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INSTANT INSIGHT | Brexit, #GrowthSlowing & European Equities Still Crashing

Takeaway: The Brexit vote is a coin toss and, despite today's pop, European equities remain in crash mode.

INSTANT INSIGHT | Brexit, #GrowthSlowing & European Equities Still Crashing - bear chart 02.26.2016

 

Here's analysis via Hedgeye CEO Keith McCullough in a note sent to subscribers earlier today:

 

"BREXIT – coin toss? I’d say so. And since I don’t make calls on coin tosses, I’ll just give you both bearish intermediate-term TREND signals in FTSE (6388 resistance) and Pound ($1.47 vs. USD) with an intermediate-term risk range of $1.39-1.47 – in other words, even if they don’t exit, odds are both remain bearish TREND (because the UK economy is slowing regardless vs. last year’s cycle peak)"

 

INSTANT INSIGHT | Brexit, #GrowthSlowing & European Equities Still Crashing - Brexit cartoon 06.16.2016

 

"DAX – more definitively bearish TREND than FTSE, but that’s because DAX remains in crash mode (-22% from last year’s cycle high); reminder that we still have the Street low forecasts for both Eurozone and German GDP in 2H of 2016 – #GrowthSlowing is the tail wagging the political dog, and it’s not just the UK who has political risks accelerating in kind."

 

INSTANT INSIGHT | Brexit, #GrowthSlowing & European Equities Still Crashing - Europe Japan cartoon 04.04.2016


EXPE | Pay to Play (HomeAway)

Takeaway: AWAY is a big opportunity; time will tell. But EXPE need only show incremental progress in the next 6-9 months to drive bullish sentiment

INTRODUCTION: We’re in the later innings of digging into EXPE.  While we have reservations on the longer-term EXPE story (i.e. EXPE vs. PCLN), our sense is that the only two things that really matter to the story right now is the OWW integration (2016 EBITDA target) and the longer-term AWAY story.  We discuss the latter below, note to follow on the former.  In short, the AWAY business model transition presents a material near-term opportunity, and despite pushback from property owners, EXPE may be holding all the cards here (Pay to Play).   More importantly, EXPE really doesn’t need much out of AWAY this year to drive sentiment around the longer-term story.   

 

KEY POINTS

  1. MODEL TRANSITION: EXPE is trying to shift AWAY’s model more toward transactional than subscription-based.  EXPE isn’t abandoning AWAY’s sub model, but trying to capture a take on its estimated $14-$16B in transactions that occur on the AWAY platform annually.  AWAY had been in the process of rolling this out since 2013, but EXPE is now aggressively expediting the transition.  Starting July 2016, EXPE will alter the search algorithm to prioritize online bookable properties rather than the prior method of ranking results by subscription tier (sub rates).  Further, EXPE will be introducing a user fee, which also acts as insurance for the user.
  2. NEAR-TERM OPPORTUNITY: The transition opportunity isn’t based on growing into some distant TAM, but capturing a commission on the $15B in estimated annual bookings that AWAY is already generating for its subs today.  The clearest opportunity is the user fee, which could provide an incremental $900M assuming full online capture, but even a fraction of that opportunity would be material vs. AWAY’s $487M in 3Q15 TTM revenues (first scenario analysis below).  If EXPE could sway its subs toward the Pay-Per-Book subscription (no sub fee, 8% take-rate), the opportunity grows to $2.1B.  However, we doubt this happens without additional changes to the paid sub model, which will be largely dependent on the initial success of the transition.
  3. PAY TO PLAY: The new cost structure is causing a bit of backlash amongst property owners (here, here, here, and addressed by AWAY CEO, Brian Sharples: here).  AWAY’s prior platform was very profitable for its listing subs (effective 3% take-rate, but much lower for US paid subscribers), so the push back makes sense.  Naturally, there is some execution risk on the online bookability opt-in since these owners are incentivized to keep as much of that offline, but EXPE basically holds all the cards here since the owner bears all the financial risk.  AWAY's paid subs are generating too much income from the service to push back; especially since that income is largely volume-dependent, and is also used to help pay down those property mortgages.  Further, competition may be picking up within the vacation rental (VR) space, adding another layer of risk.  We expect most paid subs to opt in; especially given the change to search algorithm starting 3Q16. 
  4. CONTROLLING THE STORY: EXPE doesn’t need much in online bookings conversion out of AWAY to drive optimism in the story this year given the opportunity from the user fee alone.  Remember that AWAY was a low-teens top-line grower prior to the acquisition; it’s possible that AWAY produces multiples of that rate, if not an acceleration, even under relatively restrictive bookings and conversion assumptions (see last scenario analysis below).  More importantly, all mgmt really needs to here to fuel the story is show progress with the transition; it can basically cherry pick any metric it wants to do so.  And given that we’re so early in the transition, we suspect mgmt has a pass over the 2-3 quarters if there are any hiccups along the way. 

