In recent years, there has been a rapid growth of marketplace lending (MPL)--originally known as peer-to-peer (P2P) lending--in which borrowers are matched with lenders via online platforms. Along with the growth in the size of the industry, there has also been a significant evolution of business models as MPL platforms continue to transition from players in a previously niche area of finance to competitors in the mainstream lending market. MPL funding models have become more sophisticated, institutional investor partnerships and hybrid models incorporating balance sheet funding are increasingly prevalent. MPL platforms are also demonstrating greater risk retention, leading to a stronger alignment of interests with investors, which has also helped address concerns about the originate-to-distribute business model. Furthermore, the regulatory environment is continually evolving, and MPL businesses are adapting to an increased focus from regulators and a more developed regulatory framework in many regions.
S&P Global Ratings maintains its view that distinct risks associated with the MPL sector must be assessed when evaluating securitizations. These risks include the applicable regulatory environment, as well as business strategy and operating history, management, revenue and financial performance, funding sources, and partner bank relationship incentives. We have observed a growing number of mitigants to these risks over the last few years, and also have an increased amount of performance data from both MPL platforms and securitizations of these assets. In consequence, the maximum asset-backed securities (ABS) rating achievable from S&P Global Ratings for securitizations of these assets has, in issuer-specific situations, seen ratings elevation in recent years.
Fintech? MPL? P2P? What's The Big Idea?
The terms "fintech," "P2P lending," "marketplace lending," "online lending," and "alternative finance" are often used interchangeably to group together an array of originators and services in an industry that provides a diverse range of loans to both consumers and businesses. These companies employ a wide range of business models, and there are significant differences regarding revenue and funding strategies for each business. However, the common denominator between all of these companies is their use of financial technology to connect borrowers with lenders and to underwrite loans using significantly automated algorithmic processes. Fintech simply stands for financial technology: technology that seeks to improve the delivery and management of financial services and that has enabled organizations to achieve cost efficiencies and competitive advantages over traditional lenders.
Peer-to-peer lending occurs when an online platform connects a borrower with individual lenders, who will group together to provide a loan. Over time and as they have grown, many platforms have moved away from this model and turned toward funding from larger, more stable institutional lenders. P2P has thus developed into marketplace lending. As lending volumes have increased and MPL platforms have increasingly diversified their investor base, particularly via the use of institutional partnerships, securitization of MPL assets has also become increasingly prevalent. As the number of participants in the sector has grown, the range of product offerings has also expanded to include personal consumer loans, mortgages, student loans, home improvement, and small and medium enterprise (SME) loans, among others.
Evolution Of The Market
Although MPL businesses have existed in many jurisdictions for more than a decade, the industry truly picked up speed around 2008 as a direct response to the tighter credit environment that resulted from the financial crisis. Stricter regulation and capital requirements for traditional lenders led to reduced access to credit for particular consumers and businesses. A consequence of this was the rise in demand for alternative sources of credit. The MPL industry grew in line with these developments, benefiting from an innovative use of technology, the absence of regulatory capital requirements and legacy IT architecture, and the cost benefit of not needing brick-and-mortar storefronts. These factors, among others, enabled the new lenders to implement lower cost business models than traditional banks and rapidly expand operations. Looser regulatory requirements and a solely online presence have enabled MPL platforms to, for example, be more dynamic, functioning 24 hours a day and rendering decisions and distributing borrower funds more quickly than traditional lenders.
In the pure P2P model, the platform acts as an intermediary between the obligor and individual personal lenders. As the market has matured, funding strategies of the MPL originators have evolved and can now be broadly split into three categories: P2P, balance sheet, and bank or institutional channels (investing either directly or indirectly via the wholesale funding market). A shift toward institutional funds is generally being observed as individual retail investors are sometimes expensive to attract and often perceived as less reliable in the long run than partnerships with financial institutions.
