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What’s in Your Wallet?

October 15th, 2020

Quarterly Commentary

Many of us probably remember the first time we watched Quentin Tarantino’s Pulp Fiction.  The superb cast introduced us to a wild mosaic of characters:  Vincent Vega, the Wolf, Marsellus, Mia, Butch the boxer and lest we forget, Honey Bunny.  But it was Samuel Jackson’s sermonizing Jules Winnfield character that captivated and riveted audiences.  Several years later, Capital One Financial relied on Mr. Jackson’s trademark stare and that voice to anchor its successful ad campaign (here and here), delivering the tagline “What’s in Your Wallet?”.

As investment managers, we talk to capital allocators regularly about the historic attractive risk-adjusted returns of small balance, short duration private credit. Often, we hear disbelief when we point out that prime consumers can borrow using personal installment loans at annual rates that average around 13%. Our audience tends to perceive these rates as excessively high, especially for borrowers with FICO scores above 660.  So, we ask them: What’s in your wallet?

We have observed that most people – including investment professionals – struggle to answer that question.  Few pay attention to the regular APR (“Annual Percentage Rate”) on their credit cards, mainly because most borrowers who carry a balance are more focused on the dollar amount of their monthly payment than the rate.  When they do examine their rate, many are surprised by the magnitude.

An average 13% APR on a personal installment loan to a prime borrower is cheaper and more efficient than maintaining a revolving credit card balance.  In October 2020, according to Bankrate, the average credit card in most people’s wallets has a regular APR of around 16%.  Bankrate’s website has a link to the “Best Low Interest Credit Cards for 2020” which illustrates, among many other features, the APR ranges for those cards: The lower bound starts around 13.5%, with the high end just under 30%. A typical 700-FICO prime borrower with the popular Capital One Venture card has a regular APR that ranges between 17.25% – 24.5%, plus an annual fee.

No wonder that within consumer credit, the personal installment loan category has been enjoying double-digit annual growth rates.  In 2010, the $1 trillion in revolving consumer credit debt outstanding was predominantly credit card.  Ten years later, personal installment loans hold about a 20% share. The tea leaves point to continued growth, mostly driven by FinTech.

With the ongoing digitization of financial services, borrowers – be they individual consumers or small businesses – are experiencing a more democratic availability of credit…and at lower cost. In addition, straightforward access to that credit via user-friendly apps, coupled with transparency around fees and payments, has been accelerating adoption of digital solutions.  No wonder valuations of FinTech firms keep moving higher!  According to an Economist report from early October, Ant Group had a market cap of $300 billion, the third highest of all global financial firms – behind Visa and Mastercard and just ahead of JPMorgan Chase. Paypal’s market cap, at $240 billion, was higher than other U.S. financial firms, including Bank of America ($210 billion) and Wells Fargo ($100 billion).

For capital allocators, the sandbox of fixed income investment options will continue to evolve with digitization.  Small balance private credit opportunities, such as consumer loans with 13% APRs, look increasingly attractive on a risk-adjusted basis considering a world in which most global bonds deliver real yields at or below zero (see our piece How Low Can You Go?).  Even junk bonds offer compressed yields: witness a recent BB+ 10-year bond issued at 2.875%!   Capital allocators might consider asking themselves: What should be in my wallet?


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