Marketplace lending sector prospects discussed

Representatives from Prosper Marketplace, MountainView Capital and Credit Suisse recently discussed the growth of marketplace lending during a live webinar hosted by SCI (view the webinar here). This Q&A article highlights the main talking points from the session, including the impact of rising rates and the role of ABS in the sector. For a broader and more in-depth exploration of these themes, attend SCI's Marketplace Lending Securitisation Seminar on 28 June.

Q: What is the history of the marketplace lending sector?
Ron Suber, president, Prosper Marketplace: Marketplaces are in all of our lives in a lot of different ways. Travel has been disrupted in a major way, retailers like Amazon or eBay have revolutionised shopping and companies like Uber have changed transportation without owning a single car. Now something similar is happening in how we borrow and lend.

About 10 years ago, Prosper, Lending Club and Zopa started as peer-to-peer platforms where people could invest with other people, primarily doing debt consolidation. These online marketplaces have grown rapidly and globally in consumer loans, in business loans, in student loans and in mortgages.

Partially this is because we have now seen a collision of Silicon Valley, the banking industry and Wall Street. For the first time, we now have people from each of these industries represented at all of the leading marketplaces. Additionally, we also have an increased demand for credit and a search for yield, which these marketplaces are able to provide.

Q: What effect will rising interest rates have on the sector?
RS: Some platforms have increased their rates in response to the Fed's move, while others have stayed steady for now because they have actually been increasing rates already over the last three, four or five months. These marketplaces can be canaries in the coal mine and see changes in unemployment and delinquencies and the economy well in advance of traditional lenders.

I cannot emphasise enough the importance of the risk-adjusted returns of these marketplaces and, as rates rise and defaults rise, the platforms may have to increase rates. However, historically the demand from borrowers has risen alongside rates, so I do not think that will be a major headwind for the majority of the marketplaces.

Q: How can online lenders mitigate risk?
RS: Online lenders typically have a series of loan grades for borrowers. In Prosper's case, it is double-A for the highest-income, lowest-DTI, lowest-interest rate borrower; then single-A, single-B, all the way down to HR for the higher rate, higher risk category. It is also critical that expected defaults must remain equal to or higher than actual defaults, which is why it is important to readjust expected defaults regularly.

Marketplace platforms are outperforming and marketplace lending is the number one risk-adjusted asset class in the US. We are proving to investors that platforms can adjust to different environments and continue to deliver risk-adjusted returns.

Q: What is the effect of rising rates on existing lenders and pricing of outstanding loans?
Chris Kennedy, md, MountainView Capital: There are some advantages to rising rates for lenders, not least increased duration and servicing fees. Rising rates will also encourage platforms to develop new products to meet borrower needs, and that is good for the market.

Investors are going to be more diligent on their internal model valuations and paying close attention to delinquency rates, roll rates and defaults and severities, and that will all feed into loan pricing. There is a lot of volatility in the capital markets at the minute, but as investors develop a better understanding of this market and learn how to manage the risk, the market will grow.

Q: How is performance data transparency evolving?
CK: We live in a big data world and as an investor in the platforms you have access to all of the historical loan-level data. With Reg AB 2 coming in, all new issue loans from sectors such as autos are going to have loan-level data made available, so that further enhances transparency. The challenge for investors will be aggregating all of the available data and putting it into a model in a way that provides meaningful results.

Q: What role does securitisation play in the market?
Stephanie Yeh, director, Credit Suisse: Since the first securitisations in 3Q13 and 4Q13, it has been pretty remarkable to see the marketplace lending securitisation market develop. There have been almost 50 deals now, spanning student loans, unsecured consumer loans and small business loans, totalling nearly US$9bn of issuance.

In 2014 we saw US$1.4bn of issuance across 10 deals and in 2015 we saw a significant increase to US$7bn across 32 deals. While that growth has been remarkable, if you look at the broader consumer ABS market, it still only makes up a very small portion of the US$150bn of issuance that we saw last year across consumer ABS. However, we expect the number of deals to grow and for marketplace lending to grow as a portion of the consumer ABS market.

