Delinquency Rates

• The Bottom Line: Delinquency rates are a critical economic health report, showing the percentage of borrowers who are falling behind on their loan payments, and for a value investor, they are a powerful early warning system for future financial trouble.
• Key Takeaways:
• What it is: A simple percentage that measures how many loans (by value or number) in a portfolio are past due but have not yet been written off as a complete loss.
• Why it matters: It is a direct measure of credit_risk and a leading indicator of a lender's future profitability and the health of the broader economy. Rising delinquency rates often precede rising loan losses.
• How to use it: A value investor uses it to judge the quality of a lender's assets, assess the competence of its management, and spot potential economic downturns before they are widely recognized.

Imagine you're a landlord with ten apartment units. This month, nine tenants pay their rent on time, but one tenant, let's call him Bob, misses the due date. In this small “portfolio” of tenants, you have a 10% delinquency rate. It doesn't mean you've lost Bob's rent forever—he might pay late with a fee—but it's a signal of stress. If next month, three tenants are late, your delinquency rate jumps to 30%. You'd rightly become very concerned about the stability of your income. That's precisely what delinquency rates are on a massive scale for a bank, a credit card company, an auto-financing arm, or even the entire country. A delinquency rate is the percentage of all loans in a portfolio that are past due. A loan becomes “delinquent” the first day after a payment is missed. Lenders typically track delinquencies in buckets, such as:

• 30-59 days past due: A warning light. Often a result of temporary issues or forgetfulness.
• 60-89 days past due: A more serious problem. The borrower is likely facing significant financial strain.
• 90+ days past due: A major red flag. At this stage, the probability of the lender ever getting their money back drops significantly. Loans in this bucket are on the fast track to becoming a charge-off—meaning the lender gives up on collecting it and takes a direct loss.

So, when you hear that a bank's mortgage delinquency rate is 1%, it means that for every $100 in mortgage payments it expected to receive, $1 is currently overdue. It's the financial world's equivalent of a doctor checking a patient's vital signs. A low, stable rate suggests good health; a high or rapidly rising rate signals a brewing illness.

“It's only when the tide goes out that you discover who's been swimming naked.” - Warren Buffett

This famous quote is the perfect lens through which to view delinquency rates. In good economic times (when the tide is in), almost anyone can get a loan and make payments. But when a recession hits (the tide goes out), lenders who made reckless loans to uncreditworthy borrowers are exposed by soaring delinquency rates.

For a value investor, who is obsessed with understanding the true, underlying intrinsic_value of a business and buying with a margin_of_safety, delinquency rates are not just another financial metric. They are a window into the soul of a lending business and the health of its customers. 1. A Barometer of Asset Quality For a bank or lender, what is its primary asset? Its loans. A loan is a promise of future cash flow. A delinquent loan is a broken promise. Analyzing delinquency rates is the single best way to assess the quality of a bank's balance_sheet. A bank that boasts high profits but has rapidly rising delinquencies is living on borrowed time. The value investor knows that those “profits” aren't real until the cash is collected. High delinquency rates reveal that the bank's assets (its loans) are deteriorating in value. 2. A Precursor to Pain (Future Loan Losses) Delinquency is the fever that comes before the illness of a loan loss. A loan moves from 30 days past due, to 90 days past due, and finally to a charge-off, which directly hits the bank's earnings on its income_statement. By watching the delinquency “buckets,” a prudent investor can see losses coming months before they are officially reported. This provides a huge analytical advantage over the market, which often only reacts after the charge-offs are announced. It allows you to protect your capital by avoiding or selling a deteriorating business. 3. A Test of Management's Underwriting Discipline Value investing is as much about judging the quality of management as it is about judging the numbers. In banking, the primary test of management is its underwriting discipline—its ability to say “no” to bad loans, especially during euphoric periods. A bank with consistently low delinquency rates, even through tough economic cycles, is demonstrating a culture of prudence and risk management. Conversely, a bank that “grows” rapidly by lending to riskier borrowers will see its undisciplined past show up in its delinquency numbers when the economy turns. 4. A Canary in the Economic Coal Mine Even if you don't invest in banks, you should pay attention to national delinquency rates (e.g., for auto loans, credit cards, mortgages). These figures, often released by central banks like the Federal Reserve, are powerful macroeconomic indicators. Rising credit card delinquencies signal that consumers are stretched thin and may cut back on spending, which affects retailers, restaurants, and travel companies. Rising commercial real estate delinquencies can signal trouble for a wide range of businesses. A value investor uses this data to inform their view of the overall economic climate and adjust their margin_of_safety accordingly.

