Fintech lenders tighten lending standards, bolstering debt financing

During the COVID-19 pandemic, many fintechs began lending to borrowers with imperfect credit, but Wall Street investors were comfortable buying their asset-backed securities as government stimulus ensured consumers had the money to meet repayments.

Asset-backed securities (ABS) are a type of bond backed by a pool of assets, such as auto or credit card loans, which pay a fixed yield. They are a key source of financing for some fintech lenders, which have fewer funding options than banks.

As the end of pandemic stimulus and rising inflation led delinquency rates to normalize, investors shunned the fintech ABS market late last year.

Fintechs like Upstart, Affirm and OneMain Financial say they are boosting credit quality, in another example of how lenders have been pulling back amid uncertainty over the economic outlook. That in turn has improved the quality of their ABS offerings, executives say.

“As delinquencies have risen over the past year and a half, we’ve adjusted accordingly in how we calibrate our models and assess default risk,” said Sanjay Datta, the chief financial officer at Upstart, which specializes in loans for subprime borrowers.

Discover the stories of your interest

“The outcome of that is that the collateral that’s forming the basis of these ABS deals looks very different and is much more conservative now,” Datta added. Buy-now-pay-later giant Affirm mostly lends to near-prime and prime borrowers, but has tightened its credit standards further this year, said CEO Max Levchin. The average credit score of non-interest bearing loans in its ABS offering in 2023 was 731, compared to 706 in its previous offering last year, according to Morningstar.

A OneMain spokesperson referred Reuters to the lender’s April 25 earnings call, where CEO Doug Shulman said that roughly 65% of OneMain’s new loans in the first quarter went to borrowers with the best credit quality, compared to 30% to 40% in 2021.

These efforts appear to be wooing back some ABS investors.

After hitting a two-year low in the first quarter of 2023, issuance of ABS that bundled unsecured consumer loans mostly from fintechs or marketplace lenders rose 17% in the second quarter to reach $3.4 billion, according to data provider Finsight.

To be sure, that is a slow pace compared to the $9.6 billion issued in the first half of 2022, and fintech issuers are offering higher yields to compensate for loan loss risk. The average yield for the highest quality AAA-rated tranches of unsecured consumer loan ABS issued so far this year is 6.24%, compared with 3.78% this time last year, according to Finsight.

Still, analysts say it is a sign the fintech ABS market is recovering.

“The year started better than many would have expected,” said Robert Wildhack, an analyst at Autonomous Research.

In addition to pandemic stimulus phasing out, inflation has hit subprime consumers who spend most of their income on rent, groceries and gasoline, according to Moody’s.

For fintech loans to borrowers with weighted average credit scores between 710 and 760, annualized net losses rose by 1.98% from May to June, to 8.11%, according to Kroll Bond Rating Agency, which noted this primarily reflects charge-offs on 2022 loans. Delinquencies of at least 30 days on loans in this tier rose 0.58%, to 3.74%.

For fintech loans to borrowers with weighted average credit scores between 660 and 710, annualized net losses rose by 1.88% month-over-month to 16.61%. Thirty plus-day delinquencies rose 0.51%, to 6.36%.