Tag Archives: Lending

More Alarm Bells As Banks Report Tightening Lending Standards While Loan Demand Slides

The latest alarm signal that the US economy is on collision course with a recession came after today’s release of the latest Senior Loan Officer Opinion Survey (SLOOS) by the Federal Reserve, which was conducted for bank lending activity during the fourth quarter of last year, and which reported a double whammy of tightening lending standards and terms for commercial and industrial loans on one hand, and weaker demand for those loans on the other. Even more concerning is that banks also reported weaker demand for both commercial and residential real estate loans, echoing the softer housing data in recent months.

This tightening in C&I lending standards coupled with sharp declines loan demand, especially for mortgage and auto loans, is shown below.

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Here are the details via Goldman:

  • 20% of banks surveyed reportedly widened spreads of loan rates over the cost of funds for large- and medium-sized firms, while 16% narrowed spreads. 14% of banks surveyed reported higher premiums charged on riskier loans, while 4% reported lower premiums. Other terms, such as loan covenants and collateralization requirements, remained largely unchanged. Demand for loans reportedly weakened on balance.
  • Relative to the last survey, standards on commercial real estate (CRE) loans tightened on net over the fourth quarter of the year. On net, 17% of banks reported tightening credit standards on loans secured by multifamily residential properties, while 13% of banks on net reported tightening standards for construction and land development loans. As above, banks reported that demand for CRE loans across a broad range of categories moderately weakened on net.
  • Banks reported that lending standards for residential mortgage loans remained largely unchanged on net in 2018Q4 relative to the prior quarter. However, this benign environment was largely as a result of slumping demand for credit, as banks reported weaker demand across all surveyed residential loan categories, including home equity lines of credit.
  • While banks reported that lending standards on consumer installment loans and autos remained largely unchanged, banks reported that lending standards for credit cards had tightened slightly. Here too demand – for all categories of consumer loans – was moderately weaker, while respondent willingness to make consumer installment loans tumbled to the lowest value since the financial crisis.

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Finally, and most concerning of all, is that in their response to special questions on their 2019 outlook, assuming that economic activity continues to be in line with consensus forecasts, banks reported they plan to tighten lending standards somewhat for C&I loans, commercial real estate loans, and residential mortgage loans, in other words the most important credit would become even more difficult to attain. As a result, or perhaps due to the slowdown in the economy, banks also expect demand for C&I, CRE, and residential mortgage loans to weaken somewhat in 2019.

Banks also reported expecting delinquencies and charge-offs to increase somewhat on C&I, CRE, and residential mortgage loans; as Bloomberg’s Andrew Cinko muses “if America was heading toward an economic contraction that would be a typical expectation. But this doesn’t seem to be the case for the foreseeable future. So what gives?”

Perhaps “what gives” is that the economy is not nearly as strong as consensus would make it appear, and behind closed door, loan officers are already batting down the hatches and preparing for a recession. 

* * *

Here would be a good time to remind readers that according to a Reuters investigation conducted in mid-December, when looking behind headline numbers showing healthy loan books, “problems appear to be cropping up in areas such as home-equity lines of credit, commercial real estate and credit cards” according to federal data reviewed by the wire service and interviews with bank execs.

Worse, banks are also starting to aggressively cut relationships with customers who seem too risky, which is to be expected: after all financial conditions in the real economy, if not the markets which just enjoyed the best January since 1987, are getting ever tighter as short-term rates remain sticky high and the result will be a waterfall of defaults sooner or later. Here are the all too clear signs which Reuters found that banks are starting to prepare for the next recession by slashing and/or limiting risky loan exposure:

  • First, nearly half of the applications from customers with low credit scores were rejected in the four months ending in October, compared with 43 percent in the year-ago period, according to a survey released by the Federal Reserve Bank of New York.
  • Second, banks shuttered 7 percent of existing accounts, particularly among subprime borrowers, the highest rate since the Fed started conducting surveys in 2013.
  • Third, home-equity lines of credit declined 8 percent across the industry, with growth slowing in areas such as credit cards and commercial-and-industrial loans, the survey showed.

