Marketplace lending securitization remains a bright spot in the ABS market. Total issuance topped $3 Bn this quarter with cumulative issuance now totaling $18.0 Bn across 80 deals.
The movement towards rated securitizations at larger transaction sizes continues. All deals were rated in this quarter, with record-sized consumer deals from SoFi, a large multi-seller deal from Marlette, and the first prime paper deal from Lending Club. All deals this quarter had at least one rating.
New issuance spreads continued to tighten and flatten—a credit friendly environment for securitization. In 1Q2017, we saw spreads tighten in riskier tranches, indicating strong investor appetite for MPL ABS paper in the market.
Bank and non-bank platform partnerships continue to emerge.
Over 15 banks are purchasing loans from marketplace lenders.
Our year-end forecasts volumes for new issuance of $11.2 Bn remain on-track. New issuers and repeat issuers are increasing deal activity.
3rd party solutions are emerging to improve investor confidence.
Originators are relying on 3rd party solutions to address “stacking”, perform data verification, loan validation, and improve investor confidence.
We expect higher volatility from rising rates, regulatory uncertainty, and an exit from a period of unusually benign credit conditions. Platforms that can sustain low-cost stable capital access, build investor confidence via 3rd party tools, and embrace strong risk management frameworks will grow and acquire market share.
Authors
Wilfred Daye wilfred@peeriq.com
Jianguo Xiao jianguo@peeriq.com
Yishu Song yishu@peeriq.com
Investors should consider PeerIQ as only a single factor in making their investment decision. Please refer to the Disclosure Section, located at the end of this report, for information on disclaimers and disclosures.
Introduction
Benign Macro Conditions Amidst Rising Rates
On March 15th, the FOMC announced an increase in the Fed Funds rate with a new target of between 75 and 100 basis points. The decision comes at a time when the unemployment rate is at 4.7%, the US economy generated 2.1% GDP growth in 4Q2016, and robust year-over-year wage growth of 2.8%. Fed futures forecast two more rate hikes before end of year. Consumer confidence continues to climb to its highest levels since August 2001.
The “risk-on” environment has continued in the first quarter of 2017 as the global reach for yield intensifies. 10-year bond yields remain at 2.4%, while the equity markets have continued to rally with the S&P 500 up 5.8% YTD and other equity indices near record highs.
For 1Q2017, overall credit markets have exhibited low volatility and credit conditions remain relatively favorable. Implied volatility on 3-month CDX HY options reached another historical low of 34%. On-the-run CDX HY traded 16 basis points tighter than 2016 year-end close with a range bound between 307 to 355 basis points. Further, in the US CLO market, new-issue spreads continue to grind tighter and reach historical tights.
Strong Capital Markets Activity in Marketplace Lending ABS
The encouraging macro conditions continued to support the growth of the MPL ABS market after the holiday season. The first quarter of 2017 witnessed several record-sized MPL securitizations. Seven deals priced, totaling $3.0 Bn, comprised of consumer, student, and SME collateralized deals. New issuance volume doubled in 1Q2017 vis-à-vis 1Q2016; the cumulative issuance volume now stands at $18.0 Bn since the inception of MPL ABS market in 2013.
The industry continues to experience strong investor sentiment as evidenced by growing deal size and improved deal execution. SCLP2017-1 is not only SoFi’s largest deal, but is also the largest unsecured consumer ABS in MPL ABS history with a collateral pool of $650 Mn. Marlette Funding Trust 2017-1 is the largest deal to date for the MFT shelf, with a size of $333 Mn, pricing tighter than MFT 2016-1 across all tranches with a flattened credit curve. On the SME side, Kabbage’s $525 Mn deal, led by Guggenheim, was also oversubscribed.
Another milestone reached in this quarter was the Arcadia Receivables Credit Trust 2017-1, which was the first ABS deal backed by LendingClub Prime loans. This continues
LendingClub’s presence in the securitization market after last quarter’s initial deal from the LCIT LendingClub shelf.
In addition to securitization activity, several partnerships with non-bank lenders developed in this quarter. Deutsche Bank upsized its revolving credit facility with OnDeck to $214 Mn. Prosper announced a $5.0 Bn loan-buying deal with a consortium of structured credit investors.
