Philadelphia (February 11, 2002) — The consumer is being weakened by this downturn and the economic fallout from the consumer's difficult situation is evidenced in their debt loads. During a recent RMA audioconference, Ron Cathcart, executive vice president and chief risk officer, retail, Bank One, Chicago, outlined the major consumer issues currently affecting the industry. His observations are based on securitization data and information available in the public domain.
Consumers in the subprime sectors are especially under pressure. "The consumer is likely to remain under pressure even as the economy starts to strengthen because of the lag effect related to unemployment," said Cathcart.
He noted, however, that there's a lot of liquidity in the market, particularly in the form of home equity loans. He noted also that the consumer is feeling the effects of expansive fiscal and monetary policies that have been put in place since September.
Consumer debt for the month of December was at a record high of approximately $20 billion, a 15% increase over the prior month. (These figures were the latest available at the time Cathcart addressed the RMA audioconference in January.) "The debt is largely being driven by the 0% vehicle financing, which the auto companies brought into play after September," said Cathcart.
Mortgage Debt
Mortgage debt is also increasing. "In the short term, this increase represents the pay-down of consumer debt," said Cathcart. "But is that consumer debt going to build back up, further leveraging the household? There's also been a great deal of refinancing activity relating to the record low interest rates that troughed in November and have come back about 50 basis points."
Bankruptcies
But even with these historically low mortgage rates, bankruptcy filings were 20% higher last year. Projections are that they will increase 17% to 20% in 2002, the upward spike in bankruptcies has been seen across all regions. "We are not expecting another 'panic to file for bankruptcy' because of legislative changes as we did last March," said Cathcart. "But having looked at the first two weeks of the year—and this is a very short period—bankruptcies are actually 32% higher than they were the first two weeks of last year. That's not a good indicator."
Unemployment
"Unemployment is expected to peak in the 6–7% range in 2002," said Cathcart. "It tends to lag the recovery, as job build-back takes place over an extended period of time."
Vehicle Sales
"Looking at vehicle sales, last year was a record year with 17.2 million units sold, largely as a result of the 0% financing offered at the end of last year. To what extent those sales were an acceleration of sales that would have taken place at the beginning of this year is not known," said Cathcart.
"New vehicle sales are putting pressure on used car prices. Consumer confidence came back a bit at 94 from hitting a trough of 85 for two months in a row. The interesting thing is that retail sales did not slow. Once again the autos were partly responsible, but with respect to Christmas sales, retail sales were actually up 2.5%, which was not widely predicted."
Housing Market
Calling the housing market "a bit of a surprise," Cathcart noted, "New home sales continue at a fairly healthy clip. Collateral values are holding their own. There has been rapid price increases in the past 18 months but the inventories remain low and with the exception of certain pockets, the housing market continues to be strong."
Mortgage Refinancings
"Mortgage refinancings continue," he said. "Approximately 50% of mortgage applications are for the rate change advantage. We are seeing a greater proportion of people who are not pulling money out of their houses, but are simply refinancing at current levels to reduce interest rates—a more prudent consumer behavior. "So what does all this mean in terms of the credit in our portfolio? Delinquencies are rising as unemployment filters through the economy. Credit bureau risk profiles are deteriorating and these are a leading indicator of stress to follow."
Credit Cards
"Charge-offs are running at approximately 6% on average, which is 70 basis points over what they were a year ago," said Cathcart. "That's not a surprise. The news with credit cards is that last year favorable margin spreads provided an earnings cushion to cover an increase in charge-offs. 2002 may not provide the same level of interest rate cushion. "Credit card sales volumes are also lower as rates begin to rise again. Retail sales are softer, particularly in leisure and business. And there's a tendency toward consolidation of debt, which is also affecting the speed with which credit card portfolios are growing. The subprime business models in credit card have come under a great deal of stress as indicated by the performance of Providian, NextCard, and some other market participants."
Home Equity
Home equity interest rates are very low and delinquency rates are starting to rise significantly in the subprime near-subprime portfolios. 'Although prepayment rates have eased, utilization rates are remaining stable," said Cathcart. "Valuations continue to hold firm. The market really hasn't softened as we expected it would. Home equity represents a good opportunity for most of us over the next year."
Indirect Auto
"The 0% financing drove a lot of people into the showrooms, which meant sales volumes were pretty robust," said Cathcart. "But there was an adverse selection process at work where the very best credit customers went for the 0% options, and the third party financiers found it more difficult to originate high quality loans. That's past now with the new 2002 dollar-back offer. The adverse selection associated with 0% financing has moved on. Applicant quality has come back to where it was.
"In January, auction pricing seemed to be coming back. There was a deterioration in used car prices as a result of the flood of used cars that were coming onto the market. Obviously, the prices have gotten suppressed and that affects recovery rates. It also affects loss on lease residuals in lease portfolios. More recently those numbers have come back. The auctions are heavily attended, which is a good sign."
Small Business
"Criticized loans obviously are higher across the industry, particularly in manufacturing and a lot of that is in the Detroit area. Health care, travel and entertainment are also on the criticized list. However, the undrawn commitments have remained stable, which suggests a more prudent management of individual, small business balance sheets. "In summary, the picture isn't altogether bleak, said Cathcart. "Those of us who have positioned ourselves in terms of underwriting criteria for the current environment are not falling off a cliff. But obviously, we are seeing an increase in losses across the board."
For more information, please contact Kathie Beans.