Investors Pour Funds Into Online Lenders, Raising Some Concerns

There is no doubt that online lending startups are the rage, as the credit profiles of consumers and business owners improve and demand for loans is on the rise.
These sites, including Lending Club, Prosper, OnDeck and SoFi, provide quick personal, business, home and car loans with minimal fees and at reasonable rates.

Online lenders are drawing hundreds of millions of dollars at big valuations. In recent days, there have been two enormous funding rounds. SoFi took in a staggering $1 billion round led by SoftBank. Meanwhile, Avant, a lender that seeks to provide credit to consumers with lower scores, also took on funding that values the company at $2 billion.
Here is the catch that is spurring some concerns of a repeat to the run-up to the financial crisis seven years ago. The big funds moving into these lending startups are taking two distinct shapes: The actual investment in the startups, and the securitization of loans, according to a Keefe, Bruyette & Woods report.
The KBW report focuses on three online lenders (Lending Club, Prosper, OnDeck) as a model for the industry. It estimates that they generated $7 billion in loans last year, but says the industry overall generated about $14 billion — consumer and small business loans together. Analysts predict just three startups could generate $38 billion in loans by 2018.
BusinessInsider reports that startups like SoFi and Commonbond are repackaging consumer loans into asset-backed securities (bonds) and selling them onto investors that include hedge funds and banks.
Asset-backed securities were infamous for their use in bundling mortgages during the run-up to the financial/housing market crisis – and blamed for excessive risk taking by mortgage lenders who dumped the debt onto other investors.
KBW says the loans now tied to the online lending startups are “A-rated,” meaning of high quality – a factor that’s attracting investors. However, KBW analysts caution that – even with these high lending standards – there’s a risk of relying on the ABS market too much, creating a potential bubble if investors get spooked and stop buying.
Says KBW: “A thriving asset-based securitization market can be robust until demand drops dramatically given concerns about asset quality and corresponding risk. While we are not trying to draw the comparison to the last financial crisis … we believe these thriving upstarts could find a significant change in their business models in the future if institutional investors were to pull back.”

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