During the downturn in the economy, many financial institutions pulled back on personal loan lending. Since 2010, the personal loan space has grown dramatically, now well above previous highs seen in the mid-2000s. By the second quarter of 2017, nearly 16 million consumers had a personal loan.
FinTechs have emerged as a driving force behind this resurgence in personal loans. While banks, credit unions and traditional finance companies have realized strong growth in personal loan originations during the same period, FinTechs have grown from only 1% of personal loan originations in 2010 to nearly a third of the entire personal loan market by the end of Q2 2017.
To explore the FinTech narratives, we analyzed over 40 million personal loans issued between 2014 and 2016. In this article, we will separate the fact from the fiction surrounding five of the most common FinTech narratives.
Narrative 1: FinTech consumers are mostly millennials
-FALSE-
Perhaps due to their digital nature, many assume FinTechs serve primarily younger consumers. An extension of this narrative is that older consumers are not interested in turning to a FinTech, since the whole “tech thing” is beyond them.
But the data show otherwise. In fact, FinTechs have the lowest proportion of younger consumers and the largest concentration of consumers aged between 30 and 64 years old. FinTechs appear to resonate with consumers across all age groups.
Narrative 2: FinTech consumers turn to FinTechs as their only source of financing
-FALSE-
Often we hear that FinTechs appeal only as a last resort for consumers who are unable to obtain financing from other lenders. But FinTech consumers typically have other loans, and have a similar distribution and penetration to bank and credit union consumers. FinTech consumers elect to incorporate FinTech loans into their broader personal finance portfolio.
Narrative 3: FinTechs originate loans to riskier consumers
-FALSE-
We also hear that FinTechs originate mostly to riskier consumers, and this has fueled their growth. But when we compared the FinTechs’ risk appetite to other lenders, FinTechs were actually somewhere in the middle. FinTechs are more conservative than traditional finance companies, but have a higher risk appetite than banks.
Surprisingly, we found that FinTechs’ risk distribution is nearly identical to that of credit unions. Credit unions pride themselves on their in-depth understanding of their members. Using advanced analytics and non-traditional credit, such as FCRA-compliant trended credit and alternative data, FinTechs have achieved a similar degree of consumer insight.
Narrative 4: FinTechs suffer from high delinquency rates
-MOSTLY FALSE-
Another common narrative is that FinTech delinquency rates are higher than other lenders or their delinquency rates have been increasing. And in the subprime risk tier, which accounts for 10% of FinTech balances, FinTechs have the highest rates of delinquency.
Looking at the near prime risk tier, FinTech delinquency rates drop below traditional lender delinquencies. For the prime risk tiers, delinquency rates for all lender types begin to converge, becoming almost indistinguishable as we move up the credit spectrum.
While FinTechs do have the highest level of delinquencies for 10% of their loan balances, the data show that 90% of Fintech delinquencies are in between or very similar to other lenders.
Narrative 5: FinTech portfolios are not performing well
-FALSE-
Typically, the discussion about FinTech performance stops at delinquencies. But one can argue this provides an incomplete view of loan performance. To obtain a deeper understanding of how Fintech portfolios are performing, we looked at their performance from a risk-return perspective. To do this, we calculated the risk-adjusted margins (RAM) FinTechs generate and compared these to the RAM generated by the other lender types.
We observed risk-based pricing for all lender types, but FinTechs have the most robust risk-based pricing. With analytics and trended credit and alternative data, FinTechs gain a more refined view of risk, enabling them to compete effectively across the entire credit spectrum.
To evaluate FinTechs on a risk-return basis, we developed a coarse risk-return metric* and the data show FinTechs generate portfolio risk-return ratios that actually exceed those of banks and credit unions.
Certainly, there are FinTechs whose portfolios have generated lower returns. Likewise, there are those whose returns exceed this sector average. But for investors evaluating FinTech opportunities and traditional lenders trying to understand the viability of adopting more FinTech-like capabilities, FinTech portfolios appear to be performing well.
For more information on how TransUnion works with FinTechs, visit transunion.com/fintech.
*To develop the risk-return metric, the first step was to estimate APRs and calculate interest income over the first year on books for any given cohort of personal loans. Next, loan balances that were delinquent 60 or more days past due were subtracted from this interest income measure as a conservative estimate of losses. The net difference was then divided by the total original balance of the cohort to arrive at a risk-return measure. For example, a $100M portfolio generating $15M in interest income and having $5M in 60+ DPD balances in the first year would yield a risk-return measure of 10%. This is a coarse measure of risk versus return, in that costs associated with funding, branches, operating expenses, collections, and technology are not accounted for—but it is a good starting point for comparison of performance across lender types.