It is also common for MPL platforms to collaborate with partner banks either for temporary funding prior to loans being sold or for longer-term capital. A common structure is one in which loans are originated onto the balance sheet of a partner bank, which retains them for a brief period of time before selling them to the MPL platform. Once acquired by the MPL lender, many MPL platforms are increasingly adopting a hybrid model, holding a greater proportion of their loans on their balance sheet, partly to optimize liquidity and credit risk tradeoffs and in some cases as a response to regulatory influence and investor sentiment. These platforms have also increasingly used securitizations as a funding tool, when assessing these securities backed by MPL loans S&P Global Ratings analyzes a number of factors many of which are related to our operational risk criteria (see "Global Framework For Assessing Operational Risk In Structured Finance Transactions," published Oct. 9, 2014)
The largest, most mature MPL markets are in the U.S. and the U.K. There is also a growing presence in other jurisdictions, particularly continental Europe. Although less mature, the markets in other regions, such as Australia, are expanding significantly, while in China the market has been active but heavily constrained by regulatory issues and some high-profile frauds.
In the U.S., MPL origination volumes represent a fraction of total consumer credit outstanding in the U.S., which exceeded $4 trillion as of year-end 2018. However, growth since 2014 has been rapid and continues to be strong. While it is estimated that there are more than 100 MPL platforms currently in operation, the vast majority of loan originations are concentrated among less than two dozen platforms. According to S&P Global Market Intelligence, among these platforms, originations totaled approximately $45.5 billion, $41.1 billion, and $31.6 billion in 2018, 2017, and 2016, respectively. The consumer and student loan space represents the greatest proportion of originations, with the largest lenders being SoFi (founded 2011), Lending Club (2006), Prosper (2005), and GreenSky (2006). With the exception of GreenSky, those originators also dominate the securitization space: SoFi alone has completed more than 40 transactions since 2014, totaling approximately $20 billion in issuance (combined student loan and personal loan), while Lending Club and Prosper have each completed more than 10 securitizations, together totaling more than $5 billion. The SME sector represents a smaller proportion of origination volume, with the largest participants being OnDeck (founded 2006) and Kabbage (2009). The two have together closed fewer than 10 securitizations, totaling approximately $3 billion. Over US$15 billion of MPL securitization issuance occurred in 2018, and $3.7 billion in Q1 2019, according to PeerIQ. Cumulative MPL issuance to date totals $48.1 billion across 152 deals (see "PeerIQ MPL Securitization Tracker 2019 Q1").
Barring any major shocks to the economy or credit markets, S&P Global Ratings' forecasts annual origination volume by digital lenders of just over $70 billion by 2022 in the U.S. (see "S&P Global Market Intelligence 2018 U.S. Digital Lending Market Report," published Jan. 16, 2019).
The U.K. MPL market is the largest in Europe. Data is available from the Peer 2 Peer Finance Association (P2PFA), a self-regulatory body that, as well as performing other roles, collates data on the sector (consequently, information is limited to organizations who are members). According to the P2PFA, as of 2018 year-end, total cumulative lending facilitated by P2PFA members totaled over £10 billion. Approximately 65% of this lending is classified as SME, with the remaining 35% consumer lending. There are a number of entities within the U.K. market, including Zopa, RateSetter and Lending Works in the consumer space and Funding Circle, Folk2Folk and Thin Cats in the SME sector. Despite the rapid growth in the MPL industry, lending volumes still make up only a small proportion of total lending in the respective sectors. According to the Bank of England, as of December 2018 there was £143 billion of consumer lending (personal loans, car loans, overdrafts, and store credit, but excluding credit cards) and £166 billion of SME bank lending outstanding in the U.K. When comparing the stock of lending figures available from the Bank of England and P2PFA, MPL lending still only comprises approximately 1% of (non-credit card) consumer lending and under 2% of SME lending.
