf consisting of Prosper loans on negative ratings watch citing deterioration in collateral performance.
Despite higher delinquencies, the structure of deals offered noteholders significant credit enhancement in the form of subordination, over-collateralization, and early amortization features.
Although there has been increased collateral deterioration in the unsecured consumer and SME sub-segments, overall, these concerns have been offset by structural protections and short-weighted average life:
• On July 15th, Moody’s announced it removed from negative ratings watch the Class C notes on the CHAI shelf citing the short remaining life and “because the structural features of the transactions and available credit enhancement offset the increased expected losses and volatility of the losses under various stress scenarios”. Moody’s also reaffirmed the Ba3 rating.
• In August 26th, Kroll upgraded KABB 2014-1RT A22 – a deal backed by a pool of short-term small business loan receivables. Kroll noted that the rating upgrade was based on structural improvements and the existence of more historical data relating to Kabbage’s collateral.
From a consumer borrowing perspective, we hypothesize that unsecured consumer loans are positioned at or near the bottom of the payment hierarchy (e.g., after auto, mortgages, credit cards, etc.). During times of distress, such as the Great Recession of 2008, this could mean that default rates have the potential to increase.
From both securitizers’ and investors’ perspective, understanding the collateral performance of a deal is central to structuring and investment analysis. Specifically, securitizers would like to know the economics of excess spreads, sizing, and trigger structuring.
We have seen several securitization deals in the market breaching triggers; they are MPLT 2015-LD1 (LoanDepot), MPLT 2015-OD1 (OnDeck), MPLT 2015-OD3 (OnDeck), GLCII 2014-A (Lending Club), and MPLT 2015-CB1 (Circleback). MPLT 2015-OD1 (OnDeck) was paid down recently; the other deals are still active. As the collateral pool breaches pre-defined triggers, cash flows from subordinate bonds divert to the senior part of capital structure, eroding the returns for subordinate and residuals holders. MPLT 2015-LD1 experienced a 4.97% cumulative loss in September, which breached the cumulative loss trigger of 4.9%. The above trigger breaches highlight the importance of collateral analysis and credit modeling, and motivates us to focus on collateral performance in this Quarterly report.
We first illustrate the historical performance of Lending Club and Prosper loans, using three key collateral performance metrics, the delinquency rate, cumulative gross loss rate and cumulative prepayment rate.
To generate a holistic and consistent view on performance, we define the origination bucket as quarterly or annual cohort of loan production. Specifically, for loans originated prior to 2012 but after 2009, we group them as one cohort, representing the early phase of marketplace lending evolution. We show five quarterly vintages for 1Q16, 4Q15, 3Q15, 2Q15 and 1Q15. Since 2Q16 vintage is a relatively young vintage, we ignore 2Q16 for the purposes of this analysis. To gain a general view, we did not break down the loan cohorts by grade. We also show the differentiation between two platforms, Lending Club and Prosper.
First, we explore delinquency rates by various vintages.
“Percentage delinquency rate” per origination bucket measures the proportion of loans that have more than one missed payments for any payment period. This indicates the overall credit health of the whole loan pool.
As can be observed in Exhibit 10, loans originated from 2009-2012 tend to suffer higher delinquency. Further, the delinquency curves peak around month 11, indicating loan pools tend to have the highest risk of default approximately one year after origination. Borrowers who remain current with the payment program tend to exhibit declining delinquency rate until maturity. As the term of loans extends from 36 months to 60 months, the peak delinquency rate also increases, from about 2% to 3.2% for 36-month and 60-month loan pools, respectively. Across platforms, Lending Club shows significantly less peak delinquency rates than those of Prosper, 2% – 3% for Lending Club vs. 6%-7% for Prosper. Interestingly, 2009-2012 Prosper loan pools show significantly higher delinquency rate than recent vintages, suggesting Prosper has significantly improved its underwriting standards in recent years.
We also see higher delinquency profile for recent Lending Club and Prosper loan pools. For instance, 4Q15 36-month Prosper loans exhibit notably higher delinquency rate, riding on top of other vintages, but inside of the delinquency rate for the 2009-2012 loan pool.
“Cumulative gross loss rate” is the amount of loans charged off before recovery over the original pool balance (Exhibit 11). The cumulative loss curve plateaus as the loan pool seasons and the delinquency rate drops.
The steepness of the loss curves is related to the timing of the delinquency peak. Loan default occurs after several months of delinquency; delinquency is an early indication of future charge-offs.
For instance, as delinquency comes in the early part of the loan life for Prosper 36-month term loans in the 2009-2012 cohort, the loss curves pick up quickly. As expected, 2009-2012 vintages exhibit the steepest cumulative gross loss profile, reaching about 8% for 36-month term loans and 17% for 60-month loans.
Prosper loans shows more severe cumulative loss behavior than those of Lending Club. Prosper 2015 quarterly vintages tend to show higher loss rates than those from 2013 vintage, indicating deteriorating credit profile for 2015 loan pools. The cumulative gross loss rate curves for Prosper 2014 loan pools show a recent uptick in loss, piercing 6% for the 60-month term loan pool. We remind the reader that these loss trends do not incorporate recent improvements in pricing and underwriting.
