Fifth Weekly Commentary: COVID-19 Response


D.I.S.T.O.R.T.I.O.N.

A symphony conductor listens to the orchestra’s sound. A chef savors tastes and senses aromas.  A ski racer surveys a slope for the perfect line.

Credit investors study delinquency trends. They tell the story of a credit portfolio’s performance.

What is Delinquency?  In credit terms, delinquency is a state between two endpoints: “current” and “default.”  Most of the time, borrowers are current on their credit obligations, paying owed principal and interest by specified dates per a contractual arrangement. When borrowers do not meet their obligation at the specified date, they enter a state of delinquency.  They stay there until they make their contractual payment, plus any late fees, and go back to current status, or they do not make a payment and, ultimately, default on their obligation.

We look at delinquency behavior to project lifetime credit loss in a portfolio.  Delinquency trends and migration through stages of delinquency inform the assumptions we use to construct future credit loss estimates, which are needed to calculate a portfolio’s fair value.

During normal times, the path from initial delinquency to default is statistically predictable.  For example, a personal installment borrower in a delinquency bucket of 16-30 days past due may have a probability of default of 30%. If that same borrower rolls to a more serious delinquency bucket of 31-60 days past due and then 61-90 days past due, their probability of default may increase to 70% and 95%, respectively.  Defaults generally occur no later than 120 days past due.

But these are not normal times. To help borrowers make it through this intense and near ubiquitous economic shock, loan servicers extended payment relief measures to impacted borrowers.

What is Payment Relief?  Payment relief is the explicit consent of a platform acting as servicer to allow borrowers to delay making contractual payments for a defined period. It is not debt forgiveness. In practical terms, it is financial life support to help people get through a period of economic difficulty and uncertainty.

Credit Outlook Distortion: Payment relief introduces two challenges for the credit investor. First, it temporarily slows incoming cash flow because borrowers in hardship generally skip one or two payments.  More importantly, relief programs allow borrowers to maintain current status (thereby preventing a negative impact on the borrower’s credit score) even though they will be missing one or two future payments.  The implication here is distortion: Digital finance portfolios may show little credit deterioration and will not reflect the scale and scope of the economic pain being experienced across the country during the next several months. Given that, we expect that posted portfolio delinquency statistics will be less reliable until payment relief programs are suspended and credit assets can age naturally for several months.

Until relief programs are suspended because they are no longer necessary, and credit assets can age naturally for several months, digital finance managers will not be able to rely on posted portfolio delinquency statistics to inform views on forward loss. Given that, we expect that posted portfolio delinquency statistics will be less reliable until payment relief programs are suspended and credit assets can age naturally for several months.

Final Note

As we look at the data, knowing that many loans tagged as “current” may in reality be sliding into delinquency, we are reminded of the men, women and families struggling to keep their businesses and lives afloat. The digitalization of financial services is designed to help us manage data and facilitate access to capital for new generations of small businesses, students, and individuals. We do not allow this digitized view to blur our vision into the individual struggles behind the data.  Our rooting interest in the performance of our portfolios is inherently a round of applause for our fellow human beings and a sign of our faith in their ability to persevere, survive and succeed again in the future.

As always, and particularly during this time of uncertainty, we appreciate your support and welcome your questions and comments.

We wish you a healthy weekend.

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