We believe that significant further growth is likely due to a number of factors, including the growing involvement of institutional funds and increased securitization issuance. Furthermore, there has also been involvement from certain government-supported entities such as the British Business Bank and European Investment Fund to support certain lenders, such as Funding Circle, with the aim of boosting access to finance for SMEs. The two entities that have completed public securitizations of MPL assets in the U.K. are also the largest platforms by origination volumes in their respective sectors; Funding Circle, which competes in the SME sector, and Zopa, which operates in the consumer sector. We are aware of five public deals that have been placed in the U.K.: Funding Circle has now completed three under its S-BOLT platform, and Zopa has completed two under its MOCA platform. The wider European, the market is also showing increasing securitisation activity; for example, YOUNI- 2019-1 is a French consumer loan securitization with Fintech and marketplace characteristics backed by loans originated from Younited Credit, a French ECB-regulated Credit Institution that closed on May 29, 2019. We expect securitization issuance of MPL assets to continue throughout Europe throughout 2019 and beyond.
Summary Of The Current Regulatory State
The regulatory environment is a key consideration when rating a transaction. In many jurisdictions, the lender must have regulatory permission to lend; similarly, they must often have permission to undertake the ongoing servicing of the loans. This can present legal challenges for the securitization of loans originated through MPL platforms. Furthermore, in most jurisdictions the regulatory focus has increased as the market has matured.
Developments in the legal landscape in the U.S. in connection with platforms that use partner bank arrangements have created uncertainty surrounding the "valid when made" doctrine and raised questions of who is the "true lender" for loans originated by MPL platforms through their partner banks. Given this legal uncertainty, S&P Global Ratings has rated only a handful of marketplace lending securitizations for which we felt risks arising from these issues were absent--particularly where sponsors do not use partner banks--and we maintain a measured approach in evaluating the broader sector. (See "Marketplace Lending and the True Lender Conundrum," published Feb. 22, 2019.)
In China, regulations initiated in 2016 kicked off the business registration requirements and follow-up market cleaning activities (for unqualified players) for China's P2P lending platforms. A dedicated authority was set up for the management of this industry, before which P2P was a loosely defined term in China and usually confused with the general online lending platforms operated by finance companies.
This industry drew broad market attention more recently due to the number of operators that have failed and the many controversial business activities that have been revealed, such as direct lending, providing guarantees, irresponsible marketing, and funding behaviors. China regulators ramped up market cleaning efforts in 2018 when negative macro and industry news mounted and hundreds of P2P platforms went into liquidation, or became victims of theft or fraud. The effort is continuing, and some market players expect more than half of the current operators to eventually exit the market.
The regulatory focus includes a proper business review and registration for qualified operators, and responsible origination, and funding processes. China's highly regulated securitization market is not open to P2P lending, and we expect this prohibition to continue in the near future.
We are not aware of any public MPL securitizations; however there are clear requirements for MPL platforms published by the Australian Securities and Investments Commission (ASIC). These state that under Australia's financial services and credit laws, providers of marketplace lending products and related services will generally need to hold an Australian Financial Services (AFS) license and hold an Australian credit license if the loans made through the platform are consumer loans. If a managed investment scheme is only made available to investors that are wholesale clients, it does not need to be registered. The MPL provider will need an AFS license that covers any financial product advice, dealing, or custodial or depository financial services activities undertaken in relation to the scheme, unless an exemption applies.
Europe, Middle East, And Africa (EMEA)
The regulatory framework in many European countries is relatively more mature. In March 2018, the European Commission proposed a new Regulation to create an EU-level regulatory framework for investment- and loan-based crowdfunding platforms that provide funding for businesses, referred to as the "European Crowdfunding Service Provider" (ECSP) label. The proposal is part of both the EU's Capital Markets Union work program and the Commission's recent Fintech Action Plan. The objective of the regulation is to allow crowdfunding platforms to solicit investments from investors across the EU after being authorized to do so centrally by the European Securities & Markets Authority (ESMA). However, platforms could only apply for the ECSP label if they do not already hold authorization to provide crowdfunding services under national law to avoid interfering in functioning domestic regulatory framework. Our experience in EMEA has been that MPL lenders are generally committed to working with regulators as these new regulations evolve.