“Cumulative prepayment rate” is the quotient of the cumulative dollar amount prepaid and the total original loan pool (Exhibit 12). We show the cumulative prepayment rate for the same cohorts for both Lending Club and Prosper. Investors bear the potential risk that borrowers may pay back loans before maturity, exposing investors to reinvestment risk and cash drag.
Lower creditworthy borrowers exhibit less propensity to prepay voluntarily. Indeed, the weakest vintage in the Lending Club 2009-2012 pools exhibit the slowest prepayment profile.
Faster prepayment rate of a loan pool suggests that higher quality borrowers leave the cohort sooner than expected and weaken credit quality of the remaining pool. Prosper loan pools in the 2009-2012 vintage show steep and elevated prepayment and loss curves.
As strong borrowers prepay and leave the loan pool, the remaining pool credit quality deteriorates. This “tug-of-war” between prepayment and default leads to dynamics of pool loss behavior that require sophisticated loan-level analytics to model
From the above short discussion on historical delinquency, cumulative gross default, and cumulative prepayment rates, we underscore the complicated dynamics of loan behavior. PeerIQ’s family of internal credit models attempt to deepen our understanding of these interactions.
We caution investors on drawing investment decisions purely on historical vintage performance. Originators have taken various actions—tightening underwriting criteria, increasing coupons, addressing stacking issues (see, e.g. TransUnion’s newly launched Fraud Prevention Exchange)— and such actions will not be reflected in go-forward performance. For instance, Prosper projects a 7.4% risk-adjusted return on a vertical slice of forward production.
Nevertheless, we encourage investors to use loan-level, forward-looking independent risk analytics to develop their own investment views.
As we noted in the Q2 securitization tracker, numerous factors—platform rate increases, tighter underwriting, spread tightening in the primary and secondary ABS markets—improve the economics for whole loan buyers that fund via securitization.
For Q4, we expect:
1. An increase in ABS volumes and greater dealer participation
2. A shift towards standardized and repeat issuance
3. New products and additional modes of distribution
4. Greater investments in 3rd party solutions to improve investor confidence
Increase in ABS Issuance Volumes
As marketplace lending loan growth rates in the US have accelerated over the last few years, lenders have become increasingly reliant on institutional capital, with many platforms particularly focused on securitization as core pillar of funding.
Exhibit 13 confirms our thesis that securitization becomes a key financing solution for the marketplace lending industry:
We anticipate greater participation in the securitization space as one-off issuers seek to become repeat issuers to optimize deal cost and capital market distribution. We expect other issuers to adopt repeat-issuer best practices.
Further Standardization and Repeat Issuance
One of the major characteristics of this quarter was the emergence of strong repeat issuer like SoFi. Marketplace lenders will similarly seek to shape and control their deals driving increased transparency and standardization across securitization programs. We believe that other platforms will follow suit. Indeed, in 3Q16, we saw the establishment of a new shelf (MFT) from Marlette as the sponsor, setting the stage for securitization of loans originated by Cross River Bank (CRB). Similar to SoFi, both CRB and Marlette retain a share of loans issued through their online platform addressing potential “skin in the game” and true lender concerns.
Given the above trends in MPL ABS issuance, we expect to see over $2 billion Q4, with 2016 issuance over $7.4 billion and total issuance of $15 billion since 2013.
PeerIQ anticipates the rise of contributed collateral “club deals” as platforms seek to dive standardization in deal terms while also offering whole loan investors a quarterly path to liquidity.
Outside of securitization, additional modes of distribution will emerge. RiverNorth received SEC approval for a MPL-dedicated close-end fund in Q3, signaling the maturation of another major funding source for marketplace lending platforms. Other funding channels including asset managers offering term capital, CUSIPs, private equity, and seasoning vehicles will expand the investors base for marketplace lending category.
Greater Investments in 3rd Party Data Analytics Solutions
To gain investor confidence, marketplace lenders are now adjusting to the demand for greater transparency and due diligence, including independent reviews, “hot” back-up servicing arrangements, and heightened data integrity and data validation standards.
Further, the recent uptick in delinquency and losses in SME and other sub-segments, in general, leads to a persistent focus on fundamentals, such as credit underwriting and acquisition cost.
Originators and ABS investors will extend their investments in 3rd party data and analytics for a variety of investment and distribution activities, such as structuring deal waterfalls, determining deal collateral triggers, monitoring deal performance, and improving investor confidence with loan-level data transparency.
The above trends highlight the need for 3rd party analytics, such as those offered by PeerIQ, to improve transparency, standardization, comparability, with the goal of improving investor confidence and the smooth functioning of lending markets.
We remain optimistic on the marketplace lending ecosystem. The recent regulatory uncertainties and headline risk motivate the industry to reflect, adapt, and mature. The broad secular trends underpinning non-bank lending growth and the global demand for yield remain intact.
About the author: PeerIQ offers portfolio monitoring and loan surveillance, structured finance analytics, third-party reporting, pricing and valuation and advisory services across both whole loans and ABS products.