P2P Lending Securitization: Should We Be Afraid?
Since it presented itself in 2005, the P2P lending market (which matches lenders with borrowers for personal loans, real estate, commercial loans, mortgages, and student debt) redefined the traditional loan model from that of commercial banks and has a healthy growth trajectory ahead.
The vast inventory of loans originated on marketplace platforms has caught the attention of fund managers, institutions, and individual investors alike.
This begs the question… Should we be concerned about the increased momentum of securitization of P2P loans?
By definition, securitization is the process in which an issuer pools together debts (in this case P2P loans) and issues an asset based upon those loans. The new asset-backed security is then marketed to investors.
2008: The Dark History of Securitization
One of the causes of the 2008 Global Financial Crisis was the securitization of poorly underwritten subprime home mortgages. Toxic lending practices such as “pick-a-pay” loans and “stated income” contributed to the demise of the housing bubble spanning years 2001 through 2005. Once homeowners began failing to make their monthly payments, investors in these securitized assets rapidly lost money due to the exponential rise in mortgage defaults.
Simultaneously, ratings agencies – such as Moody’s, Fitch, and S&P operated under the faulty idea that the overall loan pool was predominantly investment grade (i.e. AAA rating) when in fact, this was not the case.
Large commercial and investment banks bought into this idea as well. Banks effectively borrowed from short-term cash and cash equivalents as means to fund their long-term investing in mortgage-backed securities and other collateralized debt obligations. The rapid rise in default rates had catastrophic impacts on bank balance sheets; therefore, sending many institutions into receivership.
2016: The Bright Future of Securitization
Post the Financial Crisis, changes were implemented in the spirit of addressing the issues associated with the faults of the Credit Rating Agencies (CRAs). Extensive disclosure requirements and increased transparency guide the newly implemented protocols for CRAs. For example, credit rating analysts are prohibited from giving recommendations or guidance on securitized products they rate, disclosures regarding the limitations of an assigned credit rating is required, and internal credit rating procedures are routinely reevaluated. Additionally, the disruptive nature of marketplace lenders helps alleviate many of the pain-points historically associated with CRAs in addition to providing enhanced auditing, internal oversight, and communication.
As consumer lending dried up from the big banks, P2P lending exploded on the scene as a new conduit matching lenders with borrowers. Individuals that would’ve normally been serviced by their local bank are now taking advantage of newer ways to access capital. The improved efficiencies marketplace platforms provide also create opportunistic investment options for passive institutions and active investors. The increased volume of loans passing through platforms such as Lending Club and Prosper, paired with optimal and fair credit underwriting policies, fuel these opportunities.
Securitization: P2P Lending Comes of Age
The maturation of marketplace lending, combined with experienced regulatory oversight, provide an improved environment for securitization. Marketplace platforms that sell their loans to institutions also help to create additional revenue streams for their organization, while simultaneously providing investment opportunities for passive and active managers. Most importantly, securitization of P2P loans gives investors access to highly diversified income streams and an additional non-correlated asset.
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