  

MODEL TRANSITION

EXPE is trying to shift AWAY’s model more toward transactional than subscription based.  EXPE isn’t abandoning AWAY’s sub model (yet), but trying to capture a take on its estimated $14-$16B in transactions that occur on the AWAY platform annually. 

 

AWAY had been in the process of rolling this out since 2013, but had been fairly passive about it.  The only real incentive to adopt online bookability was a $50 discount off the subscription rate.  AWAY’s search algorithm would still prioritize by the subscription tier (rate), so online bookability didn’t really have much of a draw unless the sub really believed it drive more transaction volume by doing so.  Based on 3Q15 results, only about 25% had opted in for online bookability

 

However, EXPE is now aggressively expediting the transition.  Starting July 11th the search algorithm will be on a “Best Match” Policy, which will be largely driven by whether the listing is online bookable and related factors such as inquiry response time and maintaining up-to-date calendars.  EXPE is also providing only one subscription plan at $499 with a $150 discount if the property is online bookable.

 

EXPE is also introducing a service fee, which ranges from 4%-9% of the total transaction; EXPE expects the average rate to be around 6%.  Certainly, the fee raises the price to the end consumer (and/or cuts into the price received by the owner).  However, we don’t necessarily see the fee as a major deterrent to booking since the percentage is still lower than the 6%-12% charged by Airbnb.  It’s also worth noting that the fee % is inversely correlated to transaction size (see table below) with a cap of $399, which would only be trigged on a rental of over $7300.  Further, the fee comes with a booking guarantee, which protects against fraud, double-bookings, etc.   In essence, the fee is also serving as insurance, which seems like it would be a big draw within the sharing economy, but granted that’s anecdotal. 

 

EXPE | Pay to Play (HomeAway) - EXPE   AWAY model change

EXPE | Pay to Play (HomeAway) - EXPE   AWAY User Fee Breakdown 2

EXPE | Pay to Play (HomeAway) - EXPE   AWAY online bookability

 

NEAR-TERM OPPORTUNITY

The opportunity from the transition isn’t based on growing into a magical TAM, but on capturing a commission on the $15B in estimated annual bookings that AWAY is already generating for its subs today.  Granted, that $15B is purely an estimate by AWAY’s own admission, but there’s still a strong opportunity for the transactional model even if the actual booking number is half of its estimate (see first scenario analysis below).

 

The clearest opportunity is in the user fee, which could provide an incremental $900M vs. $487M in AWAY’s TTM revenues (3Q15) if AWAY can capture 100% of the estimated $15B transactions online.  If EXPE could sway its subs toward the Pay-Per-Book subscription (no sub fee, 8% take-rate), the total opportunity grows to $2.1B.  However, we don’t believe the latter will happen unless AWAY forces it subs into it the pay-per-book (PPB) option, jacks up the price on paid subscriptions, or introducing a bookings fee for paid subs. 

