The coronavirus pandemic is causing sharp economic contraction and a rapid spike in unemployment that will lead to significant performance degradation in U.S. Marketplace Loan (MPL) portfolios and potentially imperil the viability of some MPL originators, according to Fitch Ratings.

The significant GDP decline and unemployment spike in 2020 will pressure borrowers' income levels and ability to make loan payments. Fitch believes negative performance will be more pronounced in MPL portfolios compared to other consumer ABS sectors, especially for recently originated transactions and transactions from less experienced originators whose credit models remain the most untested. Fitch's rating participation in the MPL sector has been limited to date due to a confluence of asset performance and operational risks as discussed below. Fitch currently has ratings on only one MPL transaction, Prosper Marketplace Issuance Trust, Series 2018-1 (PMIT 2018-1). The class C notes of PMIT 2018-1 remain outstanding, rated 'BBB-sf'; Outlook Stable by Fitch.

Asset Performance Risks

Most MPL sponsors did not originate in material volumes until after the 2008-2009 financial crisis, and ABS issuance began slowly around 2013. These more recent origination periods mean that all performance data available comes from a stable economic time period with low unemployment. Furthermore, Fitch observed volatility in vintage default performance for most originators over the benign economic period prior to the pandemic, even when accounting for portfolio composition. Fitch's default assumptions have generally been higher than indicated by recent performance to account for originator specific variability in performance.

MPL sponsors' underwriting models, and the loans themselves, are untested by times of high, or even moderate, unemployment or other significant macroeconomic stress. Additionally, Fitch believes MPLs are lower in an obligor's payment hierarchy relative to other consumer debt classes. MPLs have higher fixed monthly payments compared to some consumer loans such as credit cards, and provide no ongoing utility to the consumer post-origination (vs. other consumer loans such as handset receivables, auto loans, and credit cards). The pandemic-led unemployment shock may cause consumers to increasingly prioritize other debt payments, which would substantially reduce ability to pay their MPLs. This is especially true of sponsors focused on near prime or subprime obligors.

This weakened performance will especially impact transactions with lower credit enhancement. In Fitch's view, serial declines in initial credit enhancement observed over the last two years leave more recently issued MPL ABS transactions more exposed to rating downgrades. For example, Fitch observed average declines of two to three hundred basis points per year for the senior class of newly issued transactions over the last three years, without similar improvement in underlying collateral quality (please see Fitch's May 13, 2019 report "Declining Credit Enhancement in US MPL ABS is Unwarranted" https://www.fitchratings.com/research/structured-finance/declining-credit-enhancement-in-us-mpl-abs-is-unwarranted-13-05-2019). Because of this, trust structures rely on the deleveraging of the notes to provide additional enhancement should performance degrade further from recently observed levels.

Operational Risks

Since the MPL sector began to scale up in origination volumes and issue ABS around 2013, Fitch has maintained a sector cap of 'Asf', primarily due to operational and business model risks including less experience servicing through an economic cycle than is typical of other consumer ABS sectors, pressure for growth of origination volumes, higher dependence on origination fees due to their "originate to sell" model and lack of longer term committed funding sources. Fitch views positively announcements made by some MPL originators over the last year to reduce origination volumes to maintain credit quality, but the pandemic-led shock increases most of these concerns, particularly for newer MPL originators. Furthermore, since the start of the pandemic some originators have already announced steep declines in origination volumes along with increased interest rates and tighter underwriting criteria for new originations.

Although some have re-positioned their business models to enable at least a portion of loan originations to remain on balance sheet, most MPL sponsors operate an "originate to sell" model by conducting whole loan sales to investors, packaging the loans in ABS transactions or through bank warehouse lines. Thus a substantial proportion of their revenue is derived from the sale or securitization of loan originations. Furthermore, dislocations in the capital markets are impacting MPL sponsors' funding sources and thus the sponsors' ability to originate loans and generate origination fees.

While most MPL sponsors have backup servicing arrangements, we have concerns with the ability of backup servicers to take on the volume of MPL receivables without operational issues that can exacerbate defaults at a time of much higher delinquencies, even if operational challenges are short lived. In a period of higher economic stress, a more hands-on servicing approach is needed to cure early stage delinquencies, particularly for subprime borrowers (most subprime MPL pools have average FICO scores between 630 and 650). Any deficiency servicing in a period of increasing delinquencies could cause more delinquencies to roll to charge-off, reducing excess spread and negatively impacting trust credit enhancement. The roll rate of early stage to late stage delinquencies is a key leading performance metric to watch to gauge servicer capability across MPL originators, keeping in mind forbearance programs could mask delinquencies in the near term.