Marketplace lenders balance growth and quality

Fintechs taking larger share of personal loans while improving risk-return performance

11/06/2017 - 12:27
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Written by Steve Cocheo

One in three personal loans now come from a fintech lender. This is only the beginning, an expert suggests.

Fintech lenders now account for nearly a third of the personal unsecured loan market, from nearly 0% in 2010. The new players appear poised to not only continue building share there, but to begin gaining share in other credit types.

Personal loans are the easiest asset for a new player to move into, according to John Wirth, vice-president, fintech strategy and consumer lending market development, at TransUnion. Wirth, who was involved with fintech startups prior to joining the credit data company, says the natural progression for fintech lenders from the starting point of relatively simple personal loans is then into more complicated forms of credit, such as auto loans, cards, student loans, and finally mortgage loans.

“I think we’ll see continued evolution among fintech lenders,” says Wirth in an interview with Banking Exchange. How much further growth in the personal loan category remains to be seen.

Rapid growth in personal loans

Wirth says TransUnion records indicate that there are over 100 fintech consumer lenders in the U.S. now—way beyond the usual companies mentioned in this area—and that new firms with new models continue to enter the market.

Pent-up demand for personal loans, and the pullback by many traditional consumer lenders post crisis, created a vacuum that fintech lenders had the opportunity to fill with new technology that made the application process easier and faster, according to Wirth. That has brought about the market share mix reflected in the table below:

TransUnion studied over 40 million personal loans originated by banks, credit unions, traditional finance companies, and fintech consumer lenders from 2014 to 2016. Among the findings of the research was that in spite of the perception that fintech personal loan borrowers skew towards the young end of the demographic spectrum, this is not the case. In fact, among the four categories of lenders, consumers 18-29 accounted for the smallest portion of borrowers from fintech lenders.

In addition, the research found that fintechs’ personal loan borrowers are as “credit-active” as other lenders’ personal loan customers. This chart shows the “debt-wallet,” to use TransUnion’s term, of borrowers by type of loan and type of lender.

Where fintech lenders differ

TransUnion found that fintech lenders differed from other categories in a couple of important respects.

One is the term of the loan. Fintech lenders have a preference for loans of between one and three years, as shown in the chart below. Traditional finance companies lean much more heavily to loans of a year or less. (The TransUnion research specifically excluded payday lending.)

The study also found that fintech lenders tended to make the largest loans out of the four lender categories at any given VantageScore level.

Reviewing quality and return

A surprise for some in the TransUnion research is the fintechs’ choice of credit strata. Many see fintech consumer lenders chiefly as subprime creditors, but it turns out that six out of ten fintech personal loans are made to prime or near-prime borrowers. The latest figures indicate that 10% of fintech personal loan originations are subprime borrowers, while among all lenders the total is 14%.

However, Wirth says that the study makes it clear that fintech lenders typically experience higher delinquencies than competing lenders, notably in the lower credit risk tiers. However, he says simply looking at raw delinquencies isn’t enough.

Delinquencies are neither good nor bad in the overall picture, Wirth elaborates. If a lender understands the source of the delinquencies—in this case, fintech lenders’ greater willingness to lend to consumers with lower traditional creditworthiness—and prices the credit according to the risk seen, then this philosophy can work out.

To obtain a general perspective on how well it does work out, TransUnion devised what it calls a coarse risk-return measurement. This required several steps. First, Transunion estimated annual percentage rates on loans and calculated first-year interest income on a lender’s personal loans. Then, as an estimate of losses, TransUnion subtracted loan balances 60 days or more delinquent. The difference was divided by total original balances to produce a rough risk-return measure. This does not account for funding or operational expenses.

“Investors want to see that fintech lenders can not only build portfolios but also collect on them,” says Wirth.

Using the risk-return methodology outlined above, TransUnion computes that the first-year effective portfolio risk-returns rank as follows: traditional finance companies, 11.5%; fintech lenders, 8.7%; banks, 6.7%; and credit unions, 6.3%.

Differences in approach

Wirth says fintech lenders came into this competition without legacy systems and credit cultures that other lenders had. As they moved into personal loans, they adopted newer additions to the traditional credit scores, he says, including “trended data.”

The latter is an approach that gives potential lenders an idea of whether an applicant’s credit performance has been improving, deteriorating, or remaining steady over a given period of time. It’s a “motion picture” of credit versus the traditional “snapshot.”

As Wirth explains, three consumers with an identical credit score can actually present very different credit risks depending on their trend. Trended data give lenders a deeper understanding of the applicant.

Wirth adds that some fintech lenders have also added “alternative data” to their credit evaluations. As Wirth is using the term here, this refers to such nontraditional measures as how a borrower is performing on rental and utility payments. (Some advocates of alternative data tap such unusual measures as an applicants’ usage of and following on social media.)

One plus that fintech lenders currently enjoy, adds Wirth, is an engaged borrower base. He believes that people who borrow from fintech lenders tend to be active internet users. They often arrive at a fintech lender after comparison shopping, not only on price but also availability and speed. He says that engagement in their credit continues after they obtain it—they are more likely than the typical customer to keep tabs on their credit rating, for example—and may account in part for the performance of fintech borrowers.

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