Banks are flocking to personal credit, but at what risk?
The consumer credit card industry is so heavy – five major banks have about 70% of the market share – that head-on competition can be daunting.
So in recent years, many mid-sized banks have been successful in convincing Americans using plastic to refinance their existing debt at a lower interest rate. Taking a page from the fintechs playbook, these banks have launched online platforms that allow personal loans to consumers from coast to coast.
But as more banks adopt this strategy, the risks increase. Total personal loan balances reached $ 132 billion in the third quarter, an increase of 59% in just three years, according to TransUnion. And the evidence suggests that many borrowers use the loans to fuel additional consumption, rather than to pay off existing debt.
For now, the unemployment rate in the United States remains low and industry-wide personal loan losses are manageable. But more of these loans are expected to deteriorate when the economy inevitably weakens.
Banks say they lend to customers with strong credit scores, unlike online lenders who take higher risk. Still, unsecured installment loans to senior borrowers have a limited track record.
“We don’t really know how these loans will work during a recession,” said Todd Baker, senior researcher at the Richman Center at Columbia University.
The personal loan industry was once primarily the domain of companies that targeted subprime borrowers, and in the aftermath of the financial crisis the market was left for dead. But online lenders such as LendingClub, Avant, and Prosper Marketplace quickly entered the void.
For borrowers, applying for loans from these upstarts was quick and easy, especially compared to home equity loans available at banks. For issuers, personal loans offered both strong margins and a relatively easy way to gain a foothold in the consumer credit industry.
One of the first banks to take note was SunTrust Banks. In 2013, the Atlanta-based bank, which operates branches primarily in the Southeast, launched an online lending platform, LightStream, designed for consumers with good to great credit.
Since then, SunTrust has made more than $ 7.5 billion in loans on its LightStream platform. It offers loans for a range of goods and services – from recreational equipment to medical procedures to adoptions – and funds these loans with low-cost deposits, a benefit other banks are also taking advantage of as ‘they are looking to compete with online lenders.
“It’s no surprise that other banks are now thinking: how can we copy the success of SunTrust?” said Todd Nelson, senior vice president of LightStream. “At the end of the day, most lending businesses are large-scale businesses, and banks are good at the construction scale.”
BBVA Compass, based in Birmingham, Alabama, began offering its Express Personal Loan to non-clients earlier this year. Borrowers may be eligible for a maximum of $ 35,000, repayable over six years, and can receive the money in less than 24 hours.
“The general population is quite savvy with digital products,” said Shayan Khwaja, executive director of consumer loans at BBVA Compass, told American Banker in March. “They’re not only used to it, but they demand it.”
Goldman Sachs, the Wall Street giant that is now making a game for Main Street customers, has been offering online personal loans under the Marcus brand since 2016. Loans of up to $ 40,000 carry annual percentage rates between 6.99% and 24.99%.
Lloyd Blankfein, who retired as CEO of Goldman in September, said the bank sees an opportunity to cut some of the profits enjoyed by large card issuers. “Traditional banks in this space have no real incentive to refinance credit card balances,” he said. said at a conference in February.
As banks become more active players in personal lending, the volume of loans increases. As of September 30, there were 20.3 million personal loans outstanding at banks, credit unions and non-bank lenders, up from 17.5 million in the same quarter last year and 14.3 million three years older. early.
Banks interested in the US personal loan market include HSBC, Barclays, and Citizens Financial.
HSBC’s U.S. bank announced in October that it plans to make its new online lending platform available to consumers in the first half of next year.
Pablo Sanchez, who heads HSBC’s retail banking business in the United States and Canada, said in an interview that personal loans have enjoyed a compound annual growth rate of 23% over the past four years. “And frankly, we don’t see this slowdown,” he added.
Rising interest rates can boost demand for personal loans, as credit card users who pay more to borrow have an incentive to consolidate their debt at a lower rate.
Consumers who pay 18% on their credit card may be able to reduce their interest rate to 10% or 11% with a personal loan, Citizens CEO Bruce Van Saun noted. Providence, RI-based Citizens advertises personal loans of up to $ 50,000, with applicants receiving a personalized quote in under two minutes.
Lenders often ask borrowers how they plan to use a personal loan, but they usually have no way of knowing how the funds are actually spent. Instead of paying off their credit cards, some consumers use them to pay for renovations, to buy a car or boat, or to pay for a wedding. And there are signs that despite its rapid growth, the personal loan market is not reducing credit card balances.
Revolving consumer credit hit an all-time high of $ 1.04 trillion in August, according to the Federal Reserve Board.
What else, an academic study published in September found that customers of fintech lenders are more likely to use their funds for consumption than to consolidate their existing credit card debt.
“Overall, these results suggest that fintech lenders allow households with a particular desire for immediate consumption to finance their spending and borrow beyond their means,” the study authors wrote.
As new entrants continue to enter the market, Discover Financial Services, a long-standing personal loan issuer, issued warnings about weakening credit quality. Meanwhile, Goldman Sachs would have reduced his loan origination goal for 2019 given concerns about the stage of the credit cycle.
“There is definitely a risk,” said Nick Clements, a former executive in the card industry, adding that some banks will prove to be much better than others at managing that risk.
Clements, who co-founded loan-selling site MagnifyMoney, said banks offering personal loans need to build collections that are large enough to handle higher call volumes in the next downturn. He also said banks should be wary of giving too much credit to heavy users.
“We’re taking a very thoughtful and cautious approach,” said Ben Harvey, head of consumer lending at Barclays US, which started inviting-only personal loans in 2016, and recently opened its doors to more clients. . “We are not changing our appetite for credit.”
A recent LightStream survey found that 15% of American adults have a personal loan. By comparison, 43% of those surveyed had credit card debt, 32% had a mortgage, and 16% had student loans.
“In terms of market size and potential,” said Jason Laky, senior vice president at TransUnion, “there is enormous leeway for personal lending to grow.”