ABS Vegas, the world’s largest securitization conference, drew a record number of attendees this year. Marketplace lending was the topic du jour.
PeerIQ participated on the “Development of Securitization in Marketplace Lending” and “Future of Regulation in US Marketplace Lending” panels. The panels were standing room only, underscoring interest in this rapidly growing market.
Positive Impact of Securitization on Real Economy
SEC Commissioner Piwowar’s keynote speech highlighted the benefits of the ABS market:
“Securitization can transform illiquid assets like mortgages, auto loans, credit card receivables, and future sales of David Bowie albums into marketable securities . . . securitization supports economic growth, business development, and job creation.”
The commissioner cautioned on the potential for regulation to stifle securitization and, by extension, credit extension:
“…we must keep in mind that unnecessary or inappropriate regulation of securitizations may lead to less availability of capital, increased borrowing rates, and a more limited supply of credit. These effects are likely to be passed on to borrowers, either in terms of increased borrowing costs or loss of access to credit, and thus will cut directly against the benefits of securitization.”
The commissioner also made reference to the Eurozone market where, along with China, policy-makers are taking steps to grow the ABS market and reduce reliance on bank funding.
We believe current and proposed capital and liquidity rules, particularly when combined, will have the effect of deterring banks from holding and making markets in ABS. Specifically,
- Tier 1 Capital ratio: Under Basel III, Tier 1 capital requirements for banks increase, with the new ratio for some large banks exceeding 10% of risk-weighted assets (RWAs)
- Differing RWA treatment: Currently, the risk-weighting of highly-rated securitizations of consumer and small business loans is higher than that of lower-rated corporates—surprising given the outperformance of consumer ABS over CLOs during the crisis
- Liquidity Coverage Ratio: The LCR rules do not treat any tranche of ABS as a high-quality liquid asset (‘HQLA’). The LCR has reduced investor interest in ABS and curtailed the supply of credit to consumers and small businesses
- Fundamental Review of the Trading Book: Under this proposal, the risk-weighting given to many securitizations, including AAA paper, will soar – in some cases doubling, or more. So, when multiplied by the doubling of the Tier 1 capital required by Basel III, large banks could face a quadrupling of their cost of holding even AAA consumer ABS
We recommend Richard Johns’ SFIG testimony for more explication of the above.
The consequences of current and proposed regulations are significant as banks currently hold around 15-20% of ABS at any given time. Indeed, banks are responding to incentives by shrinking balance sheets and shedding businesses that cannot clear ROE hurdles after capital charges.
As an example, we predict that Citi’s CHAI securitization which funds US consumer loans, will sunset after risk retention rules kick-in in Dec 2016.
We see the impact of the above liquidity and capital rules impacting the markets today. Bid-ask spreads are tight during benign times. Yet we see liquidity vanish during distress. In January, we saw the funding chain linking originators to the ABS market break down. We see deals that price wider than their warehouses lines.
By 2020, after regulations phase-in, we see a radically different ABS market emerging.
A number of additional regulations are re-shaping market structure. We view the following as positive for markets as they reduce informational asymmetries and promote price discovery. For instance:
- Asset Review tests: Section 945 of Dodd-Frank requires the SEC to issue rules requiring an asset-backed issuer in a Securities Act to perform a review of the assets underlying the ABS, and disclose the nature of such review
- Disclosure: Section 942 contains disclosure and Exchange Act asset-level and loan-level reporting requirements for ABS issuers
- Transparency: Post-trade transparency via TRACE covering Rule 144A and publicly registered securities
Shared utilities – clearinghouses, data & analytics, exchanges – will assume an increasing set of functions that dealers have historically provided.
Against this evolving landscape, platforms such as PeerIQ and others will play a role in enabling consumer and small business credit to successfully fund via the capital markets.
- PeerIQ will be at LendIt in San Francisco next month, giving a presentation entitled, ‘P2P Lending Securitization Market Overview’ on April 11th
- Regulatory kicking of US ABS ‘will drive next crisis’ (GlobalCapital, 2/18/16) Regulators see ABS as engine for growth
- Darien Rowayton Diversifies Assets (AB Alert, 3/6/16, subscription required) DRB entering personal loan space
- Student Lender SoFi Said to Explore Mortgage REIT Formation (Bloomberg, 3/4/16) SoFi plans to launch REIT
- Markets nears “end of the road,” warns El-Erian (GlobalCapital, 2/29/16) Economic advisor Mohamed El-Erian’s keynote speech at ABS Vegas called for ‘structural reforms that unleash growth’ in order to break from a cycle of sluggish growth
- Avant Blasts Past the $3bn Mark (Altfi.com, 3/1/16) Avant reaches $3b in originations, illustrating market demand for affordable and accessible personal loans
- Why China’s Fintech Will Change How The World Thinks About Banking (Forbes, 3/1/16) Chinese regulation in combination with China’s 3 major technology companies, Baidu, Alibaba and Tencent, to play critical role in the future of FinTech
- Online Lenders Are Answer to Unbanked Problem (American Banker, 2/26/16) Web-based companies address gaps in consumer credit and increasingly meet demand
- ABS Vegas: P2P Underwriting Remains Strong, Ahluwalia Says (Bloomberg First Word, 3/3/16) PeerIQ analysis of ABS and credit performance trends in marketplace lending
- Liquidity, not credit, driving MPL ABS widening (GlobalCapital, 3/1/16) PeerIQ offers insight on uptick in delinquencies, ‘mild in comparison to historical credit card charge off rates’
- Former Deutsche Bank Executive Jain to Join SoFi Board (WSJ, 2/28/16)