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