This week’s news centered around the presidential Inauguration. As one of the final acts of the Obama administration, the National Economic Council published a FinTech white paper highlighting principles for FinTech. The paper cited policy objectives including financial inclusion, transparency, and the need to increase efficiency in financial infrastructure.
In the ABS market, SoFi announced plans to expand its mortgage business and issued a $477 Mn unsecured consumer loan ABS. Also, industry buzz focused on an ABS 15-G filing from Mosaic suggesting an imminent securitization. Mosaic, a provider of affordable solar financing to homeowners, raised $220 Mn in a round this past August led by Warburg Pincus.
This week, we expand upon our summary of trigger breaches in the 4Q 2016 Securitization Tracker. We introduce the concept of triggers, analyze the consequences of breach in marketplace lending ABS deals, and highlight steps issuers and investors can take to manage these risks.
Trigger Breaches May Magnify Reputational Risk for Originators
MPL ABS transactions are comprised of static pools with a pre-defined collateral pool and structural features designed to align the interests of noteholders with equity holders.
After closing, the collateral cashflow is allocated to noteholders and equityholders according to the cashflow waterfall logic in the offering documents. A Trustee will represent the interests of senior noteholders and monitor for compliance with covenants.
Triggers are a structural feature that provide senior bondholders with protection against a reduction in credit support. Triggers applying pre-defined tests (e.g., minimum excess spread, cumulative loss levels, delinquency rates, violations of reps & warranties, etc.) and may re-direct cashflows to senior noteholders if one or more tests are violated.
A trigger breach may force originators/sponsors to divert capital to repay noteholders rather than re-invest precious capital into revenue-generating origination activities. Such a “double whammy” is associated with headline risk, which can leader to reputation damage, and negatively impact future financing activities, either in a warehouse facility setting or during ABS transactions.
Noteholders may demand greater compensation or credit enhancement in future transactions. This reduces the economics for first-loss, residual investors which may be reluctant to co-fund residual interests alongside the sponsor of the securitization.
Trigger Breaches in MPL ABS Deals
Over the last four months, we have observed a few trigger breaches in MPL ABS structures. Trigger breaches are a manifestation of unexpected credit performance, poor credit modeling, or unguarded structuring practice.
The average time to breach performance triggers for consumer MPL ABS deals was approximately 11 months as collateral losses ramped up within the deal. Exhibit 1 summarizes the ten active deals that breached triggers in the MPL ABS sector (eight unsecured consumer and two SME deals) with $1.3 Bn of the total issuance volume. We excluded two retired deals that breached triggers (MPLT 2015-OD2 and MPLT 2015-OD1).
Exhibit 1 Trigger Breaches in Active MPL ABS Deals
Source: Bloomberg, PeerIQ, Ratings Agencies
The negative headlines associated with trigger breaches increases the cost of capital for originators, and reduces the availability of funding.
CAN 2014-1A illustrates the potentially severe consequence of unexpected failing deal triggers. After two years of seasoning, CAN re-classified a portion of collateral loans that were represented as current, but should have been treated as delinquent in the CAN 2014-1A transaction. This led to a breach of the minimum excess spread trigger. The unexpected trigger prompted a $46 Mn balloon payment to senior bond holders. The payment created significant liquidity pressure on CAN Capital and forced suspension of origination activities. The trigger breach and data integrity issues together led to expulsion of C-level management, significant headcount reductions, and a review of strategic alternatives.
We note that the vast majority of extant MPL ABS deals have low probability of breaching, and that the CAN Capital case is also severe given the related data integrity issue.
Trigger Play: “Tug-of-War” between Senior Noteholder and Equity Holders
Investors need to be aware of trigger breach implications from the investor perspective as well. Early amortization triggers have differing effects to investors across the capital structure.
If an early amortization trigger is violated, excess spread (e.g., collateral cashflows less financing costs payable to noteholders) are diverted from equity investors to senior noteholders with the goal de-risking the senior noteholders as quickly as possible. Therefore, although senior noteholders may be structurally insulated from first loss-risk, senior noteholders are nevertheless exposed to high levels of prepayment and reinvestment risk.
From the equity investor’s perspective, tighter triggers allow higher potential equity returns in the absence of any collateral losses. However, if losses exceed the available cushion before the triggers are breached, cashflows to the equity investors will be cut off faster and cause a reduction in the expected equity returns.
Conversely, less restrictive triggers allow more cushion for losses before the coverage tests are breached. Additionally, senior notes would carry lower prepayment risk as the early amortization scenario is minimized. Further, less restrictive triggers require greater subordination levels and more capital.
