Fintech

The current and future state of non-bank platform lending: Part I

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As current world events have prompted a pause, we are fielding a lot of questions on the state of the platform lending space. Early conversations with market participants have raised questions about whether the current returns accurately reflect market risk, the relationship between senior and junior lenders as senior lenders demand higher returns, as well as whether the segment is adequately prepared to manage current and future stress.

Alterest is a loan data management and analytics platform focused on facilitating more meaningful interactions between institutional funders and platforms/originators. Our cloud-based software enables seamless loan data delivery, in-depth analytics, and flexible reporting across geographies and asset classes. By automating manual, spreadsheet-heavy processes we help our users focus on scaling their business while removing operational risks and keeping headcount low. We have recently conducted a survey of banks, asset managers, and HNW individuals involved in the debt financing of non-bank lending platforms across the world. With multi-billion-dollar structured credit operations managed on our platform, deployed across dozens of lending platforms covering a wide range of asset classes including SME, Consumer, Leasing, Autos, RMBS, and many more, we see a gamut of deal structures, terms, and strategies across our user base.

After the financial crisis of 2008, traditional lenders pulled back from many areas significantly, creating a void that has been filled in large part by non-bank platforms employing digitisation to gain a competitive advantage. While record-low central bank interest rates buoyed the syndicated loan and bond markets to record highs in the decade following the crisis, these markets mostly serve larger corporations. This has meant that the vast majority of these platforms entered to fill the gap within the SME and consumer space, underserved by traditional banks. From an investor perspective, low central bank rates and quantitative easing have steadily eroded returns from traditional credit markets leading to an influx of capital to private credit, where senior lenders can typically expect returns in the high single-digit range, significantly higher than comparable returns in the syndicated loan market.

The growth of platform lending across the globe has enabled investors to gain exposure to the real economy, supporting growth for SMEs shut out of the syndicated loan market regardless of creditworthiness and consumer borrowers. As the recent global pandemic has taken hold, lockdowns and travel restrictions have brought economic activity to a near standstill, adversely affecting lending platforms and their investors. Our surveyed firms have spoken, for example, of non-payments rates in SMEs going from below 5% to well over 40% in many instances from one month to the next leading to discussion of the segment pre and post-Covid.

Unlike the more standardised syndicated loan market, financing terms for lending platforms are highly bespoke and are going through the first major period of stress for a large number of platforms. The majority of respondents indicated that they would take a pause on deploying new capital, and would be focussed on supporting their current platforms in weathering the initial shock and positioning themselves for the new normal. A minority of respondents expressed an active interest in offloading illiquid paper in order to take advantage of market dislocation and buy rated, more liquid paper at better yields. There is a general consensus that real interest rates will need to increase, to reflect the risks exposed by the pandemic and this has created a faultline of sorts between senior and junior lenders. Senior lenders widely are expected to increase their return expectations and given the lack of standardisation, and in many cases, inter-creditor agreements, junior lenders surveyed were mostly at the mercy of the senior lenders in the structure. This has left a number of junior lenders looking at participating on the equity side, through instruments like warrants to strengthen their positions. As a segment going through its first major shock, when respondents were posed with questions of whether standardisation of terms as seen in syndicated loans was necessary or inevitable, the majority of respondents were opposed to this as they saw their competitive advantage as being in the ability to create bespoke structures as they did not see a significant illiquidity premium.

Senior lenders expect a significant uplift in returns post-Covid, with most respondents anticipating the new normal in the 8%-12% range. Expectations are that we will see a stark increase in secured vs unsecured structures as well as lenders demanding more credit enhancement for existing as well as new investments. Along with changes in financing structures, the pandemic has prompted a number of questions about the platforms themselves and the robustness of their business models.

While technology, demand for credit, and an influx of capital has driven the growth of this segment, the current economic climate has presented a number of significant challenges to platforms and their ability to weather the storm. Investors surveyed view the ultimate success of a platform being down to their underwriting standards, technology may speed up the process and cut costs, but it comes down to fundamental credit work. The robustness of origination channels was also widely cited, especially given the demand side shock caused by Covid. A platform’s management and cash position were cited as important factors for investors as this will determine its runway. When it comes to SME financing, for example, government support and the ability to make use of it were also highlighted. Government guarantee schemes could represent a mitigant to the inevitable rise in loss rates if platforms can use them to refinance existing positions.

Taking a step back and looking at a more macro picture, the majority of respondents held optimistic views, with many expecting economic activity to rebound to pre-Covid levels in the 4Q 2020 or Q1 2021. It is, however, worth noting the most bearish view had 2023 for a recovery. It is expected that sectors like aviation, leisure, and luxury goods would likely lag behind in recovery with sectors like healthcare and e-commerce seen as mostly insulated. One of Alterest’s key missions is to bring increased transparency and reduce the asymmetry of information for investors and platforms alike to promote a more efficient marketplace. While this article aims to provide a high-level view of the segment, keep an eye out for follow up articles that will dig deeper at an asset class and geographical level to provide greater clarity. If you are interested in finding out more about Alterest or participating in our surveys, please contact: taka@alterest.co

July 16, 2017
by 
Jeevan Param

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