Credit Cards and Installment Loans: Misery May Love Company, But I’ll Take a Plastic Everyday
Our December 2019 Viewpoint, titled “Credit card lenders: refine your strategies and don’t let fintech scare you awayexplained how credit card issuers should not fear installment lenders trying to turn credit card balances into consolidation loans and acquire point-of-sale financing into term loans.
The premise was simple: alternative lenders have not yet experienced an economic transition, unlike credit card issuers, which adapted their business during the recessions of 1960 (10 months), 1970 (11 months), 1973-1975 (16 months), 1980-1982 (22 months), 1990-1991 (9 months), 2001 (8 months) and 2008-2009 (20 months).
There have been a few credit card flops along the way, like Advantage, International Householdand MBNA. Yet for the most part, the industry has moved on, with more robust credit scoring, better risk tools, and economies pushing towards digital cash.
Installment loans predated credit cards, but at first they involved lump sum payments. You pay monthly interest, then at the end pay the principal balance. It was a crazy model that created a false sense of security for borrowers and lenders.
Things changed in the late 1800s when retailers such as Singer Sewing Machines and loan companies such as Household Finance created a business model in which a portion of the balance and monthly interest were owed each month. When credit cards emerged in the early 1970s, plastic proved to be a more accessible tool, with a new feature: revolving credit.
Fintechs have taken over this model over the past five years and have become the main source of installment loans; they attempted to redirect credit card volumes to the old installment process. There have been some successes, but we challenge the model by saying that revolving debt is more manageable than installment debt. Another factor is that financial institutions have a functional, proven and resilient model.
Here we are today.
Forbes looks at the same issue and has similar conclusions to our December viewpoint. While we certainly had no idea of a global pandemic, we believe a recession is long overdue. Forbes points to an interesting analyst firm named dv01, which is an investment management formula used to calculate the value of a basis point. Nerdy, but exciting stuff.
But according to Data provided by New York-based fintech Dv01, loan defaults are already a serious problem for online lenders.
As of April 9, some 12% of consumer loans granted by online lenders are already “depreciated”.
This means that the borrower skipped a payment either by negotiating an extension of the due date with a lender or simply by not paying.
That’s a near doubling of troubled loans in three weeks, according to data that tracks 1.7 million loans worth $19 billion provided by Dv01, which is named after a formula that traders use to calculate their exposure to changes in interest rates.
Well, the cards aren’t pretty, but they’re acid-tested.
In its annual stress tests, the Federal Reserve models major bank credit card loss rates at 11.3% in an “unfavorable scenario” and 16.35% in an “extremely adverse” scenario.
The new findings from Dv01 mean that at least among online lenders, credit problems have already outgrown a bad recession and are heading towards depression-like levels.
Data from Dv01 tracks loans from online platforms such as LendingClub, SoFi, Best Egg and Prosper Marketplace.
The average FICO score of the loans tracked was 715 and the average loan balance was $11,400.
While large and comprehensive, the dataset only covers a fraction of America’s record $14 trillion household debt, including more than $4 trillion in credit card debt.
Misery may love company, but I still feel more comfortable with my range of American Express, Discover, Mastercard and Visa in my wallet.
Preview by Brian RileyDirector, Credit Advisory Services at Groupe Conseil Mercator