Planning to Win: Lending Strategies for an Uncertain Economy

0:00 The unknown. It depends on the month, it depends on the week, it depends on the quarterer. It's kind of been the whole theme through twenty twenty five. Some progressive lenders out there right now that I'm seen actually ramping up, so where some start to wind down into the fourth quarter and say, oh no, we're all good. We're kind of closing up shop about Thanksgiving or early December. Some are going, no, let's hit the gas. You can go on Amazon. You can go on to Walmart's website and buy TVs and things of that nature and make four monthly install the payments of fifty dollars. This is like navigating your sale boat across choppy seas or rough wards or calm seats. I don't think anyone sees calm seas. No one is saying, oh yeah, twenty six is going to be a layup. Welcome back to upstarts leaders in lending. I'm Barry Roach, and I'm here with our co host Drew Megriy. Today we're tackling one of the biggest challenges executives are facing right now, navigating an economy that's constantly shifting from high rates and regulatory changes to evolving consumer behavior. We'll walk through the key shifts that are shaping lending today and the practical playbook leaders are using to stay resilient. Let's get started. How are you doing today, Drew?

1:05 I'm doing well. Thanks, very good. Good So, Drew, You and I are out there talking to CEOs chief lending officers CFOs all the time. It's the fourth quarter of twenty twenty five, we're getting into business planning. A lot of them are trying to sort of figure out what the rest of the year looks like and gets some momentum going into twenty twenty six. So what are you hearing from the executives out there today in terms of what their biggest concerns are, not just as we're getting into the end of the year, but into the beginning of next year as. Well, first off, fourth quarter during peak football season. Love love the analogy. I would say it's almost the unknown, right.

1:46 It depends on the month, it depends on the week, it depends on the quarter. It's kind of been the whole kind of theme through twenty twenty five, and then we've talked about this on prior podcasts. With market volatility, interest rate risk, global unrest, I mean potential recession. We've heard that time and time again, and that's still kind of the same theme going into next year. But what I do feel that a lot of the executives that we've talked to they've kind of mitigated their businesses going into twenty twenty six with assumptions as all that stuff relates. What I would say though, that I have been hearing an increasing kind of unknown is as it relates to like cybersecurity and tech risk. The use of AI has definitely taken off, the leveraging of partners that use AI and just AI and tech in general. I mean it's a very antiquated system with all the technology kind of things in the background that run cybersecurity and so on and so forth. So I think kind of to sum it up, it's still unknown. But all of the other stuff that I outlined as it relates to kind of the economy things have been mitigated. But there's other stuff on the forefront as it relates to cybersecurity, use of AI, regulatory stuff around around all that. What are your thoughts on that, Barry?

2:59 Yeah, I mean, think of of the the the I budget, the traditional I budget, You've got some allocated for development work, you know, some allocated for how you're going to move your business forward, whether it's productivity for your employees or a better value proposition, very digital value proposition for your for your members, for your customers out there. But then cybersecurity is out there as well, and it seems to be an area of business that is becoming more and more uncertain and you need to have more and more protections and more barriers up against that. So, you know, I think of it as as you and I have both been previous CEOs, what's what's the right balance of spend on that, because cybersecurity can shut down your business, as we've seen in financial services, banks and credit unis have both had some pretty significant and notorious cybersecurity incidents in the past couple of years or so. So it's it's how do you waste or of that that spend against secure versus moving your business forward using AI and technology.

4:04 Yeah, it's it's kind of a reoccurring theme. I don't know how many pieces of mail I get anymore, not in financial services, but oh, you may have been a part of a data breach as it relates to I went to the doctor for my annual exam and they have my social and all that fun stuff. Yeah. So as it relates kind of to the key themes that we've been hearing for I'd say the past twenty four months, market volatility fed like just juicing up rates over the past two years. What are your thoughts like going into twenty twenty six, Right, we've got a consensus here that they're going to reduce, but there's still a lot of pressure on the consumer because in aggregate the rates are still fairly high across most assets. Like, do you think the American consumer is going to remain resilient? Are they going to still be able to have affordability? As it relates to those rate cuts, are we still going to see some type of compression there or what are your what are your thoughts or what have you been hearing from the executives?

