The analysts said that the spread differential between online and traditional personal loans “seems narrow” for a market that has not been through a credit cycle, versus one that already has been tested.
“We continue to prefer traditional personal loan ABS over marketplace personal loan ABS as current spread levels fail to reflect the limited history in marketplace lending,” wrote the analysts in a Friday report.
According to BAML data, recently issued marketplace loan ABS have been priced in the 50bp-80bp range for the AA and A-rated senior notes with a weighted average life (WAL) of 0.5-1.3 years, compared with the 145bp-180bp range in early 2017. Recently issued traditional personal loan ABS priced in the 60bp-100bp range for the AAA to A- rated senior notes with a WAL of 3-3.6 years.
The analysts added that online loans could benefit from “more robust structure at issuance”, pointing out that at least 14 outstanding securitizations have breached their cumulative net loss triggers over the past three years.
“Our sense is losses have come in higher than market participants’ expectations, particularly for deals issued in 2015 and earlier, although the sector has not seen any ratings downgrades,” they wrote.
BAML is one of a handful of consumer credit observers that are urging caution around the online lending sector, which saw explosive growth over the past three years as more issuers began to access the securitization market. In December, Semper Capital Management said that the firm will be sitting things out in 2018, amid credit concerns and lack of data in marketplace loan ABS.
A consumer ABS investor speaking with GlobalCapital agreed with BAML’s view, adding that subpar collateral performance has prevented him from participating in deals issued to date.
“The levels of pricing... it’s quite amazing and the search for yield has definitely driven most of it. But I’m concerned about declining collateral quality. There has been a growing number of subprime loans in portfolios in 2017 — cumulative default rates have been in the teens on portfolios of loans with FICO scores of high-600,” he said.
Already, some lenders are taking steps to address weak performance, either through revising their credit models or by narrowing their underwriting criteria.
“Overcoming the credit deterioration we saw in 2015 to 2016 is key to gaining and growing investor confidence,” said Valerie Kay, LendingClub’s head of institutional investor group, via email. “Many platforms, including LendingClub, have tightened credit as a response to the credit normalisation and we expect that the future will positively reflect those improvements.”
LendingClub has a loan grading system where each consumer loan is assigned a grade ranging from ‘A’ to ‘G’, reflecting the borrower’s credit report. In November 2017, the company announced that it had stopped selling ‘F’ and ‘G’ grade loans to investors because of a push to tighten underwriting standards. It also unrolled a new credit model last September, which takes into account deteriorating loan quality and increasing consumer leverage.
The BAML analysts also indicated that unlike the traditional consumer lending sector, online lending could face strong competition from incumbent banks, a concern that was raised by some delegates at last month’s SFIG Vegas conference.
Goldman Sachs’s Marcus platform is an example of new competition from established players.
Meanwhile, GlobalCapital reported last month that Citi is also eyeing the launch of an online consumer lending service similar to Marcus. This was later confirmed by Citi CFO John Gerspach at an investor conference last Tuesday. Gerspach indicated that its digital banking product would be launched within the next three years.
“We believe the MPL market will continue to see increased competition from other consumer debt lenders, including banks with personal loan portfolios, credit card lenders, and student loan lenders. These lenders have alternative funding sources like deposits, and well-established securitization platforms, which enable them to be competitive on the terms of loans,” the BAML analysts wrote.