Securitization offers discipline as online lending ‘matures’

In a keynote address at the Lendit USA conference in New York on Tuesday, Ron Suber, president of Prosper, one of the US’s largest marketplace lenders , called on the burgeoning industry to support the growth of a securitization market for the product.

“Some people like it and some people don’t,” he told an audience in the main room of the conference, which registered over 50% more attendees than last year’s event. “Today it is the secondary market.”

“There is no choice for platforms anymore to say ‘I don’t want to do securitizations.’ Investors have spoken, they have seen the success, and we’re going to see more of it. One day the securitization window will be closed, today it is open.”

Marketplace lending securitizations so far have mostly been unrated deals sponsored by specialised third party investors, such as Eaglewood Capital, Blue Elephant Capital Management and Garrison Investment Group, that have purchased loans from platforms like Lending Club and Prosper.

BlackRock joined the party in February this year with the first publicly rated securitization of unsecured consumer loans, which it purchased from Prosper.

Large banks are getting more involved in the marketplace, either by buying loans themselves, extending warehouse credit to buyers like Eaglewood and Blue Elephant, or by partnering with platforms directly.

Lending Club on Tuesday announced a partnership with Citi, whereby Citi will subsidise up to $150m of loans to low and moderate income borrowers in the US.

The loans will be purchased by New York-based hedge fund Varadero Capital through a credit facility provided by Citibank. Given Varadero’s background in securitization, many conference attendees said they expected the loans to eventually collateralise ABS deals, although neither Varadero nor Lending Club would comment on this.

The programme is a sign that marketplace lending is “maturing”, said Lending Club chief executive Renaud Laplanche at the conference.

Jefferies has also been quietly building a presence in marketplace lending. One of the sector’s first large securitization warehouse agreements, a $500m partnership between the investment bank and Florida-based CircleBack Lending, is expected to bear its first ABS transaction in the next few months, according to people familiar with the situation.

CMBS may also soon be part of the mix. Having secured a large funding agreement from SF Capital, online real estate lender Patch of Land expects to see third party securitizations of its small scale commercial mortgages in the coming months.

The third-party securitization model has dominated dealflow so far. But with more marketplace lending platforms using hybrid models — passing some loans on to investors but keeping others on their own balance sheet — direct securitizations, such as those issued by student loan and mortgage platform SoFi, could become more prevalent.

One ratings agency told GlobalCapital it had had “serious conversations” about potential ABS transactions with at least 12 marketplace lending players, split between origination platforms looking to directly securitize their loans and third party investors acquiring loans from platforms with the intention of securitizing.

In addition to offering investor diversification and competitive financing, securitization can also enforce a much-needed discipline at new lending firms, said Nino Fanlo , chief financial officer of SoFi, which has brought three securitizations of its private student loan product to date.

“[You’re] not just telling a story pleasantly with anecdotes to a group of receptive folks, but filling out a thorough checklist that is verified by independent people that other people can trust,” he said during a panel discussion.

“A new company needs incredible discipline in every single area — technology, marketing, capital markets. That exercise is extraordinary sensible and it is very bracing to go through that and be challenged by people who are placed in an objective time frame across credit cycles.”

“Anyone that does not see this as a plausible tool to not just expand your business but to think about this as a useful method of disciplining your processes, credit operations, marketing, internal audit, and communication, as a vital tool to improving your business, misses a tremendous opportunity,” he added.

In the future, any large platform will feature securitization as an “essential part” of their funding strategy, said Ram Ahluwalia, CEO of PeerIQ, a company that seeks to provide risk management services for marketplace lending investors.

But while the ABS market can provide the support and capital necessary to fund the market’s growth, platforms need to invest in technology and standards to make this process smoother, he added.

“Standards might consist for example of prepackaged representations and warranties to simplify the securitization process,” he said. “Technology might include independent third party credit models that model out prepayment and default curves, so you can have a standardised view and pricing of risk from a de-conflicted third party.”

“As these tools and standards develop I think you’re going to see an acceleration in securitization and an improvement in terms of ratings, advance rate and… deductions in the cost of capital.”

PeerIQ has been looking at ways to build a derivatives market for marketplace lending, which Ahluwalia says will make the asset class “that much more attractive” for institutional investors that need to hedge their portfolio.

However, the mention of derivatives raises the hackles of some participants in the nascent sector. During his otherwise overwhelmingly positive keynote speech, Prosper’s Suber had some choice words for derivatives, which he accompanied in his visual presentation with a picture of a bomb.

“We have a great thing here, and if we allow derivatives and the financial engineers of Wall Street to take over this quality product and do what it did to the mortgage industry, and the CDOs and the CLOs and all that other stuff from 2008 and 2009, we’re going to give it away,” he said.

“If it’s done right, with data and control, that’s great because it will bring liquidity and bring people ability to get exposure to us, to hedge us and to adjust their portfolios. But I put a question mark here, not because I don’t like the people talking about it, but I caution us: it could be the end if it’s done wrong.”

The big question on everyone’s lips, however, is how marketplace lending assets will perform when the credit cycle turns.

Some platforms have confident answers when asked this question; others not so much. Peter Behrens, co-founder of UK P2P platform Ratesetter , grew visibly frustrated when pressed on this issue during a Tuesday panel at the conference, leaving the audience without a definitive response.

Frank Rotman, a partner at QED Investors, on Wednesday recalled visiting one platform that could not identify simple data points, such as debt-to-income ratios, within its complex machine learning, big data-driven underwriting model.

“A lot of the innovation is bringing a new breed of people that don’t have an appreciation of what cycles look like, and they believe that the data just tells them everything,” said Rotman.

Will Black, a managing director in Moody’s ABS ratings team, told GlobalCapital he found it refreshing to see prominent figures within the industry begin to confront this issue at the conference.

“We won’t know how strong a foothold any of these companies have until we’re in a less benign credit environment,” he said. “These business models have not been battle tested.”

“When the going gets tough, there will be a shakeout in this industry. There will be winners and losers, and some may be consolidated and purchased. This happens time and again — we’ve already seen it in subprime auto.”