Know-How - 27.01.2020

How Fixed Income is being fundamentally changed by technology

Alternative Lending: What investors need to know to benefit from this development.

 

  • Loan approvals used to rely heavily on personal relations and local expertise. As banks got consolidated away or centralized in the wake of the global financial crisis, this brought specific segments of the industry almost to a standstill.
  • While certain private equity players quickly stepped into that void to assume quasi-bank activities, the smaller, specialized end of that segment would only get serious attention from the fintech industry.
  • Today, fixed-income investors can participate in the success of technology-driven lending platforms, who can approve financing often within minutes at competitive rates and almost no administrative overhead.

 

Investors into Alternative Lending are expecting almost equity-like returns while dealing with volatility levels that can be compared to traditional fixed-income investments. From a portfolio diversification perspective, this fascinating segment that rose from the ashes of the global financial industry also tends to correlate little to traditional stocks and bonds.

Today, traditional bank business models are getting increasingly under pressure from technology-driven startups and platforms that are quickly getting into the lead when it comes to providing financing for small and medium-sized companies (SMEs) and private individuals.

Getting financed by your local bank used to be the norm

Before the global financial crisis, local banks were a place where individuals and small to medium-sized companies would go to obtain financing. The former might seek consumer loans, pawnbroking loans, car loans, or real estate financing. The latter would look to get a business loan, invoice financing, asset-backed lending, trade or project finance, or agricultural loans.

In many cases, the credit approval process in those days relied heavily on personal relations and local expertise. While the local knowledge might have contributed positively to making more accurate loan approval decisions, there is more than anecdotal evidence to suggest that proximity between the parties may not precisely have positively contributed to the quality of loans issued.

Lax credit approval standards as a contributing factor for the global financial crisis

On the backdrop of a rallying economy in the mid-2000s, the competition in the real estate industry in the United States regarding who could underwrite more and bigger loans significantly contributed to pulling the rest of the world into a global financial crisis.

Centralization in the wake of the global financial crisis made obtaining certain types of loans difficult

While a certain distance between the banks and those seeking loans may have been a welcome change, the newly-gained ‘objectivity’ by loan officers consolidated in corporate centers, sometimes in other parts of the world, also led to less understanding of the characteristics and unique requirements of specialized business models in their portfolios.

Suddenly, approving the false loan became a career risk

While it is easy to understand that banks were looking to optimize their loan portfolios according to profitability (the more, the better) and risk (as little as reasonably possible), this started to impact loans not considered mainstream. Understandably, those loan officers became wary of risking their careers over a loan that required significantly more in-depth due diligence. It did not help that some banks instituted loan approval processes that took so long to complete that time-critical loan applications were thwarted.

In the wake of the global financial crisis, this vicious cycle intensified, essentially bringing certain types of loan approvals to a grinding halt. Certain of those quasi-bank activities could or would not be easily picked up by the private markets industry for years. It was only with the recent advent of the fintech industry that the smaller, specialized end would get the attention it deserved.

 

 

Lending (002)

alternative Lending (002)

When crisis drives innovation

 New players in the market, making use of emerging technology, started to exploit the space vacated by banks. Increasingly, they also began to enter those segments banks had held onto because they were profitable.

Technology drives alternative lending today

Lending platforms and their FinTech operators are profiting from various advantages and trends: Firstly, they enjoy a cost and technology advantage over banks (who are still burdened with legacy IT systems) by leveraging the wide-spread accessibility of distributed computing power and the availability of software-as-a-service (SaaS).

Improving complex loan decision-making at a click of a button

Secondly, that they can build on open source solutions to crunch vast amounts of data, identify patterns, and draw conclusions which loans to approve or reject with very high confidence ratios. This is supported and sometimes driven by the latest developments in data science, artificial intelligence, and machine learning.

Financing can be secured within minutes and at competitive rates

As a result, lending processes have already changed radically. A lender today can apply online and supply a selected array of data and information (as opposed to spending days filling out forms in the past).

Based on this data, the platform's system will analyze the received information against their dataset that contains highly accurate indicators of probable future loan delinquency or default. As a result, the platform will then adjust the loan conditions dynamically to make them acceptable to both the lender and the issuer. This process, from application to approval, can often take minutes vs. days or weeks it took in the past.

No wonder are big banks trying to get back into this space. Their legacy systems, complex organizational setup and processes, and their high-cost structure make this challenge almost impossible to overcome.

 

 

Stableton’s approach to alternative lending

We believe that this attractive investment universe should be made available to qualified investors and their financial intermediaries through a single point of contact.

Stableton’s approach to the segment is to look beyond investment funds that indirectly allocate to securitized loan portfolios. Stableton prefers to partner directly with leading alternative lending platforms worldwide, with an initial focus on Switzerland, Germany, and selected countries in Europe that are operating at the forefront of the industry and applying stringent criteria. Tried and tested investment strategy. Now available via Stableton, all strategies have a multi-year live strategy record.

This gives us unprecedented transparency into their loan books and the opportunity to diversify our approach across loan segments, credit quality, security interest, ticket size, duration, etc.

Our focus is on opportunities in the short-term end of the market

From a time horizon perspective, our current focus is on loan maturities up to one year as we feel this provides a less crowded market with a more predictable risk profile. Without being locked into multi-year loans, it allows us to make necessary adjustments should loan metrics worsen. This short time horizon also tends to result in an attractive yield-to-duration ratio.

This article barely scratches the surface. If you are interested to learn more about Alternative Investments and how to efficiently access them, please visit www.stableton.com.

About Stableton Financial AG

Stableton Financial AG is a Switzerland-based, rapidly growing financial technology company.

The company’s alternative investment Fintech platform is designed to be Europe’s leading gateway for qualified investors and financial advisors seeking simplified access to absolute return and alternative investment strategies such as hedge funds, startups, alternative lending, and real estate. Stableton was founded by entrepreneurs with decades of experience across the alternative investments value chain.


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