Then there are the bank-specific signs, starting with Capital One – one of the biggest U.S. card lenders – which is restricting how much it lends to each customer even as it aggressively recruits new ones, CEO Richard Fairbank said last December.

We have been more cautious in the extension of credit, initial credit lines, the broad-based credit line increase programs,” he said. “At this point in the cycle, we’re going to hold back on that option a bit.”

Regional banks have become more cautious lately as well, as they avoid financing riskier projects like early-stage construction loans and properties without pre-lease agreements (here traders vividly recall the OZK commercial real estate repricing fiasco that sent the stock crashing). New Jersey’s OceanFirst Bank also pulled back on refinancing transactions that let customers cash out on their debt, and has started reducing exposure to industrial loans, CEO Chris Maher told Reuters.

“In a downturn, industrial property is extremely illiquid,” he said. “If you don’t want it and it’s not needed it could be almost valueless.”

What happens next?

While a recession is looking increasingly likely, especially as it becomes a self-fulfilling prophecy with banks slashing loans resulting in even slower velocity of money, while demand for credit shrinks in response to tighter loan standards and hitting economic growth, the only question whether a recession is a 2019 or 2020 event, bankers and analysts remain optimistic that the next recession will look much more like the 2001 tech bubble bursting than the 2007-09 global financial crisis.

We wonder why they are so confident, and statements such as this one from Flagship Bank CFO Schornack will hardly instill confidence:

“I lived through the pain of the last recession. We are much more prudent today in how we underwrite deals.”

We disagree, and as evidence we present Exhibit A: the shock write down that Bank OZK took on its commercial real estate, which nobody in the market had expected. As for banks being more “solid”, let’s remove the $1.5 trillion buffer in excess reserves that provides an ocean of artificial liquidity, and see just how stable banks are then. After all, it is this $1.5 trillion in excess reserves that prompt Powell to capitulate and tell the markets he is willing to slowdown or even pause the Fed’s balance sheet shrinkage.

Source: ZeroHedge

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No Credit History? No Problem. Lenders Can Underwrite Your Phone Data

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Phone carriers and banks have gained confidence in using mobile data for lending after seeing startups show preliminary success with the method in the past few years.

Financial institutions, overcoming some initial trepidation about privacy, are increasingly gauging consumers’ creditworthiness by using phone-company data on mobile calling patterns and locations.

The practice is tantalizing for lenders because it could help them reach some of the 2 billion people who don’t have bank accounts. On the other hand, some of the phone data could open up the risk of being used to discriminate against potential borrowers.

Phone carriers and banks have gained confidence in using mobile data for lending after seeing startups show preliminary success with the method in the past few years. Selling such data could become a more than $1 billion-a-year business for U.S. phone companies over the next decade, according to Crone Consulting LLC.

Fair Isaac Corp., whose FICO scores are the world’s most-used credit ratings, partnered up last month with startups Lenddo and EFL Global Ltd. to use mobile-phone information to help facilitate loans for small businesses and individuals in India and Russia. Last week, startup Juvo announced it’s working with Liberty Global Plc’s Cable & Wireless Communications to help with credit scoring using cellphone data in 15 Caribbean markets.

And Equifax Inc., the credit-score company, has started using utility and telecommunications data in Latin America over the past two years. The number of calls and text messages a potential borrower in Latin America receives can help predict a consumer’s credit risk, said Robin Moriarty, chief marketing officer at Equifax Latin America.

“It turns out, the more economically active you are, the more people want to call you,” Moriarty said. “That level of activity, that level of usage is what’s really most predictive.”

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The new credit-assessment methods could allow more people in areas without bank branches to open accounts online. They could also make credit cards and loans more accessible and prevalent in some parts of the world. In the past, lenders mainly relied on bank information, such as savings and past loan repayments, to judge whether to let someone borrow.

Some of the data financial institutions are using come directly from interactions with potential borrowers, while other information is collected in the background. FICO’s partner EFL sends psychological questionnaires of about 60 questions to potential borrowers’ mobile phones. With Lenddo’s technology, FICO can check if users’ phones were physically present at their stated home or work address, and if they are in touch with other good borrowers — or with people with long histories of fooling lenders.

