In recent weeks, we have fielded several inquiries regarding how marketplace lending bonds are trading after the Lending Club earnings announcement and disclosures on May 9th.
We attempt to answer these questions in this month’s newsletter.
How are ABS deals impacted by Lending Club news?
Going into May, spreads on marketplace lending bonds tightened with broader credit markets leading up to the May 9th Lending Club event. MPL spreads, particularly unsecured consumer installment loans, have tended to act as a frontier market–risk premiums were first to widen and last to tighten. After the event, credit spreads continued to tighten in sharp contrast to the volatility observed in the stock price of Lending Club.
This week, we studied the credit investors’ response to the recent news through secondary market ABS, using the CHAI and SoFi shelves as market barometer. We choose to focus on these two shelves as they have the longest running history, deal size, popularity amongst investors and market-makers, and consistency across deals.
Note that the CHAI shelf, issued by Citi, has historically consisted principally of unsecured consumer installment loans issued by Prosper. The SoFi shelf below consists of student loans. (Student loans are non-dischargeable and have substantially different default, prepayment characteristics and loan terms as compared to consumer loans, so we should limit our conclusions accordingly.)
Since we want to address the market reaction before and after the Lending Club event, we reviewed quote history from the beginning of the year to last week. CHAI 2015-PM2, CHAI 2015-PM3, CHAI 2016-MF1 and CHAI 2016-PM1 are included for CHAI shelf; and SOFI 2013-A, SOFI 2014-B, SOFI 2015-B, SOFI 2015-C, SOFI 2016-A are included for SOFI shelf.
The most actively quoted parts of the CHAI capital structure are the Class B and C subordinate tranches. There are fewer quoted observations on the senior tranches owing to the short-duration of these bonds. In contrast, the SoFi senior pieces, A, A1, and A2’s, frequently appear on dealers’ inventory and quote sheets and the B’s exhibit limited trading.
We show below the average quoted credit spread for the senior and sub pieces for CHAI and SoFi shelves. The vertical blue line indicates the Lending Club Q1 earnings event and disclosure on May 9th, 2016.
The results are consistent with our impressionistic survey of investors in the aftermath of the event–existing MPL ABS investors are eager for more deals.
The results are also consistent with our spring thaw hypothesis on March 27th–namely, that the wide spreads observed on CHAI PM-3 were incompatible with improvement in market action and other credit spread products.
We perform a similar analysis–this time looking at the average quoted spreads by tranche.
The tightening is most prevalent for the riskiest CHAI C bonds, indicating a reduction in the market’s expectations of cumulative losses.
The SoFi senior tranche has tightened substantially and its current levels are the tightest we have seen. The tightening is welcome news–it affords SoFi the ability to extend even lower rates to consumers and increase their effective net interest margin. As noted in the PeerIQ analysis of SoFi’s deal last week, the base of participating ABS investors in the deal has expanded considerably and includes 38 investors across Europe and Asia. Broader market acceptance and interest is lowering the yield.
Why should platforms monitor secondary ABS spreads?
Securitization as a funding source is in competition with other term financing solutions as aggregators will seek to minimize their overall total financing cost. A tightening in credit spreads suggests a reduction in financing costs as credit facilities come up for renewal.
As noted in our Q1 2016 Securitization Tracker, one of the impediments to attracting whole loan buyers is the increased financing cost. Institutional investors–particularly credit hedge funds, large asset managers, and BDCs––have a return objective above 10%. Higher financing costs imply lower margins for institutional investors who will demand a commensurate step-up in rates to earn the same net return.
We illustrate the sensitivity of Net Returns as a function of financing costs and defaults in this simplified example.
(For simplicity, we assume an advance rate of 80%, no ramp-up and cash-drag effects, no legal fees, fixed-rate financing, and maximum utilization of the facility.)
Platforms can influence financing costs
The visible, traded securitization market sets pricing for other distribution channels. Platforms are increasingly taking a hands-on approach to improving execution in their ABS market by promoting transparency, standardization, and liquidity. Securitization is an essential feature of the funding strategy for any mature platform–marketplace, balance sheet, or otherwise.
Platforms that successfully implement ABS programs see the knock-on benefits in terms of reduced funding costs for whole loan buyers.
- CEO, Ram Ahluwalia, will join a panel discussion entitled, “Alternative Lending Securitization and Similar Capital Sources,” on June 9th in New York—RSVP here.
- PeerIQ will speak at SCI’s 2nd Annual Marketplace Lending Securitisation Seminar onJune 28 in New York.
- Ram Ahluwalia will speak on a panel at AltLend 2016 on July 13-14 in New York. PeerIQ guests will receive a 35% discount off of the standard rate. Email firstname.lastname@example.org with any inquiries.
- PeerIQ will be in Miami for the ABS East Conference September 16-18.
Hiring Update: Introducing Amit Siroya!
- Amit Siroya joins PeerIQ as VP Quantitative Strategies. Prior to PeerIQ, Amit worked as an Investment Analyst at IMC Investment Management. He was responsible for developing quantitative and event-based credit trading strategies in RMBS and ABS. Amit earned his Master of Science in Financial Engineering from Columbia University. He also holds a Master of Technology in Microelectronics and Bachelor of Technology in Electrical Engineering from IIT Bombay.
- Payday-Lending Curbs: Thumbs Down From Banks, Thumbs Up From Fintech (WSJ, 6/2/16) New rules proposed by CFPB to curb abusive payday lending praised by online lenders and disliked by banks and credit unions.
- Federal Reserve to Toughen Stress Tests for Big US Banks (FT, 6/2/16) Fed to impose stiffer requirements on annual CCAR stress test for larger banks.
- Funding Shortage Shakes Up Online Lenders (AB Alert, 6/3/16) Smaller originators feel greatest impact from struggle to find sources of funding.
- Should P2P Lenders Be Concerned About Rising Rates? (Forbes, 6/3/16) P2P lenders can continue to offer savings to borrowers in a rising interest rate environment due to low rate sensitivity.
- China’s CreditEase Commits to Purchasing U.S. Peer-to-Peer Loans (Bloomberg, 5/31/16) CreditEase to buy $50M of loans from Prosper and Avant, making it the first Chinese offshore fund to invest in unsecured personal loans made to Western borrowers.
- Lending Club Corp: Retail Platform Funding Spikes (Morgan Stanley, 6/1/16) Surge in retail platform funding–drivers are inconclusive.
- In Defense of Online Lending (TechCrunch, 6/2/16) Recent turmoil in MPL industry fueled by uncertainty, not a fundamental flaw.
- Ellington Goes Long Consumer Loans as Americans Borrow Less (Bloomberg, 6/1/16) Ellington Financial considers buying online personal loans and funding loan via securitization.
- New York State Launches Inquiry of Online Lenders (Reuters, 6/3/16) New York state’s financial regulator requests information from various online lenders.
- Fair Value? (SCI, 5/31/16) “Market participants currently employ a number of different methodologies to price MPL loans, not all of which provide an accurate representation of fair value.”
- No Credit Card? No Big: Startup for Under-Banked Shoppers Clinches Series B(Bizjournals, 6/2/16) PeerIQ investor, VPC, leads funding round for Zibby, a New York based lease-to-own payment start up.
- PeerIQ Software Engineer, Brendon Villalobos, wins $100K as a finalist on Intel sponsored America’s Greatest Makers.