As the rise of fintech and digital banking technology have helped drive a new wave of growth for non-bank peer-to-peer lending platforms, the emergence of marketplace lending ("MPL") securitisation has provided a route to more advantageous funding for lenders and opportunities for institutional investor participation, as the structured finance market gains more comfort with this developing asset class.
Over US$15 billion of MPL securitisation issuance took place in 2018, according to industry tracker PeerIQ. That took cumulative issuance to date to US$45 billion from 142 deals since they first started counting them in 2013. An increase in average deal size from around US$50 million to above US$430 million over that period, alongside greater involvement by rating agencies and institutional investors, has seen MPL securitisation move out of its niche and closer to the mainstream, with growth accelerating significantly over the past two years.
Although consumer loan MPL securitisations account for just over half the market, the biggest ticket deals are coming from the student loan side, which represents 38 percent of the sector’s deal history (PeerIQ/Bloomberg). San Francisco based SoFi, which specialises in student loan refinancing, brought the first US$1 billion MPL securitisation to market in early 2018 and issued over US$7 billion during the year in ten deals across consumer and student loans. A further US$3.6 billion in ten MPL securitisations priced in Q1 2019, according to the research group, taking total cumulative issuance since 2013 to US$48.1 billion.
Positive Market Feedback
It seems as though a virtuous circle is playing out. The ability to securitise loans on their books presents an important and growing funding opportunity for the major market participants, further fuelling the underlying industry which could originate US$1 trillion in the US by 2025 according to a forecast in a PwC report . At the same time, the general increase in MPL securitisation dealflow and greater awareness and acceptance from investors, looks set to drive momentum in marketplace lending. In addition to opening a window for institutions to participate in the dynamic non-bank lending business, MPL securitisation also offers a key avenue of growth for new market entrants. Indeed, when a new non-bank lender emerges in the sector, the long term strategy that tends to follow is to start to build up a track record and when it makes sense begin to securitise.
Having disrupted the traditional banking through online loan origination, firms such as Lending Club, Prosper and Avant have now become household names, providing an alternative method of finance for consumers, students and businesses, particularly SMEs. In fact, non-bank technology firms have now captured over a third of the US personal lending market, according to a July 2018, US Treasury report . While question marks persist over how liquidity for some of these lenders might hold up in a market downturn, it is also clear that funding costs present a significant obstacle to increased growth. More efficient funding through securitisation also offers access to new investors and institutional capital, making for a wider, more stable investor base.
According to a Deloitte report on the sector last year, 77 percent of non-bank online lenders said that their cost of funding was a concern and 38 percent said it was the issue they were most concerned about. For lenders sized between US$50 and US$499 million, some 10% of funding was achieved through securitisation, rather than more costly equity and bank lines of credit. For lenders sized above US$500 million that proportion rises to 28 percent, which is a number likely to increase as more first-time issuers enter the market, such as Freedom Financial, Upgrade and Enova, which all issued inaugural deals in 2018, together worth over US$1 billion, including Freedom’s US$384 million follow up issue in the final quarter.
Key Questions for New Issuers
When it comes to preparing to launch a securitisation in this sector, which at a macro level tends to be structured similarly to a credit card or auto loan deal, key considerations for new issuers boil down to understanding who their borrowers are, undertaking the appropriate and necessary due diligence and modifying that process as required. For student loan or SME borrowers, for example, additional parameters may be necessary for overcollateralisation and in order to get to grips with borrowers who have no historical track record or those with decades of default rates as is the case with credit card and auto loan lending. Potential issuers will also need to think about who is servicing the loans, whether this will be done in-house or through a third party, as well as what type of reports will be made and how far those reports will drill down.
From an investor standpoint, the presence of an independent director on the board of the issuing vehicle can be a positive differentiating factor. First and foremost, investors want principal protection, but depending on the individual nature of the deal, they also want transparency and not just to be reliant on the originator for providing the information they need. On that score, corporate governance in this space can also be improved through the adoption of institutional board support and professional accounting functions. In addition to providing transparency and independence for the bankruptcy remote vehicle, platforms established outside the US may require the necessary legal assistance and coordination for compliance with AML and other regulations.
As the marketplace lending sector evolves further, there will no doubt be winners and losers in terms of profitability and ability to scale enough to tap the capital markets for funding. For every Lending Club or SoFi there are also platforms that will need to securitise in order to pay their overheads or firms blowing their capital raising on plush, expensive offices.
Further advances in technology will also help drive future growth, considering the impact that blockchain and 5G may have on a lending model more in tune with the key millennial demographic, with the days of having to put on a suit in order to get a loan more than a distant memory. As this cultural shift continues to disintermediate traditional banks and democratise borrowing, the ground looks fertile for MPL securitisations to become a mainstay of the global structured finance market.