On the equity side, SoFi reached a $500 Mn investment led by Silver Lake for another round of financing, and further extended its distribution channel to community banks by partnering with Promontory Financial. Upstart announced a $33 Mn financing led by Rakuten.
M&A prospects increased in the small business sector this quarter. EJF and Marathon have built sizeable positions in small business lender ONDK. Kabbage is reportedly raising capital to fund acquisitions as well.
The IPO markets are re-opening to non-bank lenders. Elevate Credit (ticker: ELVT) set a $12 to $14 price range and intends to raise up to $107.8 Mn this week.
Strong Credit Facility Deal Flow
Besides securitization, credit facility warehousing is an alternative venue for lenders to source financing; however, the cost of credit facility depends the borrowers’ counterparty risk, asset class, credit performance, and pricing in the competing ABS market.
OnDeck continued to restructure its financing framework. It amended its asset-backed revolving credit facility with Deutsche Bank, extending the maturity date and increasing borrowing capacity. The Class A tranche of the facility has an advanced rate of 85%; and Class B 91%.
Further, Fundation secured an asset-backed credit facility to expand its business from MidCap Financial, a specialty finance firm. Renovate America completed a $100 million credit facility with Credit Suisse to expand its unsecured consumer home-improvement lending product.
Waterfall Asset management provided a £100 Mn credit facility to UK-based Lendable and $100 Mn facility to BorrowersFirst. Victory Park Capital provided a $100 Mn facility to LendUp.
Deal Performance Weakens, Structures Protecting Senior Notes
Elevated charge-offs have contributed to trigger breaches in ten active MPL ABS deals, eight unsecured consumer and one SME deal, representing $1.5 Bn of total issuance volume.
Data integrity continues to be in the mind of all participants in the marketplace lending ecosystem. In December 2016, Structured Finance Industry Group (SFIG) released the ”Green Paper” on data reporting standards. To further bolster SFIG’s effort, PeerIQ offered the industry Data Standards and Best Practices, which summarized the key learnings and best practices we have developed from years of experience as the leading data & analytics provider in the marketplace lending ecosystem.
Definitions and Inclusion Rules
Our Tracker includes all issuances connected to assets originated by marketplace lending platforms, which we define as including both:
(i) Online and other novel technologies to increase operational efficiency, risk accuracy, and borrower experience, and
(ii) Non-deposit funding for lending capital.
We recognize there is rapid innovation in lending channels, and welcome all comments and consideration on inclusion rules.
I. Quarterly Round-up
The first quarter of 2017 witnessed seven securitization deals, totaling $3.0 Bn in new issuance, the largest quarterly total that the MPL ABS market has seen, which brings total issuance to $18.1 Bn. This represents a 20% increase over 4Q2016, and 100% increase over 1Q2016.
Total securitization issuance to date now stands at $18.1 Bn, with 80 deals issued to date (48 Consumer, 22 Student, 1 Mortgage and 9 SME) since September 2013 (Exhibit 1).
Exhibit 1
Cumulative Marketplace Securitizations
Examining issuance by underlying collateral segment, we see large increases in consumer and student relative to the first quarter of 2016, up 76% and 54% respectively. SME remains the smallest segment, but Kabbage’s $525 Mn issuance is the largest SME deal since their previous one in 2014 (Exhibit 2).
Q1 2017:
• SoFi: SOFI 2017-A, SOFI 2017-B, SCLP 2017-1, SCLP 2017-2
• LendingClub: ARCT 2017-1
• Marlette: MFT 2017-1
• Kabbage: KABB 2017-1
This quarter, SoFi priced its largest consumer securitization, which is backed by a $650 Mn pool of consumer loans. SoFi continues to remain active in the student sector as well with two deals this quarter totaling over $1 Bn.
Prior to this quarter, the market had only seen deals backed by LendingClub Non-Prime loans; however, with the Arcadia Receivables Credit Trust 2017-1, we witnessed the pricing of the first deal backed by LendingClub Prime loans. The deal consists of loans with higher average loan balances and higher FICO scores, which resulted in tighter pricing than tranches backed by non-prime loans.
