Twenty-Twenty Vision: Securitisation in the new decade

TWENTYTWENTY VISION

SECURITISATION IN THE NEW DECADE

1 Twenty-Twenty Vision – Securitisation in the New Decade

CONTENTS

INTRODUCTION

1

THE STATE OF THE MARKET

2

EMERGING TRENDS

6

INNOVATION IN SECURITISATION

12

FINTECHS AND NEOBANKS IN FOCUS

19

THE DECADE AHEAD

28

WORDS OF WISDOM

30

INTRODUCTION Over the course of 2020, the Australian Securitisation Forum (ASF) and Perpetual have collaborated on this comprehensive study of securitisation industry participants’ views of the emerging industry landscape in the new decade.

After a strong start, 2020 has been a tumultuous year for the global financial system, the Australian economy as well as the securitisation industry, both locally and overseas.

With its strong fundamentals, the Australian securitisation market has proved to be remarkably resilient and securitisation continues to have an important role to play, particularly with the involvement of smaller lenders who predominantly provide consumer and business finance.

THE STUDY The rise of non-bank lenders, FinTechs, diversification and innovation are all likely to alter the shape of the industry in coming years and this study has been designed to provide this insight into how these factors might impact the industry.

In January and early February this year we spoke to a wide range of securitisation industry participants including CEOs, Treasurers, CFOs, Head of Funding,

Head of Credit about the decade ahead, innovation and the rise of FinTechs and NeoBanks. Following the onset of the pandemic, it was decided to pause the study and take stock. We have since followed up with a range of participants to see if the sentiments and thoughts that were prevalent earlier in the year have changed in material ways and what this might mean for securitisation in the coming decade.

The study follows a similar approach to the studies undertaken in the past three years which have focused on local and global securitisation investors and Australian issuers.

The ASF and Perpetual sincerely thank the industry participants who made this report possible. Their time, candid opinions and views are greatly appreciated and lend this report both rigour and insight. Their responses have been relayed liberally throughout the report whilst maintaining their anonymity.

We hope you enjoy the fascinating insights this report provides.

Chris Dalton – Chief Executive Officer, Australian Securitisation Forum Richard McCarthy – Group Executive, Perpetual Corporate Trust

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THE STATE OF THE MARKET

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THE STATE OF THE MARKET

On February 11 2020 the treasurer of a NeoBank – an online only bank – told us, “the biggest existential threat for securitisation is still around the global financial system and liquidity. For example the potential for pandemics and the possible flow on impacts to the economy.”

Just a month later and we were putting the theory to the test. At the time it was the last thing on the mind of industry participants who overwhelmingly spoke in positive terms about the health of the industry.

On February 6, the treasurer of one of our most established non-bank lenders said “It’s going quite well – almost gangbusters I think!” when talking about the securitisation industry So, on the one hand, we had many thought leaders expressing a positive outlook for the securitisation industry.

And on the other, a global crisis that threatened to bring whole economies to their knees. We figured the best thing to do would be to pause and take stock.

The insight we’d captured was an accurate reflection of their beliefs in February, yet their relevance would be fully tested in the months that followed.

We decided to check in on the true impact of COVID-19 by going back out to the industry and asking how the pandemic had impacted what looked likely to be a cracker of a year for securitisation.

But before we look at what they said, let’s return to January and early February 2020 and see what the industry was telling us about securitisation, innovation and the emergence of FinTechs, NeoBanks and other new players.

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A HEALTHY INDUSTRY AT THE BEGINNING OF 2020 The following comment sums up what many industry participants were saying about securitisation coming into the new decade.

“We’ve seen some really positive developments in the securitisation industry in Australia of late. We’re seeing issuance volumes getting back up to levels that we saw preGFC, which is very encouraging.

We’re seeing more issuers look to issue offshore as well. And we’re seeing new issuers come to market too, so, that’s all been very encouraging.”

Intermediary Warehouse Looking through more comments about the industry at the start of the year, many were similar in sentiment. There was a range of indicators participants felt were strong signs of a healthy industry.

The primary factors participants believe make the industry healthy were:

AN INCREASE IN PARTICIPATION IN THE INDUSTRY

A GROWING BASE OF GLOBAL INVESTORS AND THE RETURN OF OVERSEAS BASED WAREHOUSES

A strong sense that volumes are increasing was evident despite being so early in the year. Participants felt the year had begun with a flurry of activity that was much more than the presence of new issuers.

The increase in ABS activity and the diversity of assets within ABS was seen as a bright spot for many. In recent years when talking to investors and issuers, the lack of ABS and the relatively small size of ABS deals was seen as a hindrance to the growth of securitisation. The emergence of FinTechs and NeoBanks, often in the ABS sector, has captured the market’s imagination and raised the prospect that new value opportunities will emerge.

LIQUIDITY AND CREDIT VOLUMES

DIVERSITY OF ASSET CLASSES

VALUE

All participants have taken an active interest in the emergence of new participants, whether they be issuers, investors or warehouses. There are divergent views on whether the majority of new entrants will be successful, but the increase in the level of activity they are generating was welcomed.

The growth in Asset Backed Securities (ABS) and the increasing diversity of asset classes was perceived to have a positive impact on value and the ability to attract overseas investors.

“I think the industry I think the industry is in very good shape, more than 10 years after the GFC. than 10 years post GFC. Volumes have been increasing, the performance of collateral’s been very good. We’ve got an expanding universe of investors. We’ve got a number of new issuers, particularly in the FinTech space and some innovation and new asset classes, so all the signs are pretty positive.”

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“I see that in the non-bank space on the funding side of the world, the competition is not other non-banks.

The competition is other asset classes and it seems to me that our world is becoming somewhat good value.” Fintech

Non-bank lender Underpinning the confidence in the market is the belief that credit quality continues to be a strong positive feature of the Australian market.

“In Australia it’s always been a reasonably healthy market. I don’t think we’ve written any forms of assets that have been too far to the right on the risk spectrum whereby it’s caused problems. It does exist but I think it exists in the banking system, not in the securitised markets and not to say that we’d get there, but I don’t think the Australian market really went that far down the rabbit hole because there was enough of the good stuff around.” Fintech

Investor We believe, despite the uncertainty created by COVID-19 there is a positive momentum within the securitisation industry that is well-placed to weather the storm.

We went back to the industry in August 2020 to investigate how the positive signs of a healthy industry might be affected by the COVID-19 crisis. Here are some of their thoughts.

Participants have been pleasantly surprised with how things have gone but there is an underlying note of caution. There is widespread appreciation of the positive impact of the AOFM and the fact that it has allowed the industry to keep moving.

Equally, there is concern that the stimulus will only delay a more severe downturn down the track.

“I'd say resilient. I think there’s been plenty of support for the industry whether its government support and even in a lot of circumstances investor support.” Fintech “I’ve probably been surprised that loan deferral and impairment haven’t been higher. People have generally, notwithstanding the difficulties their businesses are facing, made good attempts to repay their loans. Government stimulus has been a big factor in that.”

Fintech “The AOFM has supported our warehouse in a way that we would not have been able to get from a private financier.” Fintech

There has been a noticeable shift in pricing which is having most impact on newer players.

“From a pricing perspective we don’t have as much leverage with investors who are interested in deploying capital and supporting programs that are younger and definitely their rates are blowing out particularly in the mez.” Fintech Investors are saying the pricing reflects the impact of the pandemic on liquidity.

“Most of the liquidity associated with the securities is probably no longer there because the underlying nature of the securities in securitisation is already not very liquid and with the crisis that makes it even harder.

When the market becomes illiquid it’s just too hard to know what the value is.” Investor There are lingering doubts about the long term effects COVID-19 will have on the economy but most are pleased with the state of the play as it stands.

“The COVID shock was indiscriminate in who it affected and I expected to see huge amounts of distress and hardship in our book as everywhere else but what has been surprising has been the size and the hard hitting nature of the government response to the problem which has meant borrowers have been able to struggle through.”

Fintech

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Despite the caution and the uncertainty participants remain positive about the future. Many have quickly responded to the need to adapt, whether that has involved shifting their focus to new market segments or re-assessing the types of risk they are prepared to accept.

“Our hardships spiked early when everybody panicked but it's come right down and there's a lot of confidence in our client base who are continuing to expand. I thought it would be a lot worse.”Fintech

EMERGING TRENDS

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THE EMERGING TRENDS

At the beginning of 2019 we talked to issuers about asset class diversification.

