Banking industry executives are confident that their consumer loan portfolios are holding up, but nonbanks that lend to Americans with lower credit scores are starting to see cracks.
The deterioration in credit is prompting investors to take a more cautious view of certain lenders and is already contributing to funding issues for at least one company. Upstart Holdings, a digital consumer lender, said last month that the marketplace where it sells consumer loans to investors was "funding constrained."
Other lenders that focus more on borrowers with below-prime credit scores — offering products such as auto loans, personal loans, credit cards and short-term buy now/pay later loans — are also starting to see more people fall behind on their payments. Higher loan delinquencies raise the risk that borrowers won't pay back their loans, and lenders will have to charge them off.
"I don't think we're at the red-flag stage," said Michael Taiano, senior director at Fitch Ratings. "Maybe it's starting to turn a little bit yellow."
The picture is different for banks, where CEOs were largely positive about the health of their higher-credit-score customer bases in recent earnings calls. The lending industry is "definitely seeing a bifurcation" in credit quality, Taiano said, with those that lend to people with stronger credit profiles faring better while nonprime lenders report rising delinquencies.
The credit deterioration is still in its early stages, and how far it goes will largely depend on whether the strong job market continues, Taiano said. Jobs ensure that borrowers have enough income to pay back their loans.
But high inflation is putting the U.S. in somewhat "uncharted territory," Taiano said, since Americans had far less debt in the 1980s, the last time inflation was around 9%.
Late payment rates on low-income borrowers' credit cards and auto loans are
A weakening of credit quality is also occurring in the unsecured personal loan business, which is geared a bit more toward borrowers with below-prime credit scores than the credit card market.
The percentage of personal loan borrowers who were at least 60 days late on their bills hit 3.37% in the second quarter, according to the credit reporting firm TransUnion. While that percentage remains a bit below historical averages, the 60-plus-day delinquency rate surpassed its pre-pandemic level of just above 3.10%.
Late payments are becoming more common in part because lenders earlier this year started offering more loans to nonprime borrowers, whose delinquency figures are generally higher, said Salman Chand, vice president at TransUnion.
The trend also reflects the fading impacts of assistance earlier in the pandemic — such as stimulus checks, loan deferments and expanded unemployment benefits — which helped keep many consumers afloat, Chand said.
Companies that have reported delinquency upticks include the subprime installment lender OneMain Financial, where the 30-plus-day delinquency ratio rose to 4.88% as of June 30, up from 3.12% a year earlier. Net charge-offs reached nearly 6% in the quarter, up from 4.41% a year earlier.
"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," OneMain CEO Douglas Shulman told analysts last month.
OneMain has tightened its underwriting criteria significantly in the past two months to focus on lower-risk customers, whose credit performance has been "very much in line with our expectations," Shulman said.
Credit has also been deteriorating at buy now/pay later lenders, which exploded in popularity during the pandemic as consumers spent more money on goods at retailer websites that were offering deferred payment options.
At Affirm Holdings, a publicly traded U.S.-based lender, the 30-plus-day delinquency rate rose to 3.7% of loans at the end of March, up from 1.4% a year earlier. Afterpay, a recently acquired subsidiary of
Other large buy now/pay later companies operating in the United States include the Swedish company Klarna, Minneapolis-based Sezzle and Australia-based Zip. Last month, Zip
While these companies have enjoyed substantial growth, their novelty means their underwriting models haven't "really been tested through a challenging cycle," Fitch's Taiano said.
"We're probably entering a stretch where you're going to see a separation between those that are relatively good underwriters and those that are not," Taiano said, recalling the famous Warren Buffett line that you don't know who's been swimming naked until the tide goes out.
Another challenge facing some nonbank lenders: increased funding costs. Banks and fintechs with bank charters, such as
But other fintechs rely more on selling their loans in venues like the securitization market, where individual loans are bundled up into securities for investors to buy chunks.
Growing recession fears have made investors in those securities "a little more cautious," said Ray Barretto, head asset-backed securities trader at Mitsubishi UFJ Financial Group. While funding isn't drying up, investors are looking for more compensation for taking on risk, Barretto said. That revised calculus comes on top of the Federal Reserve's interest rate hikes, which are also pushing up funding costs.
Taiano pointed to a recent Affirm securitization deal as an example of how the funding environment has gotten tougher. Affirm is paying investors a 5.65% yield for a recent $371 million securitization, Taiano noted in a report last week. That rate is up from a 1.08% yield in a $320 million deal last year.
The online consumer lender touts its AI-based underwriting models as a key strength, but analysts say larger-than-expected losses on some of its loans are contributing to funding pressures.
Analysts are also watching for commentary next week from San Mateo, California-based Upstart, which says its artificial intelligence underwriting models allow it to lend to a broader population.
The company's loan delinquencies and charge-offs have risen faster than expected, which
In a press release last month, Upstart attributed its funding constraints largely to "concerns about the macroeconomy among lenders and capital market participants" and said its loans have "performed exceptionally well."
Upstart executives will discuss their results — which the company previewed a month early through unaudited results — on a conference call after the stock market closes Monday.
The company's funding constraints show the downsides of relying on third-party funders, rather than deposits, according to Wedbush Securities analyst David Chiaverini.
"We fear that weakening delinquency and loss trends combined with macro and geopolitical risks could lead to waning appetite from Upstart's credit buyers and the securitization market," Chiaverini wrote in a note to clients. "The biggest risk to Upstart, in our view, is its reliance on third-party funding, and this risk tends to become exacerbated during recessions."
