17 minute read
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.
“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.
“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
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.
“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
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
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.
