Menu
Consumer Credit Issues Worry Lenders
Kathleen M. BeansConsumer credit issues have lenders' attention these days. As the economy softens, commercial credits are affected first. Then, as corporations tighten their belts to meet shareholder expectations, layoffs become more common, causing problems to arise in the consumer portfolio.
Highly leveraged today, more consumers have credit cards than they did during the slowdown in the early 1990s. Today the total amount of consumer credit outstanding is $1.6 trillion, reports ERisk.com. That's twice the level it was in 1992 and four times what it was in 1984. The percentage of disposable income used to repay revolving credit has risen to 14.3%--higher than it has been since the mid-1980s.
Two recent RMA-sponsored events underlined the concerns bankers are facing as they navigate uncertain economic waters. The level of concern varies from institution to institution and from banker to banker. Economists, too, are in disagreement about whether today's slowdown is just that or a precursor to recession.
"We're a little more pessimistic than the rest of the industry," said Laura Labno, vice president, Discover Financial Services, at RMA's Consumer Risk Management Conference held in Philadelphia, in June. "We don't see any signs of significant improvement. We expect challenges to continue. We like to think the peak has hit for bankruptcies, but we expect it to stay high."
Registrations for the Consumer Risk Management Conference surged as the annual event drew near, with attendance increasing about 25% over the previous year. Yet not all of the bankers were as pessimistic as Labno.
"I am considerably more optimistic than Laura," said John Nuzum, senior vice president, JPMorganChase & Co., noting that the economy will benefit in the fall from the double stimuli of lower tax rates and lower interest rates.
Disagreeing with Nuzum, David Nole, chief credit officer, First Union Corporation, said consumers will have a difficult time during the next 18 to 24 months. "I think we're just at the beginning," said Nole. "I see storm clouds in front of us. If you're not preparing your portfolio for rough water ahead, you need to do it immediately." On a positive note, he added, "We have the ability to manage through this period."
The picture Nole paints of the coming months is a bleak one, however. "We're seeing a huge number of layoffs, and we'll see more as corporations try to meet shareholder expectations," he said. "Unemployment will go up. American workers are resilient, but many will be underemployed, making it difficult to meet their debt burden. Housing starts will be down, and banks with large real estate portfolios will be affected." Underlying it all will be an uncertain stock market, further eroding consumer confidence and contributing to the downward spiral.
While Nuzum believes the economy is softening, he thinks the fall can be cushioned if banks operate with defensive strategies now. "You want to have more collectors than your model says you should and be sure they're effectively trained," said Nuzum. He also advises educating customers about the ramifications of bankruptcy so they are less likely to choose that route out of hard times. "One of the things I worry about is that the consumer credit counseling system will be overwhelmed by volume. They'll have so many clients, they won't be able to handle them all if we have a prolonged downturn."
Labno agrees that adding collectors is important. She also says that now is the time to review current lending policies and decisioning tools as well as inactive accounts. In developing a strategy for leaner times, Discover is focusing on how accounts were put on the books--whether through acquisition or new product launches--and then tailoring its account management decisions based on how products fared in the past.
Retail products with the most volatility are, of course, sub prime. "We don't have a good read on how the subprime or low-prime credit card industry will perform in an extended downturn," says Nuzum, noting that the market was considerably smaller during the last downturn.
Nole agrees the unsecured lending area is most vulnerable. "We've made progress in that area during the past 10 to 15 years by beefing up our risk controls around credit cards," he said. However, over the past five years, we may have grown lax. Loans made during that period are susceptible to increased risk." He added that auto loans and lease agreements are also vulnerable to increased risk. "The finance companies are playing a different game than the banks are. Captive finance companies will offer good deals to move inventory and the banks will be left with the rest."
In an ERisk.com analysis on consumer risk, author Duncan Wood sounds a bit like Charles Dickens. "It's the best of times/It's the worst of times for consumer credit businesses in the U.S...." he wrote in his May 24, 2001 article, Consumed by Debt.
Times are good when you consider these factors:
* Vastly improved credit management has opened up the market in ways that were never possible before.
* Consumers remain hungry for more credit.
* Low interest rates are feeding a boom in mortgage lending.
* A swift economic rebound will constrain losses and support growth prospects.
Times are pretty grim when you consider these factors:
* Average credit card quality has never been lower.
* Losses have been rising steadily for the past five years.
* Risk management advances have only prompted some firms to take on more risk, which they may be managing using inappropriate data.
* Losses embedded in consumer portfolios will emerge as the economic slump continues and deepens.
The truth, Wood says, lies somewhere in the middle. But where?
At RMA's Consumer Risk Round Table, held last May in San Francisco, there were more questions than answers about the economy and the future of the consumer portfolio. Specifically, round table participants expressed concern about the following areas:
* Bankruptcies. They fear the recent surge in bankruptcies will get worse before it gets better because consumers lack liquidity and their credit card debt is high. In a softening economy, there will be less opportunity for overtime pay. Indeed, unemployment is rising. There is a question about how much equity consumers still have available.
* Energy costs. Energy costs are taking a toll on consumers disposable income, and the additional cash obtained from refinancing mortgages is being eaten away by those higher energy costs.
* Fewer homebuyers. It's taking longer to sell homes.
* Commercial loan problems. Bankers fear those problems will spill over to impact retail bank strategies.
* Small business loans. Because of the growth in small business over the past decade, lenders are concerned that many entrepreneurs have not weathered a downturn. Many personal bankruptcies are really small business failures. In terms of collateral, there is a gray area between what is personal and what is business. Businesses most likely to be affected are those offering discretionary services, such as landscapers, dry cleaners, and florists.
It's more important than ever for banks to focus on the economics of small business lending. Customer service should be excellent; products should be evaluated in terms of their usage by customers and their profitability; and scoring tools should be used with careful management of overrides, say the round table participants. Management must also stress to lenders how the risks from secured lending differ from those with unsecured lending.
Preparing for a Softer Economy
Although there is little agreement about the length or severity of the latest dip in the cycle, attendees at RMA's Consumer Risk Management Round Table this spring believe banks will play a role. The wild card in the cycle is how financial institutions respond to the softening. If they are too restrictive in their extension of credit, the hit could be doubled. It is important for them to recognize that tightening standards will not work because the losses are already baked into the cake. Tightening unused lines of credit, however, can be effective.
By revisiting the early signs of problems in the 1980s, banks can apply the lessons learned to what is happening today. They need to use models to predict and manage pre-delinquencies, collections, and bankruptcies. But it is important that financial institutions continue to market because they need to stay in business. What they book now will be a revenue source 18 months from now. Higher charge-offs may not necessarily diminish the value of the portfolio, as many built-in offsets exist. Banks must face the current problems, but keep them in perspective. It is the long-term horizon that is critical.
COPYRIGHT 2001 The Risk Management Association
COPYRIGHT 2005 Gale Group
credit card, apply online for credit card, apply for a credit card, 0 apr credit card, business credit card, credit card debt, credit card application, online credit card approval, chase credit card, credit card processing, low apr credit card, credit card debt consolidation, travel reward credit card, bad credit credit card, credit card offer, student credit card
test.com Site Map