Online Lending


By Shelly Hagan and Adam Tempkin

It’s gotten a lot harder to borrow money from the raft of fintech firms looking to bring online lending into the mainstream.

Besieged by a wave of defaults after several years of rapid growth, the biggest online-lending platforms have been forced by bond investors to tighten underwriting standards. Social Finance, Prosper, LendingClub and Avant now demand higher average credit scores and offer shorter maturities to boost the quality of loans they repackage into asset-backed securities.

The shift in the $30 billion market comes after a swarm of borrower defaults in the past three years rattled ABS investors. It also marks a coming of age of sorts for the fintech startups that offered cut-rate loans to build a customer base. Now, with rates rising and a potential economic slowdown looming, the move toward higher-quality from the push for quantity has taken on added urgency.

“They all had a pretty tough time and took losses a lot more than expected,” said Henry Song, a portfolio manager at Diamond Hill Capital Management Inc., a Columbus, Ohio-based investment firm that invests in online-lending securitizations and manages $23 billion. “Some dropped certain grades and the mentality of grabbing market share to be profitable has shifted.”

Fintech startups have sprouted up in recent years to target younger borrowers who are more comfortable applying for loans online and who have been underserved by traditional banks. The group, which tends to specialize in student and personal loans for cash-strapped millennials, hasn’t been without growing pains. Many lenders have high default rates even as unemployment levels fall to multidecade lows.

Delinquency rates for LendingClub, Prosper loans issued 2013 to 2016 are rising year over year. Source: PeerIQ

“Yields were going down, a lot of that was due to competition. They were lowering rates just to stay competitive with each other,” Bill Kassul, a principal at Ranger Capital Group in Dallas, said in an interview, adding that his firm used to invest in online-lending ABS, but backed away because the returns became less attractive, given the risk.

Online-lending platforms have responded to higher default rates and increased write-offs by raising interest rates, rejecting consumers with lower credit scores and shifting toward shorter-term loans, according to Kroll Bond Rating Agency.

“We have seen many of the platforms tightening their underwriting or essentially eliminating certain segments,” said Rosemary Kelley, a senior managing director at Kroll, in an interview. “They are changing certain criteria in order to move up-tier somewhat in terms of the credit that they’re taking.”

The number of ABS issued by online lenders that saw performance triggers activated by missed payments declined last year, even as total loan losses rose, Kroll said in a recent report. That signals an increase in overall quality in the securities.

For instance, San Francisco-based Prosper, the third-largest online-lending platform, said its loans in the first quarter were less risky compared to those issued in the same time frame last year.

According to Kroll, the weighted average of FICO credit scores of Prosper’s loans packaged in ABS increased to 717 in a March 2018 deal from 704 in a sale two years earlier.

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