In the U.K., the Financial Conduct Authority (FCA) has put in place business conduct, prudential requirements, and anti-money laundering regulations. Recent high profile investigations by the FCA include an investigation into the property P2P lender, Lendy which subsequently entered administration. As with most other jurisdictions, the regulatory framework in the U.K. is still evolving and the FCA is currently consulting on changes to the P2P industry to improve protections for consumers and to ensure investors understand the risks involved.
Operational Risk Or Limited Operating History Could Result In A Rating Cap
Many risks can affect the performance of securitizations; S&P Global Ratings will apply its asset-specific criteria but adopt a case-by-case approach in its analysis of MPL deals due to the diversity of business models, target markets, regulatory considerations, and jurisdictional characteristics.
The performance of these entities directly affects the performance of a securitization as the credit/ performance risk is transferred to the noteholders. We consider the below factors in our operational risk criteria, which generally assess the possibility that a performance key transaction participant (KTP) may become unable or unwilling to perform its duties during the transaction's life. With this view, the framework calls for the assessment of each performance KTP in a transaction and may influence our assessment of portability, severity, and disruption risk and may result in a capped rating. Other deal strengths--for example, the presence of a back-up servicer, regular cash sweeps, or pledges--may contribute to some rating elevation (see our operational risk criteria for additional details).
Business strategy and operating history
Despite some entities now having established operating histories, most MPL platforms have operated only through a period of benign economic expansion in a low interest rate environment and have not been tested through a downturn. Platforms are still evolving in terms of business operations and strategies, and they continue to experiment with new products with varying degrees of success, sometimes entering and exiting new markets within the span of a year or two. We pay close attention to origination standards and underwriting criteria and how practices compare with established lenders. There is an inherently greater challenge in formulating loss proxies for newer companies with shorter track records that have not operated through a full credit cycle. In addition, the performance of a newer company's loan pools may not be indicative of the performance of future pools if originations are growing rapidly--as is the case with many MPL platforms-–as growth may be driven by a loosening of underwriting standards or expansion into new and unfamiliar markets (see "How Much Is Enough? Information Quality Standards For The EMEA RMBS And ABS Rating Process," published Jan. 8, 2019). To compensate for these risks, our stressed default and multiple assumptions may be more severe than would otherwise be the case. At the same time, we will consider the sources of the platform's competitive advantage (speed, cost, technology, etc.) and its ability to compete in the long term.
We will review the management's background, experience, reputation, and past successes or failures in running similar businesses. We will consider the length of time the management team has worked together and their view and strategy for the company. We have observed comparatively higher management turnover in the MPL space versus traditional lenders. The level of the management's financial stake in the company is reviewed as an indicator of their commitment to the company. Frequent management turnover may lead to frequent shifts in strategy or may indicate other fundamental issues.
We may also discuss internal controls and any weaknesses identified by the company's auditor. We will discuss with the management how growth is being achieved and controlled (e.g., underwriting and/or pricing changes, geographical expansion, or expanded product offerings) and the kinds of infrastructure built to accommodate the expansion.
Revenue and financial performance
Our analysis will consider the financial position of the MPL platform. Ideally, we would like to have three years of audited financial statements, but, at minimum, the audited financials from the previous year and unaudited financials for any subsequent interim periods may suffice. Given that most platforms are still scaling up their operations and are not yet profitable (though the largest are approaching this target), we will analyze the MPL's capitalization and consider its ability to withstand future losses. We also review the company's income statements for their insights into the profitability, or future profitability, of the MPL business model.