Rating agency participation has continued to be a key driver for strong deal execution. All deals issued in 1Q2017 were rated by at least one rating agency (Exhibit 3 & 4). Again, we expect that the almost all MPL ABS deals will be rated as issuers seek to broaden the base of eligible investors and access cheap funding.
Finally, deals continue to increase in average deal size over time, led primarily by SoFi’s large placements. The average securitization deal now stands at $425 Mn for 2017 (Exhibit 5).
II. MPL Securitization League Tables
Dealers intensified their participation in MPL deals this quarter with Goldman Sachs, Deutsche Banks, and Guggenheim scoring record-sized deals. Maintaining its top rank in the league table, Goldman Sachs led $625 Mn in total new issuance, an 18% growth from 4Q2016 (Exhibit 6). It executed deals with SoFi and Marlette to maintain its 23% market share in MPL ABS. Further, Guggenheim showed over 200% growth through their role as the sole dealer in Kabbage’s $525 Mn securitization. The top three dealers, Goldman Sachs, Morgan Stanley, and Deutsche Bank have contributed to over 55% of the total market share in MPL space.
As we noted in 4Q2016, deal interest and involvement remains high despite mixed headlines, regulatory uncertainty, and firm-specific considerations throughout 2016. This positive trend continued in 1Q2017 with nine of the top ten lead managers increasing their involvement in MPL issuances. In addition, the industry saw new participant, BAML, lead the two SoFi student deals this quarter.
Risk retention regulations, now in effect, increases the capital burden for issuers and may slow the pace of deal activity. Various risk retention solutions are emerging as we have summarized here.
Turning to the co-manager league table, SoFi remains the clear leader in the co-manager league, increasing their participation value to over $3.4 Bn through their co-manager position on their two student deals (Exhibit 7).
Deutsche Bank and Morgan Stanley’s co-manager participation in these SoFi deals significantly increased their involvement as well. This brings Morgan Stanley even closer to joining the top three participants, which now maintain approximately 65% of the total market share.
From originator league table (Exhibit 8), SoFi is a clear leader and takes over 51% of the market share. The second place Prosper only has 13% of the total pie. Further, SoFi has much large sandbox, including student refi, unsecured consumer and mortgage loans, whereas other originators focus on a single vertical. 
We currently observe 143 rated MPL ABS bonds in the market. As of 1Q2017, DBRS leads Moody’s, Kroll, S&P and Fitch in the amount of rated bonds (Exhibit 9). DBRS rated $6.6 Bn Student MPL ABS, or approximately 45% of sub-segment, competing primarily against Moody’s within the student sector. Kroll dominates the Consumer MPL ABS category with 53% market share. The mortgage sub-segment currently has an even split amongst DBRS, Fitch and Kroll.
1Q2017 also saw an increase in ratings actions. For deals issued prior to 2017, there were several ratings updates. Deals from SOFI, EARN, AVNT, and CHAI shelves received ratings upgrades, serving as, yet, another positive sign from the agencies.
CAN 2014-1A was downgraded by both S&P and DBRS as the deal breached the minimum excess spread trigger.
III. New Issuance Spreads
New issuance spreads in 1Q2017 continued to tighten, reflecting a healthy risk appetite in the capital markets. We saw a continued preference for senior tranches over riskier subordinated bonds (Exhibit 10). However, in the consumer and student sectors, the term structures flattened from the previous quarter, reflecting stronger investor appetite for riskier tranches.
Kabbage executed a first SME securitization since Q216, backed by a revolving pool of receivables consisting of (i) business loans or (ii) merchant cash advances. The deal features a 36-month revolving period during which time principal collections may be reinvested to purchase additional receivables. The A tranche was priced 50 basis points tighter than deals in Q216; and the B tranche priced 270 basis points tighter. The D tranche priced at 1050 basis points, forming a steep credit curve.
IV. Deal Credit Support Profile
Deal credit performance has weakened, although structural protections continue to protect bondholders. Deteriorating collateral performance has contributed to trigger breaches in ten active MPL ABS deals, eight unsecured consumer and one SME deal, representing $1.5 Bn deal issuance. Despite weakening in credit performance, we have not seen a meaningful uptick in initial credit support for unsecured consumer loan MPL ABS, reflecting growing comfort in the current conservative rating approach by the agencies. The senior and mezzanine tranche initial credit support has been stable for SoFi, LCIT, and other shelves (Exhibit 11). Still, Avant deals have featured increasing credit support at issuance (solid lines are regression lines).