We found only a few with a substantial focus on ABS, covered bonds or other forms of securitisation. That has changed, although not necessarily as a result of renewed interest amongst established issuers - instead change has come with the emergence of FinTechs and NeoBanks.

We have also seen the emergence of ‘buy now pay later’ as a means of consumer purchasing that has characteristics akin to credit cards and lends itself to securitisation as a result. Master trusts are also increasing for non-bank lenders and in specific asset classes.

Personal loans and small business lending are becoming increasingly popular – market segments that FinTechs claim have not been well serviced in the past.

“There’s an element of a structural shift and acceptance that these nonRMB assets are good, and within ABS you’ve seen in the last couple of years credit cards coming back in.

You’ve seen autos doing reasonably well and a master trust or two.

The list goes on.” Warehouse

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Another significant trend has been the increasing share of non-bank lenders in RMBS, although some say it’s simply a return to the pre-GFC days.

“The fundamental change we've seen is the volume switch between non-banks and banks themselves.”

Warehouse “There’s been a shake-up of credit because the liquidity is there for non-banks. They’ve moved from situations where really they were lucky to have two issues a year during ’16, ’17 and ‘18 and then the market grew to support three and sometimes four.” Warehouse

The major trends:

DIVERSIFICATION OF ASSET CLASSES, PARTICULARLY ABS

INCREASE IN PARTICIPATION, PARTICULARLY EMERGENCE OF FINTECHS AND NEOBANKS

THE RISE OF THE WAREHOUSE

GROWTH IN NON-BANK SHARE OF RMBS

DIVERSIFICATION OF ASSET CLASSES THE RISE OF ABS In volume terms the rise of ABS is dwarfed by RMBS, yet the market has welcomed the activity with open arms. For several years investors have expressed a desire to see more ABS for two key reasons: •

Diversification of assets

•

The search for yield

FinTechs have gravitated towards personal lending and SME lending as they believe these markets have been under-serviced by banks and they feel their technology solutions give them a competitive advantage in engaging with customers. For personal lending that advantage is typically expressed in terms of the ease of the application process.

For SMEs it is the willingness to lend to businesses that might have been rejected or overlooked by banks, particularly for unsecured lending.

“The reason why we’re seeing all of these players at play here is because small business is still trying to work out how it gets its money.” FinTech FinTechs are often forthright about their ability to meet customer needs better than large institutions do, as this example shows: “We only operate in personal loans.

We don’t think it’s a crowded space. We do think SME lending is a crowded space, certainly in Australia, but with personal loans, you know that market is undisturbed by the banks and the margins are pretty healthy. We think we do a good job in serving that market. We meet customer needs. If you want to apply for a personal loan at the bank, it’s not a very customer-friendly process. It takes some time, you know days, possibly a week and the pricing is very inflexible. We believe that customers want convenience and price and that’s what’s important to them, so that’s what we strive to offer.” FinTech On one hand, new entrants see opportunity in ABS and on the other hand, investors and established issuers cite demand for yield as the driving force behind the renewed interest in ABS.

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“We’re in the market with a personal loan trade now. Most of that’s going to be placed locally. Probably yield. If you look at the return on ABS, given the shorter life compared to RMBS it actually offers good quality value.

There's a clear hunt for yield in the market. You’ll see all the trades are issued that sell the whole capital stack, if the lower rated tranche is many times oversubscribed compared to the more senior tranches, so they go instantly, and then in terms of the senior tranches, again ABS offers better value than major bank RMBS. So, there is a pricing differential there.” Non-bank lender There are divergent views on the impact of COVID-19 on the continued growth of the ABS sector. Some believe investor demand will continue to spur new entrants while others are concerned about the impact of COVID on credit quality. There is consensus that the rate of growth of the sector will be slower as a result of COVID-19.

“The ABS sector has a smaller capital base and has had to reign in its growth objectives in a difficult market to grow anyway. So I don’t think those sectors are going to punch above their weight. I think originally they would have punched above their weight and we would have seen them taking a greater share.” Fintech “Demand for credit is down and demand for credit by creditworthy counterparties is down. That’s probably the biggest factor in slowing demand in the ABS sector.” Fintech “Even right now if you look at SME lending, the banks can technically lend to SMEs but why are they still not lending as much? The government is giving them facilities for this and that. There’s still a lot of capacity out there but why is there still not enough lending? There is a credit quality issue.” Investor

INCREASE IN PARTICIPATION THE EMERGENCE OF FINTECHS AND NEOBANKS In January 2020 everyone was talking about blossoming participation across the industry. While FinTechs and NeoBanks were the strongest emerging segment, activity in the market was attracting a diverse range of new participants looking to be part of the action.

“On the positive there’s a lot more participants, both issuers and investors which I think by and large is positive. I’ve been in credit markets for almost 20 years and I have seen how the markets develop both here and offshore. If I would have been less generous, from a disclosure and transparency perspective the Australian securitisation markets have been somewhat behind their peers in Europe and the US, you know, because they just didn’t need to be as investor friendly, but I think the market has certainly moved on, and is moving more and more in the right direction.” Investor The Australian securitisation industry has a reputation for being collegiate and open to new participants and competition and there is a sense that diversity is not only embraced but welcomed.

“It felt like at the ASF conference this year, there’s a whole bunch of guys in t-shirts. Rewind 5, 6, 7 years there were guys in ties and suits and then the ties disappeared. It’s definitely morphed into something a lot broader.” Warehouse

The question is whether the increase in participation will be sustained, especially as the impact of COVID-19 plays out. But even pre COVID-19 there were some who had a cautious view about the potential longevity of the new players.

“I think the rate of new entrants will probably slow given the size of the market and some of the challenges there.” Intermediary On balance though there is a relatively high level of respect for the quality of the new participants, as the personnel often have a great blend of experience and energy.

“They’re very experienced. We’ve had the young guys knock on our door with an idea and a dream but the ones that have gotten off the ground are very experienced, one way or another they’ve got a lot of experience behind them. They are all experienced senior people that come out of the banks and they understand securitisation broadly, they may not have done it but certainly they understand the business, the origination, the servicing side very well. Securitisation isn’t that hard to learn. And usually what these companies do is, when they get to the size when they want to securitise, they will bring a head of funding in who’s got some experience.”

Intermediary There is consensus that the increase in participation is a sign of a healthy industry and that a wider base of participants generates opportunities rather than challenges or threats.

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“The other thing that we see as a positive is the offshore banking participation in the Aussie ABS market as well. We think that’s encouraging and again it reflects a more fully operating, healthy securitisation market, not just one dominated by non-bank resi.”

Non-bank Lender Participants are not expecting the rate of new entrants to slow down.

However they do believe it will take new entrants longer to achieve scale.

They believe investors will continue to have an appetite for new entrants in ABS and focusing onSME and personal lending. In combination with a decreasing interest among the banks to lend to some segments and borrowers, it is expected there will be opportunities for FinTechs or NeoBanks.

“Investors have appetite to back entrants trying to tackle the SME space and then you have a pullback in competition from the banks. This will drive more new entrants but there may just be a shorter-term delay due to COVID.” FinTech FinTechs have been encouraged by the success stories of their peers and the fact some have been able to be rated much more quickly than expected.

This is driving more to follow the same path.

“If you look at the buy now, pay later the players have achieved a rating in a very young book and that was a big confidence booster for others that were watching and suddenly thought it might be possible for them.”

FinTech

THE RISE OF THE WAREHOUSE The rise of the warehouse refers to the increase in warehouse participation and the emergence (or return) of offshore warehouses. The warehouse also plays a key role in bridging the gap for FinTechs and NeoBanks as they progress through the various stages of funding.

We found an appetite to engage with both new and long-term industry participants among warehouses.

“'Although we’ve only been around the securitisation industry five or six years, I’ve just been so impressed with the people in the industry. I think they’re so professional and absolutely reliable in terms of what they do and say. All the people we’ve been involved with have been effective at firstly understanding our business and then secondly going through the process of setting up a warehouse in a collaborative way which has allowed quality relationships on a day to day basis.”FinTech There is a recognition on both sides that there is hard work involved and it can take many meetings and lots of analysis before agreement is reached. FinTechs and NeoBanks have been surprised at the willingness of warehouses to engage and the flexibility they display in both understanding their business and working through the detail.

