Lessons From a Crisis

What we can learn from the impacts of COVID-19 on banks and fintech companies.

In what will likely be a recurring topic here at Fintech Takes over the next 18 months, let’s review a couple of the early lessons we’ve learned about financial services in the midst of the COVID-19 pandemic.

Small Banks are Critical in a Crisis

Three months ago, if you had asked me what the most important ingredient would be for distributing billions of dollars in guaranteed loans to small businesses, one of my last guesses would have been “a whole bunch of community banks”.

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Banks with under $10 billion in assets approved about 60% of loans in the first round of the Paycheck Protection Program … according to the Treasury Department and Small Business Administration. The smallest banks performed even better: Those with $1 billion or less in assets account for just 6% of all U.S. banking assets, but they and other small specialty lenders approved nearly 20% of loan dollars.

Indeed, it turns out that small banks’ willingness to tolerate a little regulatory ambiguity and work nights and weekends to manually submit as many PPP applications as possible led to significant benefits for the communities where smaller banks still flourish. According to analysis of the first round of the Paycheck Protection Program by The Institute for Local Self-Reliance:

nearly three times as many PPP loans were made per capita in the ten states with most community banks per capita, compared to the ten states with the fewest. This relationship is even stronger when the measure is not the number of community banks, but rather their combined market share strength, as defined by the amount of deposits these institutions hold per 100,000 residents.

These numbers don’t mean that small banks are inherently more virtuous than large banks (see: credit unions and overdraft fees). Nor do they mean that the competitive advantages that big banks have built through their scale and investments in digital technology don’t matter.

What the numbers do indicate is that in a crisis, when literally every hour counts, it’s easier for the banking industry to meet its responsibility to help all consumers and small businesses when that responsibility is diffused across a large number of companies.

Online Lenders’ Structural Weakness Has Been Exposed

This opening from American Banker pretty much sums it up:

One big warning has always hung over online lenders: The next economic decline, everyone agreed, would be a make-or-break test for these fast-growing upstarts.

Now the long-awaited downturn, brought on by the coronavirus pandemic, has arrived. And already it is more severe than most observers anticipated.

Online lenders, whose borrowers were often bank rejects, are sharply reducing or even suspending new loan originations. They are drawing down credit lines to boost liquidity. And they are cutting costs as much as possible, except in loan servicing, since their chances of survival hinge on their ability to collect payments from customers who have recently become riskier bets.

While most of the commentary on this sector is focused on the disadvantage that companies like LendingClub and OnDeck have in funding their loans compared to banks and their stable pools of deposits, I think the bigger weakness being exposed is these companies’ reliance on new originations to drive revenue:

That structural weakness has been compounded by the revenue models of many online lenders, which rely on a steady supply of new loan volume to drive growth.

Being a technology-enabled platform that connects borrowers and investors sounds great (and makes for a great S-1), until no one wants to buy the products your platform is producing anymore. Then quaint concepts like “originating loans that we can keep on our books and make a profit on” start to appear more attractive.

The Auto Lending Engine Has Overheated

This one wasn’t hard to see coming.

Now, it’s here:

At large banks and lenders, the median amount of lending in forbearance reported after the first quarter stood at 7.5% for auto loans, compared with 3.6% for credit cards, according to figures compiled by Autonomous Research … First-quarter delinquency rates on auto loans at big banks and lenders, defined as people at least 30 days late on a payment, jumped an average of 0.26 percentage point from a year earlier, according to figures compiled by Autonomous. By comparison, credit-card delinquencies were up just 0.07 point, Autonomous found.

Now, with millions of consumers unemployed, furloughed, or facing reduced wages, a 69 month-long, $32,119 loan (the average term and amount for a new car auto loan in 2019) looks a little more risky.

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Creating a 'Deferment Cliff’ is a Lose-Lose

As you might imagine, loan deferments are quite popular these days:

Lenders in April had nearly 15 million credit cards in “financial hardship” programs … That accounts for about 3% of the credit-card accounts

Nearly three million auto loans were in these hardship programs, accounting for about 3.5% of those tracked.

About 840,000 personal loans were in deferment or another type of financial hardship in April, accounting for 3.6% of those tracked.

Nearly 14% of commercial loans and 8% of mortgages were in deferment on March 31

This makes sense. A natural disaster has temporarily disrupted the ability of millions of people — across industries and credit quality tiers — to pay their bills. So it’s logical that lenders that would work with their customers to defer payments until they are back on their feet and structure realistic repayment plans once those deferments end.

Yeah, about that last part

The stimulus package that Congress passed in March allows homeowners with federally-backed loans to suspend monthly payments for up to a year without penalty, if they face financial hardship.

But the law doesn’t specify what happens after the so-called forbearance period ends. Many borrowers say they are being told they will have to make lump-sum “balloon” payments.

It’s difficult to express in words how bad an idea ballon payments after loan deferments are, but I’ll try: sheer lunacy.

We May Finally Stop Ignoring a Huge Opportunity

I recently had the opportunity to interview Zachary Karabell for a FICO webinar and I asked him how he thought the current crisis would impact different demographic groups’ financial behaviors and he predicted that we would see older adults’ usage of digital banking services increase significantly.

Nailed it:

[PayPal] has seen an older audience flock to digital payments as cash is seen as a germ risk and people across the U.S. stay at home to avoid spreading Covid-19. People over 50 were the company’s fastest growing segment from March to April, according to PayPal. 

And hey! maybe this isn’t just a weird, COVID-19 novelty. Perhaps there’s a longer-term opportunity here?

“We think that these are some sustainable trends in our business,” [PayPal CFO John] Rainey said

Theo Lau, of Unconventional Ventures, is sitting at home, banging her head against her desk. Here’s her Fintech Takes article, making the case for the ten thousandth time, that consumers age 50+ are a huge opportunity:

Older adults are a driving force in our economy, and their collective wisdom and life experiences are vital to our society at large. As Paul Irving, Chairman of the Milken Institute Center for the Future of Aging, often says: “older adults are the only growing natural resources in the world.”

It is time to shed our bias, reject the ageist stereotypes, and realize the opportunities that come with living longer. It is time to put our heart back into our ecosystem — and build what matters.

Thanks,

Alex Johnson

(@AlexH_Johnson)

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