Q2 2023 Review | Consumer Lending

Every quarter, we conduct extensive research to provide insights into the consumer lending landscape. In the second quarter, we found that while credit tightening may have kneecapped unsecured consumer origination volumes, it has so far proven effective at preventing a spike in net charge-offs. Domestic MPL new issue volume declined (32)% YoY, but rose 15% QoQ to $3,373Mn as overall costs of debt remain elevated. Catch up on current trends emerging in the consumer lending space in the latest version of our Consumer Lending Review.

Unsecured Consumer Originations Slump on Credit Tightening

Before diving into our second quarter coverage, we wanted to cover new industry data released from TransUnion, showing a continued decline in unsecured personal loan originations (originations reported through Q1 due to reporting lag). Originations fell to 4.3Mn in 1Q23, from 5.2Mn in 4Q22 and 5.6Mn in 3Q22. While originations are generally seasonally lower in Q1, originations of 4.3Mn were well below 1Q22 volumes of 5.0Mn.

The decline in originations was largely driven by a pullback in fintech originations. Starting summer 2022, many fintechs pivoted to significantly tighten credit underwriting standards. The era of fintech dominance for originations and for subprime originations has ended. Finance companies took back their lead for total originations, with 34% of total volume, with fintechs accounting for 27% of total volume, credit unions 22%, and banks 17%. Banks and credit union origination shares of total volume ticked up from a year prior.

Turning to subprime originations, fintechs have fallen to the back of the pack, with 17% of subprime originations, compared to finance companies 61%, credit unions 22%, and banks 19%. A year prior, fintechs had led both credit unions and banks, and accounted for over 25% of total volumes.

In the second quarter, below prime unsecured loan balances accounted for 32.1% of total unsecured balances, down from 32.5% a year prior and 32.8% a quarter prior.

Delinquencies rose slightly on a YoY basis with 30+ DPDs +21 bps, 60+ DPDs +21 bps, and 90+ DPDs +9 bps. Fintech 60+ DPDs rose the most, up +62 bps, followed by credit union 60+ DPDs +40 bps, finance company 60+ DPDs +9 bps, and bank 60+ DPDs +7 bps.

Overall, delinquencies were slightly elevated compared to prepandemic (2Q19) levels. 30+ DPDs were up +44 bps and 60+ DPDs up 22 bps, but 90+ DPDs remained (10) bps lower than prepandemic levels.

On a sequential basis, 30+ DPDs improved (24) bps, 60+ DPDs improved (28) bps, and 90+ DPDs improved (34) bps, though much of this can be attributed to seasonality. To put the seasonal effect into context, the second quarters of 2018 and 2019 averaged a sequential  improvement in 30+ DPDs of (32) bps, 60+ DPDs of (32) bps, and 90+DPDs of (18) bps.

In 2Q23, fintechs were the only cohort not to report a sequential decline in 60+ DPDs. All other cohorts (finance companies, banks, credit unions) reported sequential improvements.

Despite recessionary worries, cracks have yet to emerge in unsecured consumer credit. At this point, it appears that credit tightening efforts have been largely successful in preventing a spike in delinquencies (albeit at the cost of origination growth).

Consumers continued to spend, even as inflation remained at elevated levels, with spend volumes up 8% at Amex, 7% at JPMorgan, 6% at Capital One (credit cards), 3% at Bank of America and 2% at Discover on a YoY basis. July retail sales rose more than expected, up 0.7% MoM vs. the 0.4% estimate (not adjusted for inflation).

With excess pandemic savings tapped out, consumers have turned to revolving debt to finance purchases, with credit card debt hitting a record $1T in July. Despite record levels of credit card debt, TransUnion data showed serious delinquencies (90+ DPDs) of 2.06% remained below prepandemic (4Q19) levels of 2.19%. Average debt per borrower has only increased modestly, +2%, from 4Q19 levels, as the growth in total debt has been primarily fueled by a 10% increase in the number of consumers with a credit card account.

Fed data also showed that 90+ DPDs remained below 4Q19 levels. At the same time, recent Fed data found that less serious (30+ DPDs) delinquencies for credit card and auto are now slightly above prepandemic (4Q19) levels. So far, we have not seen delinquencies meaningful break prepandemic levels, as low levels of unemployment have helped the consumer.

However, as the Fed continues its aggressive rate hike campaign, business leaders still harbor recession worries. Some point to the resumption of student loan payments as a potential catalyst for a credit event. With millions taking on additional payments this fall, and many of those living paycheck-to-paycheck, it means either taking on more debt, cutting back on spending, or falling into delinquency.

While the resumption of student loan payments will put significant pressure on consumers as a whole, only 13% of student loan holders have outstanding unsecured personal loans, potentially lessening the impact on consumer unsecured delinquencies. In addition, nearly half of those who will have to resume payments will owe a monthly payment under $200.

