Has the disruptive force of the P2P lending-cum-crowdfunding tornado been rendered impotent? It certainly looks that way. The alternative lending revolution that emerged from the global financial crisis as a grass-roots anti-bank movement has been curbed. The disruptors have been disrupted by the disruptees.
Natural order has been restored. Or is that natural disorder has been restored?
Marketplace lending has been fully institutionalised at the equity and venture funding ends; and at the business origination and loan off-take ends. Far from rendering the banks redundant, some of the bigger marketplace lenders have become little more than alternative marketing platforms for banks (some even with co-branding options) and investment opportunities for banks, hedge funds, private equity and institutional real money.
Witness Citigroup’s US$150m commitment to Lending Club (to help it reach “under-served” borrowers), the agreement by Jefferies to purchase US$500m of loans from CircleBack; BlackRock’s US$330m investment in loans originated by Prosper Marketplace; Apollo Global Management’s commitment to buy US$1bn in student consolidation loans originated on the LendKey platform; or KLS’s agreement to invest £132m in small business loans originated by Funding Circle.
Witness also US$150m in equity capital provided to Funding Circle by Russian billionaire Yuri Milner’s DST Global, Baillie Gifford, BlackRock, Sands Capital Ventures and Temasek; or Prosper’s US$165m Series D financing funded by Credit Suisse Asset Management, JP Morgan Asset Management, SunTrust Banks, BBVA Ventures, Neuberger Berman and others.
Grassroots to razed earth
The list just goes on and on. The crowdfunding crowd has been squeezed out as institutional whole-loan acquisitions take over; as corporate borrowing takes over the growth agenda from retail and consumer borrowing; as institutional buyers pile in; and as securitisation becomes an increasingly crucial lifeline. The P2P companies have been pushed into the background as a means to an end.
Deals like the US$377m Citi Held for Asset Issuance 2015-PM1 securitisation tells you all you need to know. The clue is in the name: collateral backing the deal was a portfolio of unsecured consumer instalment loans purchased by Citigroup from Prosper. Collateral backing the US$327m Consumer Credit Origination Loan Trust 2015-1 securitisation consisted of an identical portfolio bought by BlackRock and also originated on the Prosper platform.
The £130m Small Business Origination Loan Trust 2016-1 DAC securitisation done two or three weeks ago consisted of those loans I noted above that were originated on the Funding Circle platform and acquired by KLS Asset Management, the hedge fund founded by Wall Street titans Jeffrey Kronthal, Harry Lengsfield and John Steinhardt. To fast-track growth in Europe, Funding Circle opted to list the Funding Circle SME Income Fund in a £150m institutional IPO rather than grow piecemeal via partial loan participation.
My point is this: the online platforms were close to irrelevant in these deals. While the KLS ABS deal was interesting in that KfW bought most of the senior tranche thanks to a guarantee under the European Investment Fund’s SME credit enhancement programme, Moody’s listed one of the credit weaknesses as “potential misalignment of interest between Funding Circle and the investors as Funding Circle does not retain direct economic interest in the transaction”.
That weakness may have been partially mitigated by KLS acting as a retention holder, but the message was clear.
The announcement that Funding Circle was starting to accept whole-loans, and the subsequent announcement of its tie-up with KLS back in 2014 was greeted with dismay by some retail customers. FC offers whole loans to institutional lenders first, and only if they are rejected are they then offered to the partial-loan market. Those funding the partial loans that had been rejected as whole loans were only told of the rejection after the auction had ended and their loan offers accepted. That led to wails of unfair bias.
If marketplace lending and its variants are becoming such a disruptive force vis-à-vis traditional banks, and if securitisation was offering the marketplace lending sector such a fabulous off-take channel, why did Lending Club (LC, until this week a poster child for the sector’s supposedly ubiquitous expansion) and online business lender OnDeck Capital end up being such lousy investments since their IPOs?
And were this week’s decisions by Goldman Sachs and Jefferies to reverse plans to securitise LC loans exclusively related to the firing of chairman and CEO Renaud Laplanche and three executives at the firm? You’d imagine so at least in the case of Jefferies, which as the purchaser of those US$22m of near-prime loans in question is at the epicentre of the ouster of Laplanche; the firm was working on a US$150m near-prime package.