5:00 Yeah, I think we're still waiting for all those ray cuts, right, three different ray cuts of one hundred base points last year, one rate cut so far this year, perhaps another coming at the end of October, but none of those have made their way into the broader interest rate market. The ten year is still roughly about the same as it was two years ago. Thirty year, mortgages have come down a little bit, but still in the mid sixes or so. So you know, I don't think we're going to see any sort of huge correction or a positive correction in housing until we get that thirty year down below six. That's kind of what I'm hearing from executives out there right now. Now. Having said that, fourth quarter is always a tome of optimism, So okay, you know, and you know how these things are.

5:45 You bring out your magic crystal ball in October and you try and predict what's going to happen over the next fifteen months, and nine times out of ten those predictions are wrong or somewhat flawed, or they never really came to pass. So your budget, this is playing, has to be very much a fluid process even throughout the year. As conditions change, you need to course correct. This is like navigating your sailboat across choppy seas or rough wars or calm seas. And I don't think anyone sees calm seas. No one is saying, oh yeah, twenty six is going to be a layup. This is going to be easy. We know exactly what's going to happen. But I do hear a lot more optimism now than I did maybe six months ago about the impact of FED funds reductions actually making their way into the marketplace, that it might create a little more demand for lending across the board, across all asset classes, including on the commercial side as well.

6:38 But then you know, now there's some credit quality concerns out there. Perhaps you know, we've seen that delinquencies and credit cards have started to increase a little bit. Unemployment still remains low relative to where it had been over say the past decade or the past two decades or so, but there's been a little more It's not as it's softened a little bit. I would say from where it was maybe a year ago. The number of job openings are less now than they were a year ago. So there may be some stress on the American consumer that way, that perhaps if they're not really feeling all that confident about their long term or even short term prognosis of their employment, that they may put off on some spending, which which would then certainly have some impact on the demand for loans.

7:29 What do you think, and Drew I would echo all of that, but going back to kind of a topic that you brought a hand. Credit quality remains to be kind of an unknown. Things have definitely elevated over the last eighteen twenty four months. But if you remember, I don't know, maybe a few episodes ago, we were talking about financial services in general, whether they be credit unions and or banks have kind of already tightened, right, and they started tightening two years ago. Is this the new norm? And what I've heard from talking to executives and just even looking at stuff within our own kind of rails is things are starting to normalize again with appetite across auto, the appetite for taking personal loans on at the higher yields as kind of rates are subject to go down.

8:15 So what I find very interesting is like this has been mitigated maybe right from a risk perspective, and there is that crystal ball if we want to grow, we want to grow. Where I think this plays into kind of the growth perspective going into twenty twenty six is if we do start to decrease rates. One, if you're borrowing from the FHLB, that's beneficial to you from an expense standpoint, so you're able to go back out and lend, maybe not to the thresholds that lending was going on in twenty twenty one and twenty twenty two. But then on another kind of subset is your cost of funds is going to reduce. And I don't know what that lag time is based on the FED reducing, but as your deposit products from an API perspective are going to reduce, your borrowings are going to reduce. That sets you up for success from a growth perspective. And we're already starting to see some of that, you know, planning going into twenty twenty six of let's start bringing back all asset classes as part of our growth plans.

9:13 Right, I mean there is a I think there's a there's a really good formula out there if you're willing to take a little bit of risk right now. And to your point about your your cost of funds, so your deposit products that you probably overpaid for two years ago and then probably still overpaid a year later PONM renewal, you know we are I'm certainly seen across the country that those those great twelve months CD rates, those eighteen months CD aren't necessarily as good as they were two years ago. For a good reason. Right, part of it is is less need for that supply. And the other part is that we have seen FED funds reduced rates and so on, so there's less pressure on the deposit side and less need to sort of try and step up your your amount deposits in order to cover your loan demand. But you've also still have high loan yields.

