By Chris Gillock
My grandfather owned and operated the general store in Curwensville, a small town in western Pennsylvania. During the Great Depression, Grandpa’s store became a “casual finance company” – folks who were short on money would convince my grandfather to sell to them on credit. This ended rather badly, as you might imagine. My Grandpa said “I learned something – sometimes even good people borrow money that they know they can’t pay back.”
It is possible that we are in that part of the credit cycle where good (and not so good) people are borrowing money they know they can’t pay back. The new crop of indirect subprime auto finance companies and online lenders have been behaving as if the credit cycle has been repealed. Obviously, it has not.
A massive flood of capital has entered into certain categories of lending as the capital markets seek some sort of positive yield in this world of negative real interest rates. More capital doesn’t magically create more good loans. When there are no good loans to make, lenders will make bad ones. Like dead bodies, these bad loans eventually float to the surface.
Peter Rudegeair of the Wall Street Journal wrote a piece in today’s paper that summarizes LendingClub’s recent SEC filing – the company disclosed that its expected losses on loans is moving up. This is a change from February when LendingClub’s CEO said that losses were steady and not increasing. Online lenders Prosper Marketplace and On Deck Capital are also seeing upticks in credit problems. So are many of the companies in the subprime auto finance sector.
I believe these credit issues are manageable and can be resolved by tightening underwriting standards. This will crimp growth, however, which is not a happy outcome for companies stuck in the “quarterly capitalism” world of the public equity markets. I also think that life will get very challenging for certain lenders if our current sluggish growth in the U.S. flips to a contraction (the current recovery is getting a bit long in the tooth, now that I think about it). If a recession hits in the next year or so, we will see a few splashy failures among the fast-growing lenders….