LendingClub’s first securitization of its own consumer installment loans is an important step in rebuilding its business following a scandal last year over its corporate controls.
The company has been seeking to broaden its funding sources after concerns about the integrity of its data caused many investors to pause or scaled back their purchases. LendingClub originally acted purely as a matchmaker, connecting borrowers with lenders over its platform. It did not hold on to the loans. Investors who funded these loans and wanted to turn around and resell them as collateral for bonds were left to their own devices.
That meant the company had no control over how these deals were structured, or when they came to market — even though the transactions’ performance could affect its reputation. Moreover, LendingClub’s original model of relying exclusively on loan sales and not using the firm’s balance sheet, while consistent with the asset-light approach of Silicon Valley darlings (Uber owns no cars), gave loan investors too much pricing power.
Now LendingClub is allowing multiple investors to sell their loans back to a securitization trust that it sponsors, a move that increases economies of scale and ensures some uniformity in the bond offerings. The inaugural $279 million deal, backed exclusively by subprime consumer loans, closed last week.
“By leading this securitization, we were able to show that we’re committed, control the process and deliver an enhanced experience for new and existing investors that buy through our platform,” said Valerie Kay, senior vice president and head of the institutional investor group at LendingClub. “We want to control our brand, promote liquidity and provide access to the capital markets to investors.”
Kay is part of a new finance team brought in since CEO Scott Sanborn took the helm last June. She spent more than 25 years on Wall Street, with stints at Morgan Stanley and Prudential Securities.
By sponsoring its own securitizations, LendingClub is also taking skin in the game, in the form of the 5% economic risk it must hold in order to satisfy risk retention rules that took effect last December.
In the past, LendingClub played a supporting role in securitizations of its loans by buyers, talking to potential bond investors and rating agencies, even if it did not have any control over the deals, Kay said.
“After supporting a few securitizations, we understood that investors and rating agencies would value LendingClub having skin in the game,” she said. “We believe in what we do here, and we want to broaden the base of investors that have access to our product. If you add all that together, securitizations make sense.”
The company has started to retain a small portion of loans on balance sheet, according to research published by Kroll Bond Rating Agency, although it did not hold or contribute any of the collateral for the inaugural deal.
“We have this whole ecosystem to support: our investors, their warehouse providers … some investors might be looking to do structured products,” Kay said. “We hope to help promote liquidity with potential programmatic access to the capital markets.”
The shift to what’s known as a hybrid model of both selling whole loans and securitizing them is hardly revolutionary. Prosper Marketplace, another online lender that previously relied exclusively on whole loan sales, completed its first securitization in May. Upstart, a relative newcomer founded by several former Google employees, completed its inaugural securitization within days of LendingClub’s.
Other marketplace lenders, including Avant and Social Finance, have completed multiple securitizations of loans made on their respective platforms and sold to investors.
Still, “LendingClub was the poster child for the idea that a pure [sales] model was workable,” said Todd Baker, a senior fellow at Harvard’s John F. Kennedy School of Government. “It’s pretty much been proven not to work."
The problem with the marketplace model today is that the investors know the lender has to sell — it has no choice, Baker said. “The only leverage the lender has [in determining pricing] is what other investors are out there.”
The shift to securitization creates a degree of freedom that LendingClub can use to bring down funding costs and get to a profit without a massive increase in origination, he said. By comparison, under the old model, it had to keep increasing originations to have any chance of being profitable.
However, a wholesale-based funding mix still leaves LendingClub vulnerable to market disruptions and to the credit performance of the loans underlying the asset-backed securities, Baker cautioned.
LendingClub, once the nation’s leading online lender, is in a stronger position than some of its peers, having raised significant equity when times were good. It currently has $534.5 million in cash available for immediate liquidity, as well as $120 million of unused capacity on a revolving line of credit that expires in December 2020, according to Kroll.
The company trimmed its losses to $29.8 million in the first quarter, less than in each of the previous three quarters.
Others online lenders are in much worse shape. OnDeck Capital, an online small-business lender based in New York, is feeling the pinch as investors continue to demand better pricing for loans. It’s now retaining the bulk of the loans it makes, at considerable cost.
“In the early days of marketplace lending, some platforms had investors sponsoring their own securitization shelves,” said Barry Rafferty, Upstart’s head of capital markets. “Issues that arose included nonhomogeneous pools due to active selection and inconsistently structured deals. Some of those early examples have had performance issues.”
By comparison, in Upstart’s first securitization, “we controlled our own shelf. We know the underwriting and collateral, we’re able to set triggers appropriately and control how the deal is marketed and structured,” Rafferty said. “And we offer the benefit of liquidity and leverage to investors.”
Kay said that standardization of deals is important to LendingClub.
“We’re talking to a bunch of investors and underwriters about what that means for them,” she said. “There are a lot of options for investors to choose from on our platform. So, this securitization is the first step in establishing a potential program that we hope will be consistent, standardized and predictable.”