5 Questions with David Hendler
David Hendler is the Founder and Principal of Viola Risk Advisors, LLC that was established in November 2014. David believes that the sophisticated risk management, capital management, and regulatory exposure management communities have an unmet need for a holistic, enterprise-wide approach toward risk assessment in a transparent, dynamic and open forum fashion.
David has a unique background as a veteran senior financial services analyst. Over his 30+ years on the Wall Street buy & sell sides and as a senior member of the independent research company CreditSights he has covered investment & financial risk advisory from both the corporate debt & equity research disciplines. On the buy-side he started his career at New York Life Insurance Company. On the sell-side for 15 years he worked at various firms including: Drexel Burnham Lambert, J.P. Morgan Securities, UBS Securities, Smith Barney Inc., & Credit Suisse First Boston. David made the Institutional Investor All-Stars from both the debt (1995) and equity sides (2000).
We are grateful to David for taking the time to share his insights on past economic issues and how it impacts both the present and future economy.
1) There is much speculation about whether the economic recovery has peaked and we are in for a cycle change. In your estimation, where are we in the consumer credit cycle?
VRA: The consumer credit cycle is long in the tooth as they used to say. So, there has not been a major consumer default cycle since the last credit crisis, which mostly bore out in the mortgage and subprime mortgage loan markets. The credit card cycle has not really been tested since the early 2000s and somewhat so during the mortgage crisis, but not as bad as it could have been if the Fed had not hyper-eased its monetary policy and bailed out the banking system as well as most of the capital markets and financial system. The auto loan cycle has not been bad since the late 1990s after several mono-line subprime/near prime lenders and other bank car lenders/lessors hit the wall with all kinds of losses in new and used car finance. Then the biggest consumer loan market, the student loan market, continues to have the highest delinquencies of the five major consumer groups (home mortgages, credit card, auto loans, student loans and unsecured consumer). Student loan borrowers have taken out more debt than the credit card or auto loan sectors as colleges have become unaffordable for the middle class, thus the lending binge.
So, to wrap up, we are in the later innings of the consumer credit cycle as the Fed’s easy money policies and thus lower borrowing rates have lessened the burden of carrying all the debt accumulated. We are at or near the all-time highs of debt to disposable income, so any catalyst (higher rates, slower economy leading to higher unemployment) can tip the Humpty Dumpty consumer over, and then fall to pieces.
Then there is the millennial generation and their untested-through-a-cycle behavior in repaying debts which are concentrated in credit cards and student loans. Millennies, as we call them, are a breed apart in their consumption of luxury items at such a young age (travel, restaurants, experiences) and have lower savings rates as a result given their “live for today” generational anthem. So, lots of different potential inflection points that could coalesce at the same time and lead to a more brutal consumer default recession than most prognosticators have factored.
2) Before the economic crisis in 2007-8, you issued a research statement warning about artificially inflated credit scores. What role did that play in ensuring defaults?
VRA: Fake mortgage company credit scores were a problem for many a large mortgage lenders and securitizers like Countrywide Credit, Washington Mutual and others not with us in the mono-line subprime originator business. It was not as much of a factor in the credit card business as it was a different set of borrowers in the prime and super prime sectors that did not need to “prime up” their score. With the GSEs, Fannie Mae & Freddie Mac, still in conservatorship, the conventional, smaller size mortgages have not ramped up at the big banks. Big banks have focused on the jumbo mortgage market of high prime to super prime mortgage borrowers. And these higher net worth borrowers are credit seasoning low and well. Some mortgage banks like Quicken Loans have stepped into the conventional space as originators that quickly securitize to the institutional investor market. The big banks have ceded this turf since conventional mortgages have onerously high capital charges on mortgage servicing assets. And the higher retained interests under the Dodd-Frank Act and the old bad memories of mortgage put back costs that have caused the big banks to underplay conventional mortgages. So no wonder the mortgage market is underproducing relative to demographic growth and demand even under an adjusted level to remove NINJA (no income, no job) and other “scratch and dent” unjustified loans of the mid-2000s mortgage craze.
So, to wrap it up, the fake credit scores did egg on the mortgage crisis and defaults, but much of that has been blunted off in this go-round as discussed above. More likely the next credit default crisis will be with credit cards, student loans, unsecured consumer, and auto loans as terms have lengthened towards 60 months and loan sizes have almost doubled with all the newfangled radar/GPS mapping/ultra stereo systems and other electronic gadgets that can add another $5K to $10K+ to a car’s price.