“The partners that we’ve worked with have been excellent. They’ve really leaned into understanding the asset class and tried to look to other jurisdictions for precedents, how you think about it, how you construct your deals. They’ve taken the time to look at our underwriting standards, look at how our borrowers come together. We value that investment because they truly want to understand our business, and then within the constraints of their organisations, are able to find a little bit of comfort that if we’ve got a book that has a spectrum like ours, they can find that the components that work for us, but also work for them.” NeoBank Despite being keen to assess new opportunities, warehouses continue to be strict about their criteria and standards, and by doing so give confidence to themselves and the businesses seeking a facility.

“You’ve got to be mindful that there will trip-ups, with anything new eventually there will be trip-ups. So we’re just making sure that we have all the processes to make sure that we assess things correctly and have the protections in the structures that we need.” Warehouse “An institutional intermediary like us would tend to get involved once there is that demonstrated track record and that critical mass.

For us to get involved, we’d need, depending on the asset class of course, a couple of years’ worth of history and some demonstration that they’re an established servicer.”

Warehouse Investors feel the role of the warehouse has become more important not only to encourage growth in securitisation but also to act as a quality filter for new entrants.

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“Warehouses have become more important. Funding relations are more important to get to that scale, get that understanding, get the confidence that you’re not going to run out of money before they get to break even and all of those type of elements that make it work.”

Investor Investors also see a role for warehouses in ensuring the market is healthy and vibrant.

“I’ve always believed to have true competition in the mortgage market you need it at the warehouse level.”

Investor Participants are expecting some contraction in warehouse capacity and a tightening of their requirements.

There is respect for the role warehouses play in stimulating growth in securitisation but some uncertainty about banks appetite for supporting new warehouses. There is also a question mark over the continued interest and participation of offshore warehouses.

“I have seen emergence of overseas warehouses all over my 30 years in the industry, they will come and go.”

Investor “Banks have tightened risk appetites at the moment, so the idea of them creating new warehouses for new proven lenders will be difficult for a lot of banks that otherwise would have looked to provide new warehouses to FinTech players at the beginning of the year. In the short to medium term warehouses may have parameters tightened and higher pricing which would cause difficulties for new entrants.”

FinTech

GROWTH IN NON-BANK SHARE OF RMBS There seem to be two driving forces that have led to the rise of non-bank share of RMBS. Firstly, the pull back in lending by banks which is attributable to the impact of the Royal Commission.

Secondly, the single-minded focus on service that is characteristic of non-bank lenders. This is a common view held by both global and local investors as evidenced in our prior investigations into the securitisation market and fully affirmed by non-bank lenders themselves.

“I think about the non-banks' ability to meet their funding needs, just given the change in dynamics in the mortgage market with the curtailing of lending appetite from the big ADIs. Then that flowing into the nonbanks and they’re obviously getting huge volumes coming through. So their ability to then recycle that is potentially a bit challenged and so they’ve been looking at various other structures and options to enable them to continue to grow in line with demand.” NeoBank But there is no question that non-bank lenders are enjoying their time in the sun.

“You absolutely need strong relationships with investors and banks. That’s true. Maintaining a transparent, ethical, honest, solid, proper relationship, doing the right things by investors and banks is massively important for a business.”

Non-bank lender There is a general view that the opportunity presented by the reduction in lending appetite among banks has been successfully capitalised on by non-banks but there always seem to be question marks over whether this too will be sustained. Consumer demand for credit is perceived as one limiting factor and increased competition from new players is another, although the latter is less often seen as a serious threat in the short term given the sheer size of the market and the very small share currently held by emerging players.

“Look, I think it’s the shake-up of credit. Again, because the liquidity is there for non-banks. They’ve moved from situations through ‘16, ‘17 and ‘18 where really they had, maybe if they were lucky two issues a year, and then the market grew to support three and sometimes four, and the market still obviously supported that liquidity.”

Warehouse “Banks have been forced to retreat and that space has been filled.”

Non-bank lender The interesting parallel that has emerged with the roll-back of bank lending is the attitude of emerging players that quality service to customers is a key differentiator. This very closely matches the views of the established non-bank lenders. Indeed, a primary focus for a large proportion of FinTechs and NeoBanks is their perceived advantage when it comes to delivering a great client experience.

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“The banks will always be there.

They’re certainly not going to disappear. You will always have customers but over time, more and more lending is shifting away from the banks towards the non-banks.

That’s a trend. Customers will go to the service providers that offer a good service.” FinTech The level of consumer demand for credit, the willingness of banks to provide it and the ability of non-banks and new players to attract customers through differentiating their service experience will be the factors shaping RMBS into the future.

Six months into COVID saw little change in the market’s view on the continued rise of the non-bank sector in RMBS. There is a recognition that many of the successful non-bank lenders are well capitalised, have loads of experience and have weathered storms in the past.

If anything, the market is looking towards emerging non-banks and NeoBanks to lead the charge on innovation.

“One of the things that has baffled me is there has not been the take up of the opportunity for super funds to directly originate their own mortgage portfolios. Non-bank and NeoBank challengers are finding ways to access capital and originate mortgages very digitally and very quickly and they're getting a lot of traction.”

INNOVATION IN SECURITISATION

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INNOVATION IN SECURITISATION

At the beginning of 2019 we talked to issuers about asset class diversification.

We found only a few with a substantial focus on ABS, covered bonds or other forms of securitisation. That has changed, although not necessarily as a result of renewed interest amongst established issuers - instead change has come with the emergence of FinTechs and NeoBanks.

Personal loans and small business lending are becoming increasingly popular – market segments that FinTechs claim have not been well serviced in the past.

INNOVATION THROUGH TECHNOLOGY There is a lot of ambiguity in the perceived value of technology as an innovation tool and it’s fair to say there are a lot of cynics when it comes to the sustainability of any competitive advantage related to technology improvements.

To most there are clear benefits in better use of technology for existing processes.

However there are equally many who feel technology is being used to do the same old things in a different way and not always with a long-term benefit. Some point to specific new functionality or systems made possible by technological enhancement while others see technological change as inevitable and not to be confused with innovation that is specific to securitisation.

An example of technology as innovation.

“The innovation is being able to have the product immediately with a payment solution attached and the payment solution delivered through digital channels.” Warehouse And an example of technology as an enabler but not necessarily a securitisation innovator.

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“There’s a lot of time and effort and rework involved in multiple systems and the potential for errors that comes with that, and the potential data cleansing issues you have down the track if you’re trying to securitise or create an eligible pool. We’d like to think that, if you don’t set things up that way in the first place that you kill two birds with one stone. So, technology is an enabler. But, you know, as I said before, this is a pretty plain vanilla product.” FinTech Most agree technology is an enabler of better business practices and many participants take a practical view towards the need to use technology to deliver business and/or customer improvements.

“A third of our staff are technology staff, and I think it’s just a virtual circle. Once you start to get ahead of the curve, then you sort of stay there and ride the wave” FinTech

“So, if you’re not investing in technology and others are, you’re just going to fall further and further behind and it’s either because people have stopped using you or it would be because others are being more efficient.” FinTech “So, we don’t use black boxes. We don’t have a computer that says ‘Yes’ or ‘No’. We still have creditor assessors check every loan.

However, the difference is there’s not paperwork lying all over the place.” FinTech There is also a degree of mystique regarding technology particularly in relation to what is on the horizon.

“Technology is an abstract term. The technology of today will be obsolete in the future, but I think the rate of technology and technological change is increasing exponentially.”

FinTech “You know with block chain and more of a standardisation of defining assets, defining collateral and also the structures – the legal and the reporting structures around a securitisation deal. It is ripe for, I don’t like to use the term, ’disrupting‘ but it’s ripe for real technology-based evolution, I guess.” Non-bank Lender

There is no expectation that COVID-19 will slow the pace of technology innovation and some believe it may even accelerate it.

Innovation in technology is seen as a universal movement that does not discriminate between industries.

“Innovation is one thing that hasn’t taken a back seat especially when it comes to technology and developing better interfaces for our clients to engage with us.” FinTech

INNOVATION THROUGH PRODUCT & STRUCTURE As a general rule, securitisation participants avoid complexity because they find it makes it harder for investors to assess risk and be comfortable with the credit. At the same time, the desire for yield makes less commonly securitised asset classes more attractive in the current environment.

