Q1 2022 Review | Consumer Lending

By Cole Gottlieb

May 24, 2022

The Fed’s anti-inflationary measures and Russian invasion of Ukraine have thrown credit markets into a new direction, with rates rising at the fastest pace in decades. As we navigate a volatile market, catch up on the latest trends we see emerging in the consumer lending space: fintech lender and bank performance, MPL new issue volume’s strength, regulatory changes, and a BNPL update.

Consumer Loans Capped off Strong 2021, But Are Rising Rates Affecting Originations?

Before we jump into covering the first quarter, industry data is now in for the full year of 2021, and shows unsecured personal loan originations hit a record to cap off the end of last year (originations reported through Q4 due to reporting lag). While originations have bounced back to exceed pre-pandemic levels, lenders have not needed to move down the credit spectrum to achieve such results. The prime vs. below prime split has remained consistent (4Q19 - 69.7% below prime, 4Q20 - 69.5% below prime, 4Q21 - 69.4% below prime).

Source: TransUnion

Source: PeerIQ

While the broader personal lending market experienced a strong end to 2021, first quarter earnings revealed that many fintech lenders eased off end-of-year origination volumes (Oportun, SoFi, Affirm, Enova (Consumer), OneMain, Navient). While some of the decline can be attributed to normal post-holiday seasonality, rising rates have played a part in dampening demand. Going forwards, c-suite execs expect rising rates to affect approval rates and demand from consumers, who will be faced with higher borrowing costs. One such example is Upstart’s CEO Dave Girouard, who explained, “In addition to increasing rates for approved borrowers, this [rising rates] also has the effect of lowering approval rates for applicants on the margin.”

In addition to reduced volume, lenders have begun to see a rise in delinquencies due to inflation and higher costs of loans. While consumers have benefited from a tight labor market, high inflation has put strain on consumer’s pocketbooks. Some of the increase in NCOs can also be attributed to a return to normal levels, as the industry moves further from historically low levels experienced during the pandemic.

Newer vintage performance is not being helped by government stimulus, something older vintage performance benefitted from. Upstart CFO Sanjay Datta reported, “virtually all of our pre-2021 vintages will substantially outperform their return targets while the two or three vintages most adjacent to the reversal in trend at the end of 2021 are set to underperform.”

In comparison, those that serve borrowers with higher credit profiles are less concerned with the impact of inflation and rate hikes, with LendingClub CEO Scott Sanborn, stating, “History would indicate that inflation typically does not correlate with the performance of unsecured loans and we expect our customers who have an average income of more than $100,000 to be particularly resilient.”

Due to the rising rates, lenders have had to increase APRs charged to customers, which could dissuade consumers from taking out personal loans. Those that serve near-prime borrowers, such as Upstart and Oportun, have noted that some higher-risk borrowers may no longer qualify for loans, as they plan to keep APRs below the 36% APR cap that some states require.

Source: PeerIQ

Banks’ consumer loan books held relatively constant sequentially (Citizens +3%, Capital One +2%, Bank of America +1%, PNC +0%, Wells Fargo +0%, Citi (1)%, JPMorgan (2)%). While Citizens credited its loan growth to strong mortgage, auto and home equity segments, other banks saw significant declines in the mortgage and auto segments due to rising rates. To note, Citizens management expected a slowdown in growth for its mortgage and auto loans, as margins on these loans are not as profitable as they once were. Home lending originations fell sequentially for Citi (9)%, Wells Fargo (21)% and JPMorgan (41)%, and auto originations fell for JPMorgan (1)% and Wells Fargo (22)% as “a lack of vehicle supply continued to affect origination volume”. On the other hand, Capital One was able to capitalize on the high demand for autos, increasing its originations by 20% from the fourth quarter.

NCOs rose slightly from the fourth quarter, as credit continues to normalize from historically low levels witnessed during the pandemic.

Source: PeerIQ

Despite battling high inflation and rising costs, consumers managed to put away cash, with average deposits mostly up from the fourth quarter (Citi +4%, JPMorgan +4%, Bank of America +3%, Citizens +3%, Wells Fargo +2%, Ally +2%, PNC +0%).

Bank and Fintech Lender Earnings Summary

Source: PeerIQ

Source: PeerIQ

Securitization Spreads Blowout on Rate Hikes, Market Turbulence, but Volume Remains Strong

Despite the Fed raising rates and signaling multiple rate hikes going forwards, the MPL securitization market still capped off a strong quarter in terms of volumes, while spreads increased significantly.

The market is pricing in roughly 200bps of rate hikes by the end of 2022, driving the widening in spreads. The Fed also announced that it plans to begin to reduce asset holdings on its $9T balance sheet.

New issue volume grew 11.8% from the prior quarter, representing the second highest quarter on record, only behind 3Q21. Demand has carried into the first part of the second quarter, with new issue volume on pace to grow yet again.

Source: PeerIQ, Finsight

Pagaya ($1,026Mn), Upstart ($623Mn), LendingPoint ($539Mn), Bankers Healthcare Group ($500Mn), Freedom Financial Network ($416Mn), Oportun ($400Mn), Affirm ($367Mn), Marlette ($317Mn), Theorem ($263Mn), and Regional Management ($250Mn) were among the most active players during the first quarter.

