Tough road for US fintech lenders as default risk rises

Tough road for US fintech lenders as default risk rises

Tough road for US fintech lenders as default risk rises

A man walks his dog without wearing a face mask during the coronavirus disease (COVID-19) pandemic, while the Empire State Building and New York skyline are seen from Weehawken, New Jersey
A man walks his dog without wearing a face mask during the coronavirus disease (COVID-19) pandemic, while the Empire State Building and the New York skyline are seen from Weehawken, New Jersey, USA , April 2, 2021.
Reuters

U.S. fintech companies that lend to consumers with downgraded credit ratings face a tough year as rising defaults and interest rates limit companies’ access to profitable debt financing.

“We expect profitability to be depressed for many businesses and financing conditions to remain difficult as higher financing costs driven by higher interest rates will not be offset by increased revenues,” he said. Moody’s said in a report Thursday. It revised its outlook for these lenders from stable to negative.

During the pandemic, many fintech startups have emerged as lenders to borrowers with imperfect credit. Using artificial intelligence, their screening tools were more likely to recommend these loan applications than traditional lenders.

Lenders like Pagaya Technologies and OneMain Holdings funded themselves by bundling subprime consumer loans into asset-backed securities, or ABS, which they sold to Wall Street investors.

Pagaya declined to comment, while OneMain did not immediately respond to a request for comment.

Lender ABS were among bonds that raised $36 billion in 2021 and 2022 by aggregating consumer and market loans, according to data from FinSight.

Investors were comfortable buying the bonds as US government stimulus measures ensured consumers had enough money to repay their loans.

But as that stimulus faded, loan losses began to mount, Moody’s said. Inflation has hit subprime consumers who spend most of their income on rent, groceries and gas, and they are struggling to pay interest on personal loans.

Losses on subprime loans that are assumed to be bad debt or write-offs rose on average about 20% in the third quarter of 2022 from 2019 levels, Moody’s said.

ABS investors demand higher returns for new trades or avoid them altogether. Funding costs have also increased by 200 basis points in recent months compared to mid-2022, according to data from FinSight.

But lender stocks haven’t lost investor appeal yet, said Theresa O’Neill, ABS strategist at BofA Securities.

She said a widening of credit spreads and a deal structure that reduced investor risk through more credit enhancements would continue to secure interest.

“We’re early in the game for what will happen in a recession or economic downturn for many of these lenders,” said Tom Capasse, founder and managing partner of Waterfall Asset Management.

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