The digital lenders that have shaken up the U.S. personal loan business over the last half-decade are getting an earful from a leader of the industry’s old guard.
Discover Financial Services CEO David Nelms said this week that many of the online lenders that have emerged in recent years do not understand how to underwrite the loans properly over the long run. He also jabbed at the technology-focused firms for their failure to achieve profitability.
“It really takes a decade of experience going through cycles to understand how to use credit bureau information to have good predictions,” Nelms said in an interview. “The funny thing is they’re not making money, even in a great cycle.”
Those barbs drew a sharp response from Nathaniel Hoopes, the executive director of the Marketplace Lending Association, a digital lending trade group whose members include LendingClub, Prosper Marketplace, Avant, Upstart and Affirm.
“The solid growth story in marketplace lending over the past few years must be starting to bite into the profitability of the credit card issuers and other traditional lenders,” Hoopes said in an email.
“Well over a million marketplace loans were issued last year, and after more than a decade of underwriting performance at some of the longest-operating platforms, marketplace platforms continue to attract investment from the most sophisticated credit investors. That simply speaks for itself,” Hoopes added.
The rising tensions come at a time when both banks and digital lenders are seeing losses in their personal loan portfolios increase. The unsecured installment loans typically feature lower interest rates than credit cards, so they can be an attractive way to consolidate existing card balances, though they can also enable consumers to add to their debt burdens.
There are a couple ways in which the emergence of online lenders is putting pressure on the bottom lines of more traditional lenders such as Discover.
First, card companies lose out on interest income when their customers consolidate their debt at an online lender. And second, some U.S. consumers have taken out personal loans from multiple firms, which has hampered their ability meet their various payment obligations, including their credit card bills. The six largest U.S. credit card issuers all reported higher credit losses in the fourth quarter of 2017 than in the same period a year earlier.
Nelms said that most of Discover’s credit card customers do not also have personal loans. “But those that do on average tend to be a little bit riskier, we’re finding,” he added.
In response to rising losses in its $7.4 billion portfolio of personal loans, Discover has tightened its lending standards in recent months. The Riverwoods, Ill.-based firm said Wednesday that it expects that personal loan growth to decline in the coming year.
The personal loan business has long been one of the most volatile segments of the consumer finance industry, and loan originations fell sharply during the financial crisis. The segment has since made a big comeback, due not only to the emergence of online lenders but also because of the involvement of banks including Discover, Wells Fargo, TD Bank and, most recently, Goldman Sachs.
Veterans of the consumer credit industry have been waiting to see how well prepared the new crop of online lenders are for the next downturn.
“Even assuming these newly developed models improve credit underwriting,” analysts at Moody’s Investors Service wrote in a 2016 report, “history strongly suggests that the most important determinant of long-term credit performance is a company’s ability to maintain underwriting disciple during periods of slowing or weak volume, or when high growth expectations need to be consistently met or exceeded to justify high company valuations.”
Mike Taiano, an analyst at Fitch Ratings, said that the business models of certain online lenders bring back memories of a decade ago, when shoddy mortgages were originated by companies that avoided taking losses by quickly selling the loans. Likewise, some online lenders pass credit risk along to investors who buy their loans.
“Some of these models are set up where they don’t have skin in the game,” Taiano said.
But David Snitkof, chief analytics officer at Orchard Platform, a company that provides data about online loans to investors, said that some industry participants have developed sophisticated underwriting techniques that draw on a deep understanding of their customers’ financial lives.
“I wouldn’t paint all of the online or fintech lenders with the same brush,” Snitkof said.