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Andrew Housser Posts

The Truth About Our Economic Expansion

Increased debt levels are responsible for the GDP growth we’ve seen since 2009 and the people least able to afford it are financing our country’s growth with debt

While economists, policymakers and the media tout the U.S. economy’s stellar economic growth since we came out of the great recession in mid-2009, a simple, harrowing truth paints a much less rosy picture: our growth is not being fueled by better jobs, better wages, or more prosperous lives for the average American. It’s being fueled by massive, historically-high debt levels that will eventually cripple the people who are least capable of handling it.

If you follow business news even sporadically, you are probably aware that we are in the midst of the second-longest economic expansion in the U.S. since before the Civil War (more than 150 years ago). In June of this year, our economic expansion celebrated its 9th birthday. But a closer look at the data suggests that celebration is probably not the most appropriate reaction. The reality is that this economic expansion has been almost entirely fueled by debt – consumer debt, corporate debt and government debt. And it is going to be consumers who bear the brunt of it when the expansion ends.

As a result of the great recession, U.S. Nominal GDP fell to $14.4 trillion in 2009, and since that time has risen to $19.4 trillion in 2017. That is a $5 trillion increase in annual GDP in an 8-year period, which certainly seems like an impressive number. But look what has happened to debt levels in our country over the same time period. Consumer debt has risen by $1 trillion since 2009, from $12.1 trillion to $13.1 trillion. At the same time, debt has ballooned on corporate balance sheets from $3.7 trillion to $6.1 trillion, an increase of $2.4 trillion. And last but not least, government debt has increased from $11.9 trillion to $20.2 trillion, a staggering increase of $8.3 trillion. Add that all up and you have an increase in total debt of $11.7 trillion in exchange for GDP growth of $5 trillion. Does anyone really think that is a good, sustainable trade off? What would the response be to a company that asked to borrow $11.7 million in order to fund revenue growth of $5 million? Even the nicest banker on Wall Street would politely end the meeting as quickly as possible, “Thanks for coming in…”

In fact, consumer debt is up by a full $1.8 trillion since it bottomed out in 2012. And it is currently half a trillion higher than the prior peak before the great recession. Does anyone remember in the wake of the 2008 crash how much attention and blame was placed on debt levels – how many journalists and politicians told us (after the fact) that it was inevitable and obvious that the game would end badly. Bubbles are always obvious – from tulip bulbs to dotcoms – after they have burst.

On the consumer side, increases in debt levels are being fueled by more and more “technology” companies jumping into the consumer lending business. That includes many here in Silicon Valley who think that simply being from Silicon Valley makes them better than companies that have been honing their credit risk and underwriting models (and learning from painful experience) for decades or centuries. It seems like a great mix at first – a Silicon Valley data and technology mindset to a staid old industry – a match made in heaven, right? The rub is that the drive for growth at all costs, mixed with credit risk and lending, is a match made in hell. The two are almost diametrically opposed. It is very easy to grow a lending business – “Here is some money, do you want it?” On the flip side, it is very easy to control credit risk “No money for you! (or anyone else).” Doing both – growing a lending business while controlling credit risk – is a real challenge – one that takes a combination of people, processes, technology, analytics and humility in order to succeed. In a typical venture backed company, the drive for growth trumps everything. And that mindset often makes sense – by growing at all costs, you are risking only two things – the time and opportunity cost of the founding team and the equity investment from the venture capitalists. That is a smart and fair trade. Whether it implodes or takes off, the founders’ and VCs’ losses or gains are commensurate with the risks they took. So put the pedal to the metal and see what happens. When you bring in lending, balance sheets, and credit risk, the game – and the associated risks – are completely different. The repercussions of an implosion expand dramatically to lenders and their counterparties, and to over-leveraged consumers stuck with loans they can’t afford to pay back.