But I wonder if there had been some pre-existing sector or market-based concerns or a relational affinity with Citigroup’s recent decision to end what looked like a solid ABS relationship with Prosper owing to an astronomical increase in yields.
Citigroup was forced to pay an average-weighted spread of around 500bp to get a Prosper deal away in March. That was double the rate on its December outing and included a tonky 12.5% yield to get the BB-/B tranche away. I imagine that was a wake-up call so was clearly already weighing on the market.
There was clear evidence that appetite for marketplace ABS had been cooling for a while. With the latest developments at LC and elsewhere, deal flow will likely cease and a process of potentially severe market repricing will ensue. The sector is in some disarray.
No knee-jerk reaction
The firing of Laplanche just weeks after LC, Prosper and Funding Circle had founded the Marketplace Lending Association with a code of conduct to “promote responsible business practices and sound public policy to benefit borrowers and investors” may have been a desperately unfortunate (but at the same time unwittingly comical) coincidence. But it wasn’t Laplanche’s ouster that reversed the direction of LC’s stock price.
The shares have been on a linear downward trajectory ever since their ridiculous first-week post-float pop. They had fallen through their IPO price within six months and continued on a downer ever since. The latest goings-on have merely added a more urgent leg down towards that ignominious low.
Between LC’s intraday all-time high of US$29.29 a week or so after the December 2014 float and the intraday all-time low of US$3.98 hit this past Tuesday May 10 on massive volume, the shares have lost almost 86.5% in value. That will make the US$130.5m in firepower left in the stock repurchase arsenal go a lot further, but still.
The performance of LC’s shares are certainly confounding in light of its Q1 results: loan originations up 68% year-on-year at US$2.75bn; operating revenue up 87% at US$151.3m; adjusted Ebitda more than double at US$25.2m; net income of US$4.1m versus a loss of US$6.4m in the year-earlier period; and adjusted EPS of five cents against two cents. The company’s servicing portfolio almost doubled to US$10.2bn and the first quarter saw the company’s first month with more than US$1bn in originations.
At OnDeck Capital, the stock price performance is almost identical. Between the post-IPO high of US$28 (note that both companies went public within a week of each other) and the US$4.65 May 10 intra-day low lies a cavernous gap of some 83.5%. What a bust.
Negative news flow
And what a contrast with the business stats. But against the heady data and general euphoria about the sector, a more concerning news stream has been emerging. This talks not of growth and lending dominance but of increasing concern about the sector’s risk assessment methodologies.
It talks about concerns over targeting growth at the expense of standards; of impending clampdown by US regulatory agencies; of legal run-ins over usurious lending rates; of rating downgrades; as well as those demands I mentioned above for higher yields from institutional ABS investors rendering the business model uneconomic.
There is anxiety over rising default rates (losses on a US$126m Jefferies securitisation of CircleBack loans hit the trigger value, according to Morgan Stanley, curtailing cash flows to mezzanine holders) and there is growing anxiety about unsustainable stock valuations. And about staff cuts (Prosper just cut 170). And slowing business volumes. And that institutional cherry-picking I referenced.
Back to the drawing board
Lenders who rely on securitisation to continue growing may need to go back to the drawing board and re-think their business models and the operational value-chain. Bear in mind Lending Club, AvantCapital, CircleBack, OnDeck, Prosper, SoFi and Funding Circle have all sold ABS deals and it’s become a sector closely-watched by other players.
What lenders do with blocked assets in a closed ABS market or a radically repriced market is a conundrum. Private portfolio sales are an option but coming up with discounts that work for buyer and seller in the current environment could also be problematic.
As a final thought I offer this: is the potential closure of the marketplace ABS sector, or at least a period of re-thinking, the best thing that could ever happen to this heretofore burgeoning market?
Think about it: non-traditional lenders fund billions of dollars of alternative consumer and small-business loans using automated credit scoring and to a lot of borrowers who can’t get credit from banks. Banks, institutional investors and hedge funds, sniffing a business opportunity, find demand in the ABS market for portfolios sourced via those non-bank platforms. They acquire whole portfolios from the non-traditional lenders to feed the beast and fulfil backwardated demand for senior and mezzanine exposure.
Banks push non-traditional lenders to originate increasingly large portfolios of assets and thus begins a dubious product supply chain. Ring any bells?