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Upstart finds a buyer for its bad loans, lowering funding costs

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Upstart, the online consumer lender founded by former Google employees, has found a buyer for its charged off loans, and this is allowing it to finance lending more cheaply in the securitization market.

In April, Upstart signed a forward flow agreement with a third-party debt buyer and has completed multiple post-charge-off loan sales. As a result, Kroll Bond Rating Agency now expects recoveries on defaulted loans in a $187 million transaction launched this week to be 8%, instead of zero. The rating agency has reduced its expectations for net losses over the life of the deal to be in the range of 18.3% - 20.3%, 1.66 percentage points lower than its initial expectations for Upstart’s prior securitization, completed in April.

The lower loss expectations, in turn, allow Upstart to lower the amount of credit enhancement on each of the four tranches of notes in the deal, which is called Upstart Securitization Trust 2018-2.

The senior tranche of Class A notes, which is rated A- by Kroll, has credit enhancement of just 61.2%, down from 71.29% for the comparable tranche of the prior deal. Similarly, CE for the BBB- rated Class B notes has fallen to 40.155 from 48.09%; CE for the BB- rated Class C notes has fallen to 22.05% from 29.93%; however the CE for the B- rated Class D notes has risen to 10.5% from 10.23%.

Credit enhancement provides protection for the notes against losses and delays in payment on the receivables or other shortfalls of cash flow. It consists of a combination of overcollateralization, subordination to the senior notes and a reserve account. The primary way that Upstart has lowered credit enhancement in the latest transaction is by reducing the amount of subordination available to the Class A notes, which are first in line to be repaid, but receive the lowest rate of interest. They represent a larger portion of the overall capital stack, 39.3%, up from 29.21% for the prior deal. So there are fewer subordinate noteholders available to absorb losses.

The overcollateralization, or excess collateral, in the deal has actually rise to 10% of the balance of the notes from 9.73% for the prior deal. And the size of the reserve account is unchanged at 0.5% of the initial balance of the notes.

Higher expected recoveries aren’t the only reason that Kroll is accepting lower levels of investor protection for the same ratings, however. Kroll also cited an improvement in the performance of Upstart’s 36-month loans, though these account for a smaller proportion of the collateral, just 29.26%, compared with 33.27% of the April deal. The remainder of the loans has terms of 60 months.

But the primary difference is the forward flow agreement with a third-party debt buyer, which Kroll said is a practice commonly used by other marketplace lending platforms. Eligible charged-off loans in the collateral for Upstart 2018-2 will be aggregated and sold in the month following the charge off. The net proceeds of any loan sale will be deposited to the collection account and allocated in accordance with the flow of funds for the transaction. Following the completion of Upstart’s new recovery strategy, KBRA updated its cash flow modeling recovery assumption to 8% from 0%. The agreed upon purchase price in the forward flow agreement is higher than KBRA’s recovery assumption. (Upstart generally charges off loans once they fall 120 days behind on payments.)

This transaction is Upstart’s fourth securitization overall of prime and near prime unsecured consumer loans originated by Cross River Bank. Upstart currently offers fixed rate, monthly amortizing unsecured consumer loans ranging from $1,000-$50,000 with terms of either three, five, or seven years and fixed annual percentage rates that range from 4.00% - 29.99%. (The company only began offering seven-year loans on Feb. 23 of this year, and none are included in the latest deal.)

So far, cumulative net losses on Upstart's first securitization, completed in early 2017, are 5.11%; the second deal, completed later that year, has sustained losses of 1.47% to date; net losses on the April 2018 deal are 0.04% to date.

As of June 30, 2018, the Upstart Program has issued over 161,000 loans for over $2.07 billion with January 2018 originations of $138.1 million being the highest historical monthly originations, according to Kroll.

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