These underlying factors influence the way participants see innovation in securitisation products and structures.

There is increased interest in personal loans as an asset class being driven by a growing willingness of new players to offer consumer lending. There is also a renewed interest in master trust type structures with the emergence of ‘buy now pay later’ schemes and the potential for a shift in demand away from traditional credit cards among younger people. There is a recognition that, while these asset classes are not new, the way they are being delivered to consumers is.

There was also talk of the potential for innovation in superannuation, issuer cooperation and the ESG sector. While these were not common themes, in combination they suggest an openness to new ideas and ways of doing things.

Participants are highly conscious of the needs of investors and the following comments by investors support a more conservative and consistent approach to the structuring of deals.

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“There are always new ways of doing things. There are perhaps slightly different structures at different times which are brought to market.

Usually I go back to my old rule that I had early on - if a structure is complicated it is probably not good for you.” Investor “If I have got a structure which is particularly obscure then I am going to have to spend a lot more time thinking, 'What do I compare that to?', or at least, 'How do I price it?'

Is it being fairly priced? Whereas if something is consistent with most other issuers, then, provided the other issues are a similar credit quality from the issuer and assets perspective, I have got a good starting point to work from.”

Investor Investor conservatism may limit the scope of deal structure variation.

Although this doesn’t stop investors taking an interest in new asset classes as another primary focus is yield.

“There’s been a positive drive back into the market of more people being interested in talking about new asset classes which is quite good. There are a lot of deals in the market, sometimes people call it hot, and there is a level of cash which is looking for a home which is driving the interest in this space. A lot of people are saying RMBS is full so they’re looking for alternatives and this is the hunt for yield.” FinTech “On the buy side, in the low-rate environment people are looking to chase yield where they can. Then from the issuers side, it’s driven by their capital requirements and wanting to free up the balance sheet to grow.” NeoBank

While participants are not expecting a major shake up to their business, they are alert to the potential for disruption.

“The sector is slow to achieve real innovation. We’ve been talking for a long time about esoteric asset classes but this is a market that is dominated by the very homogenous RMBS product. So, generally speaking, innovation is quite slow to develop. What we’re seeing at the moment, of course, is the emergence of FinTech lenders. While the asset classes that they’re originating aren’t necessarily esoteric (it’s largely consumer finance style asset classes for the most part), the innovation we’re seeing is around the product that’s being offered to the consumer and the delivery of the products. For example, ‘buy now pay later’ and the technology that supports the delivery of the product to the end user.” Warehouse The superannuation industry is an area that participants have an eye on and can easily imagine innovation may occur with the prospect of institutional funds investing directly into households.

“One of the things that has baffled me was there has not been the take up of the opportunity for super funds to directly originate their own mortgage portfolios. Non-bank and NeoBank challengers are finding ways to access capital and originate mortgages very digitally and very quickly and they're getting a lot of traction” Fintech

“There are a few people who think that the traditional way securitisation works is inefficient.

They see a replacement model effectively for mortgage funding involving institutional investors, and they typically add on Bitcoin currency. Deliverable, distributed ledger, and other nuances of structure. They think the old way is going to go completely. I’m not a buyer of that, maybe that’s because I’m embedded where I am, but it seems to me that’s a very challenging road to get institutional money lending directly to fund mortgage product, and taking out the intermediation of warehouses in the capital markets process, and the long established structure of rated agency endorsed capital.”

Warehouse Our studies into investor needs revealed a more than passing interest in master trusts and disappointment amongst global investors particularly that these are not common in Australia. The adoption by consumers of new ways of accessing credit such as ‘buy now pay later’ and the willingness of consumers to try new lenders for personal loans has created an opportunity for the emergence of new master trust type structures.

“When it comes to innovation in the context of securitisation, I’d be thinking around the way deals are structured, potentially to tap into an investor niche and to provide a funding platform that’s more flexible. So in a recent master trust deal they’ve taken existing technology, master trust technology which was originally applied to consumer or credit card deals and it’s allowing them to issue on a sort of continuous basis. So that’s applying existing technology but in a new sector in this case, you know a personal lending FinTech.”

Intermediary

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As we will see later in this report, the need to achieve scale is a significant hindrance to new issuers leaping from warehouse funding to bringing term deals to the market. Another spin on a grander scale proposed by one investor is the potential to consolidate loans from multiple issuers into a single investment vehicle thus giving the benefits of scale to smaller issuers and both yield and liquidity to investors.

“Securitisation technology is fairly simple. You put a whole bunch of assets in a trust which generate income, which then supports your liability profile which includes the creditors. And those creditors have seniority rights and some have subordinated rights and some have equity rights. So, how much more innovative can you actually make it, because really, it’s been done to death. Whether you do 20 tranches or whether you do one, the slicing and dicing and the way income can be supportive in that, it’s pretty well been done to death.

To say ’innovative‘, I think the next layer of innovation will be how do you get multiple obligors into one securitised trust, and what I mean by that is that, you might have, let’s take the mutual sector for an example. You may have 20 small mutuals that write $50 million of loans every other year, but they’re too small to go into a big warehouse, so how do you bring all of those guys and their $10 million together into a $500 million programme where they have all the different products, supporting not just their own silo, but the whole programme?” Investor

But when it comes to product and structure, the fact is that securitisation participants have more comfort in the assets they know and understand. While participants take an active interest in new issuers and different ways of putting deals together they are also conscious of the effort required to either bring a deal to the market or to assess the credit quality so it seems the more traditional assets and structures will continue to dominate market share into the foreseeable future.

“I guess the innovation is in the kinds of assets which are being brought to the market. That would be the one thing which I flag. Now I do not think it is quite as much as people sometimes say because essentially you talk about SME lending, well I have seen SME lending structures pre-GFC. You talk about personal loans, I have seen personal loan books before. Now perhaps the way that they are being structured or sourced is different and the number of issuers is different, but we had a lot of issuers before the GFC and a lot of them were cleaned out.

Looking back, there was the same sort of innovation in a sense, all these different asset classes being brought to market or attempting to be brought to market, but a financial stress did test them out and showed some of them to fail.” Investor COVID-19 has had some direct outcomes on the need for innovation and sparked interest in some new innovate structures. Issuers have had to adapt their structures to meet the requirements that make them eligible for the government guarantee.

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“We’ve had to innovate to meet the needs of the government guarantee’s case and we’re going to have to further innovate as the government is looking to change the scheme and the types of products that will be subject to a guarantee in phase 2.” FinTech Several participants were talking in relatively positive terms about the introduction of a new consolidated structure that would allow multiple small issuers to combine their assets into a single securitised structure thus giving them access to better pricing and the potential to grow more quickly than is possible on their own.

“The newer players who are subscale, may be unable to access a warehouse facility on their own but aggregated with other small lenders, you can get an economy of scale in pricing.

I think a multi seller facility would be very attractive.” FinTech There are those that doubt the likelihood that this type of structure would succeed.

“Look maybe I’m a little bit of a pessimist and a cynic. When I heard of the concept I just thought it would be a bit like herding cats and I couldn’t imagine that.” FinTech

INNOVATION IN MEETING CONSUMER NEEDS The most common word used by industry participants when describing consumer needs was ‘easy’. This was typically expressed in the context of the process of securing finance. Many FinTechs back their ability to make the process easy and invariably cite their technology as the enabler. Yet they are equally conscious of the ongoing role of people in the credit approval process.

There is a recognition that getting any kind of credit can be a difficult decision for consumers and that the decisions they make along the way often require the reassurance that only the human touch can bring.

FinTechs led the charge when discussing innovation by focusing on the consumer whereas the more established and larger participants tended to think more about asset class and structure when thinking of innovation. While established participants respect the contribution of new players in bringing technological innovation to the market, there is also cynicism about the long-term benefit that some of the technology will bring.

All FinTechs do not over-play the role of technology and some are more focused on servicing consumer segments that have traditionally found it difficult to secure funding. This is especially so in the SME market and it’s not uncommon for FinTechs that offer SME lending to feel quite strongly about it.

“The availability of capital and support that a traditional Australian SME had from the bank which was appalling to begin with has probably gotten worse. The banks are not funding them. Even though the bankers individually try to do a good job, the institutions are just horrendous. The second thing is at the point of origination we spend on marketing, we spend on branding, we spend a lot of time, money and effort to try to become front of mind to a customer at a point where they show intent of taking a SME loan.”

