The U.S. economy is the fastest growing of any developed country. Monthly unemployment just clocked in at 4.1%, the first time it has risen above 4% since November 2021, while total household wealth reached a record $156 trillion last year.
However, challenges are mounting for subprime consumers, who could be hit unusually hard if the economy turns south. This could lead to significant strategic changes for the Specialty Finance and Lending Technology sector that serves them.
By the end of last year, the gap between the household wealth of America’s richest 1% and poorest 50% had grown to almost $41 trillion, a record driven primarily by the gap in home and equity ownership.
While some nine in 10 households in the top 20 percent by income own their homes, fewer than half of the bottom 20 percent do. Almost 93% of total U.S. stock market wealth is now held by just 10% of the population, also a record.
Although wages are finally outpacing inflation, consumer prices are still 19% higher than before the pandemic. America’s personal savings rate – which spiked in 2020 and 2021 amid record government stimulus – is back to 3.9%.
Add it all up, and it is no surprise that a recent Federal Reserve survey found almost four in ten Americans saying they wouldn’t use cash to cover an unexpected $400 expense, relying instead on family, selling assets, credit, or a loan.
Strapped consumers are increasingly turning to specialty finance and tech-enabled lending companies to sustain their spending, especially as more fall behind on existing payments. Nearly 9% of credit card balances and 8% of auto loans have now transitioned to delinquency on an annualized basis.
The positive momentum across the Specialty Finance and Lending Technology sector reflects its growing role in filling an essential consumer need. Fintech banks continue to increase deposits and new customers. On average, lending technology companies have seen double-digit growth in revenue, adjusted EBITDA, and earnings per share. Cash advance providers have a growing customer base and are originating more loans and cash advances.
Although delinquency rates and charge-offs in the Specialty Finance and Lending Technology sector remain above pre-pandemic levels, they are decelerating, and charge-off rates are expected to decline in fiscal year 2025 for nearly all issuers. This should provide a tailwind for equity prices across the industry, as there has historically been a strong correlation between changes in delinquency rates and total returns.
However, companies across the sector should be mindful of the risk that an economic downturn could hit subprime consumers unusually hard. Subprime consumers typically behave similarly in recessionary and expansionary periods because they are, by definition, always in some form of financial stress. But if the U.S. were to drop into a recession in the months ahead, these consumers, already living so close to the brink, may face insurmountable difficulties paying back their debts. It could create new risks for the specialty finance and tech-enabled lending companies serving them.
One way for companies in the sector to mitigate the risk would be to consider moving up market, as there are now legions of formerly prime consumers who are having difficulty accessing credit. In recent months, banks have tightened lending standards for nearly all categories of residential mortgages, while credit card application rejections are on the rise. This could create a growing group of customers seeking alternative financing solutions.
Despite recent declines in consumer sentiment, the U.S. economy and consumer are still strong. But the Specialty Finance and Lending Technology sector should start preparing now for the day when that’s no longer the case.
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Andrea Lee is Global Co-Head of Investment Banking, Global Joint Head of Financial Institutions, and Global Head of Specialty Finance and Lending Technology at Jefferies LLC. The Specialty Finance and Lending Technology sector includes the full spectrum of consumer and commercial finance, marketplace lenders and technology enabled credit solutions providers.
