Challenges of the rampaging Covid-19 may force financial firms operating in the Unsecured Business Loans space out business soon; this writer observes.
Often, our dreams are bigger than our bank accounts. You might want to start a pizza shop downtown. Or, you might have your eye on that 2,000 square foot home in the suburbs. In these cases and others, we often don’t have the money needed to make them happen.
So, rather than spend countless years saving, we get a loan. In past years, though, that meant putting up collateral. If you didn’t already own property or an expensive asset, you were out of luck. Then, as our economies ramped up in the post-WWII era, a new type of loan emerged.
The unsecured loan, as the name suggests, didn’t require collateral. Instead, it relied on your credit score, which measured your trustworthiness as a borrower. Suddenly, you could get approved for a huge loan, all based on a number.
For decades, this system has functioned with few flaws. As of November 2019, the delinquency rate for personal loans in America stood at 4.5%. For mortgages, it was below 2%. And then, the COVID crisis struck.
Around the world, wages have contracted sharply. In America, millions of people have been left without an income. If the global economy doesn’t recover quickly, the unsecured loan industry could be facing a debt-fueled tsunami of biblical proportions.
Unsecured Loans Have Bankrolled The World’s Economic Growth
Over the past few decades, much of the developed world has become a tertiary economy. Owners of capital have mostly outsourced resource extraction and manufacturing activities. These days, domestic growth relies primarily on consumption.
However, outsourcing has led to the loss of many well-paying jobs. This development has caused wage growth to stagnate. At the same time, expenses, from health care to education, have risen sharply.
Pressures like these should have squeezed consumer spending by now. Instead, the increasing availability of unsecured loans has allowed us to finance our dreams rather than save for them.
Add in the decreased availability of secured loans, and it’s no wonder non-bank lending boomed during the 2010s. The Global Financial Crisis of 2008 led many American and UK bankers to tighten their purse strings. In 2018, Australian banks did the same after the Royal Commission exposed their lax lending standards.
Many in the non-bank lending sector patted themselves on the back. After all, these firms had algorithms that allowed them to gauge risk more accurately than the banks. Or, so they thought.
COVID-19 Has Caused These Sources Of Capital To Dry Up Overnight
In their rush to profitability, many unsecured personal loan firms failed to account for “doomsday scenarios.” Thus, when COVID-19 triggered a global lockdown, many businesses were caught with their pants down.
As we speak, countless millions of borrowers have gone into survival mode. In some countries, governments have backstopped worker wages, and they have extended loans/grants to businesses. However, in the United States, which accounts for 15.2% of global GDP, federal support has been piecemeal at best.
The SBA has offered businesses low-interest loans, and citizens got a one-time payout of $1,200. Apart from that, SMEs and consumers are on their own. In a country where consumer spending generates 68.1% of economic activity, a slow-motion economic disaster is currently in progress.
In the best-case scenario, unsecured business loan firms are making enough money to stay afloat. However, many others are rapidly burning through their cash reserves. In a few short months, some of these companies could begin to fail.
Many unsecured loan companies can’t extend new loans right now. They’re too busy trying to survive – just like the rest of the world.
Many Borrowers Now Lack The Ability To Pay
As we mentioned, the customers of unsecured loan firms are also struggling to keep their head above water. How bad have things gotten? They’ve gotten absolutely abysmal. According to recent economic indicators, things haven’t been this grim since the Great Depression.
The official US unemployment rate soared to 14.7% in April 2020. However, U6 unemployment, which some economists view as a more accurate gauge of joblessness, sat at 22.8%. 38.9 million Americans filed for unemployment benefits between March and May 2020. Annualized GDP figures for Q1 2020 came in at a chilly -5%.
Now, consider the fragility of American finances before COVID-19 struck. A survey released in 2018 revealed that 40% of Americans can’t cover a $400 emergency. Even more stunning is the fact that 78% live paycheck-to-paycheck. So, it’s not unreasonable to imagine that many American loan firms are in a world of pain right now.
Overall, the short-term outlook for the American unsecured loans industry is pretty bleak. However, things aren’t nearly as bad elsewhere. In Canada, Australia, and the UK, government support measures have buoyed both consumers and businesses.
Canada’s CERB program provides citizens with 2,000 CAD per month in emergency income support. In Britain, the Coronavirus Business Interruption Loan Scheme offers loans of up 5 million GBP to qualified businesses. Down Under, the Australian government’s JobKeeper Payment promised up to 1,500 AUD per employee per fortnight to keep people on payrolls.
In these countries, these measures have – for the most part – kept businesses and individuals afloat. However, these measures are temporary. If governments end these initiatives before the global economy has truly recovered, unsecured loan firms could be in trouble.
Unsecured Lenders Are Uniquely Vulnerable To Black Swan Events
Secured loans have a significant advantage over unsecured loans. When Black Swan Events like COVID-19 strike, the secured lender has a safety net backing them up.
For decades, lending founders never stopped to consider the impact of a Depression on their businesses. As a result, most of the unsecured loan industry grew up thinking the good times would never end. Firms didn’t develop contingency plans, or they were poorly thought out.
Now, all but the best-capitalized firms are facing an imminent reckoning. For some, nothing but a quick turnaround will save them. Lately, many have been calling for an abrupt reopening of the economy. -*Meanwhile, in many jurisdictions, the first COVID wave isn’t even over. In our view, a decent percentage of these voices are months away from insolvency.
Can The Lending Industry Survive This Crisis?
Once every generation or two, a major global event changes how we live. As we speak, COVID is re-drawing how we shop, socialize, and do business. Even so, after this pandemic ends, things will mostly go back to normal – but not totally.
Once stretched, an object never fully regains its shape. Lending firms that survive this crisis will never view risk the same way again. Unsecured loans won’t go away, but they’ll be much harder to obtain. Lenders will need more reliable sources of income, and loan sizes will likely decrease.
All failures are lessons. Finance entrepreneurs who learn them will be better equipped to thrive in the future, whatever it may bring.