10:01 So to your point, if if you've already sort of accounted for the increased risk credit risks out there and that's in your pricing, you can get some pretty good yields right now across asset classes before and almost almost get ahead of the reduction in rates. So there are some progressive lenders out there right now that I'm seeing actually ramping up. So where some start to wind down into the fourth quarter and say, oh, no, we're all good. We're kind of closing up shop about Thanksgiving or early December. Some are going, no, let's hit the gas and let's let's go out and get some real good loan income momentum going into twenty twenty six. So then that first quarter, you know you're actually at or ahead of what your expectations are, and it would help to mitigate any other choppy waters that we do have through the rest of twenty twenty six, if DQ goes up, if credit quality declines, if rates don't actually reduce as expected, if inflation starts to tick up a little bit. That's something else we have been talked about. I mean, what are your what are your lenders hearing about inflation or where are they thinking about it?

11:06 I was gonna go back like on all of that, Like, I don't think the formula is ever going to change though, right, You're going to diversify your portfolio based on risk adjustive returns. It's what everybody does going into each quarter each year, just a matter of where are you going to put your eggs in each basket. Then going back to inflation, like it's been something that's been discussed of the unknown again for quite some time. Nothing's really come of it. I mean there's a been volatility, there's a spike here and then it goes down. It depends on, you know, what's going on in the economy. But I think that of the executives that I talk to in the lending space, they're they're they're kind of okay with where everything sits right now, and and don't think much is going to change or and or impact I mean current state. The only kind of with government shutdown, right is the unknown there and how that's going to impact what's the longevity outside of that. I don't think inflation is really a concern.

11:59 It's just something that's kind of in the forefront that will continue to monitor. But again, no real concern from who I'm talking to right now. We're only nine or ten months into this administration. There's been tariff concerns that I don't know, have they come to pass or not drew. Like I don't necessarily feel it as a consumer, but then I may not be representative of the sort of average consumer. But people are still buying TVs and and still buying imported vehicles, and and I don't really see that changing a whole lot. What do you see? Yeah, that's a great point, Like, let's kind of shift here consumer behavior, right, the American consumer. We've seen data in the past, you know, a few years where still coming out of the COVID boom, they're purchasing to your point, TVs, hospitalities, maybe stuff that they don't really need. But in like recent findings, households are starting to tighten their spending. The consumer savings rate is kind of remain relatively flatt You don't see as much, you know, spending as it relates to durables. But then I kind of often think as it relates to all of that, like we're at airports quite often and they are packed. We go on vacation and the hotels are packed anytime that we're traveling for pleasure or work. I don't understand the whole like the tightening and non spending when we're seeing it. So I really don't know what the consumer behavior looks like in that aspect. Maybe it's different. Cohorts are you know, still from from a uh from having a more more funds

13:31 and things of that nature. Are ones that sat on savings longer than others are starting to kind of come out of the woodwork as it relates. But I can't pinpoint the consumer behavior as it relates to what's going on in the macro right now. Yeah, that's a good point. It's it's it's it's befuddling a little bit. Right. We all expected that the consumer would stop spending, and the consumer hasn't necessarily stopped spending, maybe at the rate that we expected. Uh, But you talk about going to airports and hotel and so on spending on experiences. We saw that spike up after COVID, where people were stuck in their homes for a year and a half or two years, and then finally we're able to go out and said, well, yeah, I've already bought my TVs, I've bought my durable goods. Let's go out and let's experience some things. And that has not slowed down at all.

14:17 Cruise ships are still packed and more and more of that happening. So you know, if you think of that from a macro perspective of what that's going to mean for our lenders going forward, it's probably a good sign. We still haven't seen sort of the typical interruptions of the economy that you would see before a recession. You and I were both in the industry with a great financial recession. I mean we felt it probably a good twelve to eighteen months before everything kind of burned down as it happened, But we were starting to see it in our delinquency. We started to see it talking to our collectors. They're the ones, they are the canaries in the coal mine, they are the ones who is saying, yeah, we're hearing a lot of stress out there, and those conditions just don't really exist right now, And from talking to blinding partners across the country, they're not really seeing that either at all. So the consumer has been resilient, continues to spend, and should continue to spend unless there's some sort of a massive economic disruption, which is so far, so good, We thankfully haven't seen anything like that.