 

Either way, that’s not likely to happen until AWAY captures actual transaction volume online in order to better size up its actual bookings and the effective take-rate off of that.  If AWAY discovers that its effective take-rate is as low as it believes, we believe it will sunset the paid sub model, at least in its existing form. 

 

EXPE | Pay to Play (HomeAway) - EXPE   AWAY scen analysis 1 a  

 

PAY TO PLAY

The new cost structure is causing a bit of backlash amongst the property owners (hereherehere, and finally addressed by AWAY CEO, Brian Sharples: here), which makes sense since AWAY’s prior platform was very profitable.  We can’t definitviely calculate average bookings/listing since AWAY can’t either.  But there are a few different ways to slice up the data to back into it, all of which point average annual bookings north of $10K for paid subs (see analysis below), which would effectively translate to commission of under 5% on its bookings.  Note that likely skews much lower for US subs since they are monetizing at 2x the rate of EU, which in turn is dragging down the average booking calculation.  For context, Int’l had represented roughly 33% of AWAY’s revenue prior to the acquisition.  At a bare minimum, it’s probably safe to say that AWAY’s paid subs are doing in excess of $5K in average bookings; otherwise they probably would have opted into the pay-per-book option.

 

Naturally, there is some execution risk on the opt-in for online bookability since these owners are doing well enough without the option, and it’s easier to avoid taxes without an electronic trail.  The user fee also effectively makes the transaction more expensive, so the user is theoretically less likely to book.  But we suspect the real reason why AWAY’s paid subs are resisting the change is that they simply don’t want to put AWAY in a position to take price on them; moving those transactions online would do exactly that.  AWAY would have a better idea of how much business it's actually generating for its subscribers, and in turn, its effective take-rate off of that.  If AWAY adjust its pricing model accordingly.

 

But ultimately we believe AWAY holds all the cards here, and the property owners need to play ball.  Naturally, the change in the search algorithm puts those without bookability at a disadvantage.  But we believe the more important factor is that there is just too much rental income at risk to try and steer the transaction offline, especially since that income is largely volume dependent.  

 

AWAY’s average bookings per transaction ranges between $1k and $2K depending on which metric you’re using (Escapia average or EXPE’s expected average user fee).  Compare that to average annual rental income that is well in excess of $10K, and there is a lot of risk to losing any transaction volume, especially considering that over 60% of vacation properties are mortgaged, with roughly half over 70% financed.  Competition may also be heating up within the Vacation Rental space.  Vacation property purchases were particularly strong for over the past two year (2014 was a record); according to the NAR, 40% of 2015 vacation home buyers plan to rent these properties out for income.  In short, the secular tailwind in VR demand is being met with increasing supply.

 

In short, EXPE is changing the rules of the game, and we don’t believe AWAY’s property owners can do much about it since they bear the brunt of the financial risk, and are in increasing competition with each another. 

 

EXPE | Pay to Play (HomeAway) - EXPE   Listings Profitability Analysis finall

EXPE | Pay to Play (HomeAway) - EXPE   AWAY mortgage chart

 

CONTROLLING THE STORY

EXPE doesn’t need that much in online bookings conversion out of AWAY to fuel optimism in the story this year given the opportunity from the user fee alone.  In the last scenario analysis below, we illustrate the opportunity by flexing annual bookings against online capture rate.  We’re only factoring in the user fee while assuming full cannibalization of AWAY’s paid subs into the online booking subscription ($118M headwind based on 3Q15 Paid Sub ARPU). 

 

The negative is the risk of declining revenue from paid sub cannibalization, but that would essentially require less than a 20% capture rate despite all listings having online bookability in our analysis.  The positive is that AWAY could still drive growth even if its actual bookings are half of its 2015 estimate.  Under most logical assumptions, AWAY is producing accelerating Listings revenue growth this year vs. the 11% growth it produced in the TTM period ending 3Q15. 

