Bond buyers forgive and forget, flock to debt from online lenders

The initial appeal of upstart online lenders was that they would disrupt traditional lending markets. But after big setbacks last year, companies are adapting to be a little more Wall Street and a little less Silicon Valley.

Changes include maintaining the risk of some loans they make, securitizing their loans – or selling them in batches – themselves rather than through third parties, and appointing veterans of banks and investment companies in management positions.

Investors in bonds secured by the loans these online platforms have helped trade have welcomed the moves. Last year, as skepticism mounted about their offers, these investors backed out of buying their loans. But since early April, more than $2 billion in loan-backed securities from LendingClub Corp.

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, Prosper Marketplace Inc. and their peers have been sold or are in the works for an imminent sale, according to ratings companies and people familiar with the matter. That’s already more than was issued in the entire second quarter of 2016, according to data tracker PeerIQ.

The deals are also being made at more favorable prices: the extra yield, or spread, that investors have demanded on recent Social Finance Inc. and Avant Inc. deals, above that of safe government debt, was much lower than similar transactions that each lender last brought. year.

The most recent activity comes on top of $3 billion in online loan-backed bonds that were issued in the first quarter of 2017, double the amount in the same period a year earlier, according to PeerIQ.

Early last year, confidence in these lenders was shaken by a spike in defaults, warnings from bond rating firms and a scandal that ousted the CEO of industry leader LendingClub. Fund managers reacted by slowing their purchases of debt securities issued by these lenders and asking for higher yields.

Since then, online lenders have rushed to make their loans more attractive to investors. They revised their lending criteria, cut off weaker consumers, shortened loan terms and started charging customers more for borrowing in a bid to increase returns.

“It was really important to see that there was some sort of consumer lending context…as opposed to just an algorithm,” said Joe Astorina, head of asset-backed securities research at AllianceBernstein Holding LP. .

Investors embrace online lenders’ debt offerings for their relative value to other debt, the higher quality of the underlying loans, and the steps they’ve taken to look more like established financial firms rather than technology-focused startups.

One factor plays in favor of lenders: the fall in yields on other categories of debt, in particular high-yield bonds. As yields on US government debt rose after last November’s election in anticipation of stronger economic growth, rates on high-yield debt fell on expectations that companies would fare better under the new administration. This made loans from lenders more attractive on a comparative basis.

The spread required by fund managers to hold bonds issued by risky companies above that of safe government debt was 3.84 percentage points on Wednesday, according to data from the Federal Reserve Bank of St. Louis. . That’s down from 6.40 on the same day in 2016 and down from a high of almost 10 percentage points in February of the same year.

“We went through a messy incident and we got over it,” said Perry Rahbar, CEO of dv01, which provides online lending analysis to bond investors.

Information from a report by ratings agency Kroll Bond on an April securitization of Avant Inc. involving 46,896 loans shows how lending standards have changed over the past year. The average loan backing the deal had a balance of $5,359 and a term of 37 months, compared to $7,572 and 47 months on a February 2016 Avant deal. Between those deals, Avant hired Grant Miles, a former senior executive of the lending industry in the United States. of HSBC Holdings PLC, as Chief Risk Officer.

These changes helped lower Kroll’s base loss scenario to a range of 16.3% to 18.3% of the pool’s loan balance, from 19% to 21% in the previous transaction. This means that investors who buy securities securing the loans might hope that they carry less risk.

The spread on the less risky tranche of Avant’s latest bond trade was 1 percentage point lower than it was on a deal the company closed in the summer of 2016, according to PeerIQ.

Admittedly, bonds backed by online loans represent only a fraction of the securitization market. In 2016, a total of $7.8 billion in bonds backed by online loans were issued, according to PeerIQ. That compares to $191 billion in total asset-backed securities issuance, according to S&P Global Ratings.

And while investors are increasingly enamored with offerings from online lenders, some bondholders continue to profit from past trades where loss estimates have been revised higher.

The next test of investors’ appetite for online offerings will come in the coming weeks when LendingClub begins marketing a deal of about $400 million of bond-backed loans it has made to consumers. less creditworthy, according to people familiar with the matter. Last week, a $450.5 million deal backed by 39,334 Prosper personal loans was oversubscribed, according to a person familiar with the matter. This was the first transaction under Prosper’s new chief executive, David Kimball, and new chief financial officer, Usama Ashraf, who each held senior positions in USAA’s finance department.

Write to Peter Rudegeair at [email protected]

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