15:23 Or how much of this is the American consumer buying said durables at an elevated rate as it attributes to buy now, pay later. You can go on Amazon, you can go on to Walmart's website and buy TVs and things of that nature and make four monthly installment payments of fifty dollars. I wonder if the American consumer is leveraging buy now, pay later more than the traditional credit card or unsecured person alone or things of that nature to finance some of that stuff. Which is opaque to most lenders because it doesn't show up in credit reports and will eventually catch up with you, you would think, right, but so far, so good. Have you used that yourself. I'm just curious because I didn't use it a couple of years ago. It just kind of made sense and the opportunity came up and I thought, well, why spend six hundred dollars on this item that I was purchasing when I could do it one fifty over four months. This kind of kind of made sense coming from the same credit card which I pay off every month anyhow, so why not as a consumer. It just kind of ticked those boxes and felt like something that I could use right now. Now did it really sort of change my financial picture? Probably not all that much, but actually made me feel a little bit better about that purchase, and I had to lay out the whole six under myself at that time.

16:42 Maybe I need to become one with the times and test out the buy now, pay later, I've not I've not done that yet. Well, you know you can DoorDash something at lunch and probably buy now and pay that one later too. So they all try that out tomorrow. So let's shift a little bit back into Upstart a little bit, so you know, Upstarted employees a lot of tools, predictive sort of tools to try and help our lenders understand sort of what the macroeconomy is and perhaps what that means for their own portfolio of loans that they've originate today and then the ones that they're going to originate down the road. And I'm talking across all asset classes, because it's not just personal loans now, it's auto loans, it's helock that sort of thing. So as you talk to your lending partners out there, you know, what's her confidence are they getting from understanding that these tools are available for them, and it's just giving them a lot more transparency into the decision making that they have to do for their business.

17:35 I think in my conversations it's it's not for lack of a better term, with rising delinquency, rising defaults, and things of that nature, that there's a scaredness associated with it. I think with leveraging these tools, it allows them to better re forecast across all assets, whether it relates to unsecured or asset backed type of loans, as well as it relates to CECIL and the overall impact that it has towards their expense and in their bottom line at the end of the day. Whereas if you if you rewind, you know three years ago, three years or so ago, one CECIL had to be adopted. There was a lot of unknowns. We didn't know how to refecast and using these tools, it allows for here's the current state of origination, whether it be month one or quarter one, and then what does it look like from a loss projection standpoint on that six, nine, twelve months down the line, And how can I reallocate my reserves into my A triple L account and go from there. So I think having those tools has helped better define the refecasting methodologies across all assets to help be set up for success as it relates to expenses and an overall net income.

18:42 Yeah, I mean, what a massive change that technology has given for CFOs and executives trying to sort of forecast things out. You can always you could have always looked at a point in time of sort of the overall quality of your portfolio, both from from from a credit risk perspective, but then also sort of forward the forward income that should be getting from it. But now you've got so much modeling ability at your fingertips to be able to sort of look at different scenarios. And again, you know, if you think the economy is going to be good, great, or poor, you could forecast all those three scenarios with really just just a click of a couple of buttons where that would have been such a massive job for me to do back in my day when I was running credit Union for you as well, Drew, it's just that much easier now to sort of model that out and and and determine well from those models, what directions should we take and do we need to course correct things with our business? Do we need to tighten or loosen thats the case may be. So it's it's fascinating just and enlightening to see how this has happened over time, with the with the quality of of of the tools that are out there for you.

19:50 Yeah, the old school Excel spreadsheet forecasting methodology, when you plug six numbers in you get an outputs as a thing of the past, right. I think Another thing though, as it relates to these these types of tools, is it allows for to your point you said, Q four is the crystal ball, We're going into twenty six and we want to do X, y Z from a lending perspective, and then things shifting Q one, Are they shifting? Q two? Being able to have these tools at your fingertips allows you to reallocate your portfolio. Let's say you were heavily weighted in helock maybe second weighted in the auto and then personal loans, credit cards, on and so forth, and as things changed in the macro, as delinquencies rise, if there's margin compression and you know, the asset backed type of loans, you can reallocate your your strategy because you kind of know what's going on in real time or maybe with a three month lag. So I think it definitely helps in doing that because I remember back in my day, we would set budget and we would manage to budget for that full year, and we really didn't know what was going to change right away. So you got to the end of the year and you're like, up, we either hit budget or we were a little bit off, and the board's wondering why were we off or why were we over? So I think having those tools definitely help kind of the real time decisions that the executives were making across the lending ecosystem.

