“Peer-to-peer lending is probably a bad idea,” we wrote, earlier this month. “Securitizing peer-to-peer loans is definitely a bad idea,” we added.
The P2P space has witnessed monumental growth over the past several years. P2P platforms lent over $12 billion in 2015 alone and as we documented last summer, Wall Street is supercharging the space by securitizing the loans.
Obviously, the idea of pooling and packaging consumer loans is a dicey proposition even when the lender is a corporation (see our coverage of Springleaf and OneMain for example). But when the lender is an individual, we’re in uncharted waters entirely.
That is, P2P-backed paper effectively embeds person-to-person counterparty risk in the financial system. Investors are buying paper backed by the “full faith and credit” of individuals seeking to refi their credit cards and the loans are made by other individuals whose capacity to absorb losses is completely opaque.
As Michael Tarkan, an equities analyst at Compass Point Research put it last year, “We’ve created a mechanism to refinance a credit card into an unsecured personal loan [and that] hasn’t been tested yet through a full credit cycle.”
Well guess what? We’re about 1% from entering a full-on default cycle according to Deutsche Bank and that means that when it comes to P2P, we’re about to see what happens when widening junk spreads collide head on with abysmal economic growth, lingering student loan debt, and the waiter and bartender “recovery.”
The cracks, we said two weeks ago, are already starting to show. A recent presentation by LendingClub showed that some P2P debt is “underperforming vs. expectations” as write-off rates for a portion of five-year LendingClub loans were roughly 7 percent to 8 percent, compared with a forecast range of around 4 percent to 6 percent. Here’s what that looks like in terms of blue spheres and red arrows:
“Matching up individual borrowers and lenders may sound like a good idea in principle, but effectively, you've got a brand new set of companies (the P2Ps) attempting to assess individual borrowers' credit risk on the fly in cyberspace,” we warned, adding that the whole model is “an absurdly difficult proposition and one that obviously comes with myriad risks especially when those credits are sliced up and sold to investors.”
Well don’t look now, but another prominent P2P lender is sounding the alarm bells on credit risk. “Prosper Marketplace Inc. has started charging borrowers more for loans on its platform, as the company deals with a greater risk of defaults while striving to keep its loans attractive to investors with higher-yielding alternatives,” WSJ wrote on Wednesday. “The San Francisco company, which runs one of the biggest online consumer-lending platforms, told investors who buy its loans Monday that it was raising its rates by on average 1.4 percentage points due to ‘the current turbulent market environment that we have witnessed since the beginning of 2016.’”
The move by Prosper - which originated some $1.6 billion in loans last year, up 350% from 2014 - comes on the heels of a similar push higher by LendingClub which hiked rates in December after Janet Yellen's ill-timed liftoff. Here's more from WSJ:
Overall, Prosper’s rates will rise to an average of 14.9% from 13.5%, the company said in the email to investors.
“This looks like a typical credit-cycle turn,” said Brian Weinstein, chief investment officer at Blue Elephant Capital Management, which invests in online consumer loans and manages $100 million in assets.
Mr. Weinstein said he urged Prosper to start charging borrowers more since August when he first noticed worsening loan performance. Prosper said in its email to investors that it had been increasing the estimated losses on its loans since last August.
The company didn’t discuss specifics in the email. Last week, ratings-firm Moody’s Investors Service said that it may downgrade a subset of a pool of Prosper loans that are securitized, citing higher-than-forecast late payments and charge-offs. The original rating on those loans was Baa3, which is investment grade.
New securitizations of consumer loans have halted since the Prosper loans deal last year. A package of loans made by Chicago’s Avant Inc., including some to people with subprime credit scores, is being shopped to investors.
Right, so the model started to fall apart last August in the wake of the market turmoil caused by the yuan deval and things have only gotten worse since. Got it.
The question now is what happens to the nascent P2P-backed ABS market once spreads start to blow out on the existing paper and what impact a meltdown will have on loan origination across the space.
We can only hope things don't go south too fast because without Prosper, good people like Syed Farook and Tashfeen Malik won't be able to obtain the $28,000 loans they need to finance the jihad in California.