In my last research note I discussed the role of WebBank in the triangle of Lending marketplaces in the US. The function of this regulated entity is clear and brings to the forefront the roles and responsibilities left to the unregulated Lending platforms.
Lending marketplaces are predominately accessing the creditworthiness of the borrowers and servicing the loans.
These two important functions are not as simple as they may seem. Lending platforms have been continuously improving on both fronts and IMHO the standard (algorithms, data and process used for creditworthiness & servicing processes in case of delinquencies and defaults) has increased. This makes it more difficult for all those flirting with the idea of launching yet another lending platform and salivating to get institutional money involved in funding borrowers (still a large underserved market). In addition, the overall online lending market has predominantly been catering to the higher end of the credit spectrum because of course, it is the safest entry point and large enough up until now.
Now that the lending market has enough deal flow, the market is looking for the next more mature stage. It is no other than the traditional securitization process, which remains “naughty” but at the same time is a process that serves many purposes. First and foremost it transforms illiquid assets (the P2P loans) into marketable securities (the tranches of the securitized deal); it provides access to a new asset class (risk/retrun payoff) for asset managers, pension funds, and wealth managers; it lowers cost of funding for the originators; it replenishes capital. The risks on the other hand, are all hidden in the details (the features of the underlying pool of assets; the opaqueness of the servicing of the pool; leverage, etc).
Given the painful experience of the 2008 blowup that was triggered from such deals, one would think that there is a collective experience that will be applied to such mechanisms this time around. Ratings agencies, Servicers of the pools of loans, Trustees, Custodians, paying agents, underwriters, and end investors; are all probably wiser this time around. The higher standard of transparency again instigated by a self-regulatory culture from the large Lending marketplace platforms, are also helping the cause.
Source: Investopedia CLO definition
Most of the securitizations deals over the past 3 yrs had been private placement deals and not noteworthy in size (ranging from $30mil-$100mil typically). The tipping point was the first rated and large size deal by SOFI. Even though the market’s first choice wouldn’t have been student loans as the topic pick for a pool of underlying loans, it set a precedent.
The other two large and rated securitization deals are from Citigroup and Blackrock. Their babies respectively are: the Citi Held for Asset Issuance (CHAI) deal and the Consumer Credit Origination Loan Trust (CCOLT) deal. The latter is an SPV created by Blackrock for the purpose of this deal. My focus is more on these two deals because they are the first rated ones with a heavy involvement of a regulated and rated financial institutions (not only as underwriters but custodians, or paying agents, etc).
Both deals are similar in many ways (detailed data can be found in “Comparing CHAI to CCOLT” by PeerIQ):
- Size: CHAI $420mil – CCOLT $306
- Consumer loans mostly 3yr average and avg. borrowing rate 13%-14%
- FICO: slightly above 700
- Number of loans $25k-$30k with average loan size $11k
The significance in these deals is in the fine print which defines delinquency and default procedures. The CHAI deal obtained an A3 rating for its Class tranche (whereas CCOLT has longer Weighted average life Class A tranche with a lower rating Baa3) mainly because the Backup service provider in the CHAI deal is a rated entity (Citibank). The CCOLT has First Associates as the backup service provider, which is a 30yr old business and is the fastest growing and largest third-party consumer loan/lease and backup servicer in the United States with $7billion under management.
“Who is afraid of securitization?”
Everybody says “yes” to be safe (not because they necessarily thought about it) from the originators of the underlying loans, the underwriters, to the rating agencies and the investors. The fear is coming from being burnt and wanting to be compliant (the new norm) which makes all stakeholders more cautious and conservative.
“Be afraid of what you don’t know”
These are not unchartered waters and Wall Street veterans are out there to deploy their expertise to make securitization work this time around. The 4th quarter of 2015 (as reported by PeerIQ in their Marketplace Lending Securitization Tracker Q4) saw $2.7bn in securitization issuance. This is five-fold from the 2015 Q4 issuance ($0.5bl), with market conditions in credit markets not all favorable during this quarter (widening of credit spreads).
Roughly 43% of the 4Q deals were rated (mostly by Moody’s). Consumer loan pools are twice as much as student loans. The growth will continue as long as there is no misstep in the servicing, in the borrower selection practices and of course, no black swan that triggers defaults that weren’t priced in.
The securitization market first needs to grow in a similar direction as the CHAI and CCOLT deals. Ideally, the market needs more consumer loan deals and also some SMB securitization deals. Funding Circle and Zopa, for example, need to get involved and OnDeck deals need to get rated. Such growth in both verticals (consumer loans and SMB) can pave the way towards deals structured from the Lending platforms themselves (similar to the SOFI deal).
Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech. Efi Pylarinou is a Digital Wealth Management thought leader.