“We see this as a good opportunity to explore that type of data for risk assessment, as a viable means of extending financial inclusion,” David Shellenberger, a senior director at FICO, said in an interview.

Juvo’s Flow Lend mobile app uses data science and games — like letting users earn points — to build real-time subscriber profiles, to let C&W personalize lending criteria and provide immediate credit extensions. Prepaid customers can request credit advances for airtime and data. Denise Williams, a spokeswoman for C&W, didn’t immediately return a request for comment.

Getting Permission

In most cases, consumers must grant permission for their telecommunications records to be accessed as part of their risk assessment. One reason it’s taken the credit-risk industry some time to work out agreements with phone carriers or their representatives is because of negotiations over how to best protect client privacy.

Companies are also concerned about making sure they don’t make themselves susceptible to claims of bias. By checking phone records to see if a credit applicant associates with people with a poor track record of repaying loans, for example, lenders risk practicing discrimination on people living in disadvantaged neighborhoods. In addition, to comply with the Fair Credit Reporting Act in the U.S., a data provider must have a process in place for investigating and resolving consumer disputes in a timely manner — something that telecommunications carriers abroad may not offer.

Several large phone companies contacted by Bloomberg declined to comment about whether they share data with financial institutions, and few of the startups or financial companies were willing to disclose their telecommunications partners.

Mirror of Life

Startup Cignifi, which helps customers like Equifax crunch data on who phone users are calling and how often, works with phone companies like Bharti Airtel Ltd.’s unit in Ghana. Cignifi scores some 100 million consumers in 10 countries each month, said Chief Executive Officer Jonathan Hakim. Banks typically use such assessments alongside other evaluations to decide whether to grant a loan. Airtel didn’t respond to requests for comment.

“The way you use the phone is a proxy for the way you live,” Hakim said. “We are capturing a mirror of the customer’s life.” His company collects phone data — such as whom the potential borrower is calling and how frequently — from partners like Airtel Ghana, and crunches it for customers like Equifax, as well as marketers. It scores some 100 million consumers in 10 countries each month, Hakim said. Banks typically use such assessments alongside other evaluations to decide whether to grant a loan. Cignifi always gets customers’ permission to use data, he said.

EFL’s questionnaire approach is already used by lenders in Spain, Latin America and Africa. More than 700,000 people have received more than $1 billion in loans thanks in part to its data, CEO Jared Miller said in an interview.

EFL’s default rate varies by country, from low single digits in India to low double digits in Brazil, Miller said. To account for the risk, lenders in Brazil charge much higher interest rates, he said.

Startups like Lenddo, Branch and Tala have collected several years’ worth of data to prove that their methods of using mobile-phone data work — and that customers flock to them for help. Started in 2011, Lenddo, for instance, spent 3 1/2 years giving out tens of thousands of loans, in the amount of $100 to $2,000, in the Philippines, Colombia and Mexico to prove out its algorithms. Its average default rate was in the single digits, CEO Richard Eldridge said in an interview.

The company stopped offering lending in 2014, and stepped into credit-related services to financial institutions and banks in early 2015. Embedded into banking mobile apps, it can collect data on users with their consent. The company’s revenue is up 150 percent from last year, Eldridge said.

“The market is changing,” Eldridge said. “More and more people are seeing examples around the world of how non-traditional data can be used to enter into new market segments that couldn’t be served before.”

By Olga Kharif | Bloomberg

RIAs Join Brokers In Promoting Securities-Backed Lending

These loans are growing quickly beyond wire houses, but some are concerned about the risks and conflicts of interest

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Traditionally a major focus at bank-owned brokerage firms, securities-backed loans — where a wealthy investor puts up their portfolio as collateral for a big-money purchase &mash; are increasingly being marketed through independent registered investment advisers.

In the past two years, use of the products has soared as custodians beef up their lending capabilities. Pershing Advisor Solutions, a subsidiary of The Bank of New York Mellon Corp., began offering the loans to RIAs last year and has already issued 254 of them worth $1 billion through more than 20% of its 570 RIA clients. Fidelity Investments, which serves about 3,000 RIAs, has seen balances for securities-backed loans increase 63% in its RIA segment over the past two years.