A Slowdown in Consumer Lending for Fintechs, Banks; but Consumer Credit Remains Stable

Fintech originations largely grew sequentially, helped by seasonal trends, but a majority of the companies we cover still posted volumes well below 2022 levels (Upstart (64.1)%, Navient (53.1)%, LendingClub (47.6)%, Oportun (44.8)%, OppFi (11.3)%, OneMain (4.0)%, Enova – Consumer (2.0)%). However, much of the credit tightening in the lending space occurred mid-2022, so looking ahead, we should see more favorable YoY comps.

Exceptions to the YoY decline included Dave – ExtraCash +43.1%, SoFi +36.7%, Affirm +25.5%, MoneyLion +25.3%, and Pagaya +0.5%. SoFi has been able to leverage its deposit base to fund loans, with management disclosing that it realizes cost savings of 216 bps by funding loans through deposits vs. funding loans through its warehouse facilities. Pagaya did not see its network volume drop YoY, but the fintech acts as a facilitator for loans, providing AI-driven analysis to lenders instead of directly originating loans.

LendingClub’s sequential decline in originations coincided with its strategy to retain fewer loans. Though originations declined to $2Bn, this figure was in line with guidance and helped the lender move from retaining 44% of originations to 33% of originations. In line with the strategy to retain fewer loans and tighten credit, LendingClub expects originations to decline further. The company provided guidance of $1.4Bn – $1.7Bn in originations for Q3, representing a decline of 15-30% from second quarter volumes.

To tighten credit, lenders have focused both on existing customers and on raising credit score requirements. Oportun’s earnings report explained that its decline in originations was, “Primarily driven by fewer loans originated due to the Company tightening its credit underwriting standards and focusing lending toward existing and returning members to improve credit outcomes, and was partially offset by growth in average loan size due to the focus on lending to returning members.” Additionally, Oportun CFO Jonathan Coblentz explained, “The percentage of underwritten loans with Vantage scores of 660 or greater was 33% for 2Q22, but increased to 40% during 4Q22 and to 47% during 2Q23.”

OneMain CEO Doug Shulman noted that, “We’ve seen notable increases in the credit quality of our originations. 64% of new customer originations since our major credit tightening in August of 2022 have been in our top two risk rates.”

Upstart reported its second straight (sequential) quarter reducing the loans held on its balance sheet, to $838Mn. This comes after the fintech had increased its balance sheet holdings throughout 2022. The (15)% QoQ decline was driven by a reduction in core personal loans held on the balance sheet. To note, Upstart completed a one-off $200Mn ABS transaction funded entirely from its balance sheet just after the quarter’s close, which was not reflected in the second quarter’s data.

After its vintages underperformed target cash flows for much of 2021-2022, Upstart’s adjustments helped its 1Q23 vintage perform in line with target cash flows. CEO Dave Girouard stated, “We continue to be confident that our core personal loan risk models are properly calibrated and have been so since November of 2022. Thus, we expect these recent vintages to deliver at or above target returns.”

Credit tightening may have kneecapped volumes, but it has so far proven effective at preventing a spike in net charge-offs. OppFi (1,500) bps, Enova – Consumer (250) bps, Navient (24) bps, OneMain (12) bps, and Ally (4) bps all reported sequential improvements in NCOs.

While Oportun +40 bps reported an increase in charge-offs, CEO Raul Vazquez stated, “We expect Q2 to have been the peak level, and we project that our loss rate will decline by approximately 80 basis points in Q3 based upon our midpoint guidance.” Additionally, Oportun reported a (20) bps sequential improvement in 30+ day delinquencies, to 5.3%, suggesting that we may see charge-offs (a lagging indicator) come down later in the year. The other lender to report a sequential increase in NCOs, LendingClub, expects origination volumes to fall another 15-30% next quarter. We would expect that with the reduction in origination volumes, the lender will focus on higher credit quality borrowers.

SoFi provided insight into its consumers’ credit quality in its earnings call, with CFO Chris LaPointe explaining, “Our on-balance sheet delinquency rates and charge off rates remain healthy and are still below pre COVID levels. Our on-balance sheet 90 day personal loan delinquency rate was 40 basis points in Q2 2023, while our annualized personal loan charge-off rate was down sequentially to 2.94%.” The annualized personal loan charge-off rate represents a (3) bps decline from the first quarter.

Turning to banks, Fed data found slowing growth for consumer loan books at commercial banks with YoY growth of just 5.9% in July, down from 7.3% in June and 10.8% in January. Along with this, total consumer loan balances at U.S. banks fell in July to $1.84T, down from $1.87T in June, marking the first MoM decline in balances since 2020.

Credit continued to normalize for bank’s consumer divisions, with YoY increases in NCOs (from historical lows) for all the consumer banks we cover. On a sequential basis, we saw marginal improvements in NCOs for Capital One, Citizens, and PNC, and marginal deteriorations in credit for Synchrony, Bank of America, Wells Fargo, and JPMorgan. Banks did not expand credit as much as fintechs during the pandemic boom, and as such, did not have the need to sharply pivot and tighten credit last year.

