Goldman Sachs
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- Goldman Sachs has some Wall Street analysts concerned by its foray into unsecured consumer debt just as many expect loan losses to increase.
- Bank execs recently gave an explanation for the loans they're making to subprime borrowers.
You might remember that Goldman Sachs is lending to subprime borrowers. Turns out it's all a part of a plan to help predict the next credit cycle.
In February, Goldman Sachs surprised Wall Street when it said that more than 80% of borrowers for its Marcus consumer lending product had a FICO score of more than 660 at year-end. The implication was that nearly 20% had a FICO score of less than 660, placing them in a group often referred to as subprime.
Wall Street analysts were perplexed. In April, Autonomous Research's Guy Moszkowski asked for an explanation, saying several of his clients were surprised by the scale of subprime lending at Marcus.
Goldman CFO Marty Chavez addressed the concern on a company earnings call saying management was well aware of the economic cycle and is always looking out for "where we might be in the credit cycle, since there will be no announcement of the turn of the credit cycle or any harbingers of when it's going to turn."
In fact, the bank is taking active steps to spot an economic downturn precisely by lending to subprime borrowers.
Deutsche Bank analyst Matt O'Connor recently met with Stephen Scherr, the Goldman Sachs partner who runs the consumer and commercial banking division that houses Marcus. He said that management "noted that it originates a low single digit % of customers in the 630-660 FICO bucket as it believes these credits are a good barometer for evaluating turns in the credit cycle,'' in a May 3 report, using abbreviations common to analyst notes.
The strategy "allows Marcus to learn more real time about the product, pricing and credit with this group and apply this to the overall credit model."
In other words, the prestigious investment bank is lending to subprime borrowers because it thinks they'll be the first to stop paying when the credit cycle turns. And it's using that ability to repay as a key input into its ever-evolving underwriting process. O'Connor added that the bank is on its eighth iteration of the model.
O'Connor said he assumes the bank is making a spread of about 10% on each loan, suggesting it's generating about $240 million in annual revenue from the $2.4 billion in loans outstanding. The bank expects credit losses to take that spread down to 6%, he wrote.
In September, the bank said it sees a $1 billion revenue opportunity in the Marcus loan-and-deposit platform based on a $13 billion lending opportunity over three years. Whether it reaches that goal or not will depend, in part, on how those subprime borrowers behave.
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