SELLING
Banks often sell assets to raise capital. Technically speaking, the behavior of sales is similar to the mechanism as in prepayment pattern. Thus, selling assets is a behavior that is driven by:
■ Policies/strategies of the institution for managing their portfolios and accounts and profit planning.
■ Market conditions, i.e., when mark-to-market valuation methods are applied.
■ Requests for funding liquidity demands under normal as well as stress conditions.5
As mentioned earlier, under stress financial risk conditions, normally liquid products may become illiquid, which makes selling them more difficult.
The main parameters of modelling the sales behavior, in addition to those considered in prepayment are the difference between the book value and the current market value, the target income and sale amount.
Why is this important for marketplace lending? The option for lenders to sell their loans already exists on some platforms. Nevertheless, we are still a long way from secondary market liquidity of marketplace lending loans. Even though retail investors may still only dream about easily swapping the notes in their portfolios, institutional investors might already sell their loans to each other via intermediaries. This has no impact on the risk in the financial system in general, as investors simply swap exposure from one owner to another. The borrowers will not even know or care who lends capital to them, so counterparty risk and credit risk remain unchanged. When many peers share the exposure to loans, some defaults in the system may result in small individual losses. However, if one party concentrated their exposure to many loans in its portfolio, it may become unduly exposed to credit risk. This may be the case by holding many loans or by offering protection against their default.
In case of borrowers defaulting ‘en masse', the investor may find himself unable to meet his own obligations to other exposures. This is especially problematic when excessive leverage is part of the equation. Examples in history abound. For instance, excessive leverage brought down American International Group (A.I.G.), the world's largest insurer. Even though the company did not own subprime loans, its London subsidiary A.I.G. Financial Products had amassed a portfolio of credit default swaps of roughly $500 billion from which it generated about $250 million in annual income in insurance premiums. Because this subsidiary was not an insurance company, it flew under the radar of state insurance regulators. When subprime loans defaulted in the financial crisis of 2007/8, its trading partners required additional collateral, which led to a liquidity crisis that essentially bankrupted A.I.G. The U.S. Federal Reserve Bank had to prevent the company's collapse, enabling it to post additional collateral to its CDS trading partners, and eventually ended up bailing out the insurer for $85 billion.6 We are still some way off such large exposure or concentration in marketplace lending. However, if the sector continues to grow and reaches the predicted exposure of $1 trillion in peer-to-peer loans,7 we will need to take the selling of assets into account to have the full picture of the sector.
8.3