BankThink

Fed’s new TALF has a major gap

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The Federal Reserve’s recent decision to revive the Term Asset-Backed Securities Loan Facility was a good and necessary one.

It will bring needed funding stability to many lenders and allow them to continue to support their borrowers as the COVID-19 crisis develops and resolves. But there’s a problem with the Fed’s 2020 version of TALF: it’s out of date.

The facility was based on a market for consumer financial services that existed in 2008 and is blind to what happened afterwards. The most glaring example of this is the rise of unsecured consumer loans.

These loans, particularly those made by nonbank consumer lenders (or fintechs), have become essential to the household finances of millions of consumers that use them. The current TALF eligibility list includes asset-backed securities (ABS) like those backed by auto loans, student loans, credit cards and even insurance premium finance loans (a tiny business in relative terms). But it does not include the nearly $10 billion in consumer loan ABS issued in 2019.

Unless the TALF is changed to include the investment-grade, ABS based on these loans, lenders will shut down originations just when they are most needed. And the Fed will fail in its goal of ensuring that credit flows to millions of vulnerable consumers.

Consumer installment lending volume has more than doubled in the last decade. Unsecured personal loans were projected to reach an all-time high of $156 billion by the end of 2019, according to the St. Louis Fed. A separate study by Experian found that 11% of consumers had such personal loans in mid-2019. Emerging fintech lenders like LendingClub, Prosper and Marlette originated about 50% of the unsecured personal loans in 2019, up from nothing 22% in 2015.

According to the St. Louis Fed, about 78% of consumers used these installment loans to consolidate or pay off existing debt, with the rest used for other purposes, including everything from weddings to home repairs.

Consumer loans also play a big — and unacknowledged — part in small business finance.

Personal loans are disproportionately relied on by disaster-affected small firms, startups and the smallest, most vulnerable businesses, according to a 2017 New York Fed report. About a third of all small business firms less than five years old, with medium or high credit risk (which describes nearly all firms now), rely on the owner’s personal loans to fund their business.

TALF supports credit granting by acquiring ABS. Last year alone, more than $9.5 billion of consumer loan ABS were issued on behalf of lenders like SoFi, LendingClub, Marlette and Prosper. All of these fintechs fund their lending with ABS.

Most of these ABS are sold into the institutional market, often as “private” issuances. But that market is frozen solid.

Reported spreads on A-rated, asset-backed securities issued by nonbank consumer lenders are now so wide that none of these lenders can generate a positive gain on sale, let alone cover other operating costs.

The hedge funds and financial institutions that typically acquire these companies’ securitizations are starting to close off market access. Unless lenders have balance sheet capacity to hold the loans they make, they will either shut down new originations and rollovers or go out of business. This would leave borrowers to fend for themselves in a world with very limited credit.

Unfortunately, few fintechs have the needed capital capacity. That’s certain to cause thousands of their customers to suffer when credit is withdrawn. And that’s exactly the situation TALF is intended to prevent.

Consumer installment lending has been around in one form or another since the days of household finance. Like most consumer lending products, it’s far from perfect.

While most consumer lenders charge reasonable risk-based interest rates, there is a subset of providers who charge way too much to lend to people who shouldn’t borrow at all. They should not be protected by government programs.

Luckily, since those lenders can’t securitize their high-cost, high-risk loans, the worst lenders won’t be eligible for TALF. While some lenders have commendably focused on consumer financial health and counseling, others seem indifferent.

And the critical flaw in many lenders’ business models — an overdependence on the ABS market for funding — is now obvious to all. Fortunately, there are already signs that some lenders may be transitioning to bank deposits for funding, such as LendingClub’s recently announced deal to acquire Radius Bank.

So, given all these issues, why should anyone care whether these lenders get TALF funding now?

The answer is simple: their customers care. Millions of individuals rely on this type of credit from these nonbank companies to manage their financial lives. It is their needs that we need to pay attention to.

Without access to fairly priced loans, especially in the current crisis, many consumers will end up without credit options or use far less friendly, and far more expensive types of credit, at exactly the wrong time. Companies that lend to these consumers need the affordable funding that can only come from TALF.

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