Vadim Verkhoglyad, Senior Product Specialist at dv01, talks to Alt Credit about the maturation of marketplace lending and opportunities for Alt Credit Managers.
Since 2006, The marketplace lending sector has transformed itself from its peer-to-peer origins, into a mature institutional asset class. Initially, due to the lack of performance trends and the dominance of young start-up firms, the sector was not established enough for institutional investors and accredited LPs looking for alternative income streams that could match their more conservative risk tolerances.
Until recently, the only way to participate in the sector was buying loans directly, as securitisations weren’t introduced until 2015. Naturally, the loans were highly illiquid and difficult to trade once acquired. As higher yield-seeking institutions began to purchase larger volumes of loans, the sector underwent breakneck growth in both volume of loans from existing start-ups, and a bevy of newly created originators with limited track records of underwriting. Many originators were also selling 100% of their loan originations and would earn money solely from origination, meaning they had less to lose if loan performance deteriorated.
Weakened underwriting was a result of sector growth moving at breakneck speed (particularly in 2015-2016). Stacking was also a prevalent issue—a process where nefarious borrowers could take loans from multiple marketplace lenders in a short span of time, significantly hampering performance on all the loans a borrower took out.
At the same time, numerous headlines outside of credit performance cast a further negative light on the sector. The Midland court case gave way to broad concerns about lending in certain states above state usury caps and additional state-level regulations. Several large marketplace firms were also plagued by internal issues which led to CEO resignations, closures and recapitalization effort. Alongside this, general market concerns about consumer credit coupled with negative headlines inspired an avoidance of the sector altogether. Since 2016, however, things have changed drastically.
Firstly, every established originator has made significant strides in their underwriting (through both machine learning and larger credit underwriting teams) to significantly curtail their riskiest and most loss-producing lending behavior. Originators have also significantly increased retainment of their own origination, more closely aligning themselves with investors in terms of post-origination performance. Today, every major originator now retains a significant percentage of all loans originated.
There have also been major changes to the type of originators that currently engage in marketplace lending. Large financial institutions, such as Marcus, have started their own platforms entirely, and there have been additional bank partnership models where online lenders have partnered, and made their services directly available to, financial institutions for internal use -such as HSBC partnering with Avant.
All originators are now further balancing volume with underwriting good credit. Unlike pre-2016, we are not seeing originators pursue the same hasty volume growth of 20%+ annually, where every new quarter was a record issuance volume. Instead, originators are now each taking their own pace, and we see a more mixed approach to volume growth and credit quality. Major originators have also banded together to increase sector transparency to combat stacking in real time, and taking additional steps to reprice, curtail or eliminate some of their most credit-sensitive originations. As a result, all originators, regardless of their total volume growth, have increased the percentage of total issuance coming from the top two internal rating grades or issuance categorisations by 20%+ year over year.
Finally, there has been tremendous growth of avenues available for investing in the space other than direct loan purchase. Securitisation programs exist in place for every major originator that are programmatic and have both investment and non-investment grade rated tranches available in each securitisation. Furthermore, every originator has created a “pass-through” program which allows for direct sales of loans, bundled into small securitisations with CUSIPs that can be far more easily traded. The growth of the pass-through programs has exceeded overall originator volume growth for every originator, and we are now seeing the first available pass-through securitisations that have a more typical securitisation structure, with senior and subordinate tranches.
The maturation we’ve seen in marketplace lending since 2016 ultimately creates a more normalised lending environment with consistent yields and improved credit standards. Market growth and origination volumes have also become more long-term oriented. This is not only beneficial to consumers taking out loans and originators issuing them, but also to capital markets firms looking to invest. Overall, now is the time for marketplace lending investments, as it is a space that should be considered for alternative income, particularly while bond yields hover near record lows and equities remain around record highs.