Aligning your asset origination risk criteria with rating agency criteria can be a key competitive advantage for fintech firms.
Why
The ultimate financing for most fintech-originated loans and other other assets is securitization transactions – in the form of public asset-backed bond deals or private credit deals. On the road to this long term financing, many fintech firms using “warehouse facilities” where a bank gives the fintech a funding facility they can use until they have a large enough portfolio (say $200m) to securitize.
Investors use ratings provided by rating agencies to help decide whether to buy securitized bonds and at what price. Rating agency securitization criteria provide the methodology that rating agencies use to assess the risk of asset pools that will be securitized. There include asset level and portfolio level assessments of the loans or other assets in the pool. These assessments then determine the ratings that rating agencies provide.
Most fintech firms start by originating assets based on their own judgment of asset quality. The problem with this is that it will not be aligned with rating agency criteria. This will result in a lower rating on the assets than could have been achieved. This directly translates to a higher cost of funding those assets for the fintech company.
How
The rating criteria from Moody’s, S&P, Fitch and other rating agencies is publicly available.
By studying the criteria and putting together a simple excel or python model, you are able to estimate how changing what your projected pool of assets looks like will change the ratings you get on your securitization of those assets. From that rating, you can estimate the cost of financing that pool.
You can use this model to work out what asset pool will be best for you – based on ratings as well as demand from your customers, market rates on those assets, and areas in which you think the rating agencies’ view on risk is wrong.
Outcome
You end up with a pool of assets that you can fund at a lower rate than your competitors.
As fintech markets get increasingly competitive, competing on the customer side of the business is getting more difficult.
But fintech firms often put much more effort into product-market fit and customer marketing, than they do into product-financing fit and investor marketing. This can give fintech firms that can figure this out a major competitive advantage. It can create network effects as lower funding costs allow fintech firms to originate the best assets – which in turn provide lower funding costs.