Martin North – Page 1011 – Digital Finance Analytics (DFA) Blog

Is P2P Lending Becoming Banks Outsourcing Their Loan Process…and Risk?

By bringing together savers and borrowers directly, peer-to-peer lending, or P2P for short, bypasses the banks. The cumulative total of loans is forecast to reach £2.5 billion in the UK this year, according to the trade body, Peer2Peer Finance Association. Although these totals are as yet still a tiny proportion of the UK’s £170 billion consumer credit market, this could change fast.

Its credentials as a game-changing industry prompted the Bank of England’s Andrew Haldane to suggest: “The banking middle men may in time become the surplus links in the chain.” However, following news that the giant investment bank Goldman Sachs may be poised to back peer-to-peer lender, Aztec Money, it is clear that the very nature of P2P lending is changing. Banks and other big institutions are quietly recasting themselves as new links in the chain.

Banks are themselves becoming major lenders on some P2P platforms. For example, Forbes estimates that in the US, 80-90% of the capital lent through the two largest P2P lenders, Prosper and LendingClub, is now institutional money.

This means that when you take out a P2P loan, you are now less likely to be borrowing from individuals who often combine a social approach to lending with their desire for investment returns. As an investor, you might find it harder to compete for the best value loans.

Some banks and big institutions are buying up bundles of loans originated on P2P platforms, in some cases repackaging them and selling them on as asset-backed securities. Those with all but the sketchiest memories will immediately recall the way US mortgages were repackaged and traded prior to the 2007 global financial crisis.

What Happens After QE?

Interesting comments from FitchRatings in their Global Perspective series.

There has long been a sense of finality about quantitative easing (QE): when policy interest rates are at or near zero, it seems the last option available to central banks in countering deflation. But this ignores other monetary and exchange rate policies implemented in the past, those recently considered implausible but being deployed at present, and additional creative ideas that may – by necessity and where possible – receive more widespread use in the future.

Ultimately, central banks control the quantity of money (narrowly defined) and exert influence over its price (the interest rate). With this in mind, it is logical to conclude that once the price of money is at its minimum, and further accommodation is desirable, central banks are left with only the quantity of money to consider. However, there are a few other policy options, although they would be likely to prove contentious and subject to questions about their effectiveness.

In the Past: Exchange Rate Interventions

Another way to express the price of money that central banks, including those in advanced economies, have at times tried to influence is the price of foreign currency, the exchange rate.

In September 1985 finance ministers and central bank governors of France, Germany, Japan, the UK and US announced in the Plaza Accord that “exchange rates should play a role in adjusting external imbalances” and that “an orderly appreciation of the main non-dollar currencies against the dollar is desirable”. This was directed primarily at the Japanese yen/US dollar exchange rate, to reduce the US-Japan trade imbalance and the broader US current account deficit. A year later the US dollar had depreciated by 35% against the yen (see chart), and two years later US inflation was more than 4%, where it remained until mid-1991.

There are two common objections to exchange rate intervention. First, it is a zero-sum game: one country’s beneficial depreciation is at the expense of others’ appreciations. Second, intervention is ineffective in the longer term when market forces take hold.

One counter to these objections is that they are inconsistent with each other, at least over time. More importantly, policymakers may eventually conclude that it is not a zero-sum game if countries in deflation represent a broader global risk to growth. And, as with QE, doubts about the effectiveness of currency intervention may be shelved when other policy options appear to have been exhausted and policymakers need to be seen to be taking all necessary steps.

In the Present: Doing the “Unthinkable”

It seems sensible that nominal interest rates have a zero lower bound, as investors would be unlikely to buy assets that, if held to maturity, deliver a nominal loss. It also seems sensible that central banks would want to avoid pushing policy rates below zero. They have long argued that the proper functioning of financial markets would be impaired by negative nominal rates.

Nevertheless, the zero lower bound has been breached by both policymakers and the market. At end-March, the Swedish central bank repo rate, the Swiss central bank three-month LIBOR (Swiss franc) target range, and the Danish central bank certificate of deposit rate were below zero. A number of European government bond yields were also negative.

At least some objections to breaching the zero lower bound on policy interest rates have clearly been set aside, and – assuming deflationary conditions warrant it – the rationale for doing so may become more appealing. From a central bank perspective, two risks associated with negative yields are that they encourage a greater reliance on cash, taking funds outside the financial system, and there could be a run-up in credit, portending asset bubbles and financial instability.