 

However, note that the new search algorithm and subscription plans don’t kick in until 3Q16 (July 11th), so we may not see a sudden surge bookable listings, especially since the opt-in will likely not occur overnight.  However, the user fee has already kicked in (Feb), and we already know booking volume more than doubled y/y in 1Q (170% y/y), so we’ll start to see some of that flow through to 2Q/3Q revenue, which is based on the stay not the booking.  Further, the transactional model is more seasonal, which should inflate AWAY’s 2Q/3Q growth rates vs. the year ago period. 

 

But more importantly, all EXPE mgmt really needs to do is show progress with the transition, and mgmt will have a handful of metrics that it can cherry pick to paint any picture it wants.  So even if revenues do initially decline from sub cannibalization, mgmt could chalk it up to higher-than-expected opt-in to online model, which will only breed optimism for the longer term story.  If transaction volume growth decelerates vs. that 1Q metric, mgmt could blame it on the timing of algo/model change.  It’s hard to envision a scenario that management couldn’t talk around since it’s still very early in the transition. 

 

That said, we suspect mgmt has a pass over the 2-3 quarters if there are any hiccups since it is still very early in the transition.  On the other hand, if mgmt shows any signs progress with the transition, the story only gains momentum.  

 

EXPE | Pay to Play (HomeAway) - EXPE   AWAY scen analysis 2 a 

 

 

Let us know if you have questions, or would like to discuss in more detail.  

 

Hesham Shaaban, CFA
Managing Director


@HedgeyeInternet 

 

Todd Jordan
Managing Director


@HedgeyeSnakeye

 


Call Invite with Top Washington Political Strategist Scott Reed

Hedgeye Potomac is hosting a call with one of Washington’s top political strategists, Scott Reed, to share his insights on the presidential election, the upcoming Democratic and Republican conventions, and outlook on the Senate and House races this fall.

 

The call will take place on Tuesday, June 21st at 11am ET with prepared remarks from Reed followed by Q&A.

 

ABOUT SCOTT REED

 

Scott Reed is the senior political strategist at the U.S. Chamber of Commerce. He is responsible for overseeing the Chamber’s federal voter education program. Reed created and implemented the blueprint for that strategy to help recruit business-friendly candidates, overseeing traditional and digital advertising campaigns, and identifying credible messengers to showcase the importance of the free enterprise system.

 

Reed was campaign manager for Bob Dole’s 1996 presidential campaign. He oversaw the national campaign, which included political strategy, policy development, communications, and advertising during the GOP primary and the general election. In addition, he directed preparations for the 1996 Republican National Convention in San Diego and the vice presidential selection process of Jack Kemp. In 1993, Reed was appointed executive director of the Republican National Committee. He served as chief operating officer of the GOP during the historic elections in 1993 and 1994 when the Republicans gained control of both the House and the Senate for the first time in more than 40 years. During the Bush administration, Reed served as chief of staff to Secretary Jack Kemp at the Department of Housing and Urban Development. He directed personnel, political, and policy matters, employing a long-term empowerment and privatization program. 

 

CALL DETAILS

 

Toll Free:

Toll:

UK: 0

Confirmation Number: 13638941


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A Humbling Moment For St. Louis Fed Head James Bullard?

A Humbling Moment For St. Louis Fed Head James Bullard? - Fed cartoon 05.04.2016

 

Even the hawks are "cooing" these days.

 

St. Louis Fed head James Bullard has finally acknowledged that the U.S. economy is slowing. The eye-opening part of Bullard's Friday morning admission is this: He now says the U.S. economy's growth is so underwhelming that we may need no more than a single additional rate hike for the next 2.5 years.

 

As we've pointed out before, Bullard joins San Francisco Fed head John Williams in dialing back prior rate hike expectations. (Williams was perhaps the most ardent hawk, yearning for as many as five rate hikes in 2016.)

