Commentary

Resolutions

January 13, 2022

2022 is already upon us and the New Year often brings up some resolutions, usually based on some form of self-improvement such as living a healthier lifestyle or picking up a new hobby. It is believed that the first resolutions were made about 4,000 years ago by the ancient Babylonians. The Babylonian New Year was actually in March, when crops were planted, and the festivities lasted for 12 days. Part of the festivities were making promises to the gods to repay debts and return any borrowed objects.

More recently, the link between the New Year and debt comes from consumers assessing their spending habits for the holiday season. A survey of 2,000 Americans by LendingTree showed that 36% of those surveyed spent more than they could afford during the holiday season, and went into debt with an average sum owed of just over $1,200. Putting debt onto a credit card remains the most popular option, and with the shift to online shopping, we saw an increase of almost 40% of “buy now, pay later” financing to spread out expenses. Whether this encourages consumers to spend more than they can afford is a different question. Credit cards remain an expensive way to borrow, and over 80% of holiday borrowers will be unable to clear their debt within a month.

During the early stages of the pandemic, credit card balances were paid down at record levels. During 2020, when American consumers were receiving more stimulus checks but had fewer ways to spend discretionary income, $83 billion was paid off in credit card debt.

However, as many predicted, there was a surge in consumer spending once vaccination campaigns progressed, COVID-19-related restrictions eased and the economy reopened, which meant people slipped back into old habits and credit card use increased during 2021. The latest data from the Federal Reserve Bank of New York saw a $17 billion increase in credit card balances.

The trend continued into the fourth quarter, fuelled by the holiday season. It was estimated that Americans were on pace to add $70 billion in credit card debt throughout the year. The expectation is that this number will continue to rise in 2022. TransUnion is expecting a further 10% increase in debt based on more applications for credit and increased spending.

By the end of this year, the balance is forecasted to reach over $800 billion, attaining its highest level since the start of the pandemic.

On a larger scale, a recent blog by the International Monetary Fund (IMF) observed that global debt was at $226 trillion at the end of 2020, which represents 235% of GDP. Debt was already high going into the pandemic, but actions were taken to protect lives and jobs and avoid significant bankruptcies.

There was a distinct difference between developed and emerging markets. Developed markets (and China) were responsible for over 90% of the $28 trillion debt that was added in 2020, primarily due to low interest rates and central bank actions. Emerging markets, faced with higher interest rates and more limited access to funding, added significantly less debt.

The problem going forward is finding the correct balance of fiscal and monetary policies in the current high debt, inflationary environment. The two combined well during the pandemic, with lower interest rates facilitating government borrowing. However, central banks are now signalling a rise in interest rates to combat inflation but this, combined with high debt, puts a brake on how governments can support the recovery and the private sector’s future investment prospects. Central banks are also reducing asset purchase programs. Fiscal responses have historically been less effective in times of rising interest rates. The greater risk is interest rates rising faster than expected, hurting economic growth. This would place heightened pressures on the most highly leveraged governments, households, and firms. If everyone has to deliver at the same time, growth will stumble.

Global Alpha has some exposure to the debt industry via two companies.

PRA Group (PRAA US)

PRA is one of the largest acquirers of non-performing loans in the world. PRA returns capital to banks and other creditors to help expand financial services for consumers. The main business consists of the purchase, collection, and management of portfolios of non-performing loans. These are typically unpaid obligations of individuals owed to credit originators: e.g., banks and other types of financing companies. The portfolios of non-performing loans are bought at a discount in two broad categories being core and insolvency operations

Core operations specialize in the purchase and collection of non-performing loans, which PRA is able to buy as the credit originator and/or other third-party collection agencies have not succeeded in collecting the full balance owed. Insolvency operations differ slightly as they seek to purchase and collect on non-performing loan accounts where the customer is bankrupt.

doValue (DOV IM)

doValue is a manager of loans and real estate assets for banks and investors. It is the market leader in Italy, Spain, Portugal, Greece, and Cyprus, which are attractive markets with significant growth opportunities because of high levels of non-performing loans and the strong interest from international investors. doValue is an independent servicer with an asset-light business model. It differs from PRA in that it does not make direct investments in loan portfolios or real estate assets. Revenues are earned from fixed and variable fees. doValue operates in high-value-added activities including the management of medium to large corporate loans secured by real estate assets (the non-performing loans), helping banks in the early stages of the loan management cycle (Early Arrears and Unable to Pay) and also in the optimization of real estate portfolios from credit recovery actions.

Have a nice day,

The Global Alpha team