Speaker 1:
Welcome to TD Cowen Insights, a space that brings leading thinkers together to share insights and ideas shaping the world around us. Join us as we converse with the top minds who are influencing our global sectors.
Jaret Seiberg:
Welcome to Two Cents, the financials podcast at TD Cowen. I am Jaret Seiberg, managing director and financial services policy analyst at TD Cowen Washington Research Group. We start our November podcast with Scott Smith, TD Cowen specialty salesperson for financials who will provide an update on the market. Then we shift to Moshe Orenbuch, a TD Cowen equity analyst who covers banks and fintechs for a discussion about consumer credit quality heading into the holiday shopping season. But first, let's catch up on the news out of Washington.
The Federal Reserve held two conferences in October at the Community Banking Conference. Treasury Secretary Scott Bessent called for reducing capital charges for mortgages and corporate credit to shift more of that business back to the banks and away from non-banks and private credit. Bessent's backing now makes this the probable outcome. At the Payments Conference, Federal Reserve Governor Chris Waller proposed creation of so-called skinny master accounts, which is a way to give crypto entities access to the payment system but not the discount window. We see this as likely with more details coming next year. And the Federal Reserve also proposed changes to the annual stress test, focused on economic scenarios and modeling. While expected, the changes will be positive for regional and mega banks.
On the housing front, the immediate focus is on the Road to Housing Act, which would benefit manufactured housing. This could become law shortly as an amendment to an unrelated defense policy bill. We also are seeing a regulatory push for Fannie Mae and Freddie Mac to do more to help finance home construction, though this is focused on small builders rather than on builders that are publicly traded.
All right, with our update out of the way. Let's turn to our first guest. Scott Smith is TD Cowen's specialty salesperson for financials. As I mentioned in each episode, no one has a better handle on how the broader financials team at TD Cowen is thinking about the sector than Scott.
So Scott, what's going on in the world of financial companies?
Scott Smith:
Well, Jaret, thank you for having me. It was an absolutely amazing month. We went through every piece of the credit cycle in an incredibly accelerated way from recognition to complete hysteria to analysis to a view that much of what was going on for the regional banks in particular was likely overblown.
Having said that, the regional bank's still down about five or so percent on the month, insurance was worse and really the only financial services sector beating any of the larger indexes on the month was the large cap banks. Capping off the end of the month, we had the FOMC, which came in a little bit more hawkish, that was another factor weighing on a number of financials, particularly real estate. Having said all of that, the big focus, like I said, was credit. It does feel like people have decided that much of that credit risk was esoteric. Most of the stories that we heard about turns out to have been fraud, although there were a couple of things that poked. There were heads up in the very last week or two, Alexandria Real Estate, ARE, came under significant pressure and investors became worried about commercial real estate exposure in the life sciences space, and there was also a mall property that went kind of bad on the credit side creating the first a AAA CNBS loss, or second I should say, AAA CNBS loss since the great financial crisis.
Still though investors are not particularly worried about credit and on the consumer side, the credit concerns have basically evaporated for the near term and people seem to be pretty constructive on a number of Moshe's name which I'm sure he'll get into.
Jaret Seiberg:
All right. Scott, that was great. Thank you very much for the update with Moshe's name already coming up. Let's go right into our featured guest speaker for this month. Moshe is the TD Cowen equity analyst who follows many of the consumer finance companies. I wanted to get him on to discuss the state of the consumer and consumer financial credit quality.
So let's just start with the basics. What is the health of the consumer now and are there significant differences by income levels?
Moshe Orenbuch:
Great. Well thanks for having me, Jaret, and glad to be here with you and Scott.
First of all, investors have been very, very concerned for a long time, in particular the last couple of years about the health of the consumer and whether we were going into recession and are constantly looking for data points as to whether that is kind of on the horizon or not. And so we've gone back and forth a few times. Certainly in April there was a high degree of concern, it moderated some and then it started up again towards the end of September. So when we think about overall how the consumer is doing, from a defensive standpoint in terms of repaying their debt, they're doing well. Outside of potentially student debt where you've got the restart of federal payments, which has caused some degree of slowing or higher delinquencies and subprime auto, which we'll talk about in more detail, everything is still getting better and in most cases getting better at a faster pace. So that's good news.
From an offensive standpoint in terms of consumer spending and how aggressive lenders are, that's a little more mixed. You're seeing some degree still are being very careful from lower-end consumers who have been hurt by the inflationary environment that has gotten less bad but is still problematic. And lenders are very, very gradually opening up the credit box and allowing a little more credit to that consumer group, particularly at the low end. At the high end, it's been pretty robust and you've seen a lot of ads for high-end credit cards, particularly this past summer, but at the middle to lower-end consumer, lenders are still being careful. And so from a spending standpoint has been a little more difficult. We've seen some signs of that having troughed, but that's where it's still a bit tight.
Jaret Seiberg:
Given all of that, Moshe, are some products performing better than others right now?
Moshe Orenbuch:
Yeah. So in general people tend to pay in certain ways. I mean they value their automobiles, so they tend to pay that first. They tend to prioritize homes and cars. Other kinds of closed-end debt like installment loans are a little less high up there in that payment hierarchy. Credit cards are interesting because you have a little bit of flexibility as to how you can pay or not pay. You can pay the total amount or you can pay just the minimum and still be current. And so typically what we see when there are credit issues, closed-end loans outside of auto, like installment, are the ones that worsen first and then you kind of see it migrate to credit cards and auto tends to be last.
So what you're seeing is the reverse of that because that really started in '22, '23 and started getting better by the end of 2024, has been getting better progressively in 2025. So we see credit cards and installment lending still getting better and as I mentioned probably at a slightly better pace. Flip side of that is auto because it's the area where people have been holding on the longest and trying to pay, is still seeing some degree of worsening and in subprime for the last few months that's probably gotten worsening has probably accelerated a bit.
