Hello everyone! We come to you today with our quarterly consumer lending wrap. Continued inflationary pressures, recession worries, and the Fed’s ongoing hikes have created turbulent times for lenders. Catch up on the latest trends we see emerging in the consumer lending space: fintech lender and bank performance, growth in the MPL market, increased regulatory scrutiny of overdraft fees, and an update on the BNPL space.
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Markets Anticipate Uptick in Subprime NCOs; Personal Loan Origination Volume Not Slowing Down
Before diving into our second quarter coverage, TransUnion just released industry data showing considerable year-over-year first quarter unsecured personal loan origination growth (originations reported through Q1 due to reporting lag). This growth is in line with what we expected, given the origination volumes reported in our Q1 review. It appears that lenders are reaching down the credit spectrum to originate loans, with the below prime originations marginally higher than in prior year periods (1Q20 – 62.3% below prime, 1Q21 – 63.2% below prime, 1Q22 – 66.1% below prime). Fintech lenders led the growth, accounting for 37.7% of all unsecured personal loan originations, up from 31.4% in 1Q21 and 28.3% in 1Q20.
Turning to our second quarter earnings coverage, fintech lenders largely grew origination volumes from the first quarter. OneMain +31.7%, LendingClub +19.4%, Oportun +9.8%, MoneyLion +7.6%, and Enova (Consumer) +7.3% did not see volumes negatively impacted by rising rates. In contrast, Navient and SoFi’s origination volumes were hampered by student and home loan origination declines, due to the student debt moratorium and effect rising rates have had on the housing market. However, SoFi’s personal loan originations continued to flourish, up 22.0% from the first quarter. Upstart reported that several of their lenders/institutional investors have temporarily paused or reduced their originations due to market conditions. Additionally, Upstart’s conversion rate fell to 13.3% from 21.4% a quarter prior. As rates have risen, applicants who were previously approvable under 36% APR may no longer be, resulting in a lower conversion rate.
While we have yet to see large jumps in NCOs across the board, cracks are beginning to emerge in nonprime credit. Stripping out the impact of its Heights Finance acquisition, Curo’s U.S. NCOs would have risen by 290bps from the first quarter. Upstart management reported that they expect most 2021 vintages to underperform their return targets.
Management has indicated that nonprime consumer credit vintages are underperforming, and that an increase in NCOs is expected going forward. Oportun raised its NCO guidance by 80bps for 2022, and OneMain raised theirs by 50bps, while both committing to tighten credit standards. OneMain CEO Douglas Shulman reported, “In May, we began to see an uptick in early-stage delinquency for certain lower credit quality, lower FICO customers, primarily concentrated in 2021 vintages… it is clear to us that there has been an increase in early-stage delinquency across the nonprime space over the past couple of months.” Oportun has aimed to reduce NCOs by increasing their lending to return customers who have successfully paid off a loan, with just 35% of loans going to new borrowers in July, compared to 51% in Q1.
Banks were able to grow their consumer loan books from the first quarter, (Citizens +12% (impacted by HSBC/ISBC transactions), Capital One +3%, JPMorgan +2%, Bank of America +2%, Wells Fargo +2%, PNC +2% QoQ, Citi +1%), as consumer spending continued to increase, both from the impact of inflation on non-discretionary spending and from increases in discretionary spending on categories like travel and dining.
Consumer deposit balances were mixed among banks, as some consumers have needed to draw down on balances to account for the increased costs of gas, groceries and rent (Citizens +13% (impacted by HSBC/ISBC transactions), JPMorgan +2% Wells Fargo +2%, Bank of America +2%, Capital One +0%, Citi (2)%, PNC (2)%, Ally (2)%). Jeremy Barnum, JPMorgan’s CFO, reported that, “With spending growing faster than incomes, median deposit balances are down across income segments for the first time since the pandemic started, though cash buffers still remain elevated.”
Looking ahead, Citizens and Capital One have announced planned reductions to their auto originations due to competitive pricing dynamics. Ally was able to increase its auto originations from the first quarter +15%, by relying on the used auto lending market (69% of originations, a high watermark). JPMorgan (17)%, Capital One (12)%, Wells Fargo (10)% saw auto origination softening, due to a continued lack of vehicle supply and to the rise in interest rates.