FinTech This sort of comment may be stronger than most, but underneath is the widespread belief among new players that making things easy for customers is both important and a key point of differentiation.

“From what I’ve seen, a lot of them (FinTechs) do seem to come from the banks and they’ve had ideas of how to improve things and innovate and just gone out on their own and done that. They’ve got a lot of experience, and a lot of ideas on how to improve an offering for the customer’s benefit. As a consumer as well as a customer, I think it’s great.”

Non-bank lender “In our business or professional lives there is the desire for customers to get a better product, at better value, in an easier way. That’s the journey of all business. At the moment we’re going through an information revolution and a technology revolution that are helping us to deliver a better service and better value to customers. That’s constant.”

FinTech

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The theme of technology as an enabler runs through many of the comments from FinTechs specifically. They are equally quick to recognise that the fulfilment of the customer’s need is the primary goal. This comes through in their recognition of the effort people have to go to in getting funding or credit and the belief in the benefits of technology in reducing that effort.

“We’ve completely rebuilt the application experience in the last 12 months for our customers on automotive finance, for example.

We’re completely changing the way we engage with brokers and other intermediaries that might refer us customers and making it easy for them and better for them - better reporting, better communications, all that sort of stuff. So, it’s really not AI. It’s none of that sort of stuff.

It’s just everything being better all the time.” FinTech “It’s all about making it easier and faster and better value for the customer. If you’re not keeping up then you fall behind.” FinTech “When we serve our customers, their rate is important to them, but I think the biggest carrot for them, and also call it validation of the model itself, is that the word ‘easy’ comes back.

So, people are finding the process a lot easier than they expected and therefore they say “I should have done that months ago and saved myself money.” There’s still a mindset that applying for a home loan is an incredibly arduous task that requires a lot of leg work and a lot paper work.” FinTech

The role of the human is also rarely underplayed, particularly where the decision to obtain credit is complex or significant. Both new and established participants understand the need to provide help and guidance to customers along the way. When an easy digital experience comes with the personal touch, the customer experience is significantly enhanced.

“You’re not talking to a robot. You’re not talking to an IVR. You actually have the ability, halfway through your application, if you’re confused about a question, you can ring and speak to someone. They can see your application live and they can either walk you through that one question or walk you right through to the end. They can see where you’ve got stuck. That’s real time technology.”

FinTech “When it is a big decision for someone at some point in time they normally want to talk to a human. You can have all of that technology that allows a rapid credit assessment of people by, for example, scraping expenses off banks. That’s all it really is and processing that.

Those lenders all claim to have some level of secret sauce but the result is a credit approval process.

But then ultimately the consumer says “Right I know that I can get a loan. It’s a big decision for me. I better talk to someone instead of just spitting it out on my phone.”

Is that going to perpetuate in the future or will people will just end up saying, “everything else comes out on my phone, of course I’m perfectly happy.” I don’t know. You need to be a futurist to work that one out.”

FinTech

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If there is one belief that has been challenged as a result of COVID-19 is the notion that the human element of customer interaction will continue to carry weight in the future. Consumers’ adaptation to a world of minimal personal contact for access to services has been swift.

“We see a huge move among anybody south of 35 years old in having a lot of trust in technology, a lot of trust in digital engagement, a lot of comfort in transacting with out the need to ever speak to a person directly. That adoption has a long way to run.” FinTech “They say that the structure of scientific revolutions is not that the existing establishment gets on board with the new technology, it’s that the existing establishment dies and gets replaced. The next generation of brokers are just going to be Facetiming their customers or doing Zoom chats and it’s going to be at scale, it’s going to be over the internet and customers are going to be more focused on how easy the solution is for them so the relationship is not always based on how much you like the person. The model of the future is going to be on how convenient the interaction is for you.” FinTech “It feels like consumers are driving the development of technology.

We're letting clients help themselves to our money.” FinTech

FINTECHS AND NEOBANKS IN FOCUS

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FINTECHS AND NEOBANKS IN FOCUS

As the focus of this year’s report is on innovation and what’s new in securitisation, it was natural to spend quality time talking to industry participants about the emergence of FinTechs and NeoBanks. While they are not currently generating a large volume of securitisation deals, and the majority are using warehouse funding if they’ve reached sufficient scale, the number of new entrants is significant.

Of course, COVID-19 may completely shift the trajectory of this segment, but it’s worth establishing whether the conditions that have given rise to their emergence are likely to be sustained through this new decade and also whether they can begin to extract market share in the same way that non-bank lenders have successfully done in recent years.

A MATTER OF DEFINITION The term FinTech has been used for at least a decade and is now freely used both within and outside the financial services industry. The term NeoBank is commonly held to be a FinTech with a banking

licence. But use the term to describe FinTech-like participants and they are not always thrilled.

“I think the first time I met them I talked about FinTech and they said, stop right there.” Intermediary The point being that many don’t like being so easily classified and all are keen to speak about their point of difference.

To arrive at a single definition is difficult but this one most closely sums up the way securitisation participants describe them.

“It’s a broad term. I just look at it simply as anyone that’s using technology to enhance old processes, but also to some extent that definition needs to acknowledge it’s more like the start-ups. That is, the business is new as well, in terms of what they’re doing.” Warehouse Others claim you can differentiate between FinTechs along lines of whether they are utilising technology to improve

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the process for traditional products or they are offering a totally new product (e.g. ‘buy now pay later’). Both FinTechs and NeoBanks rely on technology to deliver solutions in ways that have not been done or at least not done well by existing providers and this is often what FinTechs see as their competitive advantage.

“I think every new lender that enters the market has the fundamental benefit of starting from a clean sheet of paper. What I mean by that is that they are not encumbered by legacy system processes that make change inside of large institutions very difficult. When you have that strategic advantage it means that you can engineer a process for customers that is much more aligned to what customers are interested in. That is faster, easier, more convenient, simplistic and so on. That is a significant advantage for new lenders in this market and other markets.” FinTech

THE PEOPLE Many of the people starting up or working in FinTechs and NeoBanks have been in the financial services industry for a long time and/or specifically in the securitisation industry for a long time.

Overall, there is a lot of experience among these new players and that is helping them define a better experience for customers and have success in seeking funding right through to the warehouse level.

One thing many are finding challenging is the need to be as hands on as is required to manage all aspects of their business in what are typically quite lean organisations. Many come from large bank backgrounds, where resources including colleagues with specific expertise are often readily accessible. In FinTechs and NeoBanks it’s important to be able to wear many hats and have no fear of getting your hands dirty.

“Ah it’s a lot of work. We all come from a credit background. From the beginning we really had very consistent credit performance. I would say for us, it’s a lot of work, doing anything with the banks is a lot of work but we had the credit performance to demonstrate. We’ve raised enough capital to be able to fund it. We’ve got a management team with deep expertise.” FinTech There is an advantage to those who have come out of the securitisation team in a large institution and not all have.

“They’re very experienced. I mean, we’ve had the young guys knock on our door with an idea and a dream but the ones that have gotten off the ground are very experienced, one way or another they’ve got a lot of experience behind them.”

Intermediary

THE POINT OF DIFFERENCE Surprisingly, the way the market believes FinTechs and NeoBanks differentiate is not dominated by innovation in technology but more so in their ability to engage with customers both personally and through delivering a friendly interactive experience.

Flexibility is cited as a key feature of the way many FinTechs and NeoBanks do business and there is a belief several are championing the return to traditional bank practices and values. Whether the way FinTechs and NeoBanks interact involves personal contact or an entirely interactive experience, there is a strong belief that their focus is single-mindedly on the customer experience. This extends to their approach to assessing credit for the SME market in which there is a willingness to consider loan applications on a wider variety of bases than typically occurs in dealing with traditional lenders.

“The combination of a curated loan experience that is quick and simple, along with compelling and competitive interest rates makes it a pretty attractive proposition for consumers looking for an alternative.” FinTech “Their whole platform is about bringing the business and the personal back into business banking.

You can’t call them a FinTech. Their approach is about the connections with the borrower. It’s about going back, almost to how it used to be.”

An intermediary speaking about a NeoBank A common thread in many comments about FinTechs and NeoBanks is the advantage of not being encumbered by legacy systems. It means they can design the customer experience with the customer in mind. This extends to the way they do business and what they choose to do themselves and what they outsource.

