According to the Pew Research Center, there are three distinct revolutions occurring in technology: broadband access, mobile connectivity and social networking. In particular, the internet and cell phones are profoundly changing the world of financial services and securitized markets. Innovations in financial technology, or FinTech, are affecting how and where banks deliver services – and consumers conduct their business.
Investment officers Lena Harhaj, CFA®, and Mathew Kennedy discuss their take on the financial technology (FinTech) evolution in the United States — and its impact on the financial sector and the securitized market.
Q: How would you characterize the FinTech market landscape compared to 5 or 10 years ago?
Matthew: Ten years ago, the market was in its infancy and in the last few years has transitioned into a complementary partner for various financial subsectors. Upstarts have changed their thinking. Before, there was somewhat of a sense from FinTechs that they could displace an incumbent, whereas today, it is much more of a symbiotic relationship. Now and going forward, we expect to see FinTechs and banks working closer together to improve the client experience.
As a result of these two dynamics, we have seen companies bring their product to market and gain adoption easier and faster than ever. The FinTech market is likely to only get stronger, as innovation and bank resources continue to strengthen their co-existence.
Lena: We didn’t see FinTechs issuing in the securitized market 10 years ago. This was just after the financial crisis and consumer borrowing had slowed significantly, not only due to their impaired credit, but also because of the banks’ unwillingness to lend to them. This created the perfect opportunity for FinTech companies, such as LendingClub® and SoFi®, to disrupt the traditional banking sector by opening up credit to consumers again.
Soon after, we started seeing the securitization on the Asset-Backed Security platforms from those issuers as well. The sector is still relatively small today. It is estimated that FinTech companies capture roughly one-third of the $120 billion personal loan market share, up from less than 1 percent 10 years ago, when the market was approximately $70 billion, and only a portion of that is securitized.
As these companies make their way past unsecured consumer loans and into other areas, there is substantial room for growth, considering that total consumer debt outstanding is over $13 trillion. Looking at SoFi, as an example, they actually started out cherry picking the government’s student loan portfolio by lending to Stanford graduates, but soon expanded their program to include other universities and schools across the country. They are refinancing student loans to doctors, lawyers, MBA graduates and others who are out of school and gainfully employed.
Not long after, they tapped into different stages of a customer’s life, offering a mortgage when they are ready to purchase a home or unsecured personal loans that can be used to consolidate debt or do a home project. This way, they have the opportunity to work with a customer at least three different times of financial need.
Q: What are the greatest risks – including on the regulatory side? Any concerns or opportunities?
Matthew: Banking is a highly regulated industry that generally has not had to deal with big changes or new competition the way other industries have. Now that is changing.
The innovation we are seeing is greatly improving the experience for the end user where financial services activity is done more efficiently, more products and services are available and the result has been a better user experience and in many cases more wallet friendly for both clients and the financial services sector.
While this has been good on its face, some upstarts have either cut corners or been unaware of regulations and have found themselves in trouble with regulators for various reasons, such as erroneously calling out investments as being insured by the FDIC. For the most part, these troubles can be overcome. However, it highlights the risk a consumer or business faces doing business with a startup that does not understand the regulatory framework with which they are subject.
We are seeing FinTechs mature, with many working closer and in tandem with regulators as they innovate which should reduce regulatory related risks over time. The companies that can bring innovation to market within the regulatory framework have tremendous growth and profitability opportunity.
Look at our parent company, Securian Financial Group, Inc. Upstarts are now selling life insurance which in itself is not a complex contract to underwrite for a consumer; however, what happens after that contract is underwritten? What happens in 15 years when that contract needs to pay out — how is the liability accounted for and what assets are matched to these liabilities?
This is just one of the many risks that regulators are having to address to protect consumers. While there may be growing pains, the result should be a more competitive industry and ensure more consumers have access to life insurance and other financial innovations.
Lena: In the securitized markets, we are dealing with packaged loans. So one obvious risk with personal loans is that they have not been tested through a full economic cycle. The algorithms and underwriting scorecards used by these companies haven’t really been tested. 10 years ago, they barely existed. There is no getting past it — that is a huge risk.
In regards to the rating agencies that rate these securitizations — how do you put a BBB on something that has not been tested through the cycle? There is no additional utility that comes from having this personal loan and it’s likely the first thing that’s going to go unpaid if the consumer is under strain.
A credit card offers additional utility until it is maxed out. An auto loan offers utility, as long as the car continues to run. But an unsecured personal loan offers no additional utility after the proceeds are spent. FinTech has yet to experience anything remotely similar to the financial crisis that would put their underwriting to the test.
Is there any parachute for companies that offer unsecured loans that haven’t been tested? They can make immediate adjustments to their underwriting score card. There are already companies that show evidence of tightening their credit box as their portfolio losses increased around 2017. They were able to respond immediately, similar to what banks did with credit card limits during the crisis — when delinquencies and losses began to increase. Card issuers were able to immediately lower credit limits to borrowers that were more likely to default and thereby limit future losses.
As for regulation, the U.S. Consumer Financial Protection Bureau (CFPB) is still relatively new and whether they can accomplish what they set out to do is still unknown. Not everything falls under the CFPB either, and its focus is largely on mortgages due to the size of the mortgage market.
I don’t know if that is good or bad. I think it’s a better idea that consumers become more financially educated
– understand how loans, credit cards and wealth management work. That gets us to a better place versus heavy regulation. I think a lot of peoples’ fear is they will be cut off again. Who wants to be cut off from a loan when you need it most?
Q: What’s your view of financial services going online?
Matthew: Financial services going online has been successful, and while many new products are available to the end user through the digital channel, tremendous amount of runway remains. Digital improves the value proposition for consumers and allows banks to expand their value proposition in ways we have not seen since the ATM. And like the ATM, with more customers doing various activities online, banks will be able to invest in new areas and continue to enhance their offering.
Lena: It’s a huge positive for consumers to have the ability to go online. You are more likely to review loan activity, make timely or extra payments if you can do it online from your mobile device. This not only gives the consumer convenience, but better loan management, which typically leads to better credit scores and better credit terms the next time you need to borrow.
The lenders in FinTech also benefit from digital information. They can use it in the underwriting process and also offer rate incentives for access to your bank account information. Now they know what you’re doing, where you’re shopping, how much you spend and how much you save. Traditional lenders don’t typically have that kind of information. There’s power for the issuers and underwriter of the loan — what else can I sell this person?
Q: What is your outlook for FinTech?
Matthew: Innovation is going to continue to evolve in financial services, fueled by additional resources and brainpower, and lead to greater creativity and innovation. Today, we are seeing investment dollars in
technology shift from back-office and foundational infrastructure to investments in more client enhancements that make their product offering stronger. This will only grow going forward and FinTechs will play a major part in this expansion.
We expect to see new innovation each year introduced from incumbents and startups that help to better meet the needs of financial service clients. More importantly, these clients will continue to become more comfortable with innovation when addressing their financial needs — leading to greater innovation that will further move the sector away from the traditional model that saw so little change for so long.
Lena: I think consumers are in a really good spot — they have de-levered considerably post-crisis and overall delinquencies are low. However, the consumer is not one aggregate person. The financial profile of the unsecured borrower can be very different from that of the student loan borrower or home mortgage borrower and so on.
With total household debt over $13 trillion — a number that is approximately 65 percent of Gross Domestic Product — it’s always a number that’s worth watching. How well FinTech performs in the securitized markets depends heavily on the health of the consumer.