Whereas traditional balance sheet lenders collect a majority of their revenue from the interest and fees collected on loans (i.e., net interest margin minus provisions for losses), many MPL platforms' primary sources of revenue come from origination and servicing fees. As such, there may be materially less "skin in the game" versus traditional lenders, which poses a potential risk to underwriting standards and loan quality. However, as discussed above interests are increasingly aligned by the incentive to build a sustainable business and in particular by the motivation to generate ongoing servicing fees. Examples of some platforms implementing additional measures to further align interests include some transactions in the U.K. where the servicing fee is only paid on performing loans. Similarly, in the U.S., "loan trailing fees" are increasingly common and only paid to originating partner banks on performing loans.
We will look at the mix of institutional, retail, balance sheet, and securitization funding to determine the breadth and depth of the MPL platform's financial support. Funding diversity is important, as an overreliance on one form or one institution, for example, can lead to liquidity shortfalls, should that market or institution's lending appetite diminish. Similarly, any substantial dependence on ABS securitization for funding is risky should the ABS market experience dislocation as it did between 2008 and 2009. We view multiyear committed warehouse funding facilities as a strength relative to credit lines that require annual renewals. Also, because many platforms are not yet profitable, we will consider not only the existing equity capital available to absorb losses but also what the prospects are for the MPL platform's future capital raises, and the strategy for achieving this.
Partner bank relationship and incentives
The MPL platform and partner bank will typically review together and agree on underwriting criteria, loan application processes, and associated tasks such as fraud checks. Thereafter, loan applications that meet these underwriting criteria will be ring-fenced and sent to the partner bank for final approval and funding. In instances where there is a reliance on a single partner bank to maintain ongoing loan originations, we will consider the risks of and mitigants against business interruption should the partner bank become insolvent or the funding agreement be terminated. We will also review the incentives in place aligning the interests of the MPL platform and partner bank. Balance sheet lenders' funding generally comes from lenders aiming to generate a margin over their cost of capital rather than capture excess returns in the securitization markets. However, as previously mentioned, in the U.S., there have been several legal cases that have brought into question the legality and enforceability of loans originated trough bank-partner models.
These factors are all considered in our operational risk criteria, which generally assess the possibility that a performance KTP may become unable or unwilling to perform its duties during the life of a transaction. With this view, the framework calls for the assessment of each performance KTP in a transaction and may influence our assessment of portability, severity, and disruption risk and may result in a capped rating. Other deal strengths--for example, the presence of a back-up servicer, regular cash sweeps, account trusts, or pledges--may contribute to some rating elevation (see our operational risk criteria for additional details).
The Risks In Marketplace Lending Securitizations Are Generally Declining
The MPL sector has evolved significantly, including improvements as lenders operate over a longer period of time. Consequently, when we rate these deals, we often have access to a greater amount of performance history. Furthermore, as the regulatory environment continues to mature, many lenders have adapted by increasing their compliance and control functions, which has often resulted in stronger alignment of interests. Considerations include the sector in which the marketplace lender operates, the funding model and alignment of interests and the nature of the assets and certain factors may also be jurisdiction-specific. We believe that securitizations of MPL assets will increase in both the U.S. and Europe in the next few years and that significant further growth is likely due to a number of factors, including the growing involvement of institutional funds and increasing investor demand. Given the diversity of the sector, we assess whether a ratings cap is applicable on a case-by-case basis and may update the cap periodically.
- Global Framework For Assessing Operational Risk In Structured Finance Transactions, Oct. 9, 2014
S&P Global Ratings research
- Marketplace Lending And The True Lender Conundrum, Feb. 22, 2019
- How Much Is Enough? Information Quality Standards For The EMEA RMBS And ABS Rating Process, Jan. 8, 2019
- PeerIQ MPL Securitization Tracker 2019 Q1
- S&P Global Market Intelligence 2018 U.S. Digital Lending Market Report, Jan. 16, 2019
This report does not constitute a rating action.
|Primary Credit Analyst:||Doug Paterson, London (44) 20-7176-5521;|
|Secondary Contacts:||Ines A Beato, New York (1) 212-438-9372;|
|Romil Chouhan, New York + 1 (212) 438 3512;|
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