Back Cross River Intelligence Archives

PeerIQ Monthly Update: April 2016

By Vy Phan

May 1, 2016

April concluded with a trio of landmark deals across the globe making their way to market: Lending Club here in the US, Funding Circle in the UK, and Yirendai in China. We see it as evidence of our founding hypothesis that the transition of consumer/SME credit to the capital markets is a global, secular trend underpinned by deep regulatory undercurrents. Access to funding sources will separate the pack Headed into ABS Vegas we observed that deals were getting pushed down the calendar until more favorable conditions present themselves. That time is now. Credit facility utilization and risk-exposures to marketplace lending at some banks are at or near the maximum. Securitization relieves this pressure by replenishing warehouse lines and transferring risk from bank warehouse facilities to the ABS markets. Mike Cagney, CEO of SoFi, puts it succinctly, "when you originate $1 Bn a month, you need to have a take-out." Platforms that have flush funding lines and staggered maturities have flexibility to weather difficult market conditions - up to a point. As credit facilities age, platforms must trade-off the risk of rolling over recourse warehouse facilities at higher future rates vs. locking in permanent non-recourse financing through securitization at current levels. Moreover, the combination of rapid origination growth and finite warehouse lending capacity implies an inexorably higher velocity of securitization volumes over time. When a platform bumps up against their funding constraint, they must face the difficult choice of i) contracting originations (and handing market-share and revenues to competitors), or ii) selling assets into the whole loan or ABS market (even when conditions are not favorable). Promoting frictionless access to the capital markets is a C-level, board-level, and policy level responsibility. Platforms that have secure sources of funding in place will slingshot past their rivals during the next downturn. Innovation creates a new source of growing pains One of the central innovations in marketplace lending is the risk-matching function. Marketplace lenders can expand credit to traditionally underserved segments by appropriately underwriting and matching the risk to investors that have the wherewithal to price and absorb the risk. However, the de-linking of the balance sheet also brings with it a set of new challenges. We see a proliferation of emerging issuers, capital structures, diversity in rep and warrant packages, limited transparency and liquidity in ABS deals, and lack of brand awareness elevating risk premiums in the wholesale funding market. ABS investors, particularly those participating in the equity and mezzanine tranches, require incremental risk premiums for sifting through the noise and bearing uncertainty in default, prepayment, servicing, and liquidity risk. Providers of first-loss risk are the soft point in the capital structure Providers of equity and mezzanine capital are highly sophisticated and represent a small fraction of the world’s investable capital. These providers of capital typically consist of hedge funds, BDCs, private credit funds, and specialty finance funds, all of whom have high cost capital (owing to their hurdle rates of return) and, depending on their funding structure, may be subject to liquidity runs at exactly those times when platforms need funding the most. Sourcing resilient first-loss capital providers is a priority for the industry, and for regulators that seek to encourage stable securitization markets to fund the real economy. There is no silver bullet to reducing these risk premiums or funding challenges. There are many lead bullets (and a healthy dose of data and analytics). It’s an incredible challenge to work on and we are excited to do so. For more discussion, feel free to check out my recent interview with Peter Renton. We cover a range of topics in a 45-minute podcast. Or check out the transcript for those in a hurry. We also recommend reading Louise Bowman’s thoughtful piece in Euromoney, "Growing Pains of Marketplace Lenders." Conferences: Hiring Update:
We are very excited to introduce a new member to our team this month!
Sector Update: PeerIQ Mentions:
Lighter Fare: