Market Improvements; Contrarian View on U.S. Consumer; SBA PPP Program Holes

Greetings,

This week, we focus on changes in macro estimates and improvements in market fundamentals. We also share a contrarian view on the performance of consumer credit. 

Let’s get to it.

Unemployment Estimates Ratchet Higher (Again)

In macro news, the unemployment rate for March increased to 4.4% from 3.5% in February, the largest one-month increase since January 1975. 

The rate excludes the record 10 MM Americans that have filed for unemployment benefits over the last two weeks. 

The St. Louis Fed performed a study concluding that the economic freeze could cost 47 million jobs and send the unemployment rate past 32%. The analysis also concluded that 67 million Americans are working jobs that are at a high risk of layoffs. 

In a sign that markets are stabilizing for the first week, no trading day featured a +/- move of 5%.

The End of Limit Down Mondays?

Limit down is the new flat, but markets this week are starting to break the pattern. The Vix is down to a relatively balmy, but elevated 48 (although 10 Year is still tight at ~.6%, indicating a desire for safety).

Behind the awful headlines, markets are stabilizing. IG credit is stabilizing. The municipal bond market is coming back to life. Carnival issued a high-yield bond. The Fed’s term repo program received no bids for the first time since operations began last September.

The stimulus-response is making its way to consumer and small businesses, albeit in a disorderly way (e.g., unemployment sites overwhelmed, PPP program lacks clarity to truly let banks step up, SBA apps changing day before launch, etc.). 

This Time (Really) is Different

Still, so much stimulus is in motion that the major credit risk factors, we believe will shift to:

• Plumbing fixes. The pace at which clogs in the benefits machine can be stamped out (PPP still has major holes preventing widespread bank adoption, TALF 2.0 needs to include personal loans, PPP rate should be at 1.5 to 2%, etc.).
• Consumer confusion. For example, how many consumers mistakenly broaden the scope of mortgage forbearance to other credit asset classes.
• Servicing. Losses from loan modification strategies meant to blunt principal losses; how effectively lenders engage borrowers.
• Timing. The pace of job creation after the stimulus ends.

In the past, you could model losses as a function of shifts in the unemployment rate. The unemployment rate rises 1% for every 1.5 MM in jobless claims. An analyst would map unemployment and other loss drivers to an increase in credit losses calibrated by credit risk cohort.

Today, geographic variables are a major driver of losses. Pennsylvania, for instance, is clocking in unemployment claims at 2x the national average, trailing only California in total claims. 

Why the difference? States vary in sector/industry exposure and economic resilience to stay-at-home orders. Oil/Gas/Tourism heavy states are not as resilient to WFH as, say, software, grocery, logistics. States also have varied UE benefits, which will explain a pattern of losses.

We argue the best way to model losses is bottoms-up, using loan-level data that incorporates state-level UI benefits, state-level mortgage forbearance, loan-level data (industry, W-2/1099, ACH, etc.) an adjustment for the overall (dis)orderliness.

Reach out to your PeerIQ client delivery leader to learn more about how our data & analytics can help make better risk and pricing decisions.

Contrarian View on Consumer Credit

A thoughtful and well-placed investment banker noted (let’s call him “Mr. C”): 

“Consumer credit losses will be milder than people think. On average, consumers’ net income will improve due to stimulus and forbearance programs.”

Let’s unpack that.

Consumer income gains:

• Mortgage & rent forbearance ($1 to $3K / month).
• One-time direct payouts ($1,200 per qualifying adult, $500 per child).
• Retroactive federal benefits ($600/wk) layered onto state unemployment benefits (up to ~$450/wk for generally 26 weeks).
• 70% reduction in monthly discretionary expenses.

(Of course, this excludes new “consumer staples” - NetFlix and InstaCart.)

Some investors in secondary markets are using 3x default assumptions. Investors in some instances are bidding on 720 FICO 15 mo duration pools at 10 to 20% discounts off face value. 

It’s our job to take a view, even if it means putting our neck out there:

We believe losses will come in below 3x recession assumptions despite the swiftest hemorrhaging of jobs in modern history.

Email and let us know if you disagree. Strong opinion, loosely held.

Chart of The Week: Summary of Policy Efforts

Source: U.S. Department of Treasury, Federal Reserve Bank, KBRA, PeerIQ

What to Watch for in April, the Cruellest Month?

April will be instructive and will shake-out the variance in views in the market. What to look for:

• PeerIQ DQ and loan modification rates on portfolios. 
  • Right now you have to squint hard, but there are signs of DQs picking up in certain pockets. 
  • Our benchmarking application will spot pockets of under or overperformance instantly.
• Remit reports from April’s marketplace lending ABS. 
  • This will determine whether rating agencies downgrade Consumer MPL.
  • Kroll has put ~10 small business ABS bonds on downgrade watch, but none for consumer as of yet.
• Non-Prime: OneMain ABS remit reports:
  • No DQ spike in the last report (too early)
• Prime: Credit Card MasterTrust Reports:
  • A better, but imperfect comp, for prime consumer credit installment lenders

Treasury Authorizes FinTechs to Issue SBA Loans as Part of PPP; PPP has Major Gaps

Non-SBA lending is tightening amidst the sudden cessation of economic activity. Capital One, Amex, Square, OnDeck (and plenty of others) are tightening credit or requiring income documentation.