A shift towards large-scale cash holdings in advanced economies appears improbable, if for no reason other than it being impractical. Asset price bubbles and future financial instability may present a bigger problem, but the calculus of central banks could change. If faced with the choice of immediate, intractable deflation and potential financial instability, policymakers may opt to first address the more pressing challenge.

The Future: Policy Creativity

Negative interest rates and a return of more active exchange rate policies might not be the only options to consider. The government and Nationalbank of Denmark have developed another strategy to provide additional monetary accommodation. The government is issuing no bonds until further notice, and will draw on its deposits at the central bank as needed, effectively adding to base money. This may not be an option for many countries (Danish government deposits at the Natioanlbank were large), but it underscores the potential for policy creativity.

Sydney Dwelling Values Surged 3% Higher in March – CoreLogic RP Data

Home values across the combined capital cities increased by 1.4 per cent in March 2015 according to the CoreLogic RP Data Home Value Index, driven by an exceptionally strong Sydney result where dwelling values were 3.0 per cent higher over the month. The latest indices reading shows capital city dwelling values moved 3.0 per cent higher over the first quarter of the year. CoreLogic RP Data head of research Tim Lawless said, “although value growth has started 2015 on a strong note, the annual rate of growth has moderated back to 7.4 per cent, which is
the slowest annual growth rate since September 2013.”

Sydney remains the standout capital growth performer, with values rising by 3.0 per cent over the month, 5.8 per cent over the quarter and 13.9 per cent over the year. With stronger housing market conditions over the first three months of the year, annual home value growth across the Sydney market has rebounded after slowing to 12.4 per cent in December 2014. Sydney is the only housing market where dwelling value growth remains in double digits, with the next strongest performer, Melbourne, showing a much lower rate of annual capital gain at just 5.6 per cent.

Each of the remaining capital cities have recorded an annual rate of growth which is less than three per cent, with values having declined across Perth, Darwin and Hobart over the year. Since home values began their current growth phase in June 2012, dwelling values across the combined capital cities have increased by 24.3 per cent. “Most of this growth is emanating from Sydney,” Mr Lawless said. “Over the current growth phase, Sydney dwelling values have increased by 38.8 per cent with Melbourne second strongest at 23.6 per cent. On the other hand, total dwelling value growth over the current cycle has been less than 10 per cent in Adelaide, Hobart and Canberra. “Combined capital city home values have increased by 3.0 per cent over the first quarter of 2015. While that rate of growth is strong it is important to note that it is lower than the 3.5 per cent increase in home values over the first quarter of 2014,” he said.

Based on the March results, Sydney’s growth trend appears to have disengaged from the rest of the capital city housing markets in terms of demand and subsequently in terms of value growth. The 5.8 per cent growth in Sydney dwelling values over the first quarter is the strongest quarterly growth rate since home values increased by 6.2 per cent over the three months to April 2009. The strength of the Sydney housing market currently is further highlighted by the fact that since the Reserve Bank cut official interest rates to 2.25 per cent at the beginning of February, auction clearance rates have been above 80 per cent each week.

Paying For Cards

The RBA published a paper on “The Value of Payment Instruments: Estimating Willingness to Pay and Consumer Surplus” by Tai Lam and Crystal Ossolinski. This paper draws on a survey of consumers’ willingness to pay surcharges to use debit cards and credit cards, rather than cash. Just as the price a consumer is willing to pay for a good or service is indicative of the value he/she places on that item, the willingness to pay a surcharge to use a payment method reflects that method’s value to that consumer, relative to any alternatives.

They find a wide dispersion in the willingness to pay for the use of cards. Around 60 per cent of consumers are unwilling to pay a 0.1 per cent surcharge, which suggests that for these individuals, the net benefits of cards are very small or that cash is actually preferred. At the other end of the distribution, some individuals (around 5 per cent) are willing to pay more than a 4 per cent surcharge, indicating they place a substantial value on paying using cards.

On average, consumers have a higher willingness to pay for the use of credit cards than debit cards. This difference can be viewed as the additional value placed on the non-payment functions – rewards and the interest-free period – of credit cards. They estimate that on average credit card holders place a value of 0.6 basis points on every 1 basis point of effective rewards rebate.

