In a widely expected move, the FOMC raised Fed Funds target rate 25 bps to a target range of 100 to 125 bps. The US Treasury released a report on banking and regulatory form, which if implemented, would lead to the revitalization of the private-label MBS market.
The past week was a seminal one for SoFi, Lending Club, and Upstart.
SoFi filed for an ILC bank charter in the state of Utah. The application indicates SoFi seeks to offer deposits and a credit card product. SoFi Bank, led by Arkadi Kuhlman, would be capitalized with $166 Mn in equity. Kuhlman was the Former CEO of ING Direct (and money transfer service Zenbanx). ING Direct pioneered online deposit-banking and may provide a glimpse into SoFi’s mobile banking aspirations. SoFi’s focus on community, a credit card offering, and a rewards program reminds us of another highly successful mass affluent brand–American Express.
This week, we focus on Lending Club and Upstart’s first sponsored ABS securitizations.
Collateral Comparison Benchmarks
Below we show a comparison of recent deals from Upstart, Lending Club, Prosper, and One Main.
Source: PeerIQ; Kroll Bond Ratings Agency
Overall, we observe significant variation in underwriting strategies as explained by credit score, term, loan balance, pricing, and channel.
We find that:
- Lending Club’s CLUB 2017-NP1 has among the highest excess spread among its peer group – indicating an exceptional return for whole loan investors in the seven party multi-seller group under the base case scenario.
- Lending Club’s closest comp may be OneMain’s OMFIT 2016-3. Both deals have comparable credit scores, loan balances, and collateral interest rate.
- OMFIT has approximately 50% of loss estimate as compared to CLUB 2017-NP1. This is driven primarily by channel effects (e.g., retail branch vs. online origination), other forms of security attached to the loan, and potentially a conservative ratings approach in evaluating CLUB 2017-NP1.
- Upstart has the lowest loss range estimate across the cohort of marketplace lenders, and the lowest coupons. Upstart also has a greater mix of longer-term loans. Upstart’s closest comp is Prosper’s PMIT 2017-1.
- PMIT 2017-1 has a comparable loss-range as UPST 2017-1 but picks up two points in excess spread due to higher WAC.
Capital Structure and Pricing
Bond investors in the Lending Club and Upstart deal benefit from credit enhancement consisting of over-collateralization, subordination, reserve accounts, and excess spread.
Exhibit 2 compares structure and pricing side-by-side:
Notes: Initial CE is the initial hard credit enhancement and includes the percentage size of the subordinated classes, initial overcollateralization, and the reserve fund. Source: PeerIQ, Kroll Bond Rating Agency.
CLUB 2017-NP1 and UPST 2017-1 both secured an A- rating on the senior class.
However, CLUB 2017-NP1 has one notch higher ratings on its Class B and Class C tranches, at BB and BBB respectively, despite a 7% higher loss estimate as compared to UPST 2017-1.
The higher rating is due to higher excess spread and structuring – the remaining classes have greater credit enhancement in the form of initial OC. Citi and JPM we co-structuring leads on the CLUB 2017-NP1.
Both deals priced tighter than guidance. Tranches A and B of the UPST deal priced 5 bps tighter than guidance while tranche C priced at guidance. The A, B and C classes of CLUB 2017-1 priced 15, 20, 30 bps tighter than guidance.
In a notable milestone, the Class A tranche of CLUB 2017-NP1 priced at L+110 bps – the tightest pricing of any consumer loan securitization tracked by PeerIQ’s Securitization Tracker. From a funding cost perspective, the rate is competitive with term CD rates offered by GS Bank.
The tight execution is driven by a “risk-on” appetite, an alignment of interests among the sponsor and bond investors, higher levels of credit enhancement, and the short duration of the notes. Lending Club has also taken steps to structure around “true lender” risk by excluding borrowers from CO in the pool, and offering to purchase back loans that are challenged under state usury laws.
Exhibit 3 shows tranche pricing with respect to weighted-average life.
The steepening in the pricing curve again reflects demand for senior rather than equity-like risk (Exhibit 3).
