Summer might be a season when equity investors take a breather, but capital markets investors were warming up to bonds secured by online marketplace loans.
Warm is a relative term here, because between two issuers, Lending Club and Social Finance, just $571 million in loan assets were securitized. In a market where it is not unusual for individual mortgage- or asset-backed securities deals to price $1 billion in bonds, in their heyday anyway, the combined amount is very small.
Compared with traditional bank lenders, Lending Club and Social Finance, both based in San Francisco, are small. The specialty lenders connect borrowers with private investors looking to fund loans at higher yields.
The companies usually say they aim to serve borrowers who might have difficulty qualifying for traditional bank loans, either because of lower-than-average credit scores or they want to consolidate other debt and repair their credit. It’s understandable that the business model might be attractive from the consumer’s perspective.
Investors, however, appear to be less sure that the companies’ bond products serve the best interests of their portfolios, as Lending Club’s recent journey through the capital markets attests. Lending Club’s track record as a pioneer in peer-to-peer lending, and its debt offering, has been overshadowed recently by scandals involving the company’s operational practices.
Lending Club had initially begun laying the groundwork in April for a securitization deal via Jefferies, according to a Bloomberg article. Jefferies had supposedly been buying loans from Lending Club in an effort to securitize bonds collateralized by the loans, but that transaction was delayed.
In May Lending Club’s founder and CEO Renaud LaPlanche resigned after an internal review of its loans found that $22 million in loans sold to investors did not meet the company’s lending criteria. Three months later the company’s CFO Carrie Dolan had resigned from the company, to pursue other opportunities.
It’s hard not to wonder what the company’s specific internal concerns were with the loans. Some observers have summed up Lending Club’s practices, more specifically lender profiles, as frustratingly opaque. Certain lender profiles appeared to support multiple loans, according to a series of Bloomberg reports. With such questions overshadowing the company’s operations, it is little wonder that a potential ABS deal was put on ice.
Yet months later Lending Club raised $134 million from the private markets with the securitization of near-prime notes. The near-prime notes were oversubscribed, because apparently they appealed to some institutional investors who were able to look past the company’s recent troubles and see assets with keeping on their portfolios.
Even experience professionals in the private placement market, which is accustomed to completing highly customized deals that would not ordinarily sell well in the public securitization market, wondered how that transaction took place.
“Typically private placement investors are more cautious than that,” he said.
While the company completed its securitization, its core operations began to recover. In its second quarter performance update, the company’s new CEO and President, Scott Sanborn, said that 15 of its top 20 investors had returned to the lending platform.
Also, the company had facilitated $2 billion of loans to nearly 170,000 borrowers during the quarter, according to Sanborn.
Earning Its ‘AAA’ Stripes
Social Finance has a different origin story from Lending Club, and based on the size of its securitization, is able to tap into more liquidity than its peers. The organization is actually a 501(c)(3) that works to assemble financing solutions and improve the lives of people in need, according to the company’s Web site.
Its sister organization is Social Finance UK, which was founded in 2007, and completed the world’s first Social Impact Bond in 2010. SoFi seems to be operating with long-term success in mind.
SoFi’s securitization deal, also a private deal, earned a triple-A rating from Moody’s Investors Service on the senior portion of a $437 million deal, according to the rating service. SoFi collateralized the bond with its private student loans and enhanced the credit on the bonds with several features, including overcollateralization of 15.9% of the deal’s initial pool balance.
SoFi also structured its deal with reserve accounts that must be funded up to 0.25% of the outstanding Class A notes and 0.15% of the Class A’s initial outstanding balance at the time of closing.
The deal was negotiated privately, but was designed to allow for the bond to be resold under Rule 144A – so those ratings will undoubtedly come in handy.
Need A Loan? Ask ‘Marcus’
Lending Club and SoFi have had different experiences with the capital markets this time year. But the business model is sure to face mounting pressure from skeptical investors and competition from savvy financiers with deeper pockets – and the resources to support more sophisticated underwriting.
Prosper Funding, another San Francisco-based online lender, closed its loan-trading platform earlier this month, for instance, because investor interest was tepid. Now a new competitor is on the block, Marcus.com, which offers unsecured personal loans up to $30,000. And here is the plot twist: The service was launched by Goldman Sachs, which was originally supposed to co-lead the Lending Club deal with Jefferies, according to The Wall Street Journal.
Peer-to-peer lending appears to have hit the big time, with Goldman Sachs as a participant. The question now is how much liquidity and market share will the investment banking giant divert from the pioneers in the space.
This article was written exclusively for GoRion.