Hi-tech lenders target the decadesold store credit card

SAN FRANCISCO (Reuters) – The once-hot online lending industry has been battered by scandal and losses since last year. But one of the oldest forms of lending, store credit, is increasingly attracting tech companies aiming to supplant a retailer’s credit card.

One such lender, San Francisco startup Affirm, is attracting investment and large customers by using a new approach to underwriting that allows it to approve more borrowers than traditional store credit cards.

Affirm founder Max Levchin, who also cofounded one of the earliest digital payments companies, PayPal, boasts that Affirm approves 126% more borrowers than Synchrony Financial, the largest issuer of private-label credit cards.

Merchants have enjoyed the boost in sales. Affirm recently finalized a deal to become the exclusive financing option for customers of cellphone company Motorola, replacing Motorola’s private-label credit card.

As of August, the most recent data available from a case study by the companies, purchases made with Affirm’s loans represented 19% of Motorola’s sales.

“The point-of-sale market is monstrous,” said Peter Renton, an independent industry analyst who hosts an online lending conference called LendIt. “But it’s been really lowtech.”

Companies such as Affirm are using smartphone apps, online messaging with borrowers and instantaneous approvals, removing the paperwork from retail lending.

Synchrony did not respond to requests for comment. Reuters was not able to independently verify Affirm’s claim of loan approval rates.

Some industry watchers worry about the fallout of risky lending. Affirm, which is not profitable, has not yet been tested by a downturn in the economy.

“Long history will tell you, you have to be skeptical of someone saying they’ve cracked the code on underwriting,” said Todd Baker, a senior fellow at the Harvard Kennedy School and a consultant for financial-services companies. “You really won’t know until the credit cycle turns.”

Long before the Internet, stores such as Sears offered credit cards, and some built profitable financing arms. Private-label cards can provide stores with valuable consumer data and lower processing fees than general-purpose credit cards.

The total balance on store cards roughly doubled between 2007 and 2015 in the United States to $84 billion, according to the Consumer Financial Protection Bureau. But while people are buying more on credit, fewer people are opening new store accounts, with the number of accounts down from 2007.

The average in-store credit card has a 26.38% interest rate, with jeweler Zales and department store Big Lots Inc. topping the list at 30%, according to a survey this year by CreditCards.com.

‘More approvals and more sales’

That has left an opening for tech companies touting what they claim to be more transparent, economical and convenient financial products in one of the few bright spots in online lending.

Other parts of the industry, particularly marketplace lending, have suffered from controversy and poor performance. For instance, LendingClub Corp.’s CEO was forced to resign last year after a scandal over its loan-selling practices, and the company’s market capitalization has collapsed from more than $9b. in 2014 to about $1.7b.

Competing with Affirm is Klarna, founded in Sweden in 2005, which offers deferred payments and installment loans at more than 70,000 retailers, with merchants setting their own interest rates. Jim Lofgren, the CEO for North America, said Klarna has been profitable for more than a decade.

San Francisco payments company Square Inc. in June started allowing customers of selected merchants to take out loans of up to $10,000 to pay back over three months to a year.

Affirm offers installment loans to shoppers at nearly 1,300 online retailers, financing purchases such as a new couch or mattress. The loans average $750 and generally have a payback period of three months to a year. There are no late fees, but the average annual interest rate is still high, 19%.

Investors’ familiarity with Levchin from his days at PayPal Holdings Inc. has helped Affirm raise about $450 million in equity funding, including a $200m. round at a $1.75m. valuation two weeks ago.

Affirm has issued loans this year totaling more than $1b. The company, which is private, declined to provide its default or delinquency rates or say how often it rejects applicants.

By comparison, Synchrony had more than $76b. in purchases on its retail credit cards in the first three quarters this year and earned $9b. on interest and fees, according to the company’s financial earnings.

Levchin said Affirm is able to approve more loans than traditional private-label card providers because it looks at personal data, such as the borrower’s debt-to-income ratio and bank-account details, rather than simply relying on the borrower’s credit score or credit-bureau history.

This allows Levchin to lend to 20-somethings who maxed out credit cards in college and have a low credit score but a well-paying job to pay back the loan, he said.

“We do bring more approvals and more sales, but we don’t do this because we are more willing to take risks,” he said.