A group of online consumer loans that were packaged into bondsis going bad faster than lenders and bond underwriters hadexpected, the latest sign that some startups that aimed torevolutionize the banking industry underestimated the risk theywere taking.

Delinquencies and defaults are reaching key levels known as“triggers” for at least four different sets of bonds. Breachingthose levels will force lenders or underwriters to startpaying down the bonds early. Avant Inc. and its underwriters, forexample, are going to have to begin to repay three of itsasset-backed notes, according to a person with knowledge of thematter.

Two of Avant's securities breached triggers this month for thefirst time, the person said, asking for anonymity because the datais not public. Another bond, tied to the subprime lender CircleBackLending Inc., may also soon breach those levels, according toMorgan Stanley analysts. When the four offerings wereoriginally sold last year, they totaled more than $500 million insize. Around $2.8 billion of bonds backed by online consumer loanswere sold in 2015, according to research firm PeerIQ.

A representative of Avant declined to comment. CircleBack didn'trespond to messages seeking comment.

Online loans have shown other signs of weakening. LendingClubCorp. last month raised interest rates and tightened its standardsfor at least the second time this year after seeing higherdelinquencies among its customers, especially those with the mostdebt.

LendingClub's founder, Renaud Laplanche, wanted to changebanking as we know it, but many online lenders are now findingthemselves in uncharted territory. Steve Eisman, a money managerwho famously predicted the collapse of subprime mortgagesecurities, said some firms have been careless and that SiliconValley is “clueless” about the work involved in making loans toconsumers. Non-bank startups arranged more than $36 billion ofloans in 2015, mainly for consumers, up from $11 billion the yearbefore, according to a report from KPMG.

“There was a rush to grow,” said Bryan Sullivan, chief financialofficer of LoanDepot, a mortgage company that last year beganmaking unsecured loans to consumers online. He was speakinggenerally about the industry, although LoanDepot's own loanlosses on a bond in September broke through the ceilings that hadbeen set by underwriters at Jefferies Group.

Breaching those levels can force a company to divert cash flowfrom assets to paying off bonds instead of making new loans, whichoften means it has to find new, more expensive funding or to scaledown its business. Avant, based in Chicago, cut its monthly targetfor lending this summer by about 50% and decided to shrink itsworkforce in line with that, while CircleBack Lending, based inBoca Raton, Florida, stopped making new loans earlier thisyear.

Several lenders have changed management this year. LendingClub'sLaplanche left in May and on Monday, Prosper Marketplace said itsCEO Aaron Vermut is stepping aside in December.

Online loans account for a fraction of the more than $12trillion of U.S. consumer loans outstanding. Any weakness in thisarea isn't likely a systemic issue, Eisman said in his speech inSeptember, and most types of loans to Americans are performingbetter now than even last year. Delinquencies for consumer credithave been declining since 2010, and in the second quarter were at4.8%, down from 5.6% the same quarter a year earlier, according toa report from the Federal Reserve Bank of New York inAugust.

The U.S. unemployment rate, often a proxy for consumer creditquality, has been declining since 2009, and stood at 4.9% inOctober.

Weak Pockets

But there have been pockets of weakness for some kinds ofcredit. The percentage of subprime car loan borrowers that werepast due reached a six-year high in August according to S&PGlobal Ratings' analysis of debts bundled into bonds.

Lenders themselves are talking about the heavy competition forcustomers. Jay Levine, CEO of OneMain Holdings Inc., one ofAmerica's largest subprime lenders, said last week that “theavailability of unsecured credit is currently the greatest that hasbeen in recent years,” although he said much of the most intensecompetition is coming from credit card lenders. OneMain, formerlypart of Citigroup, is taking steps to curb potential losses byrequiring the weakest borrowers to pledge collateral.

Setting bond triggers is often up to the security'sunderwriters. Some lenders have been working more closely with WallStreet firms to make sure the banks know how loans will probablyperform and set triggers at reasonable levels, said Ram Ahluwalia,whose data and analytics firm PeerIQ tracks their loandata.

The startups are “playing an increasingly hands-on role,” hesaid.

The deals that have or are expected to breach triggersinclude:

• MPLT 2015-AV1, a bond deal backed by Avant loans that Jefferiesbought and securitized.
• AVNT 2015-A, a bond deal issued by Avant and underwritten byJefferies.
• AMPLT 2015-A, a bond deal backed by Avant loans andunderwritten by Morgan Stanley.

A fourth deal, tied to CircleBack, may also soon breach,according to Morgan Stanley analysts. The deal is called:

• MPLT 2015-CB2, backed by subprime loans made by CircleBackLending Inc. and underwritten by Jefferies.

Representatives for Jefferies and Morgan Stanley declined tocomment.

Bloomberg News

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