3) What economic factors are you watching closely today?
VRA: Unemployment rising to higher levels, 6-9 percent+, is always the negative indicator. But it is a huge lagging indicator. So, Millenny analysts looking for that will be way behind the action curve. We at VRA look at lagging net charge-offs in cards with a 12-month to 18-month lag. If those figures pierce 4 percent to 5 percent, then we are in for a load of credit default trouble. Usually once it heads that way, it is a one-way stop to 6 percent+ in losses on a coincident basis. At 6 percent, the credit card math starts to break down and the securitization of card pools by bank issuers and other issuers are not as easy to palm off on institutional investors. Lagged charge-offs will be linchpinned by the factors cited in the previous question. So higher short-term rates and/or slowing economics. With the presidential race almost in progress with less than two years to go, this may be delayed as the the Fed seems to be on presidential elections monetary policy hold.
4) Has regulation effectively guarded against a repeat of the overly risky practices that led to the mortgage crisis?
VRA: To some extent, yes. As noted, higher retained interests on securitization, higher capital charges on mortgage servicing and other high-risk I/Os and other residual interests have put somewhat of a squash on the near-prime to subprime mortgage lending business. But banks and especially Wall Street banks are highly creative especially in arbitraging the trifecta of company concerns as how to optimize or minimize: a) capital impacts, b) tax consequences and at the same time c) preserve or improve NRSRO ratings. This coup can be highly lucrative for high fees for the underwriting capital markets banks, and a good spread business for the bank originators that eventually hold in a packaged securitized form.
Right now we at VRA believe there is much more risk in the unsecured consumer loan market that is bootstrapped by smartphone/instant lending finance and lending. And this is going on in the commercial area with regards to direct lending by shadow banks including hedge funds/private equity companies/BDCs (business development companies) and other non-bank banks that are being warehoused and lent to underwritten by the big bank and other financial player communities. This is related to the rise in leveraged lending arenas that US bank regulators have their antenna up on, but have not specifically identified the problem or problem banks and shadow banks. We at VRA have some early thoughts on the culprits and the eventual problem banks, but that may be for another Q&A.
5) What is the state of independent financial research in today’s market?
VRA: Like other market players, it is an evolution for independent financial research. The business has been traditionally a subscription-based payment business. But with MiFid II standards required in the European region for buy-side firms to pay for all research (including broker produced), the available budgets to sell into for the independent providers has shrunk, which was an unforeseen consequence. Low rates have made it more difficult for fixed-income money managers/insurance companies/pension funds to pay for research, as that has also put a huge damper on their management fees. So the pressures are formidable.
We at VRA have a healthy subscription business. But the real opportunity is in the bespoke consulting business, where clients’ core challenges in various parts of risk management can be serviced in a unique/value-added/business-useful approach. Independent research needs to be positioned as a trusted advisor with custom-delivered features. A traditional subscription approach to research reports is too impersonal, difficult to justify and thus mostly a relic of the credit crisis aftermath.
Viola Risk Advisors seeks to be the most business-useful risk management consultant for global companies interested in a holistic approach to stakeholder stack analysis focused on the capital structure stack goals of debt and equity investors. And business-useful for the risk-exposure management needs of counterparty risk/enterprise risk management and supervisory authority/regulatory risk management clients. Only by addressing these interrelated concerns in a clear and transparent way in writing can companies optimize their overall risk management goals.
Viola Risk Advisors, LLC is driven to be the best research provider of holistic, enterprise-wide risk management and capital structure investment views focused on “Risk Advisory on Global Companies for Global Companies.” As part of this endeavor we will focus on key risk exposures including: counterparty, regulatory, and investment securities & other financial instruments owned by debt & equity investors.
These risk exposures are of most concern to our worldwide customer base that spans various communities including: counterparty/enterprise risk management, institutional investment managers, governmental and regulatory authorities, corporate strategy, and ultra-high net worth investors. As pragmatic thought-leaders, our analysis and reports will be “business-useful” by providing easy-to-use, leading-edge, unique, value-added, and actionable trading & exposure management views. In combination, this research will allow risk managers, investors, regulators, and corporate strategists the ability to make the best risk-investment-strategic decisions and reap the best outcomes.