21:04 Yeah, Like think back Q one of twenty three when there was a liquidity crunch. You know, think of your lending partners, the credit unions and banks you talked to across the country, those that had the ability to sort of course correct quickly or had already had the foresight to think of those sort of scenarios where you may need course correct. I mean, they were able to move pretty fast, and they were able to get deposit products out there and rates out there that would quickly allow them to get a little more liquidity. And I did talk unfortunately some lending partners who were sort of stuck with well, now what you know, where do we go from here? And and almost some inertia because of that, maybe because they they didn't take the time to sort of run those alternate scenarios where they didn't have the tools at their disposal or didn't know how to use those tools. So those executives on the sharper edge of the curve, with those tools available and the ability to use them, I think we're able to sort of to manipulate their balance sheet and their offerings out to their consumers faster and be able to sort of mitigate any any sort of risks of that liquated crunch that others had to experience.

22:17 Maybe it's kind of a blessing in disguise. I mean, no one really is going to rewind back and say I enjoyed lending from twenty twenty two to twenty twenty four. Right, But I remember sitting with examiners and they're wanting you to do a three hundred basis point rake shock. This is never going to happen. It's never going to happen. And here it happened. It happened. A lot of credit unions. They had to plan for scenarios like this because it happened. And while they were planning in you know, prior years in case there was a three hundred basis point shock. Now what's happened. There's risk assessments put in place, there's policies and procedures if scenario X, Y and Z happens. They know how they're going to kind of translate their business and be more resilient as it relates to any type of unrest. So as much as again is like I wouldn't want to go back to that, like maybe it was a blessing disguise.

23:05 Yeah, I mean it actually took some of the theory and put into practice. It's the one hundred year flood sort of thing. Right, Oh, this will never happen, Well every hundred years it does, right, So this is why you need to sort of protect to protect things that way, all right, Drew that was a good conversation today. Thanks for taking the time to sort of go through things on the economy and where we think things will be going. You know, if I'm a CEO watching this today and listening today, what would be a key takeaway for me to take to my team and to my board going forward. I think if I put my CEO hat back on, the number one theme from today would be scenario analysis. And reason being is you never know what's going to get thrown at you, whether it's in quarter and month and year. Setting yourself up for success in the twenty twenty six and beyond through either capital and funding models, risk mitigation, cecil methodologies, regulatory environment changes, so on and so forth. I think that is the number one scope of what I would recommend as part of our conversation today.

24:06 Yeah, so just trying to get ahead of potential scenarios that that could happen in twenty six. So you're going to have your baseline expectation and this is how we're going to perform, and these are the activities that we're going to do to get to that performance. But here's what happens. If things go sideways, that things go north, that things go south right. And you know, we always tend to think about about scenario analysis of the bad. You know what happens with the bad, But what if it's good? You know, what if what if unemployment gets better? What if inflation is fully tamed? What if rates do decline? That we see an abundance now of consumer spending going out, housing comes back, and so how are we going to be on top of that and make sure our teams are ready to leverage that. And part of that could be insert of diversification, not just of your portfolio, but also of your funny mechanisms as well. You reference before with FHLB potentially lowering rates, which is going to decrease my cost of funds. Well, maybe a reduction in interest rates on a broader term is also going to decrease my deposit costs. And as there's a race for deposits, as it's going downward, maybe there's opportunities for me to take that up as well. Okay, and one bonus last prediction then, drew college football playoff. We're in the fourth quarter, We're coming up against it. Who do you have?

25:22 I would have to say, as much as it pains me that I wish I could say the Clemson Tigers. As much as I like them, I'm gonna have to go with after watching this past week's game, the Indiana Hoosiers. Wait, I'm not talking March Madness. I'm talking college football national champions Indiana Hoosiers. Okay, well, that's a very bold prediction, and let's time stamp this and make sure that we come back to Drew later in the year to see where that's at. I'm going to front run and say Ohio State, partly because their rank number one right now and partly because I know it really irks Drew to pick Ohio State because he's not an Ohio State fans. So anyhow, there you go. That's all for this episode of Leers and lending. The economy will keep moving, but what matters most is how leaders adapt. Thanks for listening, and don't forget to subscribe so you never miss a conversation that helps you stay ahead. We'll see you next.

26:09 Thank you,