Bumps in the Road for Consumer Loan ABS

May 12, 2016

Bumps in the Road for Consumer Loan ABS Photo

Since the initial pop in Lending Club’s initial public offering (IPO) in December 2014 (NYSE: LC), it has been a rather disappointing ride for investors. The resignation of Lending Club’s CEO this past Monday is likely to keep pressure on the stock in the short term. As though the scandal associated with the CEO’s departure weren’t enough, the U.S. Treasury Department on Tuesday called for increased regulation in the industry. How could an industry darling such as Lending Club, which at one point garnered so much excitement regarding its growth prospects, land itself in such a predicament? Unfortunately, Lending Club’s troubles are a microcosm of the potential pitfalls that await the many banks, investors, and servicers that have rushed into the consumer lending space.

Servicers that have entered the space are looking to fill the credit gap left by the banks, as banks have pulled back from unsecured consumer lending since the financial market crisis. This business model of providing credit to the ‘underbanked’ has been welcomed by consumers and investors alike. Investors have benefitted from the attractive yields, and many have looked to securitization as both a complement to holding the loans and also as an exit strategy out of the trade, depending on the investors’ business models. However, the sector has hit some bumps in the road over the past few years, as rating agencies struggle with how to model the sector, government regulatory authorities (e.g., the Consumer Financial Protection Bureau) weigh the needs for additional regulation and investors seek to understand new risks in the sector (e.g., consumer fraud in the peer-to-peer framework).

This week’s chart shows that rated issuance continues to be low in the consumer loan asset backed securities (ABS) sector, and, while some near-prime deals have printed, on average the borrower credit quality is subprime. Consumer loan ABS continues to offer attractive spreads and has not participated in the recent rally in structured products to the extent of most structured sectors. However, the sector is cheap for a number of reasons that warrant the attention and caution of investors brave enough to enter the space.

Key Takeaway: The consumer loan ABS sector houses numerous business models, including business-to-business (B2B), business-to-consumer (B2C), and peer-to-peer (P2P). Each of these business models comes with its own set of risks and opportunities. However, these business models, when taken together, share some common obstacles: Low issuance, low liquidity, increasing regulation, weaker borrower credit quality and the unforeseen risks associated with a relatively new space. Until some of these obstacles are mitigated, investors can expect to see continued volatility in the sector.

Tags: Chart of the Week | Volatility | Debt | Consumer loan ABS | Asset backed securities (ABS) | Lending Club | Regulation

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