Exhibit 3 Recent Personal Loan ABS Pricing Spreads
Besides credit support, senior tranche investors have additional structural protection in the form of a cumulative net loss rate trigger, which leads to accelerated repayment of principal in the event of worse-than expected collateral performance. (We illustrated the dynamics of trigger play in our earlier newsletter by applying simple hypothetical loss and prepayment assumptions.)
The CNL trigger is another mechanism to align the interests of bond investors and sponsors to the transaction. 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.
We continue to observe a pattern of higher CNL triggers in recent deals, reflecting a conservative outlook from market participants.
Exhibit 4 shows several cumulative net loss (CNL) trigger profiles in recent personal loan ABS deals. Here, we summarize the cumulative loss trigger profiles from recent deals.
Although the equity tranche investors in CLUB 2017-NP1 are providing greater subordination to bond investors, they benefit from a less restrictive CNL trigger. CLUB 2017-NP1 has the highest starting CNL profile (MOB=1) vs. its peer group, starting at 7% and peaking at 29%.
By contrast, UPST 2017-1, structured and led by Goldman Sachs, has the lowest loss estimate amongst its peers, has a tighter initial trigger at 4% and peaks at 18% (a similar CNL profile to its closest comp PMIT 2017-1). UPST also benefits from somewhat higher structural leverage for equity tranche participants.
CLUB 2017-NP1 is a landmark ABS deal for the marketplace lending space. The deal successfully navigated regulatory challenges and the competing interests of seven whole loan investors, ABS investors, and the sponsor (a Lending Club Majority Owned Affiliate). We believe the deal template completes the marketplace lending model by linking myriad liquidity-seeking whole loan investors to the yield-hungry debt capital markets.
PeerIQ in the News:
- Lending Club Markets First Sponsored Deal (GlobalCapital, 6/12/17)
- Lending Club and The Rise of Club Deals (SmallBusinessLending.io, 6/12/17)
- Does Anyone Remember How to Make a Subprime Mortgage? (WSJ, 6/12/17) Non-bank lenders are seeking mortgage brokers for estimated $200 Bn market.\
- U.S. Treasury Department Report on Banking and Credit Union Regulatory Reform: Securitization Fact Sheet (SFIG, 6/12/17) SFIG summarizes major policy proposals contained in Treasury’s June 2017 report and potential impact to securitization and structured finance markets.
- US Treasury Reform A Financial System that Creates Economic Opportunities Banks and Credit Unions (US Department of the Treasury, 6/17) U.S. Department of Treasury released the first of several anticipated regulatory reform reports to the President.
- Online Lender SoFi Takes Step Toward Becoming a Bank (WSJ, 6/12/17) SoFi seeks to establish an industrial bank chartered by Utah to offer an FDIC-insured deposit account and a credit-card product (SoFi Bank Charter Application).
- Biggest Online Lenders Don’t Always Check Key Borrower Data (Bloomberg, 6/14/17) Investors are increasingly seeking third party tools to verify and validate credit risk.
- Subprime Auto Has ‘Credit Issues,’ Top ABS Analyst at BofA Says (Bloomberg, 6/12/17) According to BofA analyst, securities backed by certain auto loans have fundamental credit issues, specifically citing subprime deals in bonds supported by car rentals.
- Another Week, Another $5B of Auto-Related ABS (Asset Securitization Report, 6/16/17) Eight issues of auto-related securitizations totaling over $5 Bn hit the market from non-banks including Ford, Honda, Santander Consumer, GLS, United Auto Credit Corp., Ally, Navistar and Enterprise.
- Lending Club Tweaks Deal Format (AB Alert, 6/16/17) By excluding borrowers in Colorado from the pool of loans in its’s latest personal-loan securitization, Lending Club offers an example of how issuers are insulating investors from risks associated with local usury laws.
- Investors Play the Risky Role of Lender (WSJ, 6/15/17) Looking for better returns, some of the world’s most conservative investors are taking bigger risks by lending directly to companies.
- New Lending Club ABS structure a draw for Investors (Global Capital, 6/14/17) ABS investors receptive to Lending Club’s decision to do a club offering.
- Microsoft Researchers Developed An AI That Got A Perfect Score On ‘Ms. Pac-Man’ (Forbes, 6/14/17) Researchers apply reinforcement learning technique to beat Ms. Pac Man.