Based on the survey data and information on the costs to merchants of accepting payment methods, they predict the mix of cash, debit card and credit card payments chosen by consumers under different levels of surcharging and explore the implications for the efficiency of the payments system. In particular, the consumer surplus in a scenario where merchants do not surcharge and the costs of all payment methods are built into retail prices can be compared with that where merchants surcharge based on payment costs and retail prices are correspondingly lower. Their findings suggest that cost-based surcharging leads to some consumers switching to less costly payment methods, resulting in greater efficiency of the payment system and an increase in consumer surplus of 13 basis points per transaction.

Housing Credit Higher Yet Again

Today APRA released their Monthly Banking Statistics for February 2015. Overall housing lending by the banks rose by 0.53% in the month to $1.329 trillion. Investment lending rose by 0.68% and owner occupation loans by 0.45%. The lending records continue to be broken. Looking at bank by bank performance, CBA has the largest share of owner occupied loans (26.9%) whilst Westpac has 31.7% of investment home loans.

Tracking portfolio movements, we see that in the month Macquarie grew its total portfolio by 3% (compared with the market average of 0.5%), Suncorp and Members Equity Bank both grew by 1.9%, whilst AMP Bank rose by 1.2%

Looking at the YOY movements in the Investment portfolio, the market grew at 12% (above the APRA 10% monitor rate). A number of banks exceeded this growth level, with Macquarie, CBA and Suncorp at the top of the range.

Turning to deposits, balances rose by 0.53% in the month, to $1,82 trillion. The portfolio mix changed a little in the month, though CBA still has the largest share at 24.8%.

Here are the monthly portfolio movements. ANZ, Bendigo and Rabbobank lost relative share, reflecting further deposit repricing strategies.

Finally, the card portfolio rose to $41.5 billion. Little change in the market shares,with CBA at 27.8%, WBC at 22.7% and ANZ at 20.2%.

Private Funds Pose Most Systemic Asset Management Risk – Fitch

Private funds, i.e. hedge funds, pose the greatest systemic risk for the investment management sector based on key risk indicators identified by the Financial Stability Board’s (FSB) latest consultation paper, according to Fitch Ratings.

The paper on non-bank, non-insurance financial institutions that may pose systemic risk takes a dual approach for investment management, focusing on investment funds and asset managers, was published earlier this month. The latest FSB consultation paper identifies size (with and without regard to leverage), substitutability, interconnectedness, complexity and cross-jurisdictional activities as potential drivers of systemic risk in the investment management space. These factors are considered in the context of private less-regulated funds, regulated funds and asset managers.

The two key drivers of systemic risk are the use of excessive leverage (and associated counterparty relationships) and “substitutability,” or a fund’s gross (leveraged) size relative to its investment sector. If one or more large, heavily leveraged funds come to represent “the market,” this could introduce illiquidity in times of stress. The combination of these two factors, excessive leverage and a large market footprint, are most likely to create systemic risk in times of stress.

From this perspective, larger, leveraged private funds pose the most systemic risk in the investment management sector. Private funds are lightly regulated, and leverage constraints are far looser, reflecting counterparty risk limits rather than regulatory limits. Regulated investment funds are restricted from taking on excessive leverage. Leverage for regulated U.S. funds, measured as assets-to-net asset value, is restricted to 1.5x for senior debt, below the 3.0x or greater proposed by the FSB. In Europe, UCITs funds leverage is limited to 2.0x. This makes the transmission of systemic risk due to a forced deleveraging low for regulated funds.

Regulatory treatment of certain off-balance sheet derivative transactions represents one potential caveat. Certain derivatives are used by regulated funds in the U.S., where the regulatory treatment may not fully capture the true “economic leverage” that is incurred. For this reason, we “gross up” the balance sheets of rated funds that use derivatives to fully capture the underlying risks.

In the case of asset managers, Fitch notes that they operate primarily on an agency basis, acting on behalf of investors in their funds. As a result, asset management generally it is not a balance sheet intensive business and does not involve large amounts of leverage, maturity transformation or financial complexity. It is the funds themselves that take on leverage, to the degree allowed, utilize derivatives and have counterparty exposures.

Concentrating on unregulated private funds, with an emphasis on excessive leverage and fund-level market footprint, i.e. substitutability, may result in a more focused, nuanced approach. A deeper understanding of off-balance sheet activities at private funds and larger regulated funds also may help prudential regulators and the market identify less transparent sources of leverage and risk.