Booming alternative lending market flourishes at the subprime end of the credit curve

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The burgeoning non-bank lending sector continues to boom in Australia.

According to AUSTRAC data, there are now more than 600 non-bank lenders, making up around 7% of all debt financing in the country.

Competition has subsequently reached new heights, but why has the sector been so successful in attracting borrowers?

“It might have started with the Banking Royal Commission,” said the CEO of ASX-listed Cash Converters (ASX:CCV), Sam Budiselik.

“We found that big banks were taking their customers for granted, and the aftermath of that investigation led to a boom in fintech,” he told Stockhead.

Budiselik added that when fintechs came on to the scene, the disruption left the banks wanting in terms of engaging with customers in a way that’s more fun, less serious, but at the same time equally as responsible.

“People realised they wanted a simple process, and the ability to do everything in one single app without having to go to a branch,” he explained.

“I think the Buy Now Pay Later platforms were the pioneers, and really set the bar for that frictionless engagement.”

The subprime borrowers

Statistically speaking, more Aussie borrowers are turning to these alternative lenders but still, many are sceptical about being associated with them. People seem to have an ingrained perception that non-banks are for those with bad credit history.

That in fact is partly true, as most non-bank lenders do specialise in providing loans to ‘non-conforming borrowers’.

Non-conforming borrowers could come from all walks of life – including self-employed people, first time buyers, and even property investors.

But just because an applicant has been turned down for a loan by a bank doesn’t mean they’re a credit risk, according to another ASX-listed non-bank lender, Peppermoney.

Some borrowers get knocked back simply because they don’t tick the bank’s usual boxes, like having a credit history, or meeting the Lenders Mortgage Insurance (LMI) providers’ criteria.

One example is: if you’re self-employed, you might not have evidence of cash flow or PAYG statements, which can mean your loan application gets rejected by traditional banks.

As a consequence, Budiselik said that most fintech lenders are honing in on those borrowers, people that are being locked out by banks.

“That market is really interesting, because people in that segment are under-served by the big banks,” Budiselik said.

“They could have a mark on their credit file or a irregular income, and the big banks just don’t want to touch them.”

On the opposite end of the spectrum, the prime credit market is dominated by the big national or international banks, as they can raise money at a low cost and lend them out to lower risk borrowers.

A snapshot of the performance of the non-bank lending stocks on the ASX.

Are banks losing market share?

“If you look at a credit score, which determines where you sit on the credit curve, a bankrupt borrower would have a negative credit score,” Budiselik explained.

“But in certain circumstances, companies like Cash Converters would be willing to lend to someone in that extreme part of the credit curve – someone who was bankrupt and has had that bankruptcy discharged,” he said.

The bottom line is, banks and fintech lenders are operating in different verticals, and at opposite ends of the credit curve.

Because banks focus on higher creditworthy borrowers, their headline loan rates also tend to be lower. But on the flip side, they operate at lower margins and have to rely on much bigger volumes to generate profits compared to alternative lenders.

“Non-bank lenders meanwhile usually have a higher headline rate, as they focus on people who otherwise might not have been able to get a loan from a bank,” said Budiselik.

“And if you’re lending against a car as opposed to a house, the headline and loss rates will become even higher. Then you go all the way to unsecured personal loans, where the risk could be really high.”

Most big banks could also go to the offshore capital markets and raise money at low cost, and that pretty much dictates the loan pricing to customers.

“The banks’ ability to raise money cheaply has precluded fintech lenders from competing in that prime mortgage space,” Budiselik said.

Zooming in on vehicle finance

Non-bank lenders have instead been able to successfully target the fringe segments left untouched by big banks, like the automotive lending market.

In Australia, vehicle finance is a vast market, estimated to be between $35-$40bn annually, which no one lender has been able to dominate.

Plenti Group (ASX:PLT) for example has been reporting record growth in the auto segment, but it still only has a 2% penetration.

MoneyMe (ASX:MME) is currently raising $20m in an institutional placement to go after that segment.

Money3 (ASX:MNY) has been able to rapidly grow its auto lending business by acquiring smaller players like Automotive Financial Services and GoCar Finance.

For Cash Converters, outgoings within its vehicle finance business have grown over 500% on the previous corresponding period to $9.6m.

Budiselik explained that vehicles are an easy way for non-bank lenders to pledge a credit line against an asset that has some value.

“It was five years ago that things started to heat up in the auto lending space, where fintech lenders started attacking the market,” he said.

“It’s a good asset class with minimal competition, so we’re taking advantage of the lack of competition from major banks,” he said.

The massive growth in vehicle finance and personal lending within the subprime market has led to the non-bank segment posting some of the best revenue numbers on the ASX.

Apart from Plenti Group, players that have posted record numbers include Prospa. In the latest half, it doubled earnings to $9m, up from $4.1m in the last corresponding half.

Then there’s the niche players like EarlyPay (ASX:EPY) that focuses on the B2B segment of the market, providing SMEs with invoice financing.

“To succeed and dominate this market, you really need to scale and have lots of data, to assess whether a borrower is going to repay you or default,” said Budiselik.

At Stockhead we tell it like it is. While Plenti Group is a Stockhead advertiser, it did not sponsor this article.

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