Appetite grows for riskier MPL collateral and deeper sub notes
Marketplace loan ABS investors are showing a higher tolerance for risk, flocking to recent marketplace loan securitizations which are increasingly backed by a higher proportion of risky loans and structured with deeper capital stacks.
The decline in underlying collateral quality — a theme across wider consumer ABS sectors — has been playing out in marketplace loan ABS, with recent deals from Prosper, Marlette Funding and Avant featuring a growing proportion of loans taken by borrowers with credit scores of less than 680.
“The proportion of borrowers with FICO scores below 680 – normally regarded as the threshold for non-prime – rose to approximately 31% in this transaction, compared to 23% in a prior deal,” wrote Kroll Bond Rating Agency analysts in a presale for Marlette’s most recent ABS, which priced last Wednesday.
Likewise, subprime marketplace lender Avant sold a deal this week with 17.3% of loans made to borrowers with FICO scores under 620, compared with 12.8% in a prior transaction in April.
A report this month from Moody’s suggested that the main driver of riskier loans could be due to increased debt burden, especially for borrowers with modest incomes, and warned that increasing the proportion of these loans in new deals could have a negative impact on securitization.
“Although still much lower than before the crisis, increasing debt burdens among these [borrowers] are likely increasing risk particularly for securitizations and consumer lenders with the highest exposure to certain subprime and near-prime borrowers,” wrote Moody’s analysts in the report.
Yet, while many have echoed this concern, industry players speaking with GlobalCapital say that the trend has not done much to dent investor demand for the bonds. The Avant deal, which was priced on Tuesday, saw spreads grind tighter compared to its last deal, with the ‘A’ notes pricing at 80bp over euro dollar spot forwards, compared to 115bp over on its April deal. The ‘C’ notes also narrowed by 130bp, pricing at 320bp over swaps.
“It seems like no deal gets done without being multiple times oversubscribed,” said one investor. “We do need to be worried about credit quality but it seems like people are just trying to put money to work.”
Karan Mehta, head of capital markets at Marlette, noted that although the proportion of borrowers with lower credit scores had increased on its recent deal, the lender’s credit model enabled them to account for the risk.
“We don’t necessarily view that as non-prime collateral,” Mehta told GlobalCapital. “We feel like we’re able to identify opportunities where people with slightly lower FICOs carry the same credit risk as people with higher FICOs, but you can charge them a higher rate of interest. So the risk/return trade-off is compelling,” he added.
Given the persistent low yield fixed income environment, investors are also showing an increased appetite for more subordinate paper. Marlette met this demand in its latest transaction by adding a ‘D’ class of bonds, a structural feature rarely seen in most marketplace loan securitizations.
“There is market demand for it and the ‘D’ notes improve the structural efficiency and execution of the deal,” said Marlette’s Mehta. “We are definitely open to having it in the future. We expected the structure to evolve over time, and the ratings agencies have adjusted the structural enhancements accordingly,” he added.
The investor added that the addition of deeper subordinated tranches may become more frequent in future marketplace loan ABS, with many buyers willing to take on more risk with short dated paper.
“If you look at the Marlette deal, and even other short-dated esoteric deals like the Solar Mosaic ABS, there’s now more deep subordinated tranches to play in,” the investor said, adding that investors are looking at new and “compelling” investments for their money.
“The marketplace lending sector usually has pretty short-dated stuff, and so people have been contemplating going deeper into non-investment grade land there,” he added.