Beaten by coronavirus crisis, online lenders face bankruptcy
A big warning has always hung over online lenders: The next economic decline, everyone agreed, would be a litmus test for these fast-growing newcomers.
Now the long-awaited slowdown, brought on by the coronavirus pandemic, has arrived. And it is already more severe than most observers had anticipated.
Online lenders, whose borrowers were often bank scraps, sharply reduce or even suspend new loan arrangements. They draw on lines of credit to increase liquidity. And they keep costs down as much as possible, except in loan servicing, as their chances of survival depend on their ability to collect payments from clients who have recently become riskier bets.
“Someone might look like a FICO 700 today. But in reality, they’re going down, ”said Brian Korn, a lawyer who heads the fintech practice at Manatt, Phelps & Phillips. “And they might look like a FICO 600 after the next payment cycle.”
Many online lenders, especially private ones, are silent about the challenges they suddenly face. But interviews with industry insiders and an assortment of disclosures from companies like LendingClub and OnDeck Capital have revealed some of the damage the industry has suffered since mid-March.
Because these companies operate outside the banking sector, they have never been able to turn to deposits as a stable source of loan funding. Instead, they relied heavily on other sources of liquidity – securitization markets, hedge funds and other private investors – which skeptics say may run dry in the next crisis.
This structural weakness has been compounded by the revenue models of many online lenders, which rely on a constant supply of new loan volumes to drive growth. With new loans now sharply reduced, companies with a large cash reserve will likely try to weather the storm. Others may seek to sell, although they may be forced to do so at heavily discounted prices.
“FinTechs are relatively fragile and seek to save money, on the whole,” Nigel Morris, co-founder of Capital One Financial, said in a recent webinar. Morris is now a Managing Partner at QED Investors, a venture capital firm that has invested in numerous online lenders.
“The banks are largely well capitalized and in very good shape to overcome this,” he added. “And now is the time to consider mergers and acquisitions, to buy assets and capacities [they] do not have. The fintech community is more in the mood to listen.
What follows is a look at how the coronavirus crisis has rocked online lenders in the consumer and small business spheres.
Consumer lenders close hatches
Many digital consumer lenders have built their businesses around refinancing existing consumer credit card debt. Between 2016 and 2019, the volume of personal loans in the United States increased 58% to $ 161 billion, according to data from TransUnion.
These existing loans may prove more difficult for lenders to collect during the emerging recession than other types of consumer credit. Unlike mortgages, which pay for housing, and auto loans, which finance transportation, personal loans often provide no ongoing utility to consumers.
“The unemployment shock caused by the pandemic may cause consumers to increasingly prioritize other debt payments,” Fitch Ratings analysts wrote in a recent research note.
Harry Kohl, a Fitch analyst, said online lenders specializing in subprime loans may struggle to collect from their customers. In April, the unemployment rate for Americans without a high school diploma was 20.9%, compared to 8.2% for those with at least a bachelor’s degree.
“It’s not the people who have the nuggets, the cash and the money saved to make a payment,” Kohl said in an interview. “If they lose their jobs, they have to start making decisions very quickly about what bills they’re going to pay.
During the pandemic, online lenders have offered short-term payment relief to cash-strapped consumers, which could have the short-term effect of masking any deterioration in credit performance.
Industry abstention rates so far have been between 12 and 13 percent, according to Ram Ahluwalia, chief executive of analytics firm PeerIQ. He estimated that the losses could eventually reach around 20%, although he also noted that a lot depends on the future course of the virus.
The securitization market has long been a key source of funding for online lenders, but recently it has become difficult, if not impossible, to access it.
Against this backdrop, online consumer lenders are pressuring the Federal Reserve to include investment-grade unsecured personal loans in the term asset-backed securities lending facility, which was designed to take off. the asset-backed securities market.
All the bad news for the sector has been tempered to some extent by the government’s stimulus efforts – in particular, the cash payments and expanded unemployment benefits that were part of the Aid, Relief Act. and economic security from coronaviruses – which have allowed many borrowers to continue making their loan repayments.
