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When prodigies appear in markets, heed the warning

By Jon Hay
17 Jun 2021

A lion walks the streets of Rome, an owl shrieks in the marketplace at noon.

Neither of these animals killed Julius Caesar, but in Shakespeare’s play, the day after they appeared, his closest supporters took him by surprise and murdered him.

This week, GlobalCapital reports on the growth in securitizing recurring revenue loans. In the US, these are loans to companies, often young tech firms, underwritten on the basis of their revenues, such as subscription fees, rather than Ebitda or profit, since they have little or none of these.

Securitization is based on packaging stable, predictable cash flows. A credit card facility may be risky, but if you have 200,000 of them, the portfolio’s behaviour can be foreseen.

On the ladder of corporate finance risk, recurring revenue loans are about as far from securitization’s roots as you can get.

A well structured securitization can handle any collateral safely, no matter how risky. But there are incentives for error. Asset originators make money generating loans, while shedding much of the risk to investors.

With luck, all parties in recurring revenue loan ABS will behave wisely. But this is undeniably a bull market product.

Chuck Prince, chief executive of Citigroup, epitomised the fin de siècle before the last financial crisis when he declared in 2007: “As long as the music is playing, you’ve got to get up and dance.”

He was talking about leveraged finance, then widely seen as the leading danger to financial stability. Within a year, the system would be felled by something considered safe — subprime mortgages and their triple-A rated derivatives.

Recurring revenue ABS are too small to be killers. But they might be, as Shakespeare said of the lion and the owl, “portentous things unto the climate that they point upon”.

By Jon Hay
17 Jun 2021