Digital Lending Credit Risk and Yield Estimation

AV2.PNG

Autonomous Research has estimated the difference between high and low credit card interest rates against that of digital lenders. The resulting industry interest rates are as follows: (1) 28.8% for average credit cards with a penalty rate, (2) 18% for the average credit card rate and (3) 12.6% for average digital lender rates. From these figures it can noted that banks have mispriced consumer credit risk by implementing a significantly higher interest rate compared to their digital counterparts. Consequently, it is apparent that the level of divergence between the highest and lowest quality borrowers is too narrow to differentiate between the best and worst credits, indicating that digital lenders can better match a loan rate.

The right-hand side graph details the yields gained from digital lenders in comparison to that of traditional bonds. Digital lenders yields have overtaken that of bonds, with 3-year loans from digital lending firm, Lending Club, averaging at 11% in comparison to Bloomberg US high yield rates of 9%. Additionally, Lending Clubs median returns are at 7% dwarfing Bloomberg’s investment grade corporate bond rates, which are at 4%. However, these rates are heavily dependent on today’s economic environment and rates may change when credit losses or interest rates rise.