Predicting the end of an economic expansion is nearly impossible. The only thing that we say with certainty is that this economic expansion will end at some point. And unfortunately, it is going to be consumers who bear the brunt of the pain when that happens. It is not going to be possible for consumers, governments and corporations to expand their balance sheets in the way they have over the past 9 years to get us through the next recession. Debt levels are too high to double down. This leads to some combination of the following outcomes: layoffs at corporations trying to right size their cost structure and service their debt loads, a fiscal contraction (with lower wages, lower employment), and/or inflation fueled by monetary expansion as the government prints money in order to service its debts, resulting in lower real wages. Each of these outcomes results in consumers feeling the brunt of the pain as lower employment and lower real wages come face-to-face with massive debt burdens.

Household savings rates are paltry, few Americans have emergency funds to cover any unexpected expense, and – as Deutsche Bank says – “balance sheets have become more fragile for the lower part of the income distribution.” Real wages for mid-range workers have not risen, despite promises that corporate tax cuts would deliver a windfall for the American worker. And prices for everyday goods continue to rise.

On a macroeconomic level, when the proverbial music stops, not only will millions of Americans find themselves under water, but also the options available to the government to help soften the landing will be greatly reduced.

Well I am sure that was a fun read, so what can an individual consumer do about it? While it’s not always possible to live within our means, the pace at which we have been spending – as individuals and as a country – is unsustainable. It will behoove us all to think more like those trusty, old-school credit risk modelers and less like Silicon Valley VCs. In my next post, I’ll talk about ways that consumers can help prepare themselves for economic uncertainty.

Freedom Financial Network’s First Securitization

We achieved a big milestone today, closing Freedom Financial Network’s first ever loan securitization, which placed $256 million worth of investment-grade notes in an offering that was significantly over-subscribed.

This deal marks the first time that a new issuer in a non-bank lending securitization has received an A rating on its senior tranche from DBRS. Credit Suisse, who was the structuring agent, and SunTrust underwrote the transaction.

I am very thankful to the team at Credit Suisse and SunTrust for the excellent work bringing this to market. Our legal team at Sidley and rating agency DBRS were also terrific partners to work with. And finally, to everyone here at Freedom who worked incredibly hard (including many early mornings and late nights) and executed flawlessly to get this done on schedule, on budget and with terms that exceeded our goals – a huge thank you!

Back in March, Freedom Financial Asset Management (FFAM), a Freedom Financial Network platform, crossed the $2 billion threshold of loans originated, and the securitization market will be a key to continuing our growth trajectory.

This is Not Growth for Growth’s Sake

While we love celebrating milestones like this, our focus from the beginning of Freedom has never been to grow for the sake of growing. Growth itself is not our goal; growth should be a side effect of building something great.

We have always focused on investing in our people, processes, data, and technology to build a company that delivers significant value to our customers, investors, employees, and communities. The success of this securitization is a validation of that long-term approach to building value.

What’s Next

We focus on providing unique loan products to help underserved customers consolidate their debt, lower their interest rates, and build financial wellness. This will not change. That said, we also want to make sure that we produce consistent, predictable returns for our investors. We need both sides of this equation to build a strong business. And this transaction will help make that happen.

Freedom Consumer Credit Fund 2016 Year-End Review

2016 was a very successful year for the Freedom Consumer Credit Fund.  We remain committed to our core belief that a combination of process, technology, analytics and real human interaction is the best recipe for long term risk adjusted returns in the consumer lending space. Freedom Financial Asset Management is based in Silicon Valley because we love living here. But we don’t share with the worldview so commonplace in this part of the world that technology can completely disintermediate every aspect of human behavior, let alone a credit cycle.

To put it simply, we think talking to people is valuable. We learn things. We uncover information that isn’t available in a credit file or a data model. We make it very hard for fraudsters to get by our defenses. We love our amazing analytics and risk modeling team, but we know that no mathematical model, however powerful, is more powerful than common sense.