 

Oh how the mighty have fallen...

 

In a shocking mea culpa though, Bullard released a statement today about Fed forecasting and the U.S. economy saying:

 

"We are backing off the idea that we have dogmatic certainty about where the U.S. economy is headed in the medium and longer run. We are trying to replace that certainty with a manageable expression of the uncertainty surrounding medium- and longer-run outcomes."

 

A Humbling Moment For St. Louis Fed Head James Bullard? - Fed grasping cartoon 01.14.2015

 

Bullard now predicts that, “Output grows at a trend pace of 2%, but the unemployment rate remains quite low and inflation remains at 2%” over the next two-and-a-half years.

 

He even brought up the dreaded "R-word":

 

"We are currently in a no recession state, but it is possible that we could switch to a recession state. If such a switch occurred, all variables would be affected but most notably, the unemployment rate would rise substantially. Again, the possibility of such a switch does not enter directly into the forecast because we have no reason to forecast a recession given the data available today. The possibility of recession is instead a risk to the forecast."

 

And here's another interesting admission about the Fed's concern about "asset price bubble risk":

 

"The approach presented here also says little about asset price bubble risk, a factor that often enters the actual policy discussion."

 

Bullard's statement is an interesting read. Hopefully, we're moving toward a Fed that puts humility before dogma. 

 

Time will tell.


CHART OF THE DAY: The First Shot Fired Across The Credit Cycle Bow

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Financial analyst Josh Steiner. Click here to learn more.

 

"... Synchrony fired a shot across the credit cycle bow on Tuesday by raising its guidance for expected net charge offs from a range of 4.3-4.5% to a range of 4.5-4.8%. SYF shares reacted by dropping ~14%, while the rest of the card space followed suit: Capital One (COF) was down ~5%, Discover (DFS) was down ~3% and so on...

 

I think Synchrony’s announcement Tuesday will prove to be one of the early timestamps used in the future to mark the end of the current credit cycle. Incidentally, many of the lender stocks peaked in mid-2015." 

 

CHART OF THE DAY: The First Shot Fired Across The Credit Cycle Bow - 06.17.16 EL Chart


Negligible Senescence

"I am Duncan MacLeod of the Clan MacLeod."

-Highlander

 

The Highlander film & television franchise began in the mid-1980s and ran through the late 90s. To the surprise of many critics, it spawned five movies, two television series, an animated series, an animated movie, an animated flash-movie series, ten original novels, nineteen comic book issues and various licensed merchandise (h/t Wikipedia).

 

My favorite film critic, the late Roger Ebert, had this to say about the 1986 film that started it all:  

 

“[Highlander] is sort of like a garage sale at the house of a berserk screenwriter. This movie has a little bit of everything: immortality, sword fights, ancient legends, muscular heroes, exploding automobiles, wise old men, beautiful women, bloody beheadings and lightning crackling through the sky. It has an especially lot of beheadings and lightning. In fact, occasionally people’s fingertips tingle with all of the excess electrical energy in the story.” (Ebert’s YouTube review: HERE).

 

Despite what seemed like a promising list of Hollywood ingredients, Ebert was left underwhelmed, and gave it a thumb down. Siskel agreed, but that didn’t stop Hollywood from firing up a reboot 5 years later: Highlander 2: The Quickening, which is now generally considered one of the worst films ever made, and about which Ebert offered this:

 

"This movie has to be seen to be believed. On the other hand, maybe that's too high a price to pay. "Highlander 2: The Quickening" is the most hilariously incomprehensible movie I've seen in many a long day - a movie almost awesome in its badness. Wherever science fiction fans gather, in decades and generations to come, this film will be remembered in hushed tones as one of the immortal low points of the genre." (HERE).

 

Negligible Senescence - highlander

 

Back to the Global Macro Grind

 

Until recently, Highlander was always the first thing I thought of whenever I thought of immortality, but then I read something really interesting on Reddit.

