By Carole Sanz-Paris and José Ramón Torá
Fintech lenders in the region identify financing as one of their major challenges. Securitization can help them in accessing more investors and drive down financing costs.
Latin America and the Caribbean is among the world’s fastest growing markets for financial technology, which covers services such as payments and remittances, company’s financial management and lending. By the end of 2017, lending Fintech platforms, or lending techs, represented about 18 percent of all Fintech companies in Latin America, according to the IDB report Fintech: Innovations You May Not Know were from Latin America and the Caribbean. Online lenders are currently filling part of the gap left by traditional banks in offering loans to consumers and small and medium size enterprises (SMEs), contributing to improving financial market depth and efficiency in the region.
While Lending Techs represent a small share of the financial institutions market in Latin America, they are expanding rapidly in segments such as credit cards, consumer lending and lending to SMEs. They are asset-light, compliance light and legacy free allowing them to operate a low-cost business model and target segments overlooked by traditional lenders. Lending to the under-served consumer and SMEs is a “big data” problem suited for machine learning.
As lending techs build up more data, they can combine the use of algorithms and artificial intelligence to predict the probability of default. The more data a fintech lender can collect, the better it can assess creditworthiness and accurately price loans factoring in risk.
The lending conundrum
The growth in online lending is attracting the attention of investors who see loans to SMEs as a source of higher yield and diversification. Currently, funding for the loans of lending techs comes primarily from hedge funds and private investment banks through whole loan purchases and equity investments.
But limited performance history, low liquidity and lack of credit ratings in some loans are preventing other investors from investing into online lenders. Fintech lenders in Latin America identify financing as one of their major challenges. Securitization, coupled with the support of multilaterals, can provide solutions:
Securitization can help lending techs access the debt capital markets by creating asset-backed securities (ABS) attractive to a wider investor base. Assets such as SME loans, that generate predictable cash flows can be securitized. Securitization transforms those ordinarily illiquid assets into more liquid ones. It separates the credit risk of the asset pool from the credit risk of the originator and allows risk distribution between institutional investors to fit varying appetites using specific structural features. Securitization technology can also help lenders achieve cheaper financing and drive down the borrowing costs of their borrowers. In the US, marketplace lending securitization is becoming one of the funding venues for Fintech peer-to-peer lenders with over $40 billion cumulative asset backed securities (ABS) issuance by end 2018, according to PeerIQ.
Multilaterals can play an active role in establishing securitization programs for fintech lenders as a new investable asset class in Latin America. The lending tech sector lacks historical performance or sizeable origination pools to be securitized. Multilateral banks such as BID Invest can help bridge some of the gaps and develop the asset class. They can provide warehousing lines to reach critical mass and then participate in the asset-backed securities by guaranteeing or purchasing part of the issuance.
In Brazil, lending tech have made use of securitization via Fundo de Investimento em Direitos Creditórios (FIDC). IDB Invest subscribed senior notes issued by the FIDC of Mercado Livre, a leading commerce, payment and electronic credit company in Latin America and the Caribbean. This transaction allows Mercado Livre to establish a securitization funding program to grow their lending portfolios and support financial inclusion across Latin America and the Caribbean.
The lending tech industry has a short track record in the region and has not experienced a full credit cycle yet. The securitization structures are meant to follow capital markets standards to be successful and attractive to investors. For instance, the online lenders must retain “skin in the game” to ensure aligned incentives with the investors.
The Lending Tech shall only “profit” from any excess cash flow after all contractual obligations of the transaction are met –creating an incentive for strong underwriting and servicing standards. Also, transparency is key to support the development of the asset class. Issuers will need to report performance data of the underlying securitized collateral and demonstrate that origination remains within agreed eligibility criteria.
By supporting securitization issuance by lending tech, multilateral banks such as IDB Invest can send strong signals to the market about the quality of issuance and help attract institutional investors, such as pension funds and insurance companies. The liquidity and maturity transformation, the ring fencing of the assets, and the possibility of offering investors the opportunity to invest in an asset class at different levels of risk, also contribute to the development of local capital markets.