So far, the increase in the number of online loans withheld or at some stage of delinquency has been less than the spike in unemployment, according to a report released this week by data provider dv01.
“Consumers entered the COVID-19 crisis with healthy debt levels relative to income and wealth, as well as historically low debt service ratios,” the report says. “It is therefore not surprising to see credit showing signs of an earlier recovery, a very different picture from that of the 2008 crisis.”
Still, questions remain about which dominoes will fall if unemployment remains substantially high when government payments to U.S. consumers stop.
In anticipation of what might happen, LendingClub increased the size of its collection staff by about 30% in early May. The San Francisco-based company also cut its overall workforce by around 30%, while announcing plans to cut second-quarter loan issuance by 90%.
LendingClub moved quickly to consolidate its liquidity, increasing its cash and cash equivalents by 21% to $ 294 million as of March 31.
“With our lower spend execution rate, we believe we have enough cash flow through the end of 2021 under various stress scenarios,” LendingClub CFO Thomas Casey said on the earnings call for the company on May 5.
Afterpay, an Australia-based online lender that entered the U.S. market in 2018, is also bracing for a prolonged downturn, cutting operating expenses and pulling $ 97 million in warehouse debt.
Unlike online consumer lenders specializing in personal loans, Afterpay is part of a new generation of businesses that provide finance directly to buyers. Afterpay partners with retailers such as Anthropologie and Urban Outfitters, which currently offer company financing only for online purchases in the United States
Ahead of the coronavirus crisis, Afterpay said it plans to offer in-store financing in the United States in the coming months. In mid-April, the company said these preparations were continuing, but added in a written disclosure: “The timing of our launch will depend on when offline retail resumes in the United States.”
Vulnerabilities Exposed Among Online Small Business Lenders
On the contrary, the situation is even bleaker for online lenders who provide loans to small businesses.
Many of these companies lend at high interest rates to restaurants and other businesses that cannot qualify for more affordable credit from a bank. Much of this borrowing could have been unsustainable even if good economic conditions had continued.
Instead, many small businesses saw their revenues decimated this spring. Discover Financial Services said its credit card holders spent 60% less in restaurants in the first three weeks of April, compared to the same period a year earlier. For travel-related businesses, the drop was 99%.
As in the consumer arena, online small business lenders have seen their traditional sources of funding dry up. “It’s like the end of the world is happening,” said Ahluwalia of PeerIQ.
OnDeck Capital, which is one of the largest online business lenders in the United States, said about 45% of its loans were in some stage of delinquency at the end of April. The New York-based company has suspended the creation of its traditional products. OnDeck loans have an average annual percentage rate of 44.5%, a rate high enough that even healthy businesses can struggle to stay up to date.
“As of the third week of March, we started to see an increase in the volume of calls to our customer service center,” said OnDeck CEO Noah Breslow during the call for the results of the company on April 30. “Our volume of inbound calls and emails peaked at about six times normal levels during the second week of April.”
When OnDeck held its initial public offering in late 2014, the company’s shares opened at $ 26.50. In the first two months of this year, stocks were trading in a range of $ 4. On Thursday, they closed at 66 cents, giving the company a market cap of just $ 38.6 million.
It wasn’t just OnDeck that got hammered. Kabbage, another major player in the sector, would have stopped lending completely At the beginning of April.
Square, which offers financing to merchants who use its payment services, suspended new offerings on its basic loan product in mid-March, according to a public disclosure. The San Francisco-based company said unfavorable changes in economic conditions had strained its ability to correctly identify eligible borrowers.
Some online small business lenders have sought to carve out roles for themselves in the Paycheck Protection Program, the $ 660 billion federal emergency effort to stop the bleeding into U.S. small businesses. But investors aren’t counting on a government lifeline for lenders.
On Monday, the Kroll Bond rating agency said that Three in line commercial lenders crashed into securitization triggers due to what he called asset deficiencies. “In light of these unprecedented events associated with COVID-19, the risks to the industry are not specific to any company or their credit underwriting,” Kroll said in a March 30 report.