Source: PeerIQ, Finsight

Cumulative volume continued to outpace 2021 levels through the first four months of the year. While the quarter ended with strong volume, it has not all been smooth sailing. Amidst market turmoil in late-February and early March, at least 7 ABS deals were pulled. A couple examples of deals that were put on hold include World Omni Financial’s ~$820Mn auto-lease backed loan and the Canadian Imperial Bank of Commerce’s $540Mn credit card ABS deal.

Market conditions have changed for lenders and investors, with spreads increasing remarkably. The yields on Affirm’s Class A issuances have jumped from 1.03% last August, to 1.75% in February, and 4.3% in May. Yields on Upstart’s Class A issuances vaulted from 1.31% in November to 3.12% in April. We can see further proof from JPMorgan’s data, which illustrates the dramatic spike in yield premium for BBB-rated MPL loans for the year increased from ~150 bps to over 250 bps in Q1.

Image: Wall Street Journal, Source: JPMorgan

Many factors contributed to the swift change: the rate hikes, the Russian invasion of Ukraine, recession worries, and the worsening of loan performance.

The material widening in spreads indicates that funding has gotten more expensive. If the Fed continues down its path to lower inflation, we expect yields to continue to increase, potentially making it more difficult to finance MPL loans.

Regulatory Environment Surrounding the Consumer Loan Space

During the first portion of 2022, we saw Jelena McWilliams resign as Chairwoman of the FDIC following a contentious debate with fellow FDIC board members over bank merger policy. Lael Brainard replaced Richard Clarida as Fed Vice Chair following controversy over his trading patterns during the pandemic. Since the resignation of Clarida and multiple other officials, the Fed has restricted the trading activity allowed by its policymakers and senior staff, who may have nonpublic information.

Turning to the CFPB, there has been increased scrutiny of lenders, led by Director Rohit Chopra, in the name of consumer protection. The CFPB has expanded its scope in a couple ways. For one, the CFPB announced that it plans to use its UDAAP enforcement authority to go after discrimination associated with any financial product. Prior to this, the CFPB was limited to addressing discrimination in lending.

Further, last month the CFPB expanded its reach by invoking dormant authority to examine nonbank financial companies that pose risks to consumers. Organizations representing banks such as the Consumer Bankers Association have lobbied for standard supervision and regulation to apply to fintechs in the way it has applied to banks. With close to 50% of personal loans originated by fintechs, the move would level the playing field with supervised banks.

Looking ahead, Chopra wants to crackdown on repeat offenders and what he deems “junk” fees charged on financial products. Chopra has spoken about plans to go beyond fines for repeat lawbreakers, potentially taking away government privileges and going after individual executives. The argument he makes is that massive financial firms are not sufficiently dissuaded by fines and continue to take illegal risks. While Chopra has yet to implement a specific plan, threatening to take away benefits such as FDIC deposit insurance would surely have an impact on how major firms approach risk management. The regulatory pressure on fees will add to the competition from fintechs, which has led many banks to eliminate or greatly reduce overdraft fees already.

Following the CFPB’s inquiry into BNPL providers, the organization has not yet made clear how it will proceed with the information gathered. BNPL lenders maintain that the protections in place are sufficient to protect consumers, while banking and consumer advocate groups urge the CFPB to increase regulations for BNPL products.

The Latest on the BNPL Space

While consumer interest in BNPL continues to grow, there is some uncertainty on the horizon, as ecommerces’ share of retail spending moderates from a pandemic-induced spike, fees from merchants have come under pressure, regulators are asking questions, and BNPL-focused companies’ valuations have cratered along with the broader market.

Providers offering pay-in-four options have seen their take rate decline as competition in the sector intensified over the course of the pandemic. BNPL providers like Affirm and Klarna responded by attempting to move “up funnel” in the customer journey by emphasizing their websites and apps as shopping destinations. They’ve also rolled out or are planning product extensions to expand their footprint, like browser extensions, virtual cards, and physical payment cards.

Affirm announced its “Debit+” offering, a decoupled debit card that enables users to split pay any qualifying transaction. In its home European markets, Klarna offers a “Pay Now” option and operates its own payment network, Sofort. In the U.S., Klarna plans to launch a card offering via partner WebBank.

Still, the sector is facing a number of changes and risks. The CFPB’s ongoing market monitoring inquiry is focused on the risk of consumers becoming overly indebted, regulatory arbitrage, and data harvesting. It’s not yet clear what the impact of the CFPB’s investigation will be, but areas affected are likely to include how firms calculate borrowers’ ability to repay and disclosure practices, among other topics.

Further, the three major credit bureaus have each announced plans to support the furnishing of tradeline data on BNPL plans, though they’re taking different approaches on how to incorporate this data and have given conflicting opinions of how it could impact borrowers’ credit scores. While the bureaus will eventually support BNPL data, BNPL providers haven’t yet committed to furnishing this information, though they’re already facing pressure to do so. While reporting to the bureaus will improve BNPL providers’ ability to assess borrowers’ creditworthiness, it increases their operational complexity and could lower approval rates.

All of this uncertainty comes amidst market volatility that has seen BNPL providers’ valuation drop significantly. Affirm has seen its share price decline from a high of $176.65 to just $24.52. Klarna is reportedly seeking $1Bn in new funding at a valuation as much as third below the frothy $46Bn valuation attached to its last funding round. While Affirm took advantage of one-click checkout startup Fast’s demise to scoop up engineering talent, Klarna announced it will layoff 10% of its workforce.