It believes that future securitisations will see a boost in credit quality as a result of Funding Circle's decision that will affect its lending growth in the short term.
SME focused peer-to-peer lender Funding Circle was correct to proactively take the decision to tighten its lending criteria in pulling back from higher-yielding lower-quality loans, according to ratings agency DBRS.
It says that with marketplace lenders like Funding Circle competing with banks with large balance sheets, it is particularly important to ensure that they do not over extend themselves and chase volume over quality.
Funding Circle recently downgraded its outlook for its revenue and loan growth owing to an uncertain economic environment in the United Kingdom with a plan to lower lending in its riskiest loan category (Band E).
“DBRS views Funding Circle’s decision to apply higher credit standards to its lending as an overall credit positive. This change of direction will not affect Funding Circle’s existing portfolio of loans but should help its performance going forward,” it said in an update. The credit cycle appears to be peaking and this, along with the potential impact of Brexit on SMEs, could cause defaults and losses to increase in the next several years.”
Funding Circle recently completed SBOLT 2019-2, its fourth securitisation of U.K. SME loans. DBRS currently rates two of the SME lender’s securitisations: SBOLT 2018-1, and SBOLT 2019-1.
In particular, Funding Circle's strategy to focus on higher-quality risk bands could boost securitisations of Funding Circle loans' credit strength, DBRS adds.
"DBRS views Funding Circle’s actions as positive, demonstrating the maturity of the firm as a responsible lender and while it will have a neutral impact on existing portfolios, it should improve the future transaction mix. Any impact stemming from the company’s view on riskier loans will also be unlikely to affect the ratings of existing transactions as DBRS stresses for an increase in default rates as a part of its methodology."
Carlos Silva, Head of the European Structured Credit team at DBRS and lead analyst for the two DBRS-rated transactions, says the firm has remained cautious on marketplace lenders and the potential risks associated with volume-driven fee-based business models.
“Other originate-to-distribute models had very dire consequences in the last crisis”. He continues: “Funding Circle’s decision to tighten credit standards by sacrificing growth is welcome from a credit risk perspective and demonstrates a focus on the long-term sustainability of its activities rather than on a growth-at-all-costs formula,” he said.
“While the announcement will be neutral for existing transactions, future securitisations will likely see an improved credit quality as a result of the tighter origination standards announced,” he added.