Editor's note: This is the fourth in a series of 10 articles revisiting some of our most-read stories of the past year.
Marketplace lenders started out as pure matchmakers, connecting borrowers with lenders over their platforms. These matchmakers did not hold on to the loans, though the investors who funded them could turn around and resell the loans as collateral for bonds.
But the limitations of this business model are now quite clear. It gives investors too much pricing power. And the lenders themselves have no control over how these securitizations structured, or when they come to market — even though the transactions’ performance could affect their reputations.
So when LendingClub set out to rebuild its business following a scandal over its corporate controls, bringing securitization in-house was an important step. The company needed to broaden its funding sources after concerns about the integrity of its data caused many investors to pause or scaled back their purchases. Now it 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.
LendingClub’s inaugural $279 million deal, backed exclusively by subprime consumer loans, was completed in June; the company followed up with two deals backed by prime loans in September and November.
“By leading [the first] 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 also started to keep a small portion of loans on balance sheet and contribute them to collateral for deals.
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."