Selected Trigger Definitions
MPL ABS transactions typically utilize tests based on both cumulative losses, current delinquencies, and cumulative deferments/forbearances triggers. The cumulative loss trigger threshold is usually defined as a percentage of the original balance of the deal. Once both tests are satisfied, the subordinate classes may receive their allocated share of principal repayments.
Delinquency Test Example: The outstanding principal balance of all loans delinquent 60+ days or more, including loans in foreclosure, real-estate owned (REO), or bankruptcy status as well as any loan modifications.
Early amortization triggers are effective only during the early part of the deal life, typically during the first 24 months, as a mechanism to protect senior noteholders. After breaching turbo triggers, the deal’s available cashflow will not be available for the equity holders until senior notes are repaid in full. The transaction enters into “full turbo amortization” where all available funds will be used to pay:
i) senior transaction fees,
ii) interest on the senior notes,
iii) replenish the reserve account,
iv) and pay principal on the senior notes.
Cumulative Net Loss (CNL) Rate Trigger Example: This prevalent trigger can be defined in a number of ways as issuers and originators work together in the deal structuring phase. Exhibit 2 illustrates a contrived trigger threshold profile. The trigger breach level is defined and increases with respect to the deal age. A trigger event occurs if the realized cumulative net loss rate exceeds the trigger threshold of the collateral.
Exhibit 2 Stylized Cumulative Net Loss Rate Trigger
Trigger features are also specific to collateral type. In the case of student-loan refi ABS transactions, the deal will go into full turbo if any of the triggers below have been breached:
1) aggregate deferments and forbearances (as a percentage of the initial pool principal balance) exceed a predefined threshold,
2) or cumulative defaults exceed a predefined level.
Greater Control & Risk Management
A desire to improve execution combined with the growing number of deals that breach triggers in the MPL ABS space are leading marketplace lenders to take greater control of their ABS programs.
Sponsors and ABS investors are using sophisticated 3rd party analytics, such as those offered by PeerIQ, to independently model deal economics, monitor collateral and ABS programs on an on-going basis, and perform 3rd party data credit validation and verification to ensure representations and warranties are honored.
- Context Summits’ Alternative Lending Summit January 30-31st in Miami.
- SFIG Vegas on February 26-March 1 in Las Vegas.
- LendIt on March 6-7 in New York.
PeerIQ in the News:
- Finalists Announced for First Annual LendIt Industry Awards (YahooFinance, 1/19/17)
- Lendit Announces Finalists For First Annual Industry Awards (CrowdfundInsider, 1/19/17) PeerIQ named as Top Service Provider finalist.
- Banks Get Their Own P2P Lending Software (LendingTimes, 1/16/17)
- Solar Panel Deal Headed to Market (AB Alert, 1/20/16) Mosaic’s capital markets chief, Katya Baron, is bringing Mosaic’s first ABS deal to market.
- MPL Deal Flow Opens up with SoFi Consumer ABS (Global Capital, 1/17/16) SoFi’s $477 Mn unsecured consumer loan transaction to open up the marketplace loan ABS pipeline.
- SoFi: Mortgages will Experience Fastest Growth (CrowdFundInsider, 1/17/16) SoFi expects the online mortgage origination industry to be the fastest growth of any of their products to date.
- Bidders Lukewarm on CAN Loans (AB Alert, 1/20/16) Two dozen asset managers have looked at the portfolio, but bids are below expectations.
- Obama Administration Publishes Fintech Report Ahead of Trump Inauguration (AltFi, 1/19/17) National Economic Council emphasizes transparency, efficient infrastructure, and financial inclusion amidst other policy objectives.
- Newfangled FinTech Meets Oldfangled FinReg (Bloomberg, 1/19/17) NY state regulators reject the OCC proposal in a note filed Tuesday.
- Recap of Recent Performance Trends with Lending Club and Prosper – Part #2 (LendAcademy, 1/18/17) How recent vintages are trending since the first quarter of 2014.
- $100M in Debt Financing for Texas-based Online Lender (AmericanBanker, 1/19/17) BorrowersFirst secured an additional $100 Mn in debt financing from Waterfall Asset Management.
- Student-Loan Startup Raises Money from Prosper’s Suber, Others (1/18/17) Credible, which offers an online exchange for student and personal loans, raised $10 Mn to expand its business of matching borrowers with lenders.
- Alexa Gives Amazon a Powerful Data Advantage (MITTechnologyReview, 1/18/17) Millions of customers interacting Alexa provides the training data to help Amazon compete in the home voice assistant market.