Over the past week, I’ve given readers a window into the sometimes seedy world of marketplace lending.
The P2P phenomenon was all the rage there for a while, but fell on hard times when choppy credit markets and questions about the model sapped demand for the loans the companies originate. It’s pretty simple really: if companies like LendingClub, SoFi, and Prosper can’t sell the loans they make to investors, they’re f*cked. That is, the only way they can make new loans is to sell off the existing ones.
It’s essentially the old “originate to sell” model that helped create the conditions that led to the collapse of the housing market in 2007.
When demand for online lenders’ loans isn’t there (like say when the securitization machine isn’t firing on all cylinders), these companies have to get creative. In the case of SoFi, that meant starting a hedge fund to buy loans from itself. I talked a bit about that completely ridiculous trip down the full-retard-rabbit-hole here.
Earlier this month, shares of LendingClub experienced what the optimists out there deemed a “sell the news” post-earnings plunge:
Compass Point’s Michael Tarkan didn’t sound very enthusiastic in his assessment. “Shares still aren’t reflecting competition, credit/investor demand risks; sales/marketing expenses jumped 24% q/q despite 1% increase in originations, rose 4% y/y despite 23% decline in originations,” Tarkan wrote earlier this month, adding that “January’s tighter underwriting was ‘material’ [as it was] the 4th time LC cut out part of its lower-quality borrower base.” Compass Point estimates LC has shed 15%-20% of its base by tightening underwriting in the past 12 months.
“The need to tighten credit standards for certain borrowers and the company’s plan to step up investments in marketing and new products (as well as other one-time items) are expected to continue to weigh on growth and profitability, at least through 1H17,” Citi said, following LC’s Q4 results. “Considering guidance for 1Q17 issued was below our forecasts and 4Q16 saw originations and marketing efficiency below our estimates, our earnings forecasts are being revised downward,” the bank added.
But that didn’t stop Jefferies – whom LendingClub hired last year to help source demand after a highly publicized internal probe related to falsified documents on a $22 million package of loans sent investors scurrying – from taking the lead on a $213.137 million ABS deal just a week later.
When it comes to lackluster demand from investors and the deleterious knock-on effect it has on loan volume and, in turn, on the top and bottom line, Propser Marketplace is the poster child. In Q3 of last year, loan activity at the company fell to its lowest level in at least two years. Prosper blamed “negative actions, publicity at competitors [and the] limited use of investor rebates, which have become more prevalent in the industry.” That last bit refers to marketplace lenders offering investors incentives to buy loans.
Well on Monday, WSJ reported that Prosper has found a buyer for some $5 billion in consumer loans and wouldn’t you know it, Jefferies is right in the thick of things. Here’s the Journal:
Prosper Marketplace Inc. struck a deal on Monday to sell up to $5 billion worth of consumer loans to a group of investment firms over the next two years.
Members of the group arranged by the online lender include New Residential Investment Corp, a real-estate investment trust managed by an affiliate of asset manager Fortress Investment Group LLC; hedge-fund firms Soros Fund Management LLC and Third Point LLC; and the investment bank Jefferies LLC. The Wall Street Journal reported in August that the four firms in the consortium being announced Monday were in advanced talks with Prosper on a loan-buying deal.
The arrangement clears one of the biggest issues hanging over the San Francisco-based company, which was valued at $1.9 billion in an April 2015 fundraising round. A subsequent drying up of investor appetite for Prosper’s credits caused loan volume to fall by around one-third in the first nine months of 2016, prompting the company to lay off staff and slash spending to conserve cash.
“The space was maybe hotter [among money managers] than the mechanics or fundamentals would have supported at the time,” said Prosper CEO David Kimball in an interview Monday. “Now I think we’re at a stage where there’s just a little more of a thoughtful approach.”
Yes, “just a little more of a thoughtful approach.”
As it turns out, this new “thoughtful approach” comes with one tiny, itsy bitsy, little footnote.
See the consortium gets warrants depending on how many loans they buy from Prosper. Should the group end up buying the entire $5 billion, they’ll end up having the right to purchase a “small” share of the company. And by “small” I mean 35% f*cking percent. To wit:
The bulk of Prosper’s revenue comes from fees it charges borrowers to take out loans, so having a large commitment from money managers to fund loans helps ensure that revenue will be more sustainable.
That certainty won’t come cheap, though. As part of the deal, the investor group will receive warrants to buy Prosper shares that are tied to the volume of loans that they buy at face value. If the group buys the full $5 billion, they would have the right to purchase shares representing 35% of the company.
Another money manager has warrants to purchase 7% of Prosper.
Once again I remind you that this entire space is a clusterf*ck. The model hasn’t been sufficiently tested, we’re at the end of the cycle, and we’ve already seen how quickly demand dries up at the first sign of trouble.
But the most worrisome part of the whole thing is that the more of this sh*t that gets packaged and sold as ABS, the greater the potential for it to become systemic. That is, securitization embeds these loans into the system. The same is true of subprime auto ABS. It’s 2006 all over again, just on a (mercifully) smaller scale.
On the “bright” side, increased investor demand for the loans these companies originate means “good” folks like Syed Rizwan Farook will be able to get $28,500 when they need it…
This will NOT end well. Can you say “cluster-fuc*”.