The formula is straightforward: `Delinquency Rate = (Total Dollar Amount of Delinquent Loans / Total Dollar Amount of Outstanding Loans) * 100%` For example, if Prudent Trust Bank has $1 billion in total outstanding loans and $10 million of those loans are past due, the calculation is: `($10,000,000 / $1,000,000,000) * 100% = 1%` The bank's delinquency rate is 1%.

A single number is meaningless in isolation. The art is in the interpretation, which requires context.

• Look at the Trend, Not the Snapshot: Is the 1% rate up from 0.5% last year, or down from 1.5%? A rising trend is a significant warning sign, suggesting either a weakening economy or a loosening of the bank's lending standards in the past. A stable or falling rate is a sign of health.
• Compare with Peers: How does Prudent Trust's 1% rate compare to its direct competitors? If every other similar bank has a rate of 0.6%, then Prudent Trust's 1% looks troubling. If the industry average is 2%, then Prudent Trust looks like a star performer. Comparison reveals relative strength or weakness.
• Segment by Loan Type: A smart investor will dig deeper. A bank's overall delinquency rate is a blend of all its loan types. These types carry vastly different risk profiles.

^ Loan Type ^ Typical Delinquency Profile ^ Why? ^

A bank heavily exposed to unsecured credit card debt will naturally have a higher delinquency rate than one focused on prime mortgages. The key is to compare apples to apples and to watch for deterioration within each category.

Let's compare two hypothetical banks to see how a value investor would use this concept.

• Steady Brew Bank: A conservative, well-established bank. It focuses on high-quality mortgages and commercial loans to stable businesses. Its management is known for being “boring” and risk-averse.
• Flashy Tech Lending: A newer, aggressive lender. It has grown rapidly by offering high-interest “buy now, pay later” loans and subprime auto loans, marketing heavily to younger, less-established borrowers.

Here's how their key metrics might look during a stable economic period:

Mr. Market is initially thrilled with Flashy Tech. Its high growth and juicy interest margins lead to a soaring stock price. He finds Steady Brew “boring” and its stock stagnates. The value investor, however, looks at the delinquency rates and becomes cautious. Flashy Tech's 4.5% rate is a glaring red flag. It indicates that their high interest income is not high-quality; it's compensation for taking on massive credit_risk. Now, a mild recession hits. Interest rates rise and unemployment ticks up.

Steady Brew's prudent underwriting is revealed. Its delinquencies rise but remain manageable. Flashy Tech Lending, which was “swimming naked,” is exposed. Its risky loans sour en masse, leading to huge charge-offs that wipe out its profits and decimate its stock price. The value investor, by focusing on the warning sign of high delinquency rates from the beginning, avoided a catastrophic loss of capital.

• Forward-Looking: It provides an early glimpse into future charge-offs and earnings problems, unlike many accounting metrics that are purely historical.
• Objective Data: It's a hard number, less susceptible to accounting gimmickry than metrics like “goodwill” or even reported earnings. ¹⁾
• Reveals Management Quality: It serves as a report card on a lender's core competency: underwriting risk. Consistently low rates are a hallmark of a well-run institution.
• Broadly Applicable: It can be used to analyze individual companies (banks, credit unions, fintech lenders) and to gauge the health of entire economies.

• Can Be a Lagging Indicator of Risk: The bad loan was already made, perhaps years ago during a boom. The delinquency simply reveals a past mistake, it doesn't prevent it.
• Susceptible to “Extend and Pretend”: A desperate lender might try to hide rising delinquencies by offering troubled borrowers loan modifications (e.g., lower payments, extended terms). This can keep a loan “current” on paper, masking the true underlying problem. A smart investor looks for a rise in modified loans alongside delinquency rates.
• Definitions Can Vary: While generally standardized, there can be minor differences in how institutions classify and report delinquent loans. Always read the footnotes in financial reports.
• Doesn't Tell the Whole Story: Delinquency rates must be analyzed alongside other key metrics, such as net_charge-offs, the loan_loss_provision, and capital adequacy ratios (like CET1) to get a complete picture of a lender's health.

• credit_risk: The fundamental risk that delinquency rates measure—the risk of a borrower defaulting.
• net_charge-offs: The final stage after delinquency, where a lender gives up on a bad loan and writes it off as a loss.
• loan_loss_provision: The money a bank sets aside from its quarterly earnings in anticipation of future charge-offs. Rising delinquencies force higher provisions.
• margin_of_safety: Choosing lenders with low, stable delinquency rates provides a buffer against unexpected economic downturns.
• circle_of_competence: You cannot properly analyze a financial institution without a firm grasp of what drives its delinquency rates.
• balance_sheet: Where the loan assets are recorded and where their quality truly matters.
• underwriting: The process of vetting borrowers and deciding whether to lend to them. Delinquency rates are the ultimate scorecard for underwriting quality.