Digital Lending Companies Considering Stricter Credit Approvals

Fintech Investing

Digital lenders from LendingClub, Kabbage and Avant are taking measures to prepare for the industry’s first economic downturn.

After the stock market crash in September 2008, peer-to-peer lenders, marketplace lenders (MPLs) and other digital lending companies began to emerge as distrust and uncertainty surrounded the banking industry.

Over the past decade, the digital lending industry has evolved to become more sophisticated. For example, companies are integrating big data and proprietary algorithms to analyze borrowers’ credit risk scores in a matter of seconds, says Juniper Research. The ability to scale and analyze this data provides dramatic cost efficiencies. In comparison, traditional loans can take several months to be approved.

The firm states that MPLs are projected to generate US$588 billion in loan origination value annually by 2023. This is estimated to account for 41 percent of funding for small- and medium-sized enterprises around the world.

Revenue from MPLs is predicted to grow at a 48 percent compound annual growth rate. This will bring MPL platform revenue to US$137 billion annually by 2023, a 400 percent return from the estimated US$30 billion in revenue in 2019.

According to a Forbes report from March, 2019 marks the longest bull run in history, which is now entering its 10th year.

On Sunday (April 14), Reuters reported that a number of digital lending companies are taking steps to position themselves for the first economic downturn to face this industry.

The US Federal Reserve put a hold on interest rate rises earlier this year, with Fed Chair Jerome Powell citing dampening global growth and tighter credit conditions behind its reasonings. Digital lenders are taking note, and reporting that they are considering stricter credit approval processes while cutting costs in business operations.

Economists surveyed by Reuters in March put a 25 percent chance of a recession happening in the US within the next 12 months.

“We were seeing economists bringing up some warning signs, and we were following the Fed signals and that they were becoming more dovish,”  Bhanu Arora, head of consumer lending at digital lender Avant, told the media company.

Digital lending companies are preparing accordingly. For example, SoFi, an online student loan company, is focused less on profitability and originating loan volume and instead on growth, Bloomberg notes.

Recently digital lender Kabbage raised a record US$700 million in securitization financing. Despite the notable funding achievement, its executive sentiment remains cautious.

“We have been waiting for the next recession to happen for the past five years … More people feel confident that it’s imminent,” Kabbage Co-founder Kathryn Petralia told Reuters. Kabbage said the funds are planned to be used for “an existing asset-backed securitization transaction.”

Peer-to-peer lending company LendingClub (NYSE:LC) is the foremost of its kind in the US, connecting borrowers and lenders on its platform. LendingClub released its Q4 and year-end financial results in February, where it reported record net revenue of US$694.8 million and record loan origination volumes.

Even as it reported stellar financial results, the company reported lower growth expectations moving into 2019. CEO Scott Sanborn told Reuters that it is seeking more risk hungry investors to shelter from the potential loss of investors who are more risk averse. Sanborn further noted that LendingClub credit standards are tightening because of the current market environment.

Year-to-date, LendingClub shares have risen over 22 percent. Digital lending company Lendingtree (NASDAQ:TREE) has seen a share price increase of over 66 percent, and peer company GreenSky (NASDAQ:GSKY), which provides services such as online loans for home improvement and healthcare, was up over 53 percent as of Wednesday (April 17). 

Overall, digital lending companies provide investors with exposure to a new asset class in the lending sector. Morgan Stanley (NYSE:MS) reports that digital lending can provide investors with higher yields and lower durations, low correlation to fixed income asset classes and absolute returns.

In fact, between 2011 and 2017, returns from the Orchard US Consumer Marketplace Lending Index (which tracks online lending platforms with over US$250 million in aggregate loans) showed superior returns to both US real estate investment trusts and traditional fixed income assets.

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Securities Disclosure: I, Dorothy Neufeld, hold no direct investment interest in any company mentioned in this article.

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