The SBA’s PPP program is designed to fill the breach by providing $349 Bn to small businesses. The SBA lending program last year was $23 Bn. Hitting the goal requires FinTechs to partner with Banks to originate in size. 

In an extraordinary move, Treasury Secretary Mnuchin said that any fintech lender will be authorized to make loans as part of the government stimulus.

But the PPP has a number of holes making it difficult for FinTechs to execute:

• Interest Rate. The interest rate for loans is 1% (up from .5% last Thursday). This means only banks or credit unions have the capacity to fund the loans, but a bank can achieve an ROE of about 10% (assuming zero funding costs, 10x leverage, and orig costs offset servicing/CAC/underwriting). 
• Legal Risk. Banks have exposure under the False Claims Act if they rapidly approve and process applications on a simple 3-page form, but unintentionally and inevitably process fraudulent applications. Banks would also need relief, indemnification, and/or guidance, regarding the application of KYC, AML, and BSA requirements. 
• Where is the Take-Out? Banks will struggle to get comfortable with taking rep and warranty risk on FinTechs. Will the Treasury step in to provide liquidity to or purchase these SBA loans? Will the SBA provide guidance and a safe harbor for big banks and credit unions regarding R&W and the False Claims Act?

Incidentally, we think a big winner here would be a partner-funding bank. Cross River, for instance, is an SBA lender, a commercial bank that has oversight on disclosures/underwriting for partner lenders and therefore in a unique position to link non-banks to the banking sector.

Zillow vs. Steve Eisman

In other industry news, Zillow is terminating closing contracts, citing coronavirus concerns - and we would guess the drop-off in home listings and sales. 

We will find out if Steve Eisman’s critique of the iBuyer model that iBuyers get stuck holding capital intensive inventory when markets shut down plays out as indicated.

In financing news, Plastiq raised $75M to help small businesses use credit cards more. Plastiq, led by CEO, Eliot Buchanan, raised $75 million in a Series D round led by B Capital Group. 

Industry News: 

• U.S. Employers Cut 701,000 Jobs in March (WSJ, 04/03/2020) The unemployment rate for March increased to 4.4% from 3.5% in February, which is the largest one-month increase in the rate since January 1975.
• Record 6.6 Million Americans Sought Unemployment Benefits Last Week (WSJ, 03/02/2020) Another 3.1 million Americans applied for unemployment last week, marking a sharp downturn in the labor market caused by the new coronavirus.
• Fed Temporarily Eases Capital Requirements for Big Banks (WSJ, 04/01/2020) Fed Chair, Jerome Powell, said that it will ease the supplementary leverage ratio for one year. 
• Coronavirus job losses could total 47 million, unemployment rate may hit 32%, Fed estimates (CNBC, 03/30/2020) According to an analysis from the St. Louis Fed, nearly 67 million Americans are working in jobs that are at a high risk of layoffs. 
• People Need Loans as Coronavirus Spreads. Lenders Are Making Them Tougher to Get. (WSJ, 03/28/2020) As a possible recession approaches, banks and FinTechs are tightening lending standards for small businesses and riskier consumers.
• SMB loans platform Kabbage to furlough a ‘significant’ number of staff, close office in Bangalore (Tech Crunch, 03/30/2020) FinTech lending startup, Kabbage, is furloughing a “significant number” of its U.S. team of 500 employees.
• A Global Consumer Default Wave Is Just Getting Started (Bloomberg, 03/30/2020) Analysts say that it’s only a matter of time before defaults start spreading within the record $47 trillion pile of global household debt.
• Mortgage Defaults Could Pile Up at Pace That Dwarfs 2008 (Bloomberg, 04/02/2020) Mortgage lenders are bracing themselves for the biggest wave of delinquencies in history.
• Online lenders seek to balance the needs of borrowers, investors (American Banker, 03/26/2020) FinTech lenders like LendingClub, Prosper, Avant, and Sofi are giving existing borrowers short-term relief, but they are also considering tightening credit
• Zillow is terminating closing contracts, citing coronavirus concerns (Housing Wire, 03/26/2020) Zillow is one of the few companies that has paused the iBuying process due to the COVID-19.
• COVID-19: LendingClub Increases Interest Rates for New Borrowers as Unemployment Rate Jumps (CrowdFund Insider, 03/30/2020) LendingClub’s rates for new borrowers will increase between 2% to 4%, depending on grade. 
• Plastiq raises $75M to help small businesses use credit cards more (Tech Crunch, 03/25/2020) Plastiq, led by CEO, Eliot Buchanan, raised $75 million in a Series D round led by B Capital Group. 

Lighter Fare:

(We all need some humor to keep our sanity! We wish you safety and health!)