By Tracy Alloway, September, 25, 2014:
Michael Solomon spent the evening of his 47th birthday partying with Jefferies bankers at the securitisation industry’s annual gathering in Miami, Florida.
In the morning he announced a deal to sell $500m worth of the loans originated through his company – a peer-to-peer lender called CircleBack Lending – to Wall Street’s biggest broker-dealer.
Jefferies bankers now plan to securitise these “P2P” loans by bundling them into bonds that can be sold to a wide array of investors. It is the latest instance of an upstart peer-to-peer lender joining forces with large banks and investors with a view towards securitising the loans originated through online platforms.
Bankers are hungry for new types of assets to package and sell to investors and P2P loans are an attractive prospect as sales of more traditional securitisations – such as mortgage-backed securities – remain subdued after the housing bust.
“When you mention the word ‘securitisation’ people think it’s the next mortgage crisis,” says Mr Solomon, referring to the subprime mortgage bonds that wreaked havoc in the run-up to 2008. “The reason there was a mortgage crisis is because people were making loans to dogs and prisoners. We’re not making loans to dogs and prisoners.”
Peer-to-peer lenders, also known as marketplace lenders, use internet technology to directly connect borrowers with lenders. To date, the sector has focused on smaller consumer loans to high-quality borrowers, but lenders are expanding rapidly in size and style thanks to an influx of professional cash.
While the industry initially started with the goal of disintermediating banks, the biggest P2P players are now far more likely to team up with Wall Street than eschew it.
About 80 per cent of the loans originated through Prosper and Lending Club – the two largest P2P lenders – are estimated to be bought by big institutional investors rather than the individual retail investors that once dominated.
“Everyone is looking for new asset classes where they see a scaleable opportunity that can be securitised, as well as a yield play,” says Manish Kapoor of West Wheelock Capital.
In Miami, P2P lenders exhibited alongside more traditional financial players such as Bloomberg and Bank of New York Mellon. In standing-room only sessions, investors who had once flocked to Florida to learn about home loan documentation now discussed how best to plug in to P2P websites and purchase loans.
For many of them, the attraction of P2Ps can be summed up in one word: returns. At a time when two-year US Treasuries offer yields of just 59 basis points, investing in 15-month P2P loans can net investors double digit percentage point returns.
Ram Ahluwalia, chief executive of PeerIQ, a risk analytics firm for the P2P industry, says: “Short duration, high-yield credit is in scarce supply for the foreseeable future.”
For others, the lure of the burgeoning sector is more thematic.
“Internet-enabled lending is going to be the next big wave of finance and everyone here [in Miami] is trying to figure out how they should respond to it,” says John Polito of BNY Mellon.
So far hedge funds and wealth managers have been the dominant investors buying P2P loans, but that could change quickly. Creating securitisations of P2P loans evaluated by major rating agencies would open the sector up to a wider range of investors including insurers, pension funds and university endowments.
That would allow P2P lenders to get a cheaper rate of financing that they can pass on to borrowers – further spurring growth of the industry. Securitising loans could help the average online lending platform reduce its cost of funding by a few hundred basis points, Mr Kapoor estimates.
“Right now the lending platforms themselves are competing on loan growth. Over time being able to access capital more cheaply will be more important,” he adds.
For investors, securitisation promises a higher degree of leverage – meaning amplified returns – plus a standardised product they can trade among themselves. Banks earn fees from structuring the bonds.
So far there have been a handful of deals in the market. Eaglewood Capital, a hedge fund, was first out the gate with a $53m unrated securitisation sold last year. In July, SoFi, a P2P lender that specialises in student loans, scored a major win for the industry when it received an investment-grade rating from Standard & Poor’s.
Other funds, such as Garrison Investments, have been quietly selling small private deals, while Blue Elephant, a New York-based fund, is also exploring securitisation.
Yet the holy grail for the industry remains a chunky securitisation of peer-to-peer consumer loans – such as those made through Lending Club or Prosper – that would carry a stamp of approval from a major credit rating agency.
Some bankers, however, express doubts about the growing P2P asset class. “Securitisation is fine but it’s a question of the underlying asset,” says one banker at a large European bank. “P2P loans could end up being very risky.”
The threat of additional regulatory scrutiny hangs over the industry, causing some investors to be wary. Furthermore, P2P lenders have yet to weather a full economic cycle and some question how borrowers will behave during a recession or a period of rising interest rates.
Mr Solomon warns that while securitising P2P loans is not a bad thing, there is a danger the asset-class grows riskier as more bankers and investors pile-in and pressure to expand the sector increases: “At some point you’re going to have yield-chasers moving down the credit curve.”