Shift expanding the reach of tech-enabled lenders
As the U.S. and global economies continue to expand and recover from the Great Recession of 2007-2009, the consumer, a key driver of the U.S. economy, is spending again and tapping into different types of credit. The rapid growth of online lenders, expansion of digitally enabled lending technologies (e.g. point of sale solutions at the home or online), and growth in lending to subprime borrowers are all catalysts for the rise in demand.
Furthermore, increases in M&A activity in the consumer lending space demonstrate that the consumer is back and ready to borrow. Just this year, Elevate Credit completed their long-anticipated IPO, ECN paid $304 million to acquire Service Finance, and Prosper announced a $5 billion loan program.
Total consumer borrowing, which includes both loans and revolving credit accounts, rose by $18.4 billion in May 2017. This rise in borrowing is the highest since November 2016 when it increased by $25.1 billion. Additionally, total household debt reached a record $12.7 trillion in March 2017 — a $50 billion increase over its peak just prior to the height of the market in 2008.
The increase in demand for consumer credit in the U.S. is the result of three factors influencing the economy. We see these factors as key to expansion and further growth in the consumer lending segment:
1) Improved credit scores
Equifax, Experian, and TransUnion implemented a new credit rating process on July 1, 2017, which excluded certain civil debts and tax liens. As a result, FICO estimates that approximately 7 percent of consumers now have credit scores up to 20 points higher than they did previously. Many of those consumers who did not have the necessary credit score to access capital (loans, credit cards) now qualify due to higher FICO scores. This development, coupled with the general improvement of credit scores as bankruptcies roll off credit reports, will enable higher levels of consumer borrowing.
At the same time, many consumers who suffered through bankruptcies and foreclosures during the real estate collapse, which peaked in early 2010, are recovering from the blow to their credit. According to a recent report released by Barclays PLC, more than six million Americans will see personal bankruptcies disappear from their credit reports within the next five years. These consumers will soon have greater purchasing power through access to credit.
And finally, credit score education programs are proving effective at getting consumers to change behaviors that negatively impact their credit scores. FICO reports that its consumer education initiative, Open Access, now provides over 200 million consumers with free access to their credit scores and actions they can take to improve the score.
These factors alone will accelerate growth for prime consumer finance names such as Synchrony Financial and Ally Financial, but also for other companies including Elevate Credit, Prosper, and LendingClub.
2) Confidence in the economy is on the rise.
In March 2017, U.S. consumer confidence in the economy hit a 16-year high and has remained at elevated levels. This leap followed the election of President Donald Trump, whose pro-business and pro-deregulation agendas have experts predicting significant economic gains for the housing, job, and stock markets in the near future.
Furthermore, the Federal Reserve has raised interest rates only three times since the economic crisis, but now has plans to raise rates at least two — if not three — more times this year. The rise in interest rates is a key indicator of a successful economic recovery.
When consumers are confident that the economy is on an upswing, they often make large purchasing decisions again — buying homes, cars, and other substantial assets. Consequently, their credit needs increase, which contributes to the rise in demand for consumer loans. Consumers may also increase spending on smaller luxury items that require short-term credit, such as vacations and holiday gifts. We’re in the middle of vacation season now and the holiday shopping season is just around the corner. We anticipate increasing demand for consumer credit through the remainder of the year.
Companies that stand to benefit from the increase in consumer confidence and its subsequent positive effect on consumers’ demand for credit run the gamut from traditional banks; disruptive players in the online lending space such as LendingTree, Quicken Loans, and SoFi; and smaller “Main Street” businesses that are so vital to local economies.
3) Unemployment rate is declining.
The upswing in the economy has brought with it a welcome dip in the unemployment rate. In May 2017, unemployment hit a 16-year low of 4.3 percent. In the same month, disposable income reached an all-time high of $14.49 billion. Both of these numbers are highly influential on activity in the consumer lending space. After all, when more consumers are employed and potentially earning disposable income, their spending increases along with their demand for credit.
Also interesting from a lending standpoint is the creation of what experts are calling the New Middle Class, which has been caused in part by the gradual reentry of Americans into the workplace post-recession. This term applies to roughly 160 million consumers in the U.S. population, and describes the large segment of the population who were negatively affected by the financial crisis and now have near-prime or subprime credit as a result and will continue to have less-than-prime credit despite the changes in FICO score qualifications.
The New Middle Class have been largely underserved since the recession, but are gaining access to the capital they require as non-banks, online lenders, and fintech-powered alternative loan providers work to meet consumer demands. As this segment of the population’s credit needs increase, non-banks’ influence in the lending space is becoming increasingly significant. As of 2016, six non-banks — including Quicken Loans, loanDepot, and PHH Mortgage — were included in the top 10 largest lenders by volume; in 2011, non-banks made up just two of the 10.
Lenders Must Quickly Ready Themselves to Serve More Consumers
As demand for consumer credit increases, providing a highly efficient means of accessing that credit is important. Evidence indicates that the rise in demand for consumer loans and credit cards has created a unique opportunity for online lenders and other fintech-powered loan providers to meet the needs of this market — and that credit providers that leverage fintech to facilitate the application and approval processes can successfully compete with traditional lenders who still use time-consuming, antiquated processes. The door is open and the time is right for innovative solutions in the consumer lending space.
Written by Alex Koles, CEO of Evolve Capital Partners.
Alex Koles, Founder, CEO, Managing Director, Evolve Capital Partners Alexander Koles is a Managing Director and Founder of Evolve Capital Partners, based in New York City. He has over 14 years of investment banking and advisory experience working with regional and multinational corporations on merger and acquisition strategies and execution, restructurings, and complex financings.
Prior to founding Evolve Capital Partners, he worked at a number of leading investment banks in leadership roles focused on restructuring deals. His restructuring career began at BDO where he provided restructuring advisory and transaction services for distressed companies and their stakeholders, notably in the sustainability space.
He started his career at Merrill Lynch as an investment banking analyst in the corporate finance group.
Koles is qualified as a FINRA Investment Banking Representative (Series 79), Private Securities Offering Representative (Series 82) and Uniform Securities Agent (Series 63). He received a Bachelor of Arts in Economics from Macalester College in St. Paul, Minnesota.