We enjoy the energy and excitement of working in a growing organization, but we know that growth in and of itself does not create long term value. Long term value comes from an economic model that produces positive discounted cash flows, based on a foundation of great people, processes, data, technology and analytics. We have always said, and will continue to say that we will grow as fast as we can while still generating great risk adjusted returns for investors.

FFAM is blessed to have a profitable parent company, Freedom Financial Network, which allows us to have a truly long term perspective when it comes to value creation. That, combined with the fact that we have no pressure from public markets (or investors who want us to go public), allows us to stay disciplined in our approach to growing our business.

Our leadership team’s experience as operators in very complicated financial service businesses allows us to implement complicated processes to reduce risk and thereby improve returns for our investors. Our Direct Pay process lets us pay our customers’ credit cards off directly when they borrow money for debt consolidation. Our focus on co-applicants has resulted in close to 50% of our loans having a co-applicant on file. We verify 100% of our customers’ incomes. We manually underwrite all of our customers’ files, collecting valuable information and insights that are not available on a credit report.

None of the above is rocket science. All of it is common sense. But it is hard work, and it is only possible because we are consciously choosing long term value creation over short term growth. Amazingly, we do all of the above, while still funding our borrowers 1 to 2 days faster than our main competitors do. That simple statistic highlights the successful merging of great people, process, technology and analytics.

Data-driven isn’t the same thing as “Fin Tech”

This is not to say we are not big believers in technology and data and analytics. We have invested and will continue to invest heavily in both. But we are not a technology company.

“Fin Tech” is a marketing term with no apparent purpose – other than to pump up the valuations of financial services startups. A technology company is a company whose product – the stuff it sells – is technology. Apple and IBM are technology companies. A company that invests heavily in technology to help make its business more efficient, reliable, and effective, is… well, just a company operating in the 21st century. McDonalds invests more in technology every year than all Fin Tech startups combined, but nobody is under any illusion that they are a technology company (although if they were VC backed, they surely would be calling themselves a Food Tech company by now). Why is this important? Because knowing what we are keeps us focused on the right things: customer acquisition, servicing, underwriting, credit risk, compliance, unit economics, ROI, NPV and culture. It also makes sure we stay grounded with the right level of paranoia and humility. We know that no technology is ever going to disintermediate the next credit cycle.

Also, we are strong believers in alignment. The majority of our parent company’s levered free cash flow is allocated to the FCCF over the next 18 months. We love this because we can’t think of a better place to put our money. We also love it because alignment is another very simple, but very powerful concept. It is so simple that it shouldn’t even need to be a topic of conversation. But the history of financial services has been littered, over and over, with the failures of alignment. Bottom line – we succeed if our investors succeed.

It’s our people and our culture that matter most

Of the hundreds of new hires in the past few months, we want to particularly note four key additions to our senior team: Chris Capozzi, FFN’s new CFO, joins us from General Electric where he most recently helped lead the GE Capital restructuring divesting $260 billion of assets while returning $55 billion to shareholders. Freddy Huynh, FFAM’s new Credit Risk officer spent 18 years as the lead Data Scientist for FICO where he oversaw the development, maintenance and analytic support for FICO Scores and was the technical lead on all Product, Client Support, Regulatory, and Legal priorities. Mike Boyle, Head of Loan Operations brings over 30 years of lending experience, the last 18 with Chase, where he managed large underwriting, servicing and collection teams. And Megan Hanley, our new Chief Marketing Officer, was most recently CMO of Shoprunner, CMO of Auction.com, and prior to that held marketing leadership positions with Microsoft and Esurance, among others. We are lucky to have all four join the Freedom team!

It is with particular pride that I mention that FFN took first place in the 2016 “Best Place to Work” for large employee sized companies in the entire Phoenix area. All of us are so proud and excited by the award. Culture and the quality of the people we get in the front door is something that we care deeply about and work very hard at. We are by no means perfect, but we work very hard at it, and this award is an amazing validation of our culture. In the end the quality of our work is determined by the human talent we employ!

This article is excerpted from our annual FCCF report. To view the press release summary of the report, click here.