NCOs have yet to increase, as banks’ consumers have benefited from existing cash buffers, a strong job market and nominal wage growth, which has helped them from falling behind on payments.
Bank and Fintech Lender Earnings Summary
Securitization Volumes Grew Despite Rate Hikes
We continued to see growth in the MPL securitization market through the second quarter, recording the second highest new issue volume over the past couple years. Rising rates have not discouraged issuers enough to impact volumes, as securities origination grew 4.9% from the first quarter.
The Fed has hiked rates by 75bps at each of its last two meetings, the largest single-meeting increases since 1994. Markets are expecting another hike in September, with CME Group data suggesting a third 75bp hike is more likely than not.
We can see the effects of changing market conditions reflected in the increase of yields on issuances (issuances referenced use I-Curve as benchmark). Affirm saw the yield increase from 4.34% on its April Class A issuance (WAL of 1.05) to 5.65% on its June Class A issuance (WAL of 2.28). Oportun also saw an increase in yields, from 5.13% on its May Class A issuance (WAL of 2.04), to 6.02% on its July Class A issuance (WAL of 1.05).
Affirm ($871Mn), Upstart ($740Mn), Pagaya ($720Mn), Onemain Financial ($600Mn), Oportun ($389Mn), Lendmark ($332Mn), Freedom Financial Network ($324Mn), Bankers Healthcare Group ($276Mn), Marlette ($268Mn), LendingPoint ($250Mn), and Liberty Lending ($162Mn) were among the most active players in the space during the second quarter.
Through the first seven months of the year, cumulative new issue volume has outpaced 2021 levels. While funding has gotten more expensive, and some market participants anticipate a recession, there has yet to be a widespread pullback in issuances. However, if the Fed continues to hike rates to combat inflation, we expect funding to continue to become more constrained.
Barr Sworn in, Regulators Take Aim at Overdraft
In July, Michael Barr was sworn in as the Fed’s Vice Chair for Supervision, and will be responsible for overseeing the largest financial firms. The confirmation of Barr, gives the Fed a full seven-member board for the first time in nearly a decade. Barr previously served as the Dean of Public Policy at University of Michigan and is a former Treasury Department official who played key roles in the development of the CFPB as well as the Dodd-Frank Act.
While the Barr nomination was bipartisan, the Overdraft Protection Act has been a point of contention, dividing Democratic and Republican lawmakers on the House Financial Services Committee. The bill, introduced by Carolyn Maloney (D-NY), passed the democratic-controlled committee, and aims to prohibit “unfair or deceptive acts or practices in connection with overdraft coverage.”
This would include requiring the disclosure of: (i) the specific amount of overdraft coverage fees; (ii) that the consumer’s transaction may be declined if there are insufficient funds in the account; and (iii) that the consumer will not be charged a fee if the transaction is declined.
Democrats, like Maloney, argue that bank overdraft programs charge unfair, unnecessary, deceptive fees, equivalent to ~$8Bn a year, to consumers. In contrast, banking associations and some Republicans argue that overdrafts can be used responsibly by consumers as a short-term form of credit that can be an alternative to predatory payday loans.
On the state level, the New York State Department of Financial Services released guidance that aims to eliminate the use of “improper and unfair” banking fees. The NYDFS aims to end: (i) overdraft charges when the consumer’s account shows sufficient funds at the time of transaction (ii) “overdraft protection” fees that automatically transfer funds from another account but still does not cover the transaction, and (iii) double-charging accounts after a merchant takes multiple attempts to collect failed transactions.
During the second quarter, the CFPB was increasingly active. The agency rebranded its Office of Innovation as the Office of Competition and Innovation. The updated name reflects an increasing focus from the CFPB on how it can promote competition, with a particular focus on the potential negative impacts of “Big Tech” entering the banking sector. As part of the restructure, the CFPB ended its “sandbox” and “no-action letter” programs, which were managed through the previous Office of Innovation. During Q2, the CFPB also rescinded early wage access company Payactiv’s “sandbox approval order” and terminated Upstart’s “no-action letter”.