Due to the amortizing nature of the collateral pool, MPL ABS bonds typically exhibit shorter weighted-average life (WAL) and a faster deleveraging profile than other structured products, such as MBS bonds backed by 30-year mortgage collaterals. As deals season and perform as initially expected, the credit supports increases. We quantify the amount of deleveraging by measuring the differences in current and original credit support for the same bond. Exhibit 12 shows that the senior part of capital structure begins to deleverage first then mezzanine tranches (solid lines are regression lines). For instance, Prosper senior bondholders will enjoy a 40% improvement in credit support as the bond seasons.The declining credit support in Loan Depot and CircleBack deals reflectsworse-than expected collateral performance and the structural impact of breaching performance trigger
V. Credit Performance Trends
Consumer credit delinquencies and charge-offs continued to increase during the first quarter, across consumer credit verticals including installment, student, and auto loans. Prime credit card portfolios continue to exhibit low and stable levels of delinquency.
This quarter, we released a Performance Monitor to track the health of marketplace lending loans using bellwether public programs from LendingClub and Prosper. Charge-off rates for both originators continue to be elevated for loans in 2016 vintages. The increase in charge off rates agree with delinquent loan pipelines as loans transition from delinquency to charge-off states. Originators have taken actions including tightening underwriting criteria and raising rates.
Charge-offs remain elevated outside of marketplace lending as well. 60+ delinquency rates were up for private-label credit cards; FFELP and non-FFELP student loans experienced higher delinquency rates as well. In the auto sector delinquency rates on prime and subprime delinquencies may pass pre-crisis levels by end of year.
The primary driver of increased losses for non-bank lenders more generally are
i) a mix-shift to riskier borrowers as measured by credit score,
ii) increased “stacking” behavior (whereby consumers take out multiple loans simultaneously), and
iii) re-leveraging of the consumer balance sheet due to greater availability of credit.
VI. Commentary and Outlook
For 2017, we expect higher volatility from rising rates, increased regulatory uncertainty, uneven policy execution, and an exit from a post-crisis period characterized by unusually benign credit performance.
Although the macro environment remains benign with exceptionally low volatility in capital markets, we expect the next several years to pose significant challenges for risk managers due to the re-normalization of credit performance, intensifying competition for borrowers, and changing payment hierarchy trends.
Re-Normalization of Credit Performance
The Great Recession of 2008 is now more than eight years behind us. We are in the late stage of the current credit cycle.
Consistent with Fair Credit Reporting Act waiting period requirements, derogatory credit items (“derogs”) associated with bankruptcy, foreclosure, and short sales will fall off borrower credit bureau reports in 2017. As a result, we expect an expansion of marketable population to include previously ineligible borrowers.
The re-normalization of credit performance will create significant analytical challenges for underwriting and investment analysis. For instance, models trained on post-crisis borrowers that defended their credit thru the cycle will tend to underestimate losses.
Further, lenders today face new constraints in how they manage their risk from consumer protection regulation such as the CARD Act of 2009, which among other rules, eliminated “universal default” as a mechanism for mitigating risk.
Advanced risk analytics and historical data, such as offerings empowered by PeerIQ analytics and TransUnion dataset, will crucial for risk assessment and management for originations and investors alike.
Changing Consumer Behaviors & Payment Priority
Prior to the Great Recession, mortgages were the first priority of payment on the consumer’s liability. This behavior changed with eir negative equity in home values and the emergence of strategic mortgage default. During the crisis, according to a TransUnion study, consumers holding a mortgage, auto, and bank card consumers tended to default first on their mortgage debt, then credit cards, and finally auto loans – a reversal of prior payment priority trends.
Auto loans emerged at the top of the consumer liability payment hierarchy due to their need in accessing employment and impact of repossession.
The consumer’s relationship with their financial institutions and are changing with the emergence of new technology including ride-sharing services, robo advisors, and online banking services.
Increased competition amongst financial institutions and technology that can render traditional arguments of payment priority obsolete requires heightened monitoring of payment priority trends, and continuous benchmarking of originators performance vs. their peer group.
