WSJ by Telis Demos and Peter Rudegeair (3/25/16)
A bond offering based on a batch of personal loans made by Prosper Marketplace Inc. got a cold reception late Thursday, the latest sign of investor skittishness toward fast-growing online lenders.
Investors who bought the securities demanded yields as much as 5 percentage points higher than for a similar deal late last year.
The response to the Prosper loans was comparable to other recent sales of online loans, and is further evidence that the firms are facing a big hurdle in their explosive growth. It is also notable because investor fears about other parts of the credit markets, such as corporate junk bonds, have receded in recent weeks.
Startup online lenders, most of them based in Silicon Valley, have grown rapidly in recent years, in part because investors liked their potential to steal business from the established banking industry. The firms don’t have deposits, so they rely on outside funding to continue making new loans.
Investors and analysts have recently expressed a host of concerns about the online-lending industry, ranging from fears that the loans will sour more quickly than expected to regulation that could hamper the business.
As investors have demanded higher returns, the lenders have raised rates on new borrowers and in some cases dialed back on lending.
Shares of firms such as LendingClub Corp. and On Deck Capital Inc. have fallen sharply over the past year, and other lenders have pulled back planned IPOs. U.S. online platforms are expected to expand lending from $22 billion last year to $37 billion this year, according to analysts from Autonomous Research.
About 25% of loans are sold in the forms of pools known as securitizations, which slice loans into different risk levels, according to Jefferies Group LLC.
Prosper, based in San Francisco, is one of the more established online lenders.
The yield on the $278 million offering, which was done by Citigroup Inc. and priced on Thursday, was as high as 12.5% for a portion of loans, according to PeerIQ, an online lending data tracker. That was more than 5 percentage points higher than the top 7.3% yield for a prior offering of Prosper loans by Citigroup late last year.
It was also above the highest yield for a similar securitization Citigroup handled of Marlette Funding LLC loans earlier this month, at 11%. In these deals, Citigroup sells loans that it bought from the lending sites.
These yields are for the loans considered the riskiest in the pool. The less risky loans also saw their yields rise too.
Investors have also demanded higher yields on recent deals for upstart lenders Social Finance Inc., Avant Inc., and LoanDepot Inc., according to PeerIQ.
Online lenders “must consider the fact that funding costs have migrated upwards,” analysts at Jefferies wrote in a note Thursday. “They likely should consider modifying pricing and other factors” to reflect that, the note said.
A spokeswoman for Prosper, which wasn’t directly involved in the sale, said: “While investors will determine security prices in the capital markets, we continue to see underlying [loan] performance that delivers on investors’ expectations.”
So far, about 2.6% of the principal amount lent by Prosper in the first quarter of 2015 had been charged-off as of February, the latest performance available, according to MyCRO, a data tracker from online lending and securitization platform Insikt.
Citigroup declined to comment.
The appetite for such deals in the bond market is increasingly important because credit hedge funds, who previously bought many loans directly from the firms, are buying fewer of late. Those funds have generally been under pressure because of turmoil in credit markets.
“As the hedge fund money leaves, [online lenders] need to replace it with longer-term capital,” said Matt Harris, a partner at Bain Capital Ventures who was an early investor in online lenders. “I don’t believe they have fully made that transition.”
These deals are also being watched closely by broader markets to see if investors are expecting consumers to struggle against the backdrop of economic slowdowns in Europe and China.
U.S. consumers have shown only limited signs of stress, though certain loans, including subprime auto loans, have begun to see higher than expected missed payments.
But delinquency rates on U.S. consumer debt overall fell 15% in February from a year ago, according to Equifax Inc. “More consumers are getting jobs and have steady income,” said Amy Crews Cutts, Equifax chief economist.
Moody’s surprised investors in February when it raised its expectation for loan losses from as low as 8% of the balance of loans to 12% in the three Citigroup deals for Prosper loans in 2015, and warned of a possible ratings downgrade.
For the new deal, Fitch Ratings expected defaults of 11%, which was its same forecast for the prior deal. Kroll Bond Rating Agency expected 9.5% to 11.5%. Moody’s didn’t rate the new deal.
Investors are also grappling with how regulation will affect the profitability of online lenders. Earlier this week, the Supreme Court asked the Obama administration to assess a legal challenge to the practice of relying on banks to make loans that exceed state usury caps. Many online lenders follow this practice.
The case, Madden v. Midland Funding LLC, was a “key credit consideration” that Kroll told investors to account for when considering whether to invest online loan securitizations. However, the loans in the new securitization deal were all below rates that could be barred by the court decision.
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