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“They can start afresh and they don’t actually have to do everything either. They can buy stuff in as well or outsource things like servicing, whatever as well, so in many respects there’s that flexibility.”

Warehouse Investors are inherently discerning and expect transparency from issuers.

There is cynicism of new players who are reluctant to reveal their approach to assessing credit quality and as a result they tend to avoid FinTechs with ‘black box’ solutions. In contrast they can be surprised by the emphasis of some FinTechs on a more hands-on approach with less reliance on the ‘system’ to make decisions for them.

“I think, not to be ungenerous, there are a lot of FinTech issuers with an app and a dream. Within that app and a dream mentality there is a considerable divergence of quality and rigour of a credit model. The only way you find that out is to be under the hood of the issuer and ask a lot of questions.” Investor “Some of the SME lenders who may be classified as FinTechs do seem to be much more hands on and not as much about computer systems as people would think.” Investor An associated benefit of creating systems from scratch is the ability of FinTechs and NeoBanks to use data more efficiently. Not only can they innovate in the data they collect but also in the way they use that data. Most participants commented on FinTechs’ use of technology in creating the application and onboarding process and few mentioned this potential advantage in data modelling and management.

GROWTH OBJECTIVES “Whereas particularly like NeoBanks and the FinTechs, they‘ve designed these platforms now to capture all this different data points in, some sort of cloud technology system.

Their ability to capture the data and generate it is a lot cleaner and faster than what some of these banks can do. They don’t have the history, but what they currently are producing is in a much better format, more comprehensive, easier to use and read and captures more relevant data points than what some of the banks can.” Trustee Implicit in the creation of systems that potentially better meet the needs of customers is a strong sense of who their target market is. And with that comes a dedicated approach to marketing.

“For us, like anyone, you’ve got multiple marketing channels. So it could be direct mail. It could be the comparison sites like RateCity.

It could be TV or radio. You’ve always got a different approach I suppose. It could be display ads on the internet. There’s a bunch of marketing channels that I wouldn’t say are unique to credit or lending.

Everyone is trying to attract customers to their website.” FinTech Of course, marketing doesn’t start and finish with the customer. There is a strong recognition amongst FinTechs that they must be good at selling their story to capture the attention of warehouses and other potential funders.

“To build their business they have to convince other people of their story and why they are going to be different from the other FinTech that opened up down the road as well.”

Trustee

Growth is never far from the mind of the FinTech or NeoBank as they need scale to get cheaper funding and eventually become profitable. They also often start by servicing the riskier end of the market and the achievement of scale allows them to access cheaper funding, broaden their client base and slowly begin to reduce risk.

They are highly conscious of relationships with consumers but equally with funding partners. They recognise the need for flexibility and are ready to adapt at any time. While they may be focused on the long term, in reality their planning is very much for the short term simply as a result of the immediate need to drive the growth that will lead to sustainability.

Here are some of the ways FinTechs describe their growth objectives and experiences: “You start off doing whatever you can do to survive, and your business model evolves.”

“If we had implemented today all the improvements we know we want to implement over the next 12 months, I think we’d be funding 30% or 40% more loans. So, in some ways it feels like a race against the clock in terms of technology.”

“It’s a bit of a dark tunnel until you come out to break even.”

“We’re acutely aware that if you’re playing at the lower risk end where everyone wants to play because it’s less chance of incurring credit losses, then the margins will be tighter and that means you need to generate the volumes.”

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“If you started at the riskier end with a more intensive credit servicing model, higher arrears and loss rates in general, it is more difficult to head down the curve to lower risk products.”

“Obviously success is going to be in writing more widgets.”

“What gets me excited is actually thinking about our first term out.

That’ll be, you know, for us, that’ll be a big win.”

“I’m looking forward to getting rated. I’m looking forward to filling up my warehouse. I’m looking forward to my first term issuance.

It’s a different way of thinking. It’s fantastic.”

COVID-19 has not diminished FinTech’s appetite for growth but it has tempered their expectations.

Many have had to rapidly change their business model and refocus their attention on new segments and new borrowers.

“We are a company that was looking to get to term markets this year so I think the world has changed for us obviously in terms of pushing that back but it has also caused us to pivot quite dramatically in terms of our lending product and to shift focus in terms of the industries that we would have had appetite for and also to shift focus in terms of the borrowers that we have appetite for.”

FinTech

FinTechs point to the reduced interest amongst banks for certain types of lending and the ever-present investor as being the two factors that make them believe new opportunities will emerge from the crisis.

“We have seen a pullback from what you would probably have called competitors like the banks and a real opportunity to expand into prime lending. So, in a lot of ways COVID has caused us to re-evaluate our strategy but also far from presenting a crisis, we see it as an opportunity.”

FinTech “I think there is appetite from the funds and investors who would be backing these new entrants to really participate and pursue the opportunities in small business lending.” FinTech

CHALLENGES FOR FINTECHS AND NEOBANKS

Very few have arrived at the third stage with the greatest challenge being scale, yet to achieve scale most are dependent on support from private funders and the public.

“FinTech lenders have to demonstrate the performance of their books in order to give confidence to an institutional investor that a warehouse facility is appropriate. The warehouse facility also requires that FinTechs have a reasonable amount of excess working capital sitting in that warehouse to provide the appropriate credit support or subordination levels. Those are often times not conditions that relatively new FinTech lenders are able to meet and that’s a challenge."

FinTech FinTechs and NeoBanks understand that potential investors need the confidence of hard evidence to be willing to support them. But demonstrating their ability to succeed takes time.

Starting any new business has challenges and these businesses are no different.

The dominant challenges for FinTechs and NeoBanks are; the ability to secure funding, the difficulty in achieving scale, their lack of a track record and the need to learn how to do new things fast.

“Ultimately institutional investors need to be confident that they will be paid back and that requires a bit of time and seasoning for the FinTechs to demonstrate their ability to appropriately manage risk.” FinTech

FinTechs and NeoBanks are typically confident in their ability to attract customers and many have strong relationships with key people in the industry who are open to hearing their story, but with so many moving parts, a FinTech or NeoBank founder needs to wear many hats to be successful.

“I think one of the challenges for the emerging players, the FinTechs and the challengers etc is a lack of data and not having been through a full credit cycle. A lot of these companies have only been lending for two or three years. So you can extrapolate from what they’ve done now, but they don’t have full loss curves which probably means that there’s going to be some conservatism built in as you extrapolate out.” Intermediary

Most are following a similar path to growing the business, often starting with private equity, then moving to secure a warehouse and dreaming of the day they can bring a deal to the market.

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FinTechs and NeoBanks, like most new business, start very lean. It means the people running the businesses are very hands on and they have to deal with aspects of running a business they may never have dealt with personally in the past. This means they have to learn fast and rely on their business partners to a greater extent than established participants.

“I think the biggest challenge for Neos is the fact that we’re new. It’s been really good, the relationship with our trustee. My background is as a treasurer in a major bank.

You’d think I’d be across some of this stuff but it is mind blowing. It’s starting from scratch. It’s one thing managing the treasury functions.

It’s a total different thing setting them up from scratch. I know how a warehouse facility works. I know how the investment market works and how the deals go, but I’ve never had to negotiate one.” NeoBank With most FinTechs and NeoBanks setting a path to come to market with term deals, achieving scale is a primary focus, although there are different approaches to achieving it. Some are targeting those segments which tend to be avoided by traditional lenders and in which exceptionally high rates are common due to the risk associated with them and others are hoping to extract market share by offering cheap rates.

A smaller number are using a different approach, for example buying existing books.

“These businesses are very capital intensive, and the ones that have got out of the ground fast have been ones that have charged exorbitant rates in the early days. Everyone else trying to do it the other way around giving good cheap rates.

Scale is a huge challenge for them.”

Investor

Funding has its challenges for FinTechs and NeoBanks no matter what stage they are at and initially there is a strong reliance on personal networks. Most have their sights set on warehouse funding in the short to medium term as they are well aware of the scale required to start offering term deals.

The influx of overseas based warehouses and open-minded warehouses within Australia has made it easier for FinTechs to reach that stage.

“We’ve certainly been fortunate to work with some partners that are happy to sort of lean into that and try and think of what are innovative ways that we can do warehouse funding in the first instance, but the term market, I think is, there’s probably still some education that will need to happen there before we’ll be able to access that.” FinTech Intermediaries have also lent a hand with sound advice which helps to ensure these new businesses get suitable warehouse deals.

