Kroll, Fitch clash over fintech ratings trends
Two ratings agencies are butting heads over the credibility of structured-finance ratings being assigned to marketplace lender (MPL) securitizations.
As a result, Fitch Ratings and Kroll Bond Rating Agency offer fundamentally different views of the level of risk in issuances by Avant, Prosper Marketplace, LendingClub and other online lenders.
On May 13, Fitch Ratings released a report critical of the high investment-grade ratings applied to recent MPL bond offerings backed by bundles of unsecured consumer loans — including subprime originations. Although it named no agencies in the release, the report was clearly a swipe at Kroll, the agency which has rated the vast majority of fintech ABS deals since 2016.
But last week, Kroll counterpunched with its own report. It listed numerous reasons its analysts believe the credit quality and performance of MPL securitization platforms have improved enough to support existing ratings levels even though credit support has decreased. Kroll also argued that deals are deserving of upgrades as they amortize and have reduced leverage.
Fitch’s calling out of the ratings applied by Kroll to some of the lenders is the latest of its critical, unsolicited commentaries on structured finance transactions it was not asked to rate. Fitch says they warrant a second opinion for investors. Last September Fitch criticized the triple-A ratings assigned by S&P Global Ratings and DBRS for a middle-market CLO issued by Vista Credit Opportunities Management. The chief reason was the deal’s highly concentrated, 75% exposure to the tech industry.
Fitch also has critiqued residential mortgage-backed securitizations ratings as well as those for an aircraft-lease asset-backed transaction. Fitch has issued approximately 25 such deal commentaries in recent years.
The 2018 and 2019 MPL deals have received the same single-A tier ratings as lenders’ earlier-vintage ABS transactions, despite dwindling protections for investors and no improvement in underlying loan quality, Fitch said in its new report.
“Credit enhancement levels ... meaningfully declined since 2017, while asset quality remained relatively steady,” the report stated. “As a result, bondholders of more recently issued transactions have less loss protection or the same amount of asset risk.”
Fitch’s report included statistical comparisons showing how CE levels have declined across the board for lenders. Avant, for example, provided an average 43% of credit enhancement to its deals in 2017, but maintained only 31% for its latest transaction in 2019 for the same single-A rating. Avant slightly increased its band of lowest-score FICO borrowers this year (44% of the balances in the collateral pool) versus 40% in 2017.
Also, average original terms on transactions were only slightly reduced to 36 months from 37 months. Shorter-term loans are considered less risky as collateral for securitizations.
Credit enhancement in structured finance vehicles usually includes collateral value in a pool (i.e., aggregate loan balances) in excess of the issued note balance; it is supposed to provide a greater loss cushion for investors. In addition to overcollateralization, lenders will enhance investor protections by funding reserve accounts and increasing subordination levels for senior notes.
Fitch said that while MPL transactions have “rapidly deleveraging” structures that support stable ratings performance, “this dynamic only holds when there is sufficient time for CE to build from initial levels before the ratings are reviewed. Should significant stress occur too soon after deal closing, noteholders are likely to be subject to downgrades across the capital structures.”
That stress could come in the form of a macroeconomic downturn that MPL securitizations (which first launched as an asset class in 2013) have yet to experience, leaving the deals “unproven,” Fitch stated.
Fitch added that the fintech sector has “demonstrated notable volatility in its history, including underperformance compared to originator expectations, shifts in underwriting standards and regulatory challenges to the business model. Fitch believes these challenges should be reflected in stable, not declining, credit protection to investors.”
Fitch has not rated an MPL securitization since the first quarter of 2018.
Kroll, meanwhile, has ratings for all 65 transactions in 2016 (totaling $22.4 billion in bonds) and 33 of 35 securitizations issued under 144A exempt status in 2018 and 2019.
Kroll this year has issued exclusive senior-note ratings ranging from A- to A+ for lenders including Prosper, LendingClub, Opportun, Upgrade, Avant, and Upstart Holdings. Kroll was also the only agency asked to rate two transactions so far in 2019 for Marlette Funding, both of which got an AA Class A note rating.
Though 2018-2019 vintage deals have had decreasing levels of overcollateralization and lower proportions of subordinate notes in a first-loss position, the credit performance of these MPL ABS deals have improved, according to Kroll. That improvement supports continued high ratings as well as upgrades as the deals amortize.
“These improvements during the last four years have resulted in more predictable credit performance across the industry and upward rating migration for MPL securitizations,” Kroll’s report stated. “[Kroll] is better able to forecast base-case losses and, when appropriate, may accept lower loss multiples for a requested rating, which results in lower credit enhancement requirements consistent with the evolution of a maturing sector.”
Kroll also credits the sector with recruiting more executives with traditional and specialty banking finance backgrounds – as well as with introducing tighter underwriting criteria and advancing operational strength in loan servicing and fraud detection.
Veteran executives in the sector include Marlette’s Jeffrey Meiler (a U.S. credit-card executive at Barclays) and Prosper’s David Kimball (a former chief operating officer at USAA, as well as securitization roles as Ford Motor Credit).
MPL lenders are also diversifying their source of funds with warehouse lines that maintain stable lines of credit for new loan offerings. Deals are also being issued with lenders choosing to better align their interests with investors by having more skin in the game in the unsecured loans they issue, Kroll’s report stated.
Deutsche Bank weighed in last with a report on Fitch’s analysis. Its analysts agreed that Fitch may “arguably have a point” about the lower CE levels, “[but] this seems to ignore the precedent for rating agencies requiring less credit enhancement at a given rating category for an issuer as more historical performance data becomes available due to seasoning and continued issuance.”