consumer distress

[Rude Dude]

Article in Barrons today. 

http://www.barrons.com/articles/the-surprising-threat-to-the-american-economy-1496463255?mod=BOL_twm_ls&tesla=y

For some time now, Stephanie Pomboy of MacroMavens has highlighted the accumulating stress on consumers. “People who save are those who have the wherewithal to save,” she says, “while poorer consumers are borrowing out of distress to fund purchases normally paid for by income.”

The fact that delinquency rates are starting to turn higher “across all segments of the consumer space, despite near record-low interest rates, is a powerful indictment of the strong consumer narrative so widely embraced,” Pomboy says. How can folks have trouble paying their debts with unemployment at 4.3%, mortgage payments low, and net worth at record highs? “One shudders to imagine what delinquencies would look like if rates actually did move up, or—heaven forbid—stocks went down,” she adds.

When Stephanie Pomboy speaks, I  always listen.

I always knew that there's a correlation between c/o rates and interest rates, but in this cycle the correlation is even stronger. Pomboy's right that borrowers (maybe even more that just the "poor") are super sensitive to higher interest rates and can't afford to make the higher monthly payments. Compared to previous cycles, the c/o rate isn't lagging behind int rate increases - the c/o rate is moving virtually in tandem, according to Fed data:



The the inflection point in c/o rates happened in Q4 15, right when the Fed made the first hike. 

I agree with her (and Anil's) comments that some folks don't have the ability to save and are borrowing out of distress. Interest rates really have the most potential to do damage, as the Fed intends to make more rate increases. Other than increased loss provisions, are lenders protecting themselves? I don't think most lenders are ahead of this - will lenders adjust volume and pricing quickly enough this time?
 

[nonattender]

When chargeoffs rise, so, too, should interest rates.  This is what I see happening, even though I don't interpret it the way Pomboy does - she probably takes her car into the shop and says "it's firing on all cylinders and the timing and alignment are in near dead-sync --- pls fix!"

Oh, who are we kidding... she probably only rides in black cars.  That quote about her being "distressed" that chargeoffs are rising despite record low interest rates tells me exactly to which school of economics she subscribes.  To anyone without a Patrice Lumumba doctorate, a slight renormalization/rise in chargeoffs, after a massive recessionary rescue, just means that things are going swimmingly, and to tighten.

[AnilG]

Chargeoffs rise when interest rates rise making existing floating rate loans such as credit card unaffordable. As an investor you should expect higher interest rate to compensate for higher Chargeoffs but as an existing borrower higher interest rate may be the death knell.

When chargeoffs rise, so, too, should interest rates.  This is what I see happening, even though I don't interpret it the way Pomboy does - she probably takes her car into the shop and says "it's firing on all cylinders and the timing and alignment are in near dead-sync --- pls fix!"

Oh, who are we kidding... she probably only rides in black cars.  That quote about her being "distressed" that chargeoffs are rising despite record low interest rates tells me exactly to which school of economics she subscribes.  To anyone without a Patrice Lumumba doctorate, a slight renormalization/rise in chargeoffs, after a massive recessionary rescue, just means that things are going swimmingly, and to tighten.

[nonattender]

Ergo, tighten up loose policy - stay with (or ahead of) the curve - and stop borrowers from digging in so deep at artificially low rates...

I think you and I are saying the same things - though from a variety of angles...  Wrt the Pomboy talk, I was talking macroeconomically.

Chargeoffs rise when interest rates rise making existing floating rate loans such as credit card unaffordable. As an investor you should expect higher interest rate to compensate for higher Chargeoffs but as an existing borrower higher interest rate may be the death knell.

When chargeoffs rise, so, too, should interest rates.  This is what I see happening, even though I don't interpret it the way Pomboy does - she probably takes her car into the shop and says "it's firing on all cylinders and the timing and alignment are in near dead-sync --- pls fix!"

Oh, who are we kidding... she probably only rides in black cars.  That quote about her being "distressed" that chargeoffs are rising despite record low interest rates tells me exactly to which school of economics she subscribes.  To anyone without a Patrice Lumumba doctorate, a slight renormalization/rise in chargeoffs, after a massive recessionary rescue, just means that things are going swimmingly, and to tighten.

[SLCPaladin]

Ergo, tighten up loose policy - stay with (or ahead of) the curve - and stop borrowers from digging in so deep at artificially low rates...

I think you and I are saying the same things - though from a variety of angles...  Wrt the Pomboy talk, I was talking macroeconomically.

This is the biggest issue I have with LC right now. I don't feel like they have gotten ahead of the curve; they are playing catch up with rates.

[Rob L]

Ergo, tighten up loose policy - stay with (or ahead of) the curve - and stop borrowers from digging in so deep at artificially low rates...

I think you and I are saying the same things - though from a variety of angles...  Wrt the Pomboy talk, I was talking macroeconomically.

This is the biggest issue I have with LC right now. I don't feel like they have gotten ahead of the curve; they are playing catch up with rates.

It may be that LC literally can't play catch up. For the sake of argument let's say there are now enough sources of unsecured personal  loans such that competition between these sources forces rates to be what they are. LC raises rates too high and they lose borrowers to their competition. To go one step further, we can put the cart before the horse. LC knows their revenues required from loan originations to break even or make a profit. They have to set interest rates low enough to attract enough borrowers for revenues from originations to keep the company going. Of course if rates are too low LC loses lenders but that takes a while. They're between a rock and a hard place. Maybe they should think about some major cost cutting. Low cost suppliers are usually winners and LC doesn't strike me as a low cost operation (my speculation only).