“The natural evolution of a FinTech funding strategy typically begins with access to private capital, typically through ultra-high net worth family office type investors.

If you look globally, the vast majority of FinTech’s really start with that as a funding source. Often the next stage of that process is for the lending FinTech to secure capital via specialty finance firms and the trade-off there is that the cost of capital is often times quite high and perhaps not reflective of the true underlying risk of the asset.

However, as these lending FinTech’s are immature and their books have not seasoned they ultimately have to pay a price premium in order to access the capital they need to grow their businesses.

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Usually the third step in that process is some form of warehouse facility, a securitised warehouse facility and that obviously comes at lower rates and then the fourth step is the traditional term out and access to the public debt markets via bond issuance. What you’ve seen globally are those FinTech’s who’ve been able to move along that spectrum of funding sources quicker, tend to do well because they secure a lower cost of funds which gives them a sustainable cost advantage and that stable cost advantage ultimately leads to a margin advantage and things play out quite nicely when you can manage your margins effectively.” FinTech Investors are seeing a lot of FinTechs knocking on their door and are quite willing to hear what these new business have to say despite finding that the demands on their time can be challenging. They love a FinTech with a strong plan but do find many would benefit from a more realistic view of what it takes to achieve scale.

The problem with those smaller players, they can’t get scale. We’ve seen a lot of them come through the business and the conversation often goes like this:

Investor: “This is a really good program, how much have you written?”

FinTech: “Oh we’ve written $10 million.”

Investor: “How big is your market?”

FinTech: “Ah look if we can get to 30.”

Investor: “Over what timeframe?”

FinTech: “A year.”

Investor: “That’s no good mate, there’s no scale, no matter how good your product is, you’ve got no scale.

You need to put some more fat in the sausage.”

FinTech: “What do you mean?”

Investor: “You need to get some really bad stuff and mix it with your really good stuff because that’s how a sausage is made, it’s just not all good meat, you need some fat so when you cook it, it sizzles a bit and the sizzle is where you can get your scale. If you’re going to write 100% of the really good loans, it’s a really small market, so you’ve got to expand your credit criteria and write some stuff that is just near those good loans, then some stuff that sits near that, but you don’t want to write a lot of that, you just want to write enough of it so you can get to 50 and then you can get to 60, because if your current market opportunity is only 30 how are you going to get the 300?”

Not all these new players are entirely reliant on external funding. NeoBanks offering deposit products are optimistic that their relative success in capturing deposits will satisfy their funding requirements as they begin to grow.

“Right now deposits will for the foreseeable future meet our funding requirement, but as any half decent treasurer would want to do is diversify their funding base and to look at tapping into different channels to be able to both diversify but also to optimise on cost of funds.” NeoBank

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FINTECH AND NEOBANK SUCCESS FACTORS STRENGTH AND QUALITY OF THE MANAGEMENT TEAM

STRONG FUNDING

STRONG GOALS AND BUSINESS PLAN

DEEP, TECHNICAL UNDERSTANDING OF LENDING, RISK AND PRICING

ABILITY TO ORIGINATE AND SERVICE WELL

OPERATIONAL INFRASTRUCTURE

MARKETING PLAN

HEALTHY DISTRIBUTION CHANNELS

UNDERSTANDING CUSTOMER NEEDS

.

And here are some ways they expressed these requirements:

“Fundamentally it’s demonstrating that, of the many different options that institutional investors must fund, why is your model and your mouse trap a little better than the other guy’s." FinTech “It’s always some combination of credit quality and pricing. Those who are able to understand the interplay between those two things do really well.” FinTech

“You’ve got to keep your servicing history great, so you ultimately get rated.” Intermediary

“They need to have a facility that’s going to stand the test of time and not be one of those facilities that are wound up in the GFC.” Intermediary “They are well-capitalised, have proper infrastructure and proper long-term goals and they have an approach that understands the customers’ needs and delivers them with a degree of simplicity and transparency.” Non-bank Lender

“The quality of the management of people. Can they handle, not just the origination front but at the backend, have they got the systems that track the risks, you know the servicing component?” Warehouse

WHAT INVESTORS ARE LOOKING FOR Investors are excited about the growth in participation particularly as they expect to find more value opportunities, but this hasn’t changed their approach to evaluating new deals. They use just as much rigour, perhaps even more, as they seek confidence in the business models being presented to them and they come to grips with the assets being offered.

FinTechs can get a little frustrated at the caution in the market but most understand what’s driving it.

“It is like everyone sitting around the pool trying to work out who is going to jump in first to see how cold the water is.” FinTech “Realistically the more simple and plain vanilla we can prepare our offering for them, the more likely it is that they'll buy it.” FinTech “People are going to look at your arrears track record and your loss history and how the portfolio has performed, and does it do what it says on the tin. And if the answer to that is no then, you know you understand you’re going hit some pretty serious questions from investors.” FinTech Here are some of the ways investors describe their needs from these new businesses.

“For us, it’s a multi-faceted call on the quality of the people, the experience of the people behind, and the underlying ability of systems and credit processors, and the appeal to the end customer.”

“Having a core base of expertise, a clear set of parameters, a very well-defined process. These are the things which, when we look at them, will give us the comfort level.”

“They were saying that they had a prime deal but somehow the arrears were not matching the prime parameters. That was a big flag to us.”

“How quickly do they write the deals, because essentially if they are too slow then they are never going to grow. But if they are too fast, are they really doing all the work?”

“I saw one structure which was a securitisation of a large number of loans, but effectively a lot of these loans were written by a few different businesses. They would not, they could not provide enough details about the individual companies for me to be comfortable. That kind of disclosure is the kind I want, and when it gets to that sort of level it can be a deal killer.”

One thing that has not changed since COVID-19 has been the focus of investors on credit quality. They are cynical of new entrants’ ability to introduce technology that allows them to more accurately assess risk.

Similarly, they believe the government stimulus is making it difficult to accurately assess risk and this in turn affects the price they are will to take.

“I’ve been looking at the risk model for so many years and if they are claiming they have a better risk assessment tool, the question should be back on them, "How can you know better than all the lenders that have been here for many years?"

You come out of nowhere and you only begin lending recently. Where did you get your risk factor from?

Because a risk factor has to be based on fact.” Investor

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THE DECADE AHEAD

28 Twenty-Twenty Vision – Securitisation in the New Decade

THE DECADE AHEAD

At this point, in the original plan, we wanted to look at the likely trajectory of securitisation in the new decade. Based on what we heard in January the picture being painted was quite different to what we are hearing today.

It’s very difficult for people to predict the future but that doesn’t stop us trying. With COVID-19 things have changed and the extent to which the impact of COVID-19 will extend throughout the decade is not known. We’ll look first at what participants were saying pre-COVID then contrast those views with what participants are saying today.

The common themes being talked about included; A blurring of lines between payment products and lending vehicles prompted by the rapid growth of ‘buy now pay later’ products.

“I see ‘buy now pay later’ competing directly with credit cards.” FinTech The beginnings of the belief that the lending market was reaching saturation point and that this would limit growth of securitisation.

“I think the rate of new entrants will probably slow given the size of the market.” Intermediary

Ongoing consolidation and rationalisation of issuers as a variety of factors come into play including competition, weakening economic conditions and regulation. There is, however the underlying belief that quality will prevail.

“The cream will rise to the surface with some new froth, there is always going to be noise and froth and some of that froth will turn out to be cream, some of it will not. It is going to be always the dynamic push and there is going to be the question of regulation and other things which drive that. As soon as one group becomes too dominant, regulation will begin to focus more onto them.

So I think in five years’ time you will still have volatility but there will be certainly the cream rising to the top, but not dominating it.” Investor The narrowing of technology driven advantage as new technological capabilities become commonplace.

“We’ve got this energy and we’re doing stuff that other banks aren’t doing and customers are benefiting from it. So I’m curious to see how the banking landscape changes in general over the next five years, because we definitely won’t be the only ones doing it at that point.”

NeoBank

29 Twenty-Twenty Vision – Securitisation in the New Decade

Despite a widespread belief that FinTechs will continue to emerge and grow, no-one is willing to suggest that the banks won’t continue to dominate.

“Our success is not going to be to reduce the market share of the majors. If we take 1% of their market share, we’ll be a roaring success.”

NeoBank A belief that the world could ‘shrink’ was expressed by more than one.

