3 Sep 2013

Wonganomics: the role of student debt and housing costs

Wonga is making extraordinary profits of £62.5m on revenue of £309m. These figures were up 36 per cent and 67 per cent over 2012 respectively. Wonga is making £15 on average on each of its 4 million loans to 1 million customers. The average loan is £180 for 17 days, with interest of 1 per cent per day.

This is not a moral analysis of Wonga. It is an attempt at a dispassionate economic one, albeit based on a briefing with Wonga execs this morning at the release of its annual report, and I have taken the statistics within it on trust.

First, here is a transcript of what Errol Damelin, founder and CEO, told me this morning when I asked him what proportion of his customers were on benefits, and where he was winning market share. A very interesting answer citing the influence of large levels of student debt. Second, some general points from me.


What Errol Damelin told me

“Very few customers are on benefits. Our market is a banked market of people who have got smartphones. They are the one third [of applications] that get accepted. Most of our customers were not looking for a short term loan when they came to Wonga. Most of our customers are using Wonga as an alternative to an unauthorised overdraft fee and some credit cards.

“We think there is a generational shift in terms of credit card usage. We don’t think that most people want to get into long term debt paying minimum charges each month with a ballooning balance. It’s a different generation. When people came out of university with no debt, they felt it easier to take on a bit of credit card debt. When you come out of university now with significant debts already, the idea of taking on more long term debt in a product designed to make that easier to do, is not that appealing, so we’ve seen young people move away from credit cards.

“We’ve also seen people use Wonga as a conscious choice, as opposed to unauthorised overdraft late fees. In general, like for like unauthorised fees are much more expensive than Wonga. More than that, it’s a very reactive way of managing your finances. What this generation is telling us is that they prefer to take proactive decisions, and solve their problems ahead of time, and that’s where most of the market share is coming from.”

What does this mean?

So student debt = more concern about long term debt = willingness to pay more, in advance for short term credit. I’d like to see some stats underpinning that story. But it is a fascinating argument.  Some more reflections:

* All the public, political and spiritual opprobrium heaped on Wonga has resulted in a 61 per cent increase in customers, now topping 1 million, or 1 in 50 adults. They are clearly not all desperate Dickensian debtors suffering cyber debt slavery. Nor are they all stupid, as seems to be presumed by campaigners.

* Wonga is thriving in an environment of distrust of banks, in fact it is partly a product of it. CEO Errol Damelin told me that typical customers are digital savvy young people who do not want to pay unauthorised overdraft charges, and that there is a secular shift away from credit cards. Yes the APRs are horrific, but it turns out that there are hundreds of thousands of people who prefer convenience and speed.

* Wonga is also thriving in a world lacking in widespread financial illiteracy. Interest rates are too complicated. Understanding things in terms of simple pound for pound repayments works. I’d imagine that Wonga would not work in Germany, for example, not just because of the famed debt aversion, but because Germans are more financially literate.

* Funding Circle, Zopa, and Wonga will transform consumer and business finance in the coming years. The banks should be on guard, and will probably try to buy all three.

* Wonga is 100 per cent capitalised. Not a penny of leverage. Every pound of lending comes at the risk of its shareholders, and then the profit made on that. This is the ultimate “skin-in-the-game”. No question of too-big-too- fail subsidies, systemic threats or implicit taxpayer bailouts. For contrast, there was a furore when Wonga sponsored Newcastle United. It basically replaced Northern Rock on the Toon’s shirt, which the NAO calculates will have cost taxpayers £2bn.

* If Wonga raised its funding from the Bank of England at subsidised rates, the rates of interest it charges would be obscene. Conventional banks would face an uproar for borrowing on the back of taxpayers at 0.5 per cent and lending out at 5,000 per cent. I bet they are eyeing this market jealously.

* Wonga is finding a profitable new model for short term business funding in the face of an intransigent banking system, unwilling to invest in humans to allocate capital to small businesses. It uses the mysterious formula that Wonga is trumping as its secret sauce.

* The banking system is going to become more like Wonga than the other way round. Barclays CEO Antony Jenkins is constantly talking about a future of automation, less human discretion etc. This is what Wonga is doing now, albeit short term.

* Why should the equations, econometrics and extrapolations which were a root cause of the banking crisis work in Wonga’s case? Because the loans last on average for 17 days. Unlike the subprime crisis, where models of loan loss were based on house prices never going down, Wonga uses an extraordinary suite of variables to model likely default. So far, in tough economic times, it has not failed.

* If the Wonga bosses are right about their typical customers, then this is about squeezed living standards, which I have argued elsewhere ia ultimately about the cost of housing. All the political focus on this controversial product is understandable. The complete lack of focus on the innovations, failures, lax political regulation that waved through trillions in mortgages during the boom years, is what I find remarkable. If politicians want to save people from Wongaland, I’d suggest policies to create disposable income by lowering housing costs. But that does not seem to be as popular or easy as targeting Wonga.

* Wonga is benefiting from a “reverse Apple”. The ability to generate custom through free mentions in the media, out of vast proportion to its economic importance. A £1bn total loan book, out of an unsecured debt mountain in Britain of £55bn on credit cards and £100bn in other forms (not sure if the £1bn is directly comparable actually, but it gives a sense of scale).  Perhaps I should not have blogged.

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