“Non purpose loans have gotten more attention over the last year-plus with the custodians,” said John Sullivan, a former lending specialist at Smith Barney who is now a relationship manager at Dynasty Financial Partners. “Every effort is being made by firms like Dynasty and the various custodians that are out there to be able to replicate or in some cases exceed the existing platform” at the wirehouses.

For years, the loans have been a popular product at the wirehouses, including Bank of America Merrill Lynch and Morgan Stanley Wealth Management. They are billed as a way for wealthy investors to make large purchases, such as a yacht or vacation home, without having to sell a portion of their portfolio or incur capital gains taxes in the short term. Bank of America Merrill Lynch had $11.7 billion in margin loans outstanding, according to its most recent SEC filings from March.

There is no upfront cost to set up a securities-based line of credit, and firms offer competitive rates, which are sometimes lower than a traditional bank loan and are particularly attractive now with low interest rates. The loans can be made in a relatively shorter period of time than traditional bank loans as well. They take as few as eight business days at Pershing.

But there are other reasons firms, including the wirehouses like securities-backed lending. The loans provide another income source from clients in fee-based accounts and can be more profitable for the firm than other investment products because they don’t have to share as much of the revenue with their advisers who sells the clients on the loan.

“Lending growth will enhance the stability of revenue and earnings for the firm as a whole and make our client relationships deeper and stickier,” Morgan Stanley & Co.‘s former chief financial officer, Ruth Porat, said in an earnings call in July.

RIAs specifically don’t receive any additional compensation from a bank or custodian for selling securities-backed loans, but there are other benefits. For example, the loans allow wealthy clients to make multimillion dollar purchases without cutting into the assets under management. Bob LaRue, a managing director at BNY Mellon, said new business from clients often results as well — and, of course, the dollars left in the portfolio have the potential for gains, which raise AUM.

Herein lies the rub, according to Tim Welsh, president and consultant of Nexus Strategy, a wealth management consulting firm. “They don’t sell, so the assets under management stay the same — so it inherently has a conflict of interest,” he said.

That can be a problem, Mr. Welsh said, particularly because client demand typically is highest for these kinds of loans at the wrong time.

“In every bull market I’ve seen, this is always a predictor of the top,” Mr. Welsh said. “When people start borrowing money against their assets, they’re really confident that they’re going up. And investors are always one step behind in terms of tops and bottoms.”

The risk is that if the value of a client’s portfolio drops, the firm can sell the securities or ask that the client put down more money to back that up. Using securities as collateral can be subject to greater volatility than other types, such as a home equity loan.

“When the markets rationalize, bills come due, and if you don’t have liquidity, all of a sudden you have to sell,” Mr. Welsh said. “It definitely raises the risk profile up immediately.”

Adviser Josh Brown of Ritholtz Wealth Management has dubbed the growth in these loans a “rich man’s subprime.”

“Once again, super-cheap financing based on an asset whose value can fluctuate wildly (a stock and bond portfolio, in this case) is being used for the purchase of assets that can be significantly less liquid, like real estate, fine art or business expansion,” Mr. Brown wrote in a story last year on the growth of the loans in the wirehouse space. “Don’t say I didn’t warn you.”

Regulators have taken notice as well. The Financial Industry Regulatory Authority Inc., which oversees broker-dealers, warned in January that it was looking into the marketing of securities-backed loans as part of this year’s regulatory agenda.

“Finra has observed that the number of firms offering [securities-backed loans] is increasing, and is concerned about how they are marketed,” the regulator said.

That said, Mr. Sullivan and others who defend securities-backed lending said it works well if that risk is taken into account.

“It’s really about staying invested for the long-term and meeting short-term cash flow needs with some borrowing that’s not going to exceed a certain percentage on the assets,” Mr. Sullivan said.

Mr. LaRue said advisers have to consider whether it makes sense to trade leverage for the tax benefits.

“The appropriateness of leverage depends on each individual client’s needs,” he said. “If you are borrowing [to avoid the capital gains] taxes and keep a favorable investment strategy in place, then perhaps leveraging those assets at a low interest rate makes sense.”

By Mason Braswell for Investment News