“People will need to potentially be a little bit more content with where they are in life or with potentially even a bit less of what they’re enjoying because we can’t use two times the world’s resources every year after year after year and expect that it’s going to just continue.”

NeoBank And, finally that ABS will continue to grow as it satisfies the investor need for diversification and with so many new entrants willing to offer a wider spectrum of asset classes, the growth of ABS seems assured.

“Eventually to have more choice in the Australian securitisation market is the goal. As strong as Aussie mortgages are, it’s better to be skewed across an array of products in the securitisation space, credit cards and autos, the odd consumer personal, unsecured deal or whatever. I think people want choice.” Warehouse

THE COVID-19 POSTSCRIPT

30 Twenty-Twenty Vision – Securitisation in the New Decade

THE COVID-19 POSTSCRIPT

We asked participants how the impact of COVID-19 compared to the GFC and uncovered some fundamental differences including the recognition that the asset quality in the market today is far better than in the GFC. The primary factor giving confidence right now was the swiftness of the government’s response to the crisis which has allowed the market to continue operating. However, there is concern for the sustainability of the sector should the stimulus be removed and should the economy slow at a greater rate than expected.

“Can the securitisers continue to operate their business with the funding costs and capital costs increasing? Some originators are a lot better capitalised, they've been here for a very long time, they're prepared. Those original securitisers will be here in the future and others that are not well capitalised won't.” Investor

“In terms of liquidity and government response, we’ve not had the freeze up that you had during the GFC. The government took the right lessons away and has deployed helicopter money into the economy to prevent access to funding from drying up. In that respect, things are better than they were then.” FinTech "Relative to the GFC COVID-19 is much worse, the damage that is being done by COVID on the economy is not nearly visible yet.

Although we are not seeing the hardships to the extent that we expected, it is being supported by an unsustainable measure and if that measure is withdrawn there is a real risk that we might be surprised by how much damage it has done.”

FinTech Participants in the securitisation industry are exceedingly positive although equally conservative. The inherent conservatism leads to a realistic view on the challenges we are yet to face but the positive attitude of participants encourages the belief that the industry will survive and emerge stronger.

31 Twenty-Twenty Vision – Securitisation in the New Decade

“I think we’ll get through it and we’ll see the structures are resilient so I think it will be a once in a hundred year thing. The investors will all fare pretty well and that augurs well for the ongoing sustainability of the whole industry.” FinTech “It all varies by issuer and issue and the nature of the portfolio, but in general, the credit quality has performed quite well. Nonetheless we know there is a dark cloud on the horizon which is the impact of the virus on the economy, in particular the unemployment rate and also on the property value or the underlying asset value.” Investor

“I think in a funny way COVID will benefit of the industry because we've had this government stepping in supporting it. It highlights the strategic and structural importance of the industry which has given confidence to everybody to continue on and there were positive trends already pre-COVID.” FinTech

WORDS OF WISDOM

32 Twenty-Twenty Vision – Securitisation in the New Decade

WORDS OF WISDOM

Securitisation professionals have a passion for the industry and come with a lot of experience. It seems apt therefore to finish off with a selection of their words of wisdom on a wide range of topics, in no particular order.

On people

“In our job as leaders we need to develop people – we need to recruit and attract and retain good quality people. That’s the starting point for us. If you can attract and retain good quality people the magic kind of happens for the rest. You get good strategy, you get good service levels, you get good execution on your processes, you get happy customers.” FinTech

On innovation “The innovation is not in securitisation. I know this is counter intuitive. The innovation is actually in products and services. It’s around trying to use technology; you see stepping back from FinTech is a financial service company. The way credit has been assessed, the fundamentals. They have not changed from the time our ancestors were borrowing and paying back.

Those fundamentals will never change. What is changing is the way the world experiences products and the world starts to expect products to be delivered.” FinTech

On the role of the human

On ambition

“There is a human element around it.

Machine learning is quite important, we use machine learning in our bank statements analysis but there are times when you have to teach the machine to learn and the machine learns and repeats what it does. It will come to a point where it will learn by itself definitely. But humans have to have that touch about whether I can trust you and will you trust me.” FinTech

“I think, not to be ungenerous, there are a lot of FinTech issuers with an app and a dream. And within that app and a dream mentality there is a considerable divergence of quality of credit model and rigour of credit model behind that. The only way you find that out is to be under the hood of the issuer and ask a lot of questions." Investor

“I think if you’re a FinTech, you’ve got lots of things to think about.

You’ve got to keep your originations up. You’ve got to keep your servicing history great, so you ultimately get rated. You've got to keep your distribution channels healthy and your connections, your warehouse funding line good. Not give away too much equity but get the right equity people who have connections as well.” Intermediary

On risk “Well at the moment our biggest focus on risk is not on credit risk.

It’s more an operational risk. Most of our investments, we spend a lot of our time looking at operational type of risks.” Investor

33 Twenty-Twenty Vision – Securitisation in the New Decade

On the use of brokers “I think that it is also community engagement and a long history of understanding the area they are operating in. I am always cautious with RMBS issuers and it would be the same with any other issuer, when they use brokers, because that begins to disintermediate them from the client.” Investor

On the quality of assets “It is always the assets because, this company could be absolutely a 100% successful but if the assets in this particular pool are flawed, I am doomed. If I had found out on the other hand the company is less successful, but the assets are pristine, I am sweet.” Investor

On future credit growth

On economic factors

“Can the earth support 20 billion people? Well the answer is pretty clearly no, and so therefore, if ongoing economic growth is reliant on population growth and increase in consumption and increasing wealth per capita, there’s a finite sort of horizon and I don’t know exactly when that’s going to be and how it’s going to play through.”

NeoBank

“Look, I think the biggest risk for the performance of the underlying collateral supporting securitisation transactions is unemployment.

So, to the extent we see the unemployment rate increase is a result of weakening economic conditions, domestically and globally, external shocks from China, Coronavirus, etcetera, you know, I think we will see a deterioration in the performance of the underlying collateral. I don’t think it’s going to be severe, so that’s one point.

Another point is the more frequent and more severe occurrences of natural disasters. That’s something to bear in mind too, but aside from those couple of things, I don’t think there’s anything that overly concerns me.” Warehouse

On SME lending “The old adage that capital always follows a path of least resistance speaks true particularly in the SME space. But that’s really been aided by the flourishing technology and different approaches to distribution.

Also consumer acceptance of these different ways in which to engage with a potential financier.”

Non-bank lender

On master trusts “That’s the beauty of the master trust. Once investors understand the structure, when you come back with another trade, there’s actually nothing to go through again other than the assets. Has the profile of the pool changed and what’s your liability structure? So, effectively what’s the term of the notes you’re issuing?" Non-bank lender

On unsecured lending “If a guy wants to open a gelato shop and back himself to serve 200 gelatos a day in winter, we think that’s a risky bet. So, if he absolutely wants to back himself, we’ll go; “Okay mate, but we’d like some residential security for that.” That apparently is the wrong thing to do.

So, what the new breed of lender is saying that they’re doing is lending unsecured. So, does that sound risky to you? It sounds risky to me.”

Warehouse

On ethics “Maintaining a transparent, ethical, honest, solid, proper relationship, doing the right things by investors and banks is massively important for a business.” Non-bank lender

34 Twenty-Twenty Vision – Securitisation in the New Decade

FOR MORE INFORMATION PLEASE EMAIL US AT PCTSALES@PERPETUAL.COM.AU

This report was prepared by Perpetual Corporate Trust services in collaboration with the ASF. Any statements or opinions made in the report are personal to those interviewed by Perpetual and are not, nor are they deemed to be, the views of the ASF nor are they necessarily endorsed by the ASF.Perpetual Corporate Trust services are provided by Perpetual Corporate Trust Limited ABN 99 000 341 533 AFSL 392673, Perpetual Limited ABN 86 0000 431 827 and its subsidiaries. Perpetual Limited and certain of its subsidiaries act as Authorised Representatives of Perpetual Trustee Company Limited ABN 42 000 001 007, AFSL 236643. This publication contains general information only, and is not intended to provide you with financial advice.

This report was prepared by Perpetual Corporate Trust services in collaboration with the ASF. Any statements or opinions made in the report are personal to those interviewed by Perpetual and are not, nor are they deemed to be, the views of the ASF nor are they necessarily endorsed by the ASF. 2654-0418