All eyes are still on deposits, as consumers continue to chase yield to capitalize on nominal rates not seen in the past decade’s ZIRP landscape.

After the end of Q1’s “flight to safety” prompted by multiple bank failures, Bank of America (4)%  JPMorgan (excl. First Republic Bank) (4)% and Wells Fargo (1)% saw sequential declines in period-end consumer deposits.

Period-end deposits grew sequentially at SoFi +26%, Finwise +17%, Citi – Personal Banking +2%, and Synchrony +2%. Period-end deposits declined sequentially at Capital One (2)%, PNC (2)%, and LendingClub (5)%.

SoFi has continued to grow its deposit base, since launching its Checking & Savings account in 1Q22. The fintech has leaned into consumer’s yield-seeking behavior, paying an average yield of 4.48% on its interest-bearing deposits (with over 99% of deposits interest-bearing).

Finwise deposit growth was fueled by an increase in brokered CDs, primarily utilized for short term funding needs, and HSA deposits from Lively.

Funding costs continue to rise, with Finwise’s cost of deposits growing to 4.02% (up 84 bps QoQ), Synchrony paying an average yield of 3.84% (up 71 bps QoQ), Capital One paying 2.91% (up 51 bps QoQ), and Wells Fargo paying 1.13% (up 30 bps QoQ).

Further evidence of yield-seeking behavior lies within Citizens’ deposit flows. Citizens’ total deposits were up 3% QoQ, but term deposits were up 36.2% (continuing their upward trend) while checking with interest deposits only rose 0.2% and demand deposits were down (9.1)% (continuing their downward trend).

Bank and Fintech Lender Earnings Summary

Tighter Credit Conditions Curtail MPL New Issue Volume

While the Fed is still committed to fighting persistently high inflation, the central bank took a pause on rate hikes in June, before hiking another +25 bps in July to a range of 5.25% to 5.50%. With the 11th rate increase since March 2022, the Fed Funds rate is now the highest it has been since 2001. Looking ahead to the September meeting, CME Group data shows that markets expect a pause in further rate hikes. By year end, markets still expect rates to remain in the 5.25% to 5.50% range, but the likelihood of an additional hike has risen, to over 35% from under 25% (as of July).

Looking ahead, Fed officials have differing views on the right path for interest rates. The divide marks a shift from the recent past, as Powell has only seen two dissents since the Fed began hiking rates in March 2022. Hawks like Christopher Waller and Loretta Mester are in favor of continued rate hikes, while doves like Austan Goolsbee and Raphael Bostic are in favor of ending hikes soon to protect the job market.

As a refresh, in the middle of 2022, lenders (especially fintech lenders) significantly tightened credit underwriting standards and increased target returns to combat credit weakening and higher funding costs. These actions drove down origination volumes (as covered in our section above). Lower origination volumes and less attractive funding has led to lower securitization volumes.

Second quarter new issue volumes declined (32)% YoY, but grew 15% QoQ, to $3,373Mn. Through August 18, there has been $3,331Mn in new issue volume, about equal to the second quarter’s total.

Despite the decline in new issue volume, we have seen some signs of increased demand for this type of paper. OneMain upsized its August OMFIT 2023-2 deal to $1.4Bn from $750Mn. In addition, Pagaya upsized its July PAID 2023-5 issuance to $792Mn from $594Mn, noting that at the peak of the order book it had $2Bn of orders. However, Pagaya did retain $94Mn of its AB tranche, suggesting there may have been less demand for the more junior paper. Pagaya CFO Michael Kurlander stated, “Investor sentiment appears to be improving with consumer unsecured ABS issuances higher this quarter than the prior two sequential quarters, supporting our ability to continue to raise capital to fund new loan origination.”

Looking at Achieve (fka Freedom Financial Network) we saw spreads come down for July’s ACHV 2023-3PL issuance, when compared to April’s ACHV 2023-2PL issuance. July’s ACHV 2023-3PL had a weighted average spread of 295 bps, about 102 bps lower than April’s ACHV 2023-2PL weighted average spread of 397 bps. However, while spreads declined, the weighted average benchmark rate increased to 485 bps from 394 bps, a 91 bps increase. As such, the overall cost of debt declined slightly, by about 11 bps.

OneMain – $825Mn, Pagaya – $585Mn, Marlette – $411Mn, Affirm – $400Mn, Lendmark – $350Mn, Intervest Capital Partners – $237Mn, Theorem – $200Mn, Achieve – $191Mn, and Upstart – $174Mn were among the most active players in the space during the second quarter.

After closing the gap on 2022 cumulative new issue volume by April, 2023 volumes further lagged 2022 over May-July, with only one new issuance closing in June. Through August 18th, cumulative new issue volume of $9,641Mn lagged 2022 (through Aug. 18) volume of $12,173Mn by 21%.