From direct lending to programmatic funding: the ABF shift

When we start to talk about pooled consumer loans, the numbers bump up considerably to 150,000, 200,000, or more. That is an interminable loan tape to be ingested into a system. One hundred and ten thousand solar loans brings in 110K rows on a spreadsheet, and 40, 50, or more columns include rich information about the borrowers including FICO scores, geographic location, risk grade, principal amount, interest rate, maturity, etc. Many firms are not in position to take advantage of the current ABF business much less the distribution of private market investments to individual investors via RIAs, broker-dealers, and 401(k)s. These products often necessitate a higher frequency of reporting, moving from a quarterly to a daily NAV cadence, which overwhelms traditional administrators.

Another way in which private credit is remaking the world of finance is that banks are “partnering with asset managers and institutional investors to sell assets as they selectively shift to more asset-light business models.”^viii We expect to see forward flow agreements proliferate, which commit the buyer to purchase a specified volume of loans over a defined period, within a particular risk grade dominating consumer finance. This “programmatic funding” trend would put an exclamation point on the importance of mastering loan tape cracking, boosting the scale and frequency of tape processing.

Further, a firm’s purchase of a new securitized pool of loans also requires the operations team to reconcile that initial loan tape that was analyzed before the deal closing. The buyer receives a diligence tape that it must reconcile with the final pool to double check for missing or extra loans, altered position sizes, loan covenant details, and borrower information. Without perfect loan tape cracking in both the initial and diligence phases, everything a firm needs to do downstream is hampered, from monitoring portfolio health to calculating NAV. Sound loan tape management is the first step to enabling seamless modeling, validation, and integration with risk and cash flow forecasting systems.

Loan tape analysis automation for loan lifecycle oversight

Unfortunately for those in investment ops, the loan tape is not written in ink, it’s written in pencil. Things change every day. A pool of 100K consumers that, for example, borrowed money to install solar panels, will sometimes pay late, default, or pay off the loan early. Risk analysts and liquidity managers need this information in real time to make decisions every day. Delays or errors result in errant books of record, bad forecasts, late or incorrect reports, tripped up settlements, and ultimately, operational and market risks.

Firms must automate the process of daily bid tape analysis as they receive updated information from the loan servicers. Otherwise, they are manually checking for missing loans, new loans, defaults, duplicates, and so on. Now, multiply that by 5, 10, or more pooled loan structures across not just consumer but also residential mortgage or CLOs. The complexity multiplies when dealing with tranched pools to delineate risk in a single pool, thus requiring waterfall wiring. If a large firm is managing waterfalls across multiple funds, they cannot afford to neglect clear oversight in every step of the process.^ix

If loan pool analytics are done right, firms can anticipate potential shortfalls, defaults, or prepayments, can accurately forecast cash flow based on contractual schedules, and can respond quickly to unexpected market or borrower events. Done wrong, firms absorb increased borrowing costs, become non-compliant with covenants and leverage limits, and engage in bad hedging tactics and scenario modeling — resulting in bad decision-making all around the firm.

Automated tape management efficiently captures every event and validates and reconciles them against forecasts and accounting systems. Daily loan tape processing is the foundation, pillar, and shelter of ongoing portfolio management of private credit strategies.

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Mohit Jethwhani