Not surprisingly, platforms are finding ways to deepening their relationships with customers via community-based service offerings, broader product offerings, and differentiated service.
See for instance SoFi’s dating and job-matching service and new products in insurance and deposits. Lending Club’s announced an expansion into auto-lending. Real estate lender PeerStreet announced a partnership with robo advisor Betterment.
Trigger Breaches Event Stabilizes
In 1Q2017, SoFi SCLP 2015-1, a bespoke bilateral transaction between an investor and provider of financing, was the only additional transaction to breach a deal trigger.
Exhibit 12 summarizes the ten active deals that had breached triggers in MPL ABS sector (nine unsecured consumer and one SME) with $1.3 Bn of total issuance volume. Since the inception of MPL ABS market, we have observed 10% of deals breaching triggers historically.
In the context of ABS transactions, trigger breaches are manifestation of unexpected credit performance, poor credit modeling, or unguarded structuring practice. If an early amortization trigger is violated, excess spreads are diverted from equity investors to senior noteholders with the goal de-risking the senior noteholders as quickly as possible.
From the equity investor’s perspective, tighter triggers allow higher potential equity returns in the absence of any collateral losses. However, equity investors will experience higher return volatility if the collateral pool incurs credit losses. Conversely, less restrictive triggers allow more cushion for losses before the coverage tests are breached, and require greater subordination levels and, hence, more capital.
Trigger breaching events do not necessarily imply credit deterioration of the collateral pool. The art of trigger setting is a core structuring competency for an issuer, warehouse lender, or securitization deal team. A strong analytics toolset offered by firms like PeerIQ will help issuers and investors alike to guard against trigger breach scenarios.
In our 4Q2016 securitization tracker, we anticipated greater participation in the securitization space as one-off issuers seek to become repeat issuers to optimize deal cost and capital market distribution. We expected $11.2 Bn of total new issuance in 2017 for a base case scenario, representing 47% growth in ABS issuance from 2016 (Exhibit 13).
Further, rated securitization has moved from a coming-of-age milestone in the maturation of an originator to a key funding pillar. In 1Q2017, all new transactions were rated by at least one rating agency.
We expected further emergence of repeat issuer. In LendIt 2017, Prosper unveiled its new shelf Prosper Marketplace Issuance Trust (PMIT), expecting first deal in Q2. Further, LendingClub expects to retain $100 Mn of quarterly originations on balance sheet beginning in 2Q17. LendingClub also has its own branded shelf, and we speculate that these loans may potentially be securitized in multi-seller deals. This suggests a $400 Mn in new issuance from a LendingClub shelf.
Under our base case scenario, we expected $130 Mn from LendingClub shelf in 1Q2016 outlook, and we modeled $500 Mn in new issuance under a bullish scenario.
With $3.0 Bn of new issuance in 1Q2017 and recent announcements from new repeat issuers (potentially including Upstart and Prosper) and Avant returning to market, we are on track to realize our year-end projection of $11.2 Bn in new issuance.
Multi-seller trend continues
In 2016, PeerIQ predicted the rise of multi-seller deals as issuers seek to create a reliable path to liquidity for whole loan investors, drive standardization, spread deal costs, and reduce execution risk. The most recent Marlette transaction is notable in that 7 loan sellers vended loans into the deal. We expect a continuation of the multi-seller trend across several platforms.
Bank Partnerships
We argued in prior research that banks can improve their ROE position by funding or financing whole loans from marketplace lenders, and that most banks will choose to partner with marketplace lenders rather than compete.
We believe 2017 will feature a number of bank partnerships with non-banks, and increased competition from traditional banks.
In 1Q2017, Upstart announced their intention to deliver their SAAS technology to assist banks, credit unions, and retailers to originate loans. We expect to see more of this ‘capital light’ business model ahead (see Avant & Regions Bank, or OnDeck and JP Morgan for instance).
We expect traditional banks to cooperate with marketplace lenders to marry their low-cost funding profile with low-cost operations of marketplace lenders.
Higher Volatility from Regulatory Uncertainty
Concerns of heightened regulatory scrutiny last year have given way to a largely constructive outlook, although regulatory uncertainty remains high.
