10 Trends that will define Fintech Lending in 2023

1 ) Defaults will increase

During the WFC we saw default rates spike anywhere from 2.8x (US consumer PTT per Federal Reserve data) to 3.8x (US Small Business Delinquency Index PTT) from their base case (pre-crisis) levels.

I believe we will see higher peak to trough spikes in Europe due to the combined impact of the energy crisis (Ukraine war), food price increase (Ukraine war), and quantitative tightening. Lenders will need to (continue to) reprice across their score bands to reflect the macro situation and protect their net interest margins.

2) Rates will continue to rise

Recent comms from Open Market Committee (US) members, ECB policymakers (EU), and BOE advisors (UK) all point to a trend of continuing rate increases through 2023.

I believe Fed Funds will be > 5%, ECB deposit rate will be > 3%, and BOE Bank Rate will be >5%. Lenders will need to increase their pricing accordingly to maintain the attractiveness of their offering to debt funders who see global risk free rates creeping higher and higher.

3) Consumer BNPL (BNPL-C) - regulate or die

Defaults were already an issue in consumer BNPL or as many call it "buy now, pay never". Given the primary user has proven to be sub-prime, the fact that they were not taking a loan which would be registered with a credit bureau certainly didn't do much to incentive repayment (or disincentive non-payment). Too many lenders used BNPL (essentially reverse factoring of the merchants’ invoices at fixed merchant fee levels which didn't account for underlying debtor risk) as a back door to consumer lending without having to become a regulated lender.

I believe BNPL-C lenders will need to accept becoming regulated consumer lenders (and adjust their underwriting/scoring models to price the debtor/consumer risk) if they want to survive and continue sourcing debt funding.

4) Corporate BNPL (BNPL-P) - price the debtor not the seller and get insurance coverage

BNPL-P looks and smells like reverse factoring with the noticeable downside (from a debt funding/investor perspective) of the risk being mispriced, as the fee is being charged on assessment of the merchant/seller not on the buyer/debtor, as it would be in a traditional reverse factoring trade. BNPL rose in popularity over the last two years as lenders wanted to launch new products to increase their borrower base and because at face value (charging set merchant fee on super short duration underlying) it could be a high yield product. Unfortunately, the performance of the largest BNPL lenders books’ have shown us that this “one price fits all” approach may be attractive to sellers who want to increase their purchaser base by offering a new way to buy but failing to price the credit risk of the debtor doesn’t work for the end investors funding the lending.

I believe BNPL-P lenders will need to shift their pricing focus to debtors (essentially pushing the product back to simply being reverse factoring) and ensure their product is designed to be eligible for coverage by an insurer (COFACE / Atradius / Euler Hermes (Allianz Trade Credit) / Mercury / CESCE / Credito y Caution). The insurer who gets on board with the product first will capture huge market share.

5) Profitability over scalability

With equity funding becoming harder and harder to raise and as existing funders face liquidity constraints as they fail to raise follow on/new fund vehicles as easily they have in the past, lenders will need to deliver profitability in the immediate term. I expect equity investors who are asked to participate in series B/C or “interim rounds” to ask to see breakeven as a CP to funding or at minimum a revised business plan which shows breakeven being achieved well before the runway provided by the envisaged round would run out.

I believe the lenders who can make the hard decisions to cut staff and costs and adjust their business plan to deliver profitability in the shortest timeframe will survive and (as a byproduct) capture more market share in the process. Lenders who refuse to change course and stick to the “growth at all costs” mentality will burn through their cash runway and become M&A targets.

6) M&A deals, rather than raises will capture the headlines

In line with trend 5, I believe that the difficulty lenders will face in raising equity and changing course accordingly will translate to a ripe M&A market. Similarly, I expect VC/PE fund managers to launch distressed and special situations funds which can seize the opportunity to either take majority or outsized stakes in lenders who have built decent customer bases on the back of prudent lending operations or to buy outright startup/scaleup lenders who run out of capital to then provide their IP, book, staff, and/or customers to other portfolio companies.

7) Investor hurdles for deployment will get higher (dd and return basis)

In response to the combination of increasing defaults in outstanding books and deteriorating macro factors (and on the back of several high-profile fraud cases in the last 12 months), investors will scrutinize each new opportunity even more. In a way the down cycle will force investors to return to the fundamental elements of quantitative and qualitative analysis which they should have been sticking to for the last 5 years but were instead ignored or sped through as they were faced with the problem of deploying more and more capital in a steadily decreasing rate environment. Steadily increasing global risk-free rates will push up return expectations, which will need to be addressed by lenders via higher pricing on more stringently underwritten lending.

I believe the days of a two-hour call and a review of a flashy deck resulting in a term sheet will be gone (finally) and investors will get back to applying the (boring yet tried and true) due diligence techniques they learned in their analyst days. Derivation of performance analytics, in-depth analysis of underwriting and scoring policies and methodologies, reviews of controls and policies from the perspective of efficacy and enforceability, on-site visits, management interviews, legal and regulatory reviews, and “classic” discount cashflow modeling will go back to being “bare minimum” CPs to terms rather than afterthoughts to handshake deals. Lenders need to be ready to address investor dd requests if they want to receive debt or equity funding and won’t be able to rely solely on the strength of their advisor and the initial equity pitch anymore.

8) Monitoring/ongoing dd requirements will increase in scope, depth, and frequency

In line with trend 7 and the old saying that “tough times breed strong [people]”, investors will be forced by the down cycle to revisit and enhance their portfolio management strategies vis-a-vis monitoring. During the up cycle we just went through, the best credit market in 12 years, investors who focused solely on deploying at speed would often do so at the cost of monitoring the performance of previous investments. As long as coupons were paid or waterfalls were run without shortfalls, many investors (shockingly) took a “buy and forget” approach to portfolio management.

I believe that 2023 will see investors of all types (banks/asset managers/fund managers/PE/VC) implementing more comprehensive and frequent monitoring requirements into deals to ensure they catch deterioration in portfolio and/or lender performance in time to remediate and taking a loss. As such, lenders need to be ready with the data infrastructure and staff to be able to accommodate these (what I will believe will become market standard) conditions subsequent to deals.

9) Compliance will continue to hold the spotlight

As regulators continue to push forward new and more comprehensive regulation across global markets, inching ever forward towards trying their best to make all non-bank lending compliant with banking regulation, investors will continue to focus more than ever on compliance. Reviewing policies and procedures and picking apart lending operations step-by-step to establish compliance with local regulations is never fun but as most fund managers get their funding from regulated (bank, insurance company, pension fund) end investors, lenders need to be aware of their local regulatory framework and be ready to deliver on debt investor requests in order to secure funding.

10) (for regulated investors) Capital efficiency will become even more important

In line with the prediction of reduced availability of equity capital noted in trends 5 and 6 and the general truism that through recessionary periods levels of investible capital decrease, I believe that regulated investors (banks, insurance companies, pension funds) will focus more on the efficiency of their deployment strategies. For capital constrained neo-banks, being able to lend more without raising additional equity will be key to achieving profitability. Similarly, Solvency II-governed insurance companies and pension managers will (during a period with less contributions/funds to deploy) focus on optimizing the RAROC of their portfolio to highlight the strength of their deployment strategy.