Payactiv had been given special regulatory treatment, granting it temporary exemption from liability under TILA and Reg Z. Tensions rose over the company’s use of language suggesting CFPB endorsement of its EWA product. After the CFPB informed Payactiv it was considering rescinding the order, Payactiv requested termination of the order, claiming that doing so would allow them to make quicker product changes without needing to wait for CFPB review.
Upstart had been granted special regulatory treatment from the “no-action letter”, protected from being charged with fair lending law violations with respect to its underwriting algorithm. Upstart requested a termination of the “no-action letter” in April, as the company intended to add a number of new variables to its underwriting model and did not want to wait for the CFPB to review and “rigorously evaluate the implications and changes.”
Other key CFPB initiatives that continued during Q2 include the ongoing rulemaking process for 1033, which will set “open banking” requirements, 1071, which will require collection of certain data related to small business loan applications, the beginning of a review of rules implementing the CARD Act, and the agency’s market monitoring inquiry into BNPL. Expect more action in these areas in Q3.
BNPL Valuations Falling, but Financial Institutions Still Moving Forward
BNPL lender valuations have taken a significant haircut from their 2021 highs. In July, Klarna announced an $800Mn funding round at a $6.7Bn valuation, a far cry from its $45.6Bn valuation a year prior.
Companies in the public markets have not fared much better, with Affirm’s stock down over (75)% from 2021 highs, and both PayPal and Block (which acquired Afterpay) each down over (65)% from 2021 highs. Rising rates have led investors to discount growth companies’ valuations and have increased funding costs.
Opy, the U.S. subsidiary of BNPL Openpay, announced it was leaving the U.S., just four months after designating the region as its main growth market and less than a year since launching in the country. Losses had widened by 65% in 1H22, and the company had failed to find an investor to fund U.S. expansion. Rising rates played a part, decreasing investor appetite for growth companies and increasing funding costs.
The difficult macro environment has caused greater collateral damage to the BNPL space, with Zip and Sezzle calling off their planned merger. The move comes less than six months after Zip announced its intention to acquire Sezzle. Sezzle had previously announced plans to cut 20% of its workforce.
Despite valuations tumbling, it’s not all doom and gloom in the BNPL space. Afterpay announced a new partnership with beauty retail giant Sephora and PayPal processed close to $5Bn in volume for its BNPL services, a 226% increase from a year prior. Bank installment lending programs also reported significant growth from the first quarter. Citi grew its installment lending program to $4Bn, an increase of 21% from a quarter prior and 91% from a year prior. Goldman increased its installment loans to $5Bn, from $4Bn in the first quarter and $3Bn in 2Q21.
Additionally, lenders have continued to enhance and release new installment lending products. PayPal unveiled its new “Pay Monthly” product, expanding its installment lending program. The product will allow users to pay monthly installments over a 6-24-month period for purchases $199-$10,000. The move puts PayPal on par with competitors Affirm and Klarna, which offer both pay-in-4 products and longer term monthly payments.
PayPal’s “Pay Monthly” will be available (like its Pay in 4 product) to merchants for no additional cost or risk. The company makes money by charging transaction and fixed fees for PayPal checkout functionality. Management has referred to the additional business it receives from BNPL as the “halo effect”, which they estimate to be a 21% impact when a consumer uses BNPL.
TD Bank launched an installment loan product, dubbed TD Payment Plans, that allows TD credit cardholders to split purchases of $100+ over 6, 12, or 18 monthly payments. This product is similar to split pay options that card franchises Chase, Amex and Citi offer, offering consumers the flexibility to split purchases from a wide range of merchants and finance them over time. As we covered in our report on the BNPL landscape, these post-sale BNPL options enhance the user experience and can act as a retention tool to preempt credit card consolidations.
Mastercard recently began to inform merchants that it will charge them 3% of the purchase price when consumers choose to use their new BNPL service. While many merchants have embraced BNPL offerings to drive additional sales, some have pushed back against the product. Certain Mastercard retailers, including gas stations, convenience stores, and those in the fast-food industry, have chosen to opt out of the BNPL service. These retailers were frustrated that Mastercard decided to automatically opt them into the service, and have cited worries that consumers who use the lending product at their establishments may “become dissatisfied” paying for their gas or meal long after it’s gone.