Platforms are sponsoring self-regulatory efforts via trade associations such as SFIG and the Marketplace Lending Association. The message is resonating. In an important milestone for 2016, US Treasury, Federal Reserve, SEC, and the Office of the Comptroller of the Currency (OCC), each publicly acknowledged that marketplace lending is expanding access to credit to traditionally under-served segments.
Markets expect a bias to action from the Trump administration, a more favorable regulatory outlook, and potential for relief on risk retention, bank capital & liquidity requirements, and a reduction in CFPB and SEC enforcement actions.
The President-elect Trump’s transition team, including the nominee for Treasury Secretary, has indicated the new administration wants to “strip back” parts of Dodd-Frank.
Overall, we expect the pace of regulatory relief will be slower than most market participants expect. While the new administration has made some general statements about Dodd-Frank, it’s too early to tell which changes may materialize.
Within MPL specifically, the SEC, the OCC, and state regulators have differing views on jurisdiction and approach to regulation. Moreover, given the cloture rules in the Senate which require 60 votes to overcome a filibuster.
We expect the most likely areas for bank regulatory relief lie within the capital and liquidity framework which has hampered ROE for large banks and community banks alike. Banks have already adapted to incremental consumer protection obligations and shed Volcker-related prop businesses.
Non-bank lenders, especially those adopting a partner funding bank model, will seek regulatory clarity to reduce true lender risk (see for instance Madden v. Midland, Bethune v. LendingClub, or CFPB v. Cash Call) and argue for pre-emption.
In March, OCC Head Thomas Curry, re-affirmed plans to grant special purpose national charters to qualifying FinTech firms. Curry cited “public interest,” a “patchwork of supervision,” and the “great potential to expand financial inclusion” as motivations for the charter.
The charter would offer pre-emption—the ability of chartered FinTechs to export rates across state lines—and avoid the need for disparate state-by-state licensing or originating via partner-funding banks. In constructing the guidelines, the OCC seeks to continue to foster financial inclusion via FinTech innovation, while maintaining public confidence in national banks and the banking system more generally.
The supervisory guidelines in the proposal require, among other provisions, a top-down culture of compliance, a risk assessment and management framework, and to-be-specified capital and liquidity rules. (See here for PeerIQ’s summary of the supervisory guidelines).
Qualifying FinTechs require significant investment in governance, risk management systems, and financial inclusion plans. Chartered FinTechs must adopt a top-down culture of compliance, meet strict supervisory guidelines (summarized here), have seasoned bank professionals on boards and management teams, and seek approval from bank regulators on major business plan changes. More generally, under the charter, FinTechs must culturally resemble the very banks they seek to disrupt. Applications for the charter will be made available to the public on the OCC website.
More fundamentally, the charter does not address the core funding and liquidity issues impacting the sector. The strict qualitative criteria suggest that the charter will be awarded sparingly, case-by-case.
Emergence of 3rd Party Solutions to Promote Confidence
To gain investor confidence, marketplace lenders are now adjusting to the demand from warehouse lenders and whole loan investors for greater transparency and due diligence, including independent reviews, “hot” back-up servicing arrangements, verification, credit validation and heightened data integrity standards.
Further, the recent uptick in delinquency and losses in SME and other sub-segments, in general, leads to a persistent focus on fundamentals, loan modifications, and technology to benchmark performance and combat stacking, TransUnion, for instance, launched a Fraud Prevention Exchange to combat stacking via a tech-enabled consortium of leading non-bank lenders.
Issuers and investors will deepen their investments in 3rd party data and analytics for a variety of investment and distribution activities, such as analyzing deal waterfalls, evaluating deal collateral triggers, monitoring deal performance, coordinating multi-seller securitization deals, and improving investor confidence with loan-level data transparency.
The above trends highlight the need for 3rd party analytics, such as those offered by PeerIQ, to improve transparency, standardization, comparability, with the goal of improving investor confidence and the smooth functioning of ABS markets.
We remain optimistic on the lending ecosystem. The broad secular trends underpinning non-bank lending growth and the global demand for yield remain intact.
About the author: PeerIQ offers portfolio monitoring and loan surveillance, structured finance analytics, third-party reporting, pricing and valuation and advisory services across both whole loans and ABS products.
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