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April 15, 2016  

Marketplace-Loan Plan Marks Funding Shift

Morgan Stanley and Prosper Marketplace are developing a new funding mechanism that could reduce the need for securitizations of marketplace loans.

Under the arrangement, Morgan Stanley is bundling Prosper’s personal loans into unrated pass-through certificates for sale to investors. An initial $1 billion of the paper expected to hit the market in the coming weeks.

Banks including Goldman Sachs also are exploring similar projects, but aren’t as far along in those efforts. Along with Prosper, they have been talking to originators including Lending Club.

Those discussions, in turn, stem from broad efforts by marketplace-lending specialists to find new ways of distributing the accounts. The belief is that if the certificate sales catch on, they would help draw new capital into the market while also displacing a large amount of potential securitization activity, to the tune of several billion dollars per year.

A key feature of the certificates is that each would carry a Cusip number, with the idea that those identifiers would facilitate sales directly to institutional investors. Indeed, many pension systems, insurers and other mainstream buyside operations require Cusips for such purposes.

With their participation, and the Cusip numbers in place, the hope is that a liquid secondary market for marketplace loans eventually would emerge — something players in the sector recently have seen as a priority. To that end, other types of operations are looking at ways to attach Cusips to the accounts.

Take Emerald Asset Management, a Leola, Pa, investment shop that buys marketplace loans through a line of credit from Capital One. The $3 billion firm is weighing whether to seek Cusip numbers for its portfolios, apparently in response to interest from clients including Pennsylvania State Workers that require the designations for their holdings.

Technology firm Orchard Platform also is developing a loan-brokerage business that might add a unique Cusip to each loan that it places (see article on Page 4). Cusips are assigned by an American Bankers Association entity known as Cusip Global, with issuers typically footing the bill for the designations and anyone wishing to access the numbers paying for subscriptions to a database of the securities.

Cusip numbers are rare among most types of whole-loan portfolios, but often are attached to bundles of mortgages.

Cusip Global acknowledged that it has received requests to assign numbers to marketplace-loan certificates, adding that it would classify the paper as asset backed bonds for tracking purposes.

Marketplace lenders currently fund their accounts in large part by selling them to hedge funds and other specialty buyers, many of which use securitization as an exit strategy. Distributing the resulting bonds has proven a chore, however, with many prospective buyers expressing a desire to own more direct exposures to the underlying loans and collect the higher yields that come with them.

Hence, the appeal of the planned certificate sales. Interest rates on marketplace loans typically range from 6% to 31%, with expected losses of 12%. A securitization today might yield just 2% for senior bondholders, even after a severe spread-widening trend that took hold in recent months as financial-market conditions deteriorated and Moody’s threatened on Feb. 11 to downgrade three Citigroup deals backed by loans the bank bought from Prosper.

Citi then issued $278.4 million of bonds backed by Prosper loans on March 23 at almost double the funding costs of an offering it completed Dec. 11. Livid that the move devalued its loans, Prosper responded this week by halting sales of accounts to the bank.

Prosper’s arrangement with Morgan Stanley, meanwhile, comes at a time when the weak market for asset-backed bond deals has sent most issuers other than Citi to the sidelines. Counting only rated transactions, $2 billion of such offerings have priced so far, according to Asset-Backed Alert’s ABS Database.

As for the certificates, each would represent an undivided interest in a pool of loans, with the holder assuming all of the risks and rewards associated with those credits. The banks would carry out the sales by seeking commitments from investors and then issuing the notes based on the buyers’ appetites for risk — say, offering higher-yielding but riskier loans to one client while placing lower-yielding but safer accounts with another.

Unlike a securitization, which offers credit cushions through tranching and excess collateral, a certificate would carry no protections other than representations and warranties from the loan originator. Still, appetite for the paper is expected to be strong. “Every single investment bank has been talking about ways to buy marketplace loans and put them in certificates for pension funds and insurance companies,” one source said. “And there have been meetings with broker-dealers nationwide to discuss the Cusip plan in a bid to create more liquidity.”