Marriott Vacations Worldwide Corporation (NYSE:<a href="https://seekingalpha.com/symbol/VAC" title="Marriott Vacations Worldwide Corporation">VAC</a>) just announced a positive first quarter, with strong occupancy rates and sales figures. But beneath the surface, a potential financial tsunami is brewing, unnoticed by Wall Street analysts: a consistent, and concerning, trend of increasing loan defaults.

While analysts are fixated on the recovery in Maui and the transition to the Abound program, a deeper dive into the loan portfolio reveals a worrying pattern. Delinquency and default rates have been rising steadily since Q3 2023. Management acknowledges this trend, attributing it to "higher financing propensity and slightly higher reserve on originations as a result of the default trends." But are they truly grasping the magnitude of this issue?

Their answer seems to be a hesitant "maybe." Management states they "believe their reserve is currently at appropriate levels," but immediately qualify this with "though we do need to see loan performance improve." This uncertainty speaks volumes. It suggests they're banking on delinquency rates dropping back to historical norms. But what if that doesn't happen?

Looking at the numbers, the situation appears even more precarious. During the Q4 2023 earnings call <a href="https://www.marriottvacationsworldwide.com/investors/events-and-presentations/default.aspx" alt="Q4 2023 Earnings Call Transcript">[Link to Q4 2023 Transcript]</a>, management estimated that a "normalized" loan loss rate going forward would be 100 to 150 basis points higher than historical levels. This is already baked into their development margin projections. However, the actual year-on-year increase in loan loss provision in Q1 2024 is closer to 200 basis points, significantly exceeding their own "normalized" projection. <a href="https://www.marriottvacationsworldwide.com/investors/events-and-presentations/default.aspx" alt="Q1 2024 Earnings Call Transcript">[Link to Q1 2024 Transcript]</a>

This discrepancy raises a critical question: is Marriott Vacations Worldwide underestimating the potential impact of continued high default rates? If delinquencies don't decline as expected, they could be forced to take additional loan loss provisions, potentially eroding their projected margins and ultimately impacting profitability.

The company's dependence on consumer financing for a significant portion of its sales makes this issue even more critical. With high financing propensity in the mid to high 50% range, a large chunk of their revenue stream is directly tied to the performance of these loans.

While the economic indicators currently paint a rosy picture for consumer spending, several factors could easily disrupt this fragile equilibrium. Rising interest rates, coupled with persistent inflation, are already squeezing household budgets. Even if consumers prioritize travel, as Marriott Vacations Worldwide confidently asserts, their ability to service these loans could be severely tested under sustained economic pressure.

Management's decision to prioritize corporate debt reduction over share buybacks further underscores their concern about leverage. While striving to reach a 3x net debt-to-adjusted EBITDA ratio by the end of 2025, they're clearly prioritizing financial stability over aggressive shareholder returns. This cautious approach is understandable, especially in light of the potential loan default risks they face.

Potential Scenario: Sustained High Default Rates

Hypothesis:

Delinquency and default rates remain at their current elevated levels (around 200 basis points above historical norms) throughout 2024.

Impact:

Marriott Vacations Worldwide would likely be forced to take additional loan loss provisions beyond those currently embedded in their guidance. This would result in a lower-than-expected development margin, potentially impacting profitability and ultimately leading to a miss on their projected adjusted EBITDA for the year.

The company's focus on driving tour flow through packages, while a good long-term strategy for sales growth, could further exacerbate this risk. Utilizing rental inventory for packages increases the pressure to sell these units and increases exposure to financing-dependent buyers.

While management is undoubtedly working to mitigate these risks, the potential for sustained high default rates remains a significant concern. Investors would be wise to pay close attention to this hidden financial vulnerability. The success of Marriott Vacations Worldwide, it seems, might not only depend on sunny skies and eager vacationers, but also on the financial health of its loan portfolio. And right now, that outlook is far from clear.

Loan Loss Provision Trends

Reference: <a href="https://www.marriottvacationsworldwide.com/investors" alt="Marriott Vacations Worldwide Investor Relations">Marriott Vacations Worldwide Investor Relations</a>

Marriott Vacations Worldwide Financials

Reference: <a href="https://www.marriottvacationsworldwide.com/investors" alt="Marriott Vacations Worldwide Investor Relations">Marriott Vacations Worldwide Investor Relations</a>

"Fun Fact: Marriott Vacations Worldwide manages vacation ownership properties under six different brands: Marriott Vacation Club, Grand Residences by Marriott, Sheraton Vacation Club, Westin Vacation Club, Hyatt Vacation Club, and Marriott Vacation Club Pulse."

Reference: <a href="https://www.marriottvacationsworldwide.com/investors" alt="Marriott Vacations Worldwide Investor Relations">Marriott Vacations Worldwide Investor Relations</a>