Standard & Poor’s sees three challenges to rating securitizations of peer-to-peer loans: lack of performance history, a lack of consistency in underwriting, and regulatory uncertainty.
So far only two P2P deals have been completed. In October, Eaglewood Capital Management completed the first-ever $53 million securitization of a package of consumer loans originated through Lending Club. The deal was privately placed and did not receive a rating.
And in December Social Finance, a non-bank lender that focuses on student debt consolidation/refinancing but has starting to offer home loans, completed a $152 million securitization. That deal was rated single-A by DBRS.
The next deal is unlikely to be rated by S&P. In a report published Wednesday, the rating agency said it is concerned that the short history of most P2P programs compared with the more established unsecured lenders, make it difficult to assess underwriting quality and borrower behavior and, in turn, forecast potential loan losses in a downturn.
The P2P business model is based generating attractive fees on new loan originations. Lenders earn a significant portion of their revenues upfront at the time the borrowers get the loans. This model places “an incentive for these companies to open up their services to a wider base of borrowers,” said S&P.
However the lack of performance history makes it difficult to forecast how companies will manage delinquent or defaulting loans in cycles of economic stress. S&P is concerned that in an economic downturn, the escalating costs (associated with servicing a deteriorating loan portfolio), coupled with declining fees (associated with reduced loan originations), could pressure a P2P company to “curtail or cease operations”.
“P2P loans have yet to experience a full business and economic cycle, which makes it difficult to assess underwriting quality and borrower behavior and, in turn, forecast potential loan losses in a downturn,” credit analysts Ildiko Szilank and Robert Chiriani wrote in the report.
S&P also highlighted its concern with the quality and consistency of the P2P loan underwriting process. P2P lending transactions happen online, over the Internet and the platform operator acts as a facilitator and conduit for each transactions. Outside lenders make the actual decision to extend credit, explained S&P in the report.
“More traditional loans--such as credit cards--are typically originated, managed, and serviced by a single entity, retaining the risks and balancing costs and benefits from longer-term relationships,” wrote Szilank and Chiriani in the report. “This helps to promote more consistent underwriting and collateral performance, particularly in stressful economic conditions.”
The ratings agency also noted that the regulatory environment for the P2P industry is another unknown that could create risk in securitizations.
Companies today generally lack the same degree of regulatory oversight as banks, and they don't face the same operational, capital, and liquidity requirements. However, if the P2P lending sector's presence in the credit markets continues to grow, S&P believes the industry could be subject to additional regulatory oversight. “It isn't yet known how local, state, and federal regulations might evolve to monitor such a wide range of players,” the report stated.