 

I’ve become a big fan of Reddit. While something like a billion and a half people around the world whittle away the hours on Facebook, I prefer Reddit. Recently, this question was posed on Reddit: What is surprisingly NOT bulls**t?  Here’s the one answer that caught my attention: Crocodiles actually have no life span. If they lived in a perfectly suited environment with no predators/diseases etc. they would live forever. It’s a process called Negligible Senescence. This was something I had never heard of before, and when you get to your 40s you start to feel as though you’ve seen or heard most of what’s out there.

 

In the simplest sense, Negligible Senescence means that a creature is functionally immortal. It means that certain types of plants or animals will not die from old age-related wear and tear. For instance, their metabolism doesn’t slow down as they get older, their heart doesn’t show signs of aging, they don’t become incompetent or impotent, they don’t lose strength or experience declining health. At the cellular level, this is because they have no post-mitotic cells – they continually undergo cellular division, reducing/eliminating the creation of damaging free radicals – this is also why these types of plants and animals never stop growing.

 

These organisms die only from external factors like disease or predation. Examples in the real world include lobsters, crocodilians (alligators, crocodiles, caymans), turtles, tortoises, sturgeon, and certain types of trees. For instance, Aspen trees live 40-150 years above ground, but the root system can live for thousands of years. There’s an Aspen root system in Utah called Pando that’s estimated to be 80,000 years old. There’s a bristlecone pine in Eastern California called Methuselah, which scientists peg at just over 4,800 years old.

 

It’s conceivable that as our understanding of genetics continues to improve – and all signs point to it improving at an accelerating rate – we may one day be able to incorporate the genetic properties of negligible senescence into our own DNA, negating most of the effects of aging. The implications this would have on investing are interesting and profound. Consider the power of compounding interest on a multi-century investible timescale. #YaleEndowmentTimescale

 

While negligible senescence seems like a distinct possibility for humans somewhere down the line, there’s little doubt that today the economic cycle ages and decays just as people still do. The latest evidence for this comes from Synchrony Financial (SYF), a private label credit card lender spun out of GE Capital two years ago. Synchrony is a big lender with over $65 billion in consumer receivables and counts WalMart, Lowe’s and Amazon among its customers. In other words, if you have a Lowe’s card, it’s a Synchrony card.

 

Synchrony fired a shot across the credit cycle bow on Tuesday by raising its guidance for expected net charge offs from a range of 4.3-4.5% to a range of 4.5-4.8%. SYF shares reacted by dropping ~14%, while the rest of the card space followed suit: Capital One (COF) was down ~5%, Discover (DFS) was down ~3% and so on.

 

Synchrony management presented at a conference that day and said that the problems likely went beyond just them. They suggested that consumers have suffered a decline in their ability to pay debts, and speculated that it was due to auto and student loan burdens having reached a tipping point. The increase in loss guidance of 20-30bps is small in absolute terms, and nowhere near enough to justify shaving 14% off the value of SYF, but it’s the inflection that spooked the market.

 

Credit trends are autocorrelated, meaning that they self-reinforce both on the way up and down, and the market gets this. The natural progression goes something like this: credit quality deteriorates slightly on the margin, lenders tighten credit underwriting in response, which causes less credit consumption, which causes credit quality to deteriorate further, which causes lenders to further tighten underwriting and so on.

 

In other words, once you see the first cockroach in the credit cycle, you should aggressively exterminate long exposures in your portfolio because the cycle has begun to turn but still has a long way to go. It won’t be obvious that it has turned for months or even quarters to come, but rest assured … it has turned.

