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Personal and Auto and SME, Oh My!
Reviewing the state of three consumer lending categories heading into 2020.
Personal Lending: Outsourcing Efficiency
Ten years ago, unsecured personal lending was a sleepy little product category. The prevailing belief at the time was that a set amount of time and money had to be spent underwriting any loan, so it was logical to spend that time and money on products where the risk could be offset by collateral (auto, home, etc.) or where the potential profit was enormous (credit card).
However, this assumption — that unsecured personal loans couldn’t be underwritten efficiently enough to be worthwhile — was already under attack by a wave of early fintechs including Zopa, Prosper, and Lending Club. These companies (and the ones that came after) believed they could outsource the technology-enabled efficiency of Silicon Valley (and Silicon Roundabout) to the slow, paper-intensive world of personal lending. And they weren’t shy about saying so (along with a fair bit of moralizing on the evils of banking).
Fast-forward to today.
Those fintechs’ belief in the power of technology-enabled efficiency to drive growth in online lending looks prescient:
More than 20 million Americans have these unsecured loans, TransUnion found, double the number of people that had this type of debt in 2012.
Personal loan balances over $30,000 have jumped 15 percent in the past five years, Experian found.
FinTech companies account for nearly 40 percent of personal loan balances, up from just 5 percent in 2013, according to TransUnion.
[The] online P2P lending industry grew rapidly between 2011 to 2015, with the number of P2P lenders growing from 50 to nearly 3,500 respectively.
China’s P2P industry is larger than that of the rest of the world combined, with outstanding loans of US$217.96BN.
And now in India:
Last year, investors globally poured a record $9.6 billion into lending startups, with 83% of the money going outside the U.S.…A record $909 million of that went to India-based lending startups, making the country the third-biggest market behind China and the U.S.
Last year, U.S. investors backed nearly 40% of the 65 India-based loan companies that completed a funding round.
The startups are providing much-needed credit in India, where consumer lending has been limited by a lack of credit scores and by banks that are reluctant to make personal loans.
The moralizing on the evils of banking is, in retrospect, not such a good look:
there is concern that some Americans get personal loans to tide them over and then continue to take on more credit card or other debt. Credit card debt has continued to rise alongside personal loans, according to the latest data from the Federal Reserve Bank of New York.
“I have mixed feelings about personal loans. They are superior to credit cards because the payments are fixed,” said Lauren Saunders, associate director of the National Consumer Law Center. “The problem is many people still have their credit card and end up running up their credit card again, so they end up in a worse situation with credit card debt and installment loans on top of it.”
One early sign of trouble was the unraveling in early 2016 of a P2P platform described by authorities as a $7.6 billion Ponzi scheme -- China’s largest ever -- that defrauded 900,000 people.
statistics released by the Chinese Banking Regulatory Commission showed that about 40% of P2P lending platforms were in fact Ponzi schemes.
Only 427 existing P2P firms were still operating by the end of October, down from 6,000 at their 2015 peak, according to the latest data from China Banking and Insurance Regulatory Commission
Authorities in Beijing are working with local officials on guidelines that would convert qualified online lenders into small-loan companies…Firms that don’t fulfill current requirements will be pushed to exit the industry…The changes are the latest moves to rein in, and perhaps kill off, China’s P2P sector.
“Akshay Yedke, who lives in Pune, India, said he took out a 121,000 rupee loan in 2017 to pay for his wedding. He said that he was a few days late on his 7,700 rupee monthly loan payment and that PaySense’s agents targeted Mr. Yedke’s closest contacts. “They started calling my mom, my dad, they even called my grandmother,” demanding payment, he said. “They disclosed my loan details to all of them.”
“lenders’ newfound ability to leverage personal data from smartphones, which is often collected without users fully understanding how it will be used, gives startups powerful new tools to pursue them.”
“Aggressive collection tactics are illegal in India, according to Reserve Bank of India rules. But regulators, eager to bring more people into the financial system, haven’t enforced the rules. “There’s no consumer watchdog with teeth,” said a person familiar with the fintech industry.”
Bottom line: Technology-enabled efficiency can have a transformational impact on lending in any market. It’s important to remember that in the absence of ethical investing and strong regulatory oversight, the resulting transformation may not leave customers better off than they were before.
Auto Lending: This Feels Familiar
Just the facts:
Most consumers can’t afford the purchase of a new car without financing.
Just 18% of U.S. households had enough liquid assets to cover the cost of a new car, according to a Wall Street Journal analysis of 2016 data from the Fed’s triennial Survey of Consumer Finances, a proportion that hasn’t changed much in recent years.