Jaret Seiberg:
All right. Well I'm glad you brought up subprime auto because I want to go there next. There've been a number of high-profile bankruptcies, Scott referenced them a couple of minutes ago among some of the subprime auto companies. What should we make of this? Is this the beginning of broader deterioration? Is it just a blip? How do we think about it?
Moshe Orenbuch:
Yeah. Well, subprime auto is a funny business. It's very boom bust and when interest rates and credit losses are low, subprime is a highly profitable business and you had an even bigger credit cycle in '21, 2022 than you had in some of the other products. And so you're seeing the fallout from that now. You basically have the 2022 loans are probably the worst of the ones that are still on the books and those companies are having some difficulty.
Having said that, the lenders who cut back early are seeing their overall portfolios start to get better already. So while the industry as a whole is still worsening, you are seeing individual players. Capital One is a large subprime auto player, Ally is a large auto player which has a smaller subprime portfolio and both of them have said that while and their overall auto data is getting better and subprime is kind of performing in line with that.
The individual bankruptcies though are indicators of specific fraudulent situations that probably got pushed in that direction by some of the issues that the industry has had. But they are, I don't want to say one off because there's been more than one of them, but they are episodic in nature and I guarantee you both the rating agencies and others are pushing each of the servicers in subprime auto to make sure that some of the issues that caused those bankruptcies are not being repeated elsewhere in the industry.
That was a long answer. The short answer is I think it's largely episodic, although we're not seeing the overall credit improve yet.
Jaret Seiberg:
All right. So markets are always forward-looking, we're always trying to project what things are going to look like in the future. What is the outlook in your mind over the next 12 months for consumer credit quality?
Moshe Orenbuch:
The interesting thing is, and I alluded to this before, is that lenders tend to lend in certain types of lending standards and if you look at the performance by class or vintage, the 2022 vintage is the worst performing and that's pretty much in any product because lending was super competitive then and some of the smarter companies started tightening in 2022, others waited till 2023 or a little bit later. But successively, those vintages are getting somewhere between less bad and better. So the '23 I don't know if you'd call it necessarily better, but certainly less bad. And then in '24 and '25 lending standards were significantly tighter across most products.
So as you burn through those vintages, you end up with better performance. And so in a stable economy, we would expect credit on balance to be improving in 2025 pretty much across all products and I think even in the subprime auto market, although that one's a little bit dicier just because that we haven't seen that turn yet. So in general, consumer credit should be improving.
The bigger question and more difficult one to answer is how quickly, if at all, will lenders be reopening their credit box? And some like Synchrony and Bread have said that's begun in a small way. Synchrony has said they've kind of undone about a third of the tightening that they did a little hard to think about that in a truly quantitative sense, but you can think about it as partway there, probably less than half, and if the economy remains healthy, will continue to do that in 2026.
Jaret Seiberg:
Uh-oh. I mean, Moshe, it sounds almost like you're optimistic here on credit quality. Should we come away from this conversation then feeling pretty good about the consumer?
Moshe Orenbuch:
So the answer is yes, comma, but. Yes, comma, but but you need to have a relatively healthy employment situation continuing for that to continue to be true. So in that vein, the consumer is healthy. If the employment situation starts to deteriorate, then you will have those vintage curves will shift higher. I mean that's just the nature of how consumers react to the economy. There is one difference when there is significant unemployment. Keep in mind we've had four-ish percent unemployment throughout this whole episode over the last several years. So what I would say is what does react differently is what you call loss severity.
So particularly in the credit card business, consumers with higher incomes tend to get bigger credit limits and when people go bad unfortunately they don't go bad at what the average balance is, they go bad at some multiple of that because they go bad at something on the order of three quarters of their credit limit. So there is a more gearing in the high-end consumer when you see an increase in unemployment than in the low-end consumer where the credit limits are not as disparate.
Jaret Seiberg:
All right. Well that was just fantastic, Moshe. I hope we can have you back on in a couple of months to update where the consumer sits right now. Scott, we'll certainly have you back next month to wrap up where we are in financial markets. We are going to end this podcast, as we do every podcast with our November preview. This month is really all about when does the government reopen. We think it may be soon as neither party wants this to disrupt the Thanksgiving travel season. The bank regulators did not testify in October because of the government shutdown. We expect that hearing to occur in November, though the deeper we get into the month, the greater the probability that the hearing is pushed to December.
This hearing is the best opportunity since the inauguration to understand team Trump's plans for capital liquidity and other rules that impact the banks. It's why we have this starred on our calendar and why we're trying to highlight it today. And we'll be watching what happens to the Road to Housing Act and its impact on manufactured housing as Congress gets back to work. We're looking to see if the House is just going to take up the Senate version, which means this will become law this year, or if there's going to be a broader negotiation that could push this into late 2026.
In terms of the calendar, just a couple of dates to flag. November 17th is the deadline for the final briefs on whether the president is able to fire Federal Reserve Governor Lisa Cook. So expect some headlines then. We have the FOMC meeting in December on December 10th. Those are really the only firm dates we have going into the end of the year, but the regulators do have a large backlog of policy changes that we are looking to see surface and that would include final rule to average stress capital buffers, as well as to set the enhanced supplemental leverage ratio. All of this is good news for the big banks. We're also looking at the SEC and what they're going to be doing on crypto through the end of the year.
In short, I think it's going to be a pretty busy final two months of the year leading into what should be a pretty productive first quarter on the policy front. With that, we are going to wrap our November podcast. Thank you to Moshe and Scott. Thank you everybody for tuning in and we look forward to chatting with you next month.
Speaker 1:
Thanks for joining us. Stay tuned for the next episode of TD Cowen Insights.
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