 

Thinking back to the last cycle, there were many signs marking the turning of the cycle at various points leading up to Lehman’s collapse in September 2008. The early signs, for instance, came in mid-2005 when the rate of change in volume of homes sold began to slow. Coincidentally, also in mid-2005, homebuilder stocks peaked. By mid-2006 the rate of change in home prices began decelerating. By the Spring of 2007 subprime lender New Century went into a death spiral. In May 2007, the Financials ETF, XLF, peaked. In June 2007, two Bear Stearns Hedge Funds collapsed. In October 2007, the S&P 500 peaked. In March 2008, Bear Stearns collapsed. In September 2008, the Global Financial Crisis hit with its full fury.

 

I think Synchrony’s announcement Tuesday will prove to be one of the early timestamps used in the future to mark the end of the current credit cycle. Incidentally, many of the lender stocks peaked in mid-2015.

 

One thing to understand about credit cycles is that they’re like chains. The weakest link ALWAYS breaks first under pressure. The analog here is the subprime borrower – the person with the least resources to service their debt when a problem arises. Synchrony has sizeable exposure to subprime borrowers. In fact, 28% of their credit card customers have FICO scores below 660 – the cutoff point for subprime borrowers.

 

Synchrony has 65 million cardholders, which translates to roughly 18 million subprime borrowers. For reference, there are 185 million conventionally scoreable people in the US, so Synchrony’s subprime pool is roughly 10% of the total US borrower base and close to one third of all US subprime borrowers. Among big card lenders, only Capital One has a greater share of subprime borrowers at 35%.

 

Another thing to understand is what’s called the hierarchy of payments. Let’s say a borrower has three separate credit obligations: a mortgage, a car loan and a credit card balance. If that person finds that they’re unable to pay all these bills in a timely fashion, in which order will they choose to default? Notwithstanding the last cycle, which inverted the longstanding payment hierarchy pyramid, so-called normal cycles see borrowers first default on their unsecured credit card debt, then on their auto loan and finally on their mortgage.

 

Again, up until the last cycle, this is how it’s always gone. The last cycle was clearly anomalous as many borrowers chose to walk away from their mortgage while, in many cases, continuing to pay their car loans and credit cards. This cycle is not like the last cycle. This cycle will see a normal payment hierarchy. This is why seeing subprime borrowers defaulting on their credit cards is exactly what you would expect to see at the start of a credit cycle downturn.

 

A final thing to understand is a phenomenon called the denominator effect. Charge off rates have a numerator: the dollar amount of bad loans being written off, and a denominator: the average loan balance during the period. If the denominator is growing rapidly, this will cause the charge off rate to be artificially suppressed.

 

Here’s a simple example. Say a lender has $150 in charge offs on a $1,500 average loan balance. The charge off rate is 10%. But now assume that the lender grew that loan base by 50% over the past year, so the balance a year ago was $1,000. The reality is that bad loans take some time to season and they must be in default for 6 months (180 days) before they’re charged off. As such, the $150 in charge offs should really be divided by the $1,000 in loans to give an accurate depiction of the charge off rate, meaning the real charge off rate in this example is more like 15%. Once the loan growth slows, the credit quality will appear to worsen dramatically.

 

The point is that fast growth in receivables is usually enough to temporarily suppress the appearance of deteriorating credit quality, at least optically over the intermediate term. So the fact that Synchrony had to raise its charge off guidance at a time when it’s growing receivables rapidly means things are worsening in a material way.

 

In normal recessions, card lenders tend to see their shares cut in half. In the last recession, they lost 80-90% of their value. We wouldn’t expect this downturn to be on par with the last recession, but that’s not to say there isn’t still a lot of downside risk over the coming 12-24 months as cyclical senescence takes hold. The big card lenders include COF, DFS, AXP, ADS, SYF. The big banks with big card books include BAC, JPM, C. The big auto lenders with subprime exposure include SC, CACC and ALLY.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.54-1.65%

SPX 2055-2095

VIX 17.26-23.12
USD 93.39-95.25

Gold 1

 

Yours in risk management,

 

Joshua Steiner, CFA
Managing Director

 

Negligible Senescence - 06.17.16 EL Chart


Early Look

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Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

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