Unlocking the $27 Trillion Consumer Lending Market: What You Need to Know!

The world of consumer lending is alive and dynamic, driven by constant evolution in tandem with technological progress and shifts in consumer habits. This segment, worth a colossal $27 trillion and expanding, presents a plethora of opportunities for investors, ranging from traditional mortgage securities to emerging products like buy now, pay later (BNPL) loans.

Navigating through this ever-changing landscape brings forth a myriad of challenges for both investors and policymakers. From embracing new risk-return dynamics to tackling regulation and transparency gaps – understanding the nuances of this evolving sector is crucial to realizing its full potential.

In a recent Bloomberg interview, Apollo’s Global Head of Credit Product Akila Grewal predicted a growth spurt in private credit, surging to $40 trillion. What caught the attention was the spotlight on consumer loans as the fastest-growing subset within private markets and how it could complement direct lending exposures in portfolios. The future envisions a blend of direct lending for stability and consumer loans to drive growth.

What is Consumer Lending?

Consumer lending provides an avenue into the creditworthiness of individuals, a realm once dominated by banks but has since evolved dramatically due to securitization, tech advancements, and shifts in consumer behavior.

1. Property-backed residential mortgages: Historical and solidly established segment of consumer lending backed by residential properties.
2. Non-property-backed consumer loans: A more diverse group featuring personal loans, auto loans, student loans, credit card debts, and the more recent products such as BNPL services, salary advance loans, and even loans by energy credits from consumers selling renewable energy to the grid.

Traditional Assets and Emerging Opportunities

An environment thriving on innovation has fueled exponential growth, ushering in a versatile range of investment prospects.

1. Traditional lending by banks has been the norm until recently, focusing on services like home loans, car financing, and the like.
2. Over the years, the financing sector primarily depended on credit scores for risk assessment, classifying customers based on their credit history. The 1960s saw credit scores emerge as a pivotal tool in deciphering a customer’s repayment capacity, with the subprime mortgage crisis showing the pitfalls of relaxed lending standards to those with poor credit scores.
3. The industry has now opened up with online lending platforms paving the way for wider access to credit, quickening the loan approval process. These platforms, including BNPL services, provide almost instant interest-free payment deferrals during purchases, creating waves in the sector and sparking debates over credit access control.

Established Structures versus Emerging Opportunities

Each consumer loan type carries a unique set of risk-return influencers shaped by collateral, borrower demographics, and macroeconomic conditions.

1. Differentiated by asset-backing, many products deriving from consumer loans are typically asset-backed loans where investors lay claim on securitized asset pools.
2. The traditional securitization, leveraging credit card, auto, and student loan payment inflows as collateral, has been a steady source of returns with limited defaults. However, securitization of newer products like BNPL loans comes with its share of uncertainties due to unconventional characteristics like short durations and evolving underwriting standards.

The Road Ahead: Innovation Meets Regulation

The consumer lending frontier is in a constant flux, necessitating regulatory frameworks to adapt to the complexities brought about by new offerings and platforms. As the industry becomes more sophisticated, it demands transparent risk assessments, standardized reporting, and sturdy consumer safeguards.

An expanding universe of consumer lending provides both opportunities and obstacles for investors. While long-standing products offer familiar risk-return landscapes, newer offerings warrant a more cautious approach.

Stay alert for the forthcoming CFA Institute Research Foundation book on consumer lending, offering an extensive exploration of products within the space from a portfolio management perspective.