Another online lender specializing in student loan refinancing is tapping the securitization market.
Earnest, based in San Francisco, is marketing $112 million of notes backed by loans to borrowers who will graduate within six months of issuance of the loan or who have already graduated with an undergraduate or graduate degree and demonstrate a strong ability to repay their debt, according to DBRS, which is rating the notes.
Earnest was founded in 2013 by chief executive Louis Beryl and chief operating officer Benjamin Hutchinson, and operates in 38 states. It competes with other marketplace lenders, but has only been lending since 2014, while SoFi Lending Corp. and CommonBond were both founded in 2011. As of Dec. 31, 2015 Earnest had funded some $400 million of student loans to 5,580 borrowers.
Like SoFi, Earnest is courting young professionals, using its student loan refinancing product to establish a relationship in hopes of eventually selling them an array of financial products and services. Both startups aspire to be more banklike than their peers in the white-hot marketplace lending space. Securitization offers them a way to fund rapid loan growth.
DBRS has assigned provisional ratings of single-A to the senior, class A notes from Earnest's bond offering; that’s the same rating that it assigned to the senior notes issued by the most recent deals from SoFi and CommonBond.
A subordinate tranche of class B notes, to be issued by a trust called EARN 2016-1, is provisionally rated BBB.
Initial overcollateralization for the class A and class B Notes will be 12.4% and 6.5%, respectively. Prior to the February 2017 payment date, excess spread will not be released from the trust. Instead, available funds will be used to build overcollateralization to either 16% of the total pool balance plus the reserve account or $3 million, whichever is greater. Available funds will also be used to build class B Note overcollateralization to 10% of the total pool balance plus the reserve account or $2 million, whichever is greater.
The weighted-average life of the class A notes is roughly 3.53 years. This is considerably shorter that the majority of student loan-backed securities, both because the borrowers have already completed school and are making payments and because these borrowers have extra income that can be used to pay down principal. The shorter tenor reduces exposure to macroeconomic conditions that could affect borrowers’ ability to make payments.
The borrowers in the loan portfolio have a weighted average credit score of 775 and weighted average income of $143,535. Most are employed and have been making timely loan payments for a significant amount of time, which makes them less likely to default than more typical student loan borrowers who are in school or just entering repayment.
According to Earnest, since the inception of its student lending business, there have been no loans more than 60 days delinquent and two hardship forbearances granted.
About 81.0% of the pool's outstanding principal balance consists of loans made to borrowers who obtained a graduate degree. Loans made to graduate students have historically defaulted at much lower rates than loans made to undergrads. According to the Department of Education, the three-year cohort default rate for Grad PLUS loans (federally guaranteed loans to fund graduate school) is about 1%.
Earnest will service the loans; the Higher Education Loan Authority of the State of Missouri acts as the “hot” back-up servicer for this transaction and will assume the servicing responsibilities of Earnest under certain circumstances.