The securitisation of peer-to-peer loans is starting to take off in the US. We wrote last week about a report that Moody’s released on the risks of P2P securitisations. However, in Europe we are yet to see the securitisation of P2P loans. Moody’s have now released a report looking at the benefits securitisation could bring to the peer-to-business lending market in Europe.
Moody’s expects securitisation to positively effect the development of P2B lending. Igor Zelezetskii, a Moody’s Vice President, Senior Analyst and the co-author of the report, commented:
“The development of non- bank funding alternatives such as peer-to-business and securitization can play an important part in facilitating capital flows to a broader range of European corporate borrowers, but no single funding channel is likely to be a panacea for the supply of credit to European SMEs.”
When assessing P2B lending it is important to take into account credit risks that are specific to SMEs. Mr. Zelezetskii added:
“The expansion of non-bank SME financing will depend on factors such as a customized regulatory environment and the incentives for market players to maintain adequate origination standards.”
The report says that as the peer-to-business lending market scales “securitisation has the potential to become a prominent funding instrument for P2B SME lending”.
One of the main benefits of securitization is that it attracts investors who would not ordinarily invest in P2B loans:
“We expect that issuers will enter the asset-backed securities market in the near future. By relying on securitisation as a funding source, P2B companies could increase their scale and attract investors. Investors who cannot directly invest in P2B loans could do so indirectly through securitised holdings.”
To date, a small number of transactions with a total of $1.5 billion in notes issued have closed in the US, with consumer or student loans as underlying collateral. The report states that the three US platforms whose loans have been securitised are Lending Club, SoFi, and Prosper.
Another benefit of the platforms starting to securitize their loans is that larger financial institutions will demand higher levels of due diligence and operational standards from the platforms. Although, many platforms in the UK currently have links with institutional investors who, it can be assumed, demand very high standards from the platforms. Furthermore, if financial institutions have equity stakes in the P2B platforms it should help to align interests within processes, provided the institutional equity holder is exposed to any losses that occur in the platforms’ portfolios. A contrary argument suggests that institutions who will be looking to securitize these loans will be pushing for increasing origination volumes, and could have the effect of pushing the platforms down the credit curve, and so disrupt the platforms’ high standards.
The report explained:
“In our opinion, the involvement of larger financial institutions in P2B securitisations is likely to improve the standard of care, information transparency, inter-party accountability and overall level of professionalism at every level of transaction with underlying P2B SME loans.”
However, as in the US there is a problem with a lack of historical data when looking at the individual platforms, which makes it harder for ratings agencies and institutions to make predictions about platform performance. And other risks within P2B must be taken into account. These include the risk profile of the lenders and borrowers, and any risks associated with the geographical location of the platform, such as the regulatory regime of the country.
The report highlighted that the volume of traditional bank lending to SMEs has been declining since 2010, in the UK and the Euro area. And this is an area where the alternative lenders are taking up the slack.
The report highlights that the UK regulatory environment is broadly favourable to P2B lending and is unlikely to constrain it in the near future. The Department of Business Innovation and Skills prepared the report “Boosting Finance Options for Businesses” which analyses the UK SME funding scene. Among its conclusions, the report states that “Given the anticipated growth in demand for finance and the expected constraint on availability from banks and other sources, on our (Department’s) assumptions the finance gap could be between c£84bn and c£191bn over the next five years”.
Justyna Kochanska, a Moody’s Analyst and another co-author of the recent report, observed:
“We believe that securitisation of P2B loans has the potential to positively affect SME funding, with UK businesses having obtained about £1.4 billion through P2B lending so far. In our opinion, by relying on securitisation as a funding source, P2B companies could increase their scale and attract investors.”
In its appendix the report goes on to analyse Funding Circle, as an example P2B lender. It says that as of 15th February 2015 8,745 SME loans were facilitated by the Funding Circle platform, 83% were still outstanding and current, 3.0% defaulted, and 0.7% were in arrears, while 13.0% had repaid.
That report explains:
“Alternative finance companies, such as Funding Circle, may be less well placed to make a credit judgment than long-established traditional lenders, which is inherent in the seasoning of their business and restrained access to credit information. The lending platform's focus on efficiency is achieved by means of technology; their internal risk model evolves and is likely to improve over time.”