Analyses
Fintech Continues to Disrupt Consumer Lending
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Insight Article
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avril 29, 2020
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avril 29, 2020
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Fintech Continues to Disrupt Consumer Lending |
We believe that “fintech” alternative lending, an asset class born of bank disintermediation and technological innovation, may offer benefits to both borrowers and investors. Industry growth data appears to bear this out, and we think two factors have been primarily responsible for this growth. The first is the attractive structure of alternative loans, as compared to credit card debt, which benefits both borrowers and investors. And the second is the way alternative lenders cater to evolving consumer banking habits, which mirror evolving shopping habits: consumers prefer to transact online.
Alternative lending takes place through online platforms that use technology to bring together borrowers, who may be underserved by traditional banking, with loan investors seeking attractive, yield-generating investments. While the asset class originated as peer-to-peer lending, institutional investors fund most alternative loans today.1
The alternative lending universe encompasses consumer loans, small business loans and various specialty finance loans. Of these, consumer unsecured loans represent the largest segment. These loans often have three- to five-year terms and are fully amortizing via monthly installment payments. They generally have a relatively low outstanding balance of about $9,000, and borrowers often use them for debt consolidation or refinancing.2
Benefitting Borrowers and Investors
By shifting from revolving credit card debt to an amortizing unsecured installment loan, a borrower may benefit from a lower interest rate and a fixed term over which the debt can be repaid. By taking on credit risk, as compared to holding a similar duration Treasury security, an investor may obtain a higher expected return and gain consumer credit exposure, which historically has been challenging to access.
Recent Growth in Unsecured Consumer Loans Has Been Significant…and Skewed to Fintech
Personal loans underwritten by fintech alternative lending platforms have grown rapidly since the global financial crisis. A recent study by TransUnion found that outstanding unsecured personal loan balances rose by $23 billion in 2019 to $161 billion, with much of the growth coming from loans originated by fintechs.3 Indeed, fintechs accounted for roughly 36% of the outstanding balances at the end of 2019, up from just 5% only six years earlier.3 (Display 1)
Source: https://www.transunion.com/blog/consumer-credit-origination-balance-and-delinquency-trends-q4-2019 and https://onlinexperiences.com/scripts/Server.nxp?LASCmd=AI:4;F:QS!10100&ShowUUID=DBABE960-72C0-4091-99F3-EBFE91B81159&AffiliateData=HomepageBanner&Referrer=https%3A%2F%2Fwww.transunion.com%2Fbusiness market share data as of 3q19
A closer look at the data reveals that it’s not just banks that are losing ground to fintech: credit unions and traditional finance companies have also ceded market share over time. (Display 2)
Source: http://www.transunion.com/blog/consumer-credit-origination-balance-and-delinquency-trends-q4-2019and https://onlinexperiences.com/scripts/Server.nxp?LASCmd=AI:4;F:QS!10100&ShowUUID=DBABE960-72C0-4091-99F3-EBFE91B81159&AffiliateData=HomepageBanner&Referrer=https%3A%2F%2Fwww.transunion.com%2Fbusiness market share data as of 3q19
Looking at the rate of origination, $120 billion in unsecured personal loans were originated in 2019, marking the second year in a row with origination in excess of $100 billion.4 That compares to roughly $48 billion of total personal loans originated just six years ago.5 (Display 3)
What Explains the Growth?
We think two factors have been driving fintech’s ascendancy in the personal lending space: 1) the attractive structure of the loans themselves—for both borrowers and investors—in comparison to credit cards loans, and 2) the evolution in borrower behavior.
The Power of Amortization
We believe that the amortizing installment structure typical of unsecured consumer loans originated by alternative lenders is one reason why these loans have seen such significant growth in recent years. Amortization may allow unsecured consumer loans to be extended to borrowers at interest rates below what might be charged on revolving credit card loans to comparable borrowers, while still compensating lenders for the credit risk that they are taking.
When extending credit to a borrower, a lender must evaluate both the probability of default and the magnitude of potential loss. Unfortunately, default probability becomes increasingly difficult to forecast the further forward one looks from today, since the economic backdrop and a borrower’s financial situation evolve over time in potentially unpredictable ways. Amortizing loans compensate for this uncertainty through outstanding balances that progressively decline, over time reducing the magnitude of loss in the event of loan default. Conversely, credit card lenders must be compensated for the increased potential of future losses associated with revolving balances that do not necessarily decline with time. They may thus charge higher rates as compared to amortizing loans to comparable borrowers.
Display 4 compares the outstanding balance on a monthly amortizing year personal loan with an interest- only revolving loan over the expected life of the personal loan. The personal loan’s amortizing structure has lower outstanding balances over time as the probability of default becomes less predictable. By contrast, the interest-only revolving balance remains elevated.
Source: AIP Alternative Lending Group. For illustrative purposes only.
Evolving Consumer Behavior
We believe consumer behavior is another force behind the growth in fintech alternative lending. As can be seen by the widespread trend toward online shopping, consumer behavior has evolved meaningfully in recent years. Indeed today consumer preference and comfort with transacting online extends to banking.
Demographics also play a role: Millennials represent the largest generation in American history,6 and most prefer to bank online.7 Furthermore, a 2019 study showed that roughly 20% of millennials have no credit card, which may translate into thinner credit files.8 A thinner credit file makes a FICO® credit score—the backward-looking measure of creditworthiness on which banks often base lending decisions— less useful. Alternative lenders may augment traditional credit metrics with unconventional data sources that indicate borrower willingness and ability to pay, and they can do so in a highly automated fashion that accelerates crediting decisions. Many alternative lenders may also use artificial intelligence/machine learning techniques in their underwriting when incorporating non-traditional data sources. In this manner, alternative lending may increase financial inclusion and access to affordable credit.9
Looking Ahead
While growth in unsecured personal loans has been rapid, we believe that there is room for further expansion. As previously noted, outstanding unsecured personal loan balances stood at $161 billion at the end of 2019.10 This is dwarfed by the roughly 190 million credit cardholders, representing outstanding U.S. credit card debt of about $930 billion.11 Put differently, credit card penetration stands at about 75% of the U.S. population, whereas unsecured personal loan penetration is only about 6%.12 (Display 5)
The economic fallout from the COVID-19 pandemic will be an instructive test of the assumptions underpinning the growth and investment merits of fintech alternative lending. However, the combination of low penetration rate and the key growth drivers previously discussed—attractive loan structures for borrowers and investors, alongside an increasing consumer desire to do business online— suggests opportunity for continued growth in the nascent asset class of fintech alternative lending.
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Managing Director
AIP Hedge Fund Team
AIP Alternative Lending Group
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