The New Rules of Online Lending
How much is that Rocket Mortgage home loan really worth? What about your refinanced SoFi student loan? According to investors: not enough. New online lending standards aim to change that, starting today.
Asset-Backed Securities and Marketplace Lending
Let’s begin with a quick recap: what are asset-backed securities, and how do investors’ expectations shape the behavior of online lenders?
In very simple terms, an asset-backed security is a bundle of assets – such as the outstanding loans that a bank carries on its books – that the owner has packaged and sold off for a short-term profit. The banks selling their loans trade the higher potential lifetime value of the loans for a smaller sum of cash in-hand. That liquidity then allows the bank to keep making new loans and expanding its business. Meanwhile, the firms or investors buying them are betting that they can get more value out of collecting on the loans in the bundle than they paid the bank for them.
The trade-off of lower profit for more liquidity is the crucial element here. Liquid assets are what allow lenders to continue lending, and in turn continue to grow. For lenders to sell off the loans they make, the investors buying them need to be confident that they will profit.
Online Lending Standards and Investor Confidence
By now, you may be seeing the bigger picture: when lenders make risky loans, investors are less keen to buy them, and liquidity can begin to dry up.
Online lenders, as American Banker notes in a recent article, offered surprisingly cheap loans to new customers as a way to establish themselves and expand their customer base. Ever more saturated lending markets have driven online lending standards down, as fintech startups jostle for market share.
The result of all this competitive lending? Lower yield, higher risk securities. Notes Bill Kassul, principal at Ranger Capital Group in Dallas: “Yields were going down, a lot of that was due to competition. They were lowering rates just to stay competitive with each other … We stopped investing because the risk/return wasn’t as high.”
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New Standards for Lenders
Under pressure from funds like Ranger Capital Group, online lenders have begun backpedaling. Prosper, SoFi, and other lenders have all increased the weighted average credit scores of their borrowers since late 2017. SoFi’s student loan pools showed a noteworthy jump from a weighted average FICO score of 732 to an average of 744 in just one year.
Other lenders are following suit. In an emailed statement to Bloomberg News, San Francisco-based online lender Prosper said it expects credit tightening to “continue in 2018” in response to rising default rates in the consumer credit market. LendingClub, too, is backing away from risky borrowers. In early 2017, the marketplace lender stopped offering credit to the riskiest six percent of its borrower base. Marketplace lenders hope this collective tightening of online lending standards will restore investor confidence and keep capital flowing smoothly.
How Risk Assessment Technologies are Vetting New Borrowers
As a result, fintech firms fighting to raise online lending standards are turning to modern risk assessment solutions. Fintech Finance recommends that marketplace lenders “digitize core processes” and “experiment with advanced analytics and machine learning” to more thoroughly vet the borrowers to whom they extend credit. Former Morgan Stanley risk manager Viju Joseph identifies AI and big data as key technologies driving the automation of fintech risk assessment – and putting traditional risk managers out of work.
These new data-driven risk assessment technologies – from more rigorous identity verification processes to alternative credit data sources like utility data – help lenders to automate and strengthen their risk management, reducing inefficiencies and improving the risk profiles of their loan pools. New York-based research firm PeerIQ predicts continued growth for marketplace lending securities through 2018, despite a lower trajectory than 2017’s MPL security performance. Tighter online lending standards – with help from the new risk assessment technologies that enable them – are on track to keep marketplace lenders in investors’ good graces.
Do you have experience to share in marketplace lending? We want to hear from you! Reach out to Urjanet on Twitter. And to learn more about how utility data can help you lend with confidence, contact us today.
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About Nick Arehart
Nick Arehart is a marketing intern at Urjanet who specializes in financial services and sustainability. He's passionate about content that informs and inspires. When he isn't writing for us, he's finishing up his chemistry degree at Emory University.