Sometimes stocks hint at the broader appetites of investors, positive or negative, toward a specific sector. Sometimes bonds do. And when it comes to online lending, the bond market just gave it a big thumbs down.
As reported at the end of last week, there was a new bond offering in town, and it was tied to a cross section of personal loans that had been advanced by online lender Prosper Marketplace. But, as The Wall Street Journal noted, the offering “got a cold reception late Thursday, the latest sign of investor skittishness toward fast-growing online lenders.”
Here’s what went down.
Investors who took the plunge and bought into the offering did so only once yields were five percentage points higher than a comparable offering a year ago, reported The WSJ.
As for the headline numbers, Prosper floated a $278 million offering and at least part of the loans grabbed buyers at only a 12.5 percent yield, which outpaces the roughly 7 percent yield demanded upon an offering last year by the firm. The loans had been bought from Prosper and in turn sold by Citigroup. Middleman sellers such as Citi may find rougher sledding in the future as credit funds (traditionally, buyers) have been losing some of their appetite in this market. Ratings on the newest deal from various agencies have pegged expected default levels at roughly 11 percent, where previous expectations had been ratcheted up from 8 percent to 12 percent for three previous Prosper loan packages that in turn were bought by Citi.
Of course there are the usual broader concerns about the health of the consumers who live and shop globally, across borders – yes, that means China, and of course the United States.
That high yield speak tells two tales for bond investors: 1) they are holding their noses and 2) stating that they do not think the business model is attractive as it might once have been. The higher the yield, the lower the price that is settled upon, and higher yields also denote more perceived risk from a firm. And yet – even junk bonds (defined by relatively much higher yields) have seem some calm, which would imply that investors see company-specific risk on the waters ahead.
The knock is that high growth is going to be harder to come by. The engine that must run constantly is one where new loans are launched out into the marketplace via continuous new finding, as deposits are not kept on Prosper’s books. That means activity must be consistent and constant, yet sand may hit the gears in the form of increased regulations (with concerns over caps governed by usury laws) and worries by investors over the loan portfolio quality – past, present and future, and where roughly a quarter of loans are sliced and diced, securitized and then sold to outside investors.
Along with the higher yield that investors want, as at least some hedge against risk, the lenders themselves have pushed rates higher, and with that move, one question arises: How high might rates go before loan demand gets choked off – even against a backdrop where lending in the U.S. alone, and online, is expected to jump from $22 billion to $37 billion this year from last, according to Autonomous Research? The bond market salvo comes after stocks such as On Deck Capital and LendingClub sank double digits and any number of initial public offerings have been pulled.
There's also a yet another issue, which has to do with the funding model itself. Currently, as the Financial Times reported, institutional money, via hedge funds and banks, has been a strong source of capital to these online upstarts. Those conduits can be fickle ones, demanding ever higher rates, as mentioned above, and as had been seen in the wake of the Fed's latest rate increase. But even the online lenders themselves, such as Lending Club, have noted plans to cap their reliance on Wall Street's generosity. The transition may be a bumpy one, but necessary.