[rawraw]

Yeah not sure how LC will compete on costs.

[Rude Dude]

Ergo, tighten up loose policy - stay with (or ahead of) the curve - and stop borrowers from digging in so deep at artificially low rates...

I think you and I are saying the same things - though from a variety of angles...  Wrt the Pomboy talk, I was talking macroeconomically.

This is the biggest issue I have with LC right now. I don't feel like they have gotten ahead of the curve; they are playing catch up with rates.

It may be that LC literally can't play catch up. For the sake of argument let's say there are now enough sources of unsecured personal  loans such that competition between these sources forces rates to be what they are. LC raises rates too high and they lose borrowers to their competition. To go one step further, we can put the cart before the horse. LC knows their revenues required from loan originations to break even or make a profit. They have to set interest rates low enough to attract enough borrowers for revenues from originations to keep the company going. Of course if rates are too low LC loses lenders but that takes a while. They're between a rock and a hard place. Maybe they should think about some major cost cutting. Low cost suppliers are usually winners and LC doesn't strike me as a low cost operation (my speculation only).

I agree. I like LC's management, but the marketplace model is going to be seriously tested soon. In addition to your points, I'm not sure who will continue to buy the loans as defaults rise. Remember late 2016/early 2017 when almost all inst investor appetite for loans dried up? That could easily happen again. LC knows there aren't enough retail investors to support the costs of the model, so where would LC get its revenues? Even if LC begins to balance sheet loans, how much cash and how big of a credit facility will the company need to keep things afloat until buyers come back? Traditional CC lenders are also going to take it on the chin, but because they balance sheet their loans their revs/income aren't dependent on institutional investors.

Hopefully the c/o rates of 10% the largest CC issuers suffered in 2008-10 will be avoided, but I don't have any faith that the largest lenders can manage their risk properly. This is because all of the banks/lenders (including marketplace lenders) have been obsessed with growth and, again, are (historically) very poor at identifying macro risk that will damage returns. Or at least identifying it early enough and changing tack.

It all starts with the fact that top management and their staff at lenders are compensated for growth, not credit quality. And then the inevitable downturn comes, followed by high c/o's, then paltry earnings, and layoffs. Never mind what happens to the consumer or the small business, neither one of which should've been granted a loan in the first place. Granted, some borrowers do take advantage, but not most. I feel like we've all seen this movie before, but will the cycle ever end? Isn't there a better way? 

 

[SLCPaladin]

Ergo, tighten up loose policy - stay with (or ahead of) the curve - and stop borrowers from digging in so deep at artificially low rates...

I think you and I are saying the same things - though from a variety of angles...  Wrt the Pomboy talk, I was talking macroeconomically.

This is the biggest issue I have with LC right now. I don't feel like they have gotten ahead of the curve; they are playing catch up with rates.

It may be that LC literally can't play catch up. For the sake of argument let's say there are now enough sources of unsecured personal  loans such that competition between these sources forces rates to be what they are. LC raises rates too high and they lose borrowers to their competition. To go one step further, we can put the cart before the horse. LC knows their revenues required from loan originations to break even or make a profit. They have to set interest rates low enough to attract enough borrowers for revenues from originations to keep the company going. Of course if rates are too low LC loses lenders but that takes a while. They're between a rock and a hard place. Maybe they should think about some major cost cutting. Low cost suppliers are usually winners and LC doesn't strike me as a low cost operation (my speculation only).

You might be right here Rob. But I feel that rates could be hiked without killing demand for installment loans on the platform. It might very well be the case that demand would drop off, but I don't feel like we've gotten to that point yet. In the meantime, it seems like LC's problem is more on the demand side for note purchasing, which is tangentially related to risk-adjusted yield, which is related to rates and underwriting. So we've come full circle. You get rates right, and a lot of other things will fall into place.

In my mind, it makes sense to shore up investor returns (both retail and institutional, but especially "sticky" retail) by getting ahead of any credit cycle by raising rates sooner rather than later. I don't see why LC has to lag the Fed decision to raise rates; they could move first! I've always seen this as a virtuous cycle of sorts: perform good underwriting (e.g., low defaults) at attractive rates for investors -> investors get good returns -> investors reinvest more money and bring more investors to the table. Of course, the cycle works in reverse too.

[rawraw]

You can't avoid credit cycles. If you are in this thinking you can, you need to be investing in US Treasuries

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[SLCPaladin]

You can't avoid credit cycles. If you are in this thinking you can, you need to be investing in US Treasuries

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I've never stated that credit cycles can be avoided. But rates can be counter cyclical.

[rawraw]

You can't avoid credit cycles. If you are in this thinking you can, you need to be investing in US Treasuries

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I've never stated that credit cycles can be avoided. But rates can be counter cyclical.

If you raise rates, you not only impact the volume of borrowers but the type as well. LC does not exist in a bubble. They are a price taker, not a price setter. They have a narrow band the market allows to charge people interest. That's just how mass forms of  lending works. All of us would love higher rates, but I do not want the borrowers that would come from that.

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[nonattender]

My thesis:  "normal" people just waking up to uptick in defaults of last 2 years (really a renormalization), and credit expansion is just about to kick back in (tax cuts, new FICO, +NIM due to rate increases) which will propel us into the next part of the growth (credit and real) cycle = no problem.

Anyway, I just bought some DFS and some SYF - and if I'm wrong, don't you worry, the market will punish me for being so uncivil here.

Apparently, this guy reads like I do:  https://www.reuters.com/article/us-investment-funds-buffett-idUSKCN1AU2B1