So consumers are taking out more auto loans and the average size of the loans is growing (in both amount financed and term).
the size of the average auto loan has grown by about a third over the past decade to $32,119 for a new car, according to Experian. To keep payments manageable, the car industry has taken to adding more months to the end of the loan. The average loan stretches for roughly 69 months, a record. Some last much longer. In the first half of the year, 1.5% of auto loans for new vehicles had terms of 85 months or longer, according to Experian. Five years ago, these eight- and nine-year loans were practically nonexistent.
This is good for dealerships, which now make more money on financing and insurance than on the sale of the car itself.
So far this year, dealerships made an average of $982 per new vehicle on finance and insurance versus $381 on the actual sale, according to J.D. Power, a data and analytics company. A decade earlier, financing brought in $516 per car and the sale made dealers $837.
And good for yield-hungry investors, who are snapping up auto loan securities.
Last year, investors bought a record $107 billion of bonds backed by cars, according to the Securities Industry and Financial Markets Association, a trade group. That is the first issuance record since 2005 and nearly triple the amount two decades earlier. The outstanding pile of auto bonds swelled to a record $264 billion.
With subprime auto loan securities being particularly popular.
Deals have been “going gangbusters” in subprime auto asset-backed securities (ABS), said Jennifer Thomas, an analyst at Loomis Sayles...At $29bn so far this year, issuance of subprime auto ABS is on track to surpass 2018’s record haul of $32bn, according to data from Finsight, despite softer sales of new cars and trucks this year. The lower-rated slices of recent deals are “five or six times oversubscribed”, said Ms Thomas. “The market is trading very well.”
In total, Americans have amassed an unprecedented amount of auto loan debt.
U.S. consumers held a record $1.3 trillion of debt tied to their cars at the end of June, according to the Federal Reserve, up from about $740 billion a decade earlier.
And there are signs that delinquencies are trending up.
Of that $1.3tn, 4.8 per cent, or about $62bn, is seriously delinquent, up from 3.1 per cent or $29bn five years ago. That proportion is not far off the peak of 5.2 per cent in the financial crisis.
Bottom line: What’s happening in auto lending today isn’t a perfect historic parallel with mortgage lending in the lead up to the Great Recession (for a number of reasons), but the similarities are a bit troubling. As the old saying goes, “history doesn't repeat itself but it often rhymes”.
Small Business Lending: New Parent Syndrome
The first night after my wife and I brought our son home from the hospital is, in my memory, a bit of a blur. I remember getting no sleep (my son hated being swaddled). I remember being constantly terrified when he was asleep that he wasn’t breathing (I would just stand over his bassinet watching his chest for signs of movement like a lunatic). And I remember my wife and I desperately buying a bunch of baby sleep equipment that we originally thought we didn’t need on Amazon (I think it was about 3:30 AM when we placed our order).
Some of that equipment ended up working and we figured out the sleep thing over the next couple weeks, but in that moment at 3:30 AM — as tired and terrified as we were — I can tell you that we were anything but rational consumers. We needed help and we needed it immediately. Paying for next-day shipping was a no brainer. Comparing prices was a luxury we couldn’t afford. I think we ended up spending maybe $250, but I honestly would have paid 10x that without batting an eye.
I mention this because I’ve noticed that some bankers seem perplexed by the apparent contradiction of small business owners choosing to work with fintech lenders despite (generally) worse pricing and service:
79% of small businesses that borrowed from small banks came away satisfied, compared to 67% for large banks and 49% for online lenders according to the Federal Reserve.
Yet according to that same Federal Reserve study on small business lending, even though SMEs find online lenders unsatisfying to work with (largely due to high prices and unfavorable terms) they are still flocking to them. 32% of small businesses applied for credit from online lenders in 2018, up from 24% in 2017. This growth (which banks and credit unions failed to achieve) was driven by online lenders’ high approval rates and underwriting speed.
The success that fintechs have had in attracting small business customers isn’t solely due to superior technology. The best SME fintech providers also evince an understanding of the psychology that drives entrepreneurs.
“I've never heard of someone waking up in the middle of the night crying because their personal bank account is frustrating to use,” [Eytan] Bensoussan [CEO of NorthOne] said. “But I have seen small-business owners just drop into tears because they can't get insight into where their wires are or for some reason their payroll is blocked and they are concerned. I can't tell you how many business owners have told me, if you can just get this right, I will pay you 10 times what I'm paying my bank today. Just make the headache go away.”
Bottom line: Small business owners are not rational economic actors making cold, calculating financial decisions. They are frantic, anxiety-riddled, sleep-deprived new parents trying desperately to keep their “babies” alive. Understanding this mindset is key to designing compelling SME lending products and experiences.