As an extension of last week’s article, subject matter experts and analyst from the Situs family of companies provided a few additional insights and trends to watch in financial services.
1. Uncertainty About How Marketplace Loans (MPLs) Will Perform in a Recession
“Origination of marketplace loans (MPLs) will continue to grow and steal market share from the credit card space,” said Chris Kennedy, Managing Director at MountainView Financial Solutions, a Situs company. “But there are many unknowns around MPL loan performance in a recessionary environment, and this could be troubling for leading platform providers.”
As head of business development for MountainView’s MPL valuation business, Kennedy frequently interacts with leading platforms and Asset Backed Securities (ABS) investors in the MPL space. He is quick to identify the heart of the issue: Capital markets investors are generally skeptical of MPL loan-underwriting practices because most of the borrowers are sourced from the internet. Platform lenders typically rely on automated underwriting algorithms to evaluate loan risk, which, according to Kennedy, has translated to a lack of predictability on pool performance and returns. The market is priced for perfection and loss assumptions have been too optimistic.
“The average delinquency rate of the unsecured consumer bank loan is 4-5%,” said Kennedy. “MPLs, on the other hand, are showing double the delinquency in some cases.”
In the last year, ABS investors have asked platform lenders to tighten underwriting standards after a wave of MPL defaults sparked concern. While most platform lenders responded by incorporating big data from credit bureaus to improve predictability, the story of volatility continues to overpower any improvements in underwriting accuracy. Moreover, said Kennedy, the MPL business model has fallen under scrutiny and may be subject to more frequent regulator reviews.
“MPL portfolios are growing in size, but this growth rate may not be sustainable,” said Kennedy. “Marketplace lenders are already raising rates. The combination of a credit downturn, higher rates, unpredictable portfolio performance and increasing operating costs is surely raising some eyebrows.”
While ABS investor appetite for MPLs has never been strong, the loss estimates and volatility have made it even harder to model the investment. “There is very limited liquidity in the secondary market, with most loan sales clearing in the mid 90’s percent of unpaid principal balance (UPB),” said Kennedy. “As we near a downturn, it is even more critical to increase portfolio surveillance of MPLs and value loans at a monthly and quarterly basis, which may drive greater price and loan performance transparency in this space.”
2. CRE Lenders and Investors Approach 2019 with Cautious Optimism
“Lenders are approaching 2019 with cautious optimism,” said Steven Bean, Executive Managing Director at Situs. Bean recently attended the 2019 CREFC Conference in Miami, which focused heavily on the state of the industry. According to Bean, key panelists and speakers at the conference generally agreed that the CRE market is in decent shape. There is a lot of capital available to deploy and borrowers are eager to capitalize on the competitive lending environment. Investors and asset managers are raising significant funds for CRE investments and are competing heavily with the institutional players like banks and insurance companies. While the outlook remains positive, Bean lamented that the overall industry is being impacted by macro concerns related to geopolitical instability, global economic performance, market corrections, the government shutdown, and the Fed’s direction on interest rates.
There are, however, other pockets of concern. For instance, CRE investors have expressed significant interest in the multifamily sector, but investments in class A (newer luxury housing) may not gain the same level of interest if rent increases and property values flatten. Fortunately, there are a lot of positives on the lending front. For example, leverage is low, CRE markets are stable, CRE investments are offering good yields and diversified returns, and CRE continues to be an asset of choice (e.g. Blackstone just announced its $20 billion fund).
So far, 2019 is off to a good start and many investors have restocked investment pools and may be looking at this market as an investing opportunity. They hope that the recent December blip of widening spreads was just that, a blip. “So far in 2019, interest rates and spreads have declined, so it feels like the capital markets are hopefully beginning to stabilize,” said Bean.
3. Financial Institutions Flip the CECL Switch to ‘On’
“Sitting on CECL may create more problems than solutions,” said Jeff Prelle, Managing Director and Head of Risk Modeling at MountainView, a Situs company. “Businesses need to start picking up the pace on CECL implementation because model development and implementation is time and resource intensive.”
According to Prelle, institutions that have stalled in development are already trailing. Prelle said some businesses are stalling because they “were hoping that larger institutions would pave the way and create a framework to follow, or held out hope that FASB would issue some sort of rollback.”
While FASB has changed timelines for smaller institutions, said Prelle, there is no indication that CECL is going away.
Prelle warns that while larger institutions may provide some general guidance about how to interpret and implement CECL, each institution is unique and overreliance on others might make matters worse, because institutions may not be able to apply the same sophistication as their peers. Prelle warns that CECL “is not a standard check box item. It is strategy-driven, and it is far more difficult to develop an effective CECL strategy and reduce cycle times during implementation when you are scrambling to meet a deadline.”