Loan Issuance at 60% of 2019 levels, Underwriting Standards Tighter, Interest Income Higher Loan Issuance at 60% of 2019 levels, Underwriting Standards Tighter, Interest Income Higher

Loan Issuance at 60% of 2019 levels, Underwriting Standards Tighter, Interest Income Higher

Alternative Lending Market Update July 1st 2020

Mike Li - Portfolio ManagerMike Li1 July 2020 at 12:00

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Alternative Lending Market Update

While uncertainty about broader macroeconomic conditions remains as we enter month five of the COVID-19 pandemic, in the consumer loan space interest income is increasing at the same time loan underwriting standards are tightening. Prime and super-prime consumer loans as a whole has thus far performed well relative to both expectations as well as other consumer asset classes.

To be clear, with the number of COVID-19 cases passing 13 million worldwide, the world continues to adjust to life with the pandemic in the background for the foreseeable future. While Western Europe and parts of Asia continue to progress to a semblance of normalcy, we continue to see an acceleration in the number of daily new cases in many areas like (Latin) America, Eastern Europe and India. This aligns with the easing in lockdown measures we continue to see across Europe at the beginning of July as some countries have now opened external borders. However, the macroeconomic picture remains difficult as ECB President Lagarde described expectations of a complicated economic recovery using the words “sequential and restrained.” This aligns with our continuing view that the global recovery will be halting and uneven, with potentially a very long path towards pre-pandemic levels of economic activity. In the United States, new COVID-19 epicenters such as Florida have raised concerns about a return to lockdown measures, but for better or worse, the United States is unlikely to close the economy again and will serve as a testcase for life and commerce in a current pandemic economy. While much uncertainty remains about the exact shape the recovery will take, mortality rates remain relatively low compared to earlier in the pandemic. At the same time, promising new developments in treatments and potential vaccines offer reasons to be optimistic that people will be willing and able to resume normal activities on a broader scale.

On the monetary policy side, while the ECB has increased the Pandemic Emergency Purchase Program (PEPP) up to EUR 1.35 trillion, the European policy response remains muted compared to the response by the US Federal Reserve which has signaled effectively unlimited resources to counter the effects of an economic slowdown. While progress on additional fiscal policy measures have stalled since the unprecedented CARES stimulus package was passed at the end of March (along with numerous state and local measures to alleviate financial stress on households), it remains likely that another, albeit smaller, stimulus package will be passed before the August Senate recess. Despite the ongoing turmoil to economic activity and the resulting sharp increases in unemployment in April, the weight of the US monetary and fiscal policy response combined with continued economic reopening in the face of rising COVID-19 cases (for better or worse) has resulted in unexpected strength in both the stock market as well unemployment rates. The S&P 500 has retraced much of the losses from March and is now about flat for the year (while the NASDAQ is at record highs) while both U-3 (the official unemployment rate) and U-6 (which measures underemployment as well) have declined significantly to 11.1% and 18.0% in June, respectively, from 14.7% and 22.8%, respectively, in April.

While unemployment remains above the March U-3 and U-6 rates of 4.4% and 8.7%, respectively, US consumer loans as a whole have performed well in relative terms with loan impairment rates rising about 10 points from about 6% in March to a peak of about 16.5% in April, in line with the change in unemployment rates. This is in line with the over 8 points increase of US mortgages in forbearance over the same period and is, in part, because US consumers entered this crisis with 5% less household debt, but almost 10% more income when compared to the financial crisis. Since April, the overall impairment rate has fallen by about 15%, but underlying improvement has been even better as over 40% of modified loans have resumed making at least partial payments. The improvement in the higher quality loan grades has been even stronger as 40% of modified loans are back to making full payments.

Loan issuance has remained muted at about 60% below 2019 levels as underwriting criteria has gotten considerably tighter and borrowers have become more conservative in taking on new debt. While banks and credit unions remain significant buyers of consumer loans due to attractive net interest margins, most of the decline has come from leveraged buyers as well as securitization activities due to the cost of financing. While spreads have tightened in significantly since March, a recovery in origination volumes will depend on the continued strong performance of loans through the second half of 2020.

Dynamic Credit Partners Europe B.V. (‘Dynamic Credit’) is a registered investment company (beleggingsonderneming) and a registered financial service provider (financieel dienstverlener) with the Dutch Authority for the Financial Markets (Autoriteit Financiële Markten). This document is intended for informational purposes only and is subject to change without any notice. The information provided is purely of an indicative nature and is not intended as an offer, investment advice, solicitation or recommendation for the purchase or sale of any security, financial instrument or financial product. This communication is a summary only, it may not contain all material terms. Any offering that may be related to the subject matter of this communication will be made to you pursuant to separate and distinct documentation (Legal Documentation) and in such case the information contained herein will be superseded in its entirety by any such Legal Documentation in its final form. Dynamic Credit may in the future issue, other communications that are inconsistent with, and reach different conclusions from, the information presented herein. Dynamic Credit cannot be held liable for the content of this document or any decision made by a third party on the basis of this document. Potential investors are advised to consult their independent investment and tax adviser before making an investment decision. An investment involves risks. The value of securities may fluctuate. Past returns are no guarantee for future returns.

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