As 2019 comes to a close, it is becoming increasingly evident that the next 12 months will be critical for both the U.S. and the global economy. In some of the world’s major financial centers, stability has been replaced by stagnation. The increasingly contentious political gridlock in the U.S. foretells an unclear campaign season, while the UK remains preoccupied with Brexit, and recurrent demonstrations immobilize Hong Kong.
This political unrest is unspooling against increased economic uncertainty and anxiety in virtually every corner of the world despite several measures of general stability. In its recently released World Economic Outlook, the IMF faults the U.S.–China trade war for cutting 2019 global growth to its slowest pace since the 2008-09 financial crisis and forecasts additional softening if trade tensions are not resolved.
That the global economy has so far been able to weather stresses of this magnitude — sustaining a record-breaking recovery — is a testament to its fundamental strength. At this point, it is difficult to say whether the economic cycle will end or if the worldwide economy has entered a new era of slower growth and has become inured to shocks that would have derailed it previously. Certainly, in the U.S., GDP continues to edge up, the stock market hovers near all-time highs, unemployment has sunk to record lows, and wages are rising, albeit slowly.
Regardless of the future, one thing is absolutely clear: nonbank financial institutions (NBFIs) must work harder and smarter than ever before to provide the returns their investors expect. To gain insight into how they are tackling this challenge, Capital One conducted a survey of industry professionals attending the ABS East conference in Miami Beach at the end of September. Our purpose was to gauge industry sentiment and strategy for the next 12 months. The results showcase an industry that is taking a clear-eyed view of the future and doing everything in its power to prepare accordingly.
A Mixed Outlook
When asset-backed security professionals were asked about the biggest challenge they would face over the next 12 months, they split evenly among a number of areas. A full 22% identified regulatory uncertainty as the biggest issue they faced. This is a function of the political climate, but also includes such issues as STS regulations affecting European investors’ participation in the U.S. market.
Another area of concern was increased credit risk, an outgrowth of the slowing global economy that is affecting both commercial and consumer NBFI markets. A recent report from S&P Global revealed that debt and earnings of 20,000 mostly medium-sized non-financial companies diverged for the first time since 2011 and that the resulting increased leverage could prove an issue in case of recession. S&P researchers found that the most vulnerable segments were all consumer-facing: auto, consumer products, and retail.
At the same time, higher debt levels are not necessarily harmful, as the report’s authors acknowledge. Higher debt levels are more manageable in a low-interest rate environment, and the lenders in our survey expressed confidence that low rates will persist. Fifty-three percent said they expected to maintain interest rates at current levels for the next 12 months, while 47% said they were likely to lower them.
ABS professionals are also apprehensive about an increase in competitors. In this sense, NBFIs are victims of their own success, making them a likely target for investors, both overseas and domestic, with capital to deploy. This situation also works to their advantage. Only 11% of respondents to our survey declared that access to capital would be a challenge over the next 12 months.
This abundance of capital looking for attractive returns also accounts for the respondents’ overwhelming belief the market for asset-backed securities would hold up well in the coming year. Two-thirds said buy-side interest would increase, 29% said it would remain the same, and just 5% said it would decrease.
Taking a Proactive Stance
ABS professionals are moving forward on a number of fronts to prepare for potential changes in the macroeconomic landscape as well as in the industry itself. Our survey revealed that they are focusing on locking in favorable lending rates and implementing new technologies in addition to seeking new financial partnerships and assessing underwriting risks.
NBFIs are taking advantage of low rates to refinance their existing debt, expand their businesses, and in some cases make strategic acquisitions. In many situations, they are adopting hedging options as an attractive way to make the most of low-fixed rates. In doing so, they are not only preparing for an uncertain future but also positioning themselves to more efficiently meet the funding requirements of their commercial and consumer customers.
The favorable lending environment also provides an opportunity for NBFIs to invest in technology. Historically, many NBFIs, across an increasing range of sectors, have their roots in fintech. The more traditional NBFIs are now turning to technology to compete more effectively with fintechs as well as buffer themselves from economic and competitive headwinds. In virtually every sector, they are turning to data analytics, artificial intelligence, and machine learning to better serve their clients, streamline their financial processes, lower regulatory compliance costs, develop new products, and better assess risk.
Their goal is to capitalize on the relationship-building that their physical presence allows while tapping the benefits of virtual efficiency. For instance, in consumer finance, lenders are considering integrating alternative data into credit decisions, and in commercial finance, nonbanks are beginning to use modeling and advanced analytics to validate borrowing companies and accelerate loan decisions.
Finally, our survey revealed that 38% of ABS professionals will be using the next 12 months to strengthen their lending and capital relationships. On the debt side, this means identifying a financial partner who understands their business and industry, and who understands how it performs through an entire business cycle. An ideal partner would also have the capacity to offer a broad array of products and services, including asset securitization, recourse financing and interest-rate hedging. In a business environment characterized by volatility and complexity, the flexibility and speed such a lender can provide are critical.
The asset-based securities professionals who responded to our survey pinpointed a number of key challenges in the upcoming 12 months and identified a number of strategies to address them. Those NBFIs who take advantage of this grace period to reinforce and expand their strengths and streamline their organizations have the best chance of entering 2021 — with whatever it brings — from a position of strength. •