Q: How do marketplace lending securitisations compare to other ABS?
SY: The collateral is actually quite simple to understand. If you look at the unsecured consumer loans, they are instalment loans, and so very similar to auto loans in structure. What sets this space apart - as Ron touched on earlier - is lack of historical performance data. That is developing, though, and the gap is growing smaller.

From a deal perspective, the structures have been simple. A couple of deals have had pre-funding accounts and revolving periods, but the majority of the issuance has been amortising transactions backed by a static pool of collateral. One benefit for the space which has countered the lack of historical performance has been the relatively short duration of the deals that have been done to date, as well as the significant amount of credit enhancement that mitigates potential volatility in different cycles.

The other difference which I think is probably here to stay is that the sponsor of the securitisation may not be the originating platform. While we have seen that in other consumer ABS asset classes, it is something that we expect to see more commonly in marketplace lending securitisations.

Q: What is the role of rating agencies in the market?
SY: Rating agencies have a very important role in the development of the securitisation market for marketplace lending collateral. Over time, we expect to see more and more deals being rated. From 2Q15 to 4Q15 we saw around 70% of deals being rated and we expect that to grow as more platforms mature and develop performance history that the rating agencies can look to.

The rating agencies allow for a broader investor base in the transactions. Also, because there is a broader investor base, there is less funding volatility for the sponsor of the securitisation and therefore more stable and consistent funding for both the loan aggregators and the platforms. This is because the rating agencies serve as a form of third-party validation because of the extensive qualitative and quantitative diligence they do on both the platforms themselves and on the sponsors.

Q: How can secondary trading help the marketplace to grow?
CK: This is a huge opportunity for investors to help to create a secondary market, much as they have done for residential whole loans and other consumer loans on bank balance sheets, as well as bank loans in the corporate space. What would really help the market to grow is to get more market participants looking at these asset classes - whether it is consumer loans, student loans, autos or potentially mortgages - and trading them, whether on a servicing release basis or servicing retained basis that the platforms retain that servicing relationship. That is the big challenge for the industry."

Q: What are the future prospects for marketplace lending?
RS: For me, the future is one where there are listed vehicles so that you can invest in consumer credit, or business credit, or student loan credit or mortgage credit, either through a closed-end fund or an ETF. It would mean that instead of going to one of the platforms, you could literally own a stock on one of the global exchanges.

The other key aspect is ubiquity and making sure that people understand the benefits of marketplace lenders - making sure marketplace platforms are available and understood. That relies upon educating people about why this is such a good way to borrow and then getting to the point where perhaps you could just have an app on your phone with a waiting line of credit from an online marketplace. So, if you want to buy a holiday or make another large purchase, you can swipe right on the app and borrow instantly.

Q: What are the prospects for marketplace lending securitisation?
SY: We certainly expect the securitisation market to continue to grow. Themes such as increased transparency and consistency and continuing maturity of the platforms are going to support the further development of the securitisation market and this industry.

We expect to see more platforms coming to market and more investors too, especially as more deals are rated and more time is spent developing that investor base and building that transparency with term ABS investors. Gaining the trust of that investor base as well is going to be very important, and part of that is bringing in more rating agencies.

We do also expect to see more loan aggregators that act as sponsors for securitisations, as loan investors gain scale in their portfolio and have sufficient portfolios to access the securitisation market, perhaps loan aggregators following Victory Park and KKR's path and combining their portfolios into one transaction.

This is all going to be driven by standardisation and consistency in the deals, both in collateral and in deal structure. That is a trend we are already starting to see in the market.

Q: What will we see for valuations and transparency?
CK: This market is in the hyper-growth stage and, as more investors get engaged, it will change the way these assets are valued. There is going to be a need for increasing the quality of the valuations and the level of transparency that you provide to your investors.

SCI's Marketplace Lending Securitisation Seminar is being held on 28 June at Kaye Scholer's offices at 250 West 55 Street, New York. The conference programme consists of panel debates covering regulations, the investor perspective, platform differentiation and emerging assets. There will also be a case study presentation on how a typical marketplace ABS is put together.

Click here to register for the event.

JL