Philadelphia (February 8, 2002) — Uncertainty in the economy is causing credit risk managers to balance risk management issues with customer satisfaction. It's no easy task at a time when many industries are struggling and consumers are burdened with debt and growing unemployment. Four chief risk officers from major U.S. banks discussed the challenges confronting the industry in the months ahead during a recent RMA audioconference.
"Many bankers believed we were sliding into a recession before the tragic events of September 11," said Richard McCrea, chief credit policy officer, SunTrust, Atlanta, Georgia. "Last year clearly was one of inventory correction and cost control. Presently, everybody is concerned that rising unemployment will increase the risk that an economic rebound will not happen quickly."
Although some economists, even banks' own economists, predict a rebound in the first half of 2002, McCrea and the other bankers on the RMA panel are not so optimistic. "Credit folks are worriers, and we don't see daylight breaking through the economic clouds until the second half of the year," said McCrea.
Regional Outlook
Housing markets in the Southeast have slowed, although McCrea noted that sales have recovered in recent months. "House prices have been flat with some modest deflation in some sectors. We're watching very closely the next six months to see how that impacts our portfolios.
In the West and Midwest, signs of stress in the economy appeared early last year, said Dave Munio, chief credit officer, Wells Fargo, Los Angeles. "We were not at all surprised when the recession was officially declared to have begun in March of last year." Although real estate is always a concern, Munio said it has remained fairly stable, owing to low interest rates. He noted, however, that there has been some destabilization in prices in selected markets in the far west.
Munio is worried about the lag effect of unemployment and its affect on consumer confidence and the bank's consumer portfolio, which so far has performed well. Yet, its commercial portfolio has remained flat. "Corporate customers remain reluctant to invest in capital goods," he said. "It seems like you run just to stay where you are as good customers either don't borrow or pay down on lines of credit."
In the Mid-Atlantic, manufacturing continues to be a serious concern, said Michael Hannon, chief credit policy officer at PNC Financial, Pittsburgh, Pennsylvania. "Unemployment will continue to rise. The unemployment rate probably is going to peak nationally in the 6.2 to 6.5 percent range, although the Mid-Atlantic region may do slightly better than that.
"We believe that the aggressive monetary and fiscal stimulus coupled with the lower energy prices and low inflation will lead to a transition from recession to recovery this year. But we do not see a strong economic revival. There will be some momentum building in the second half, but it will not be terribly strong. We believe we've just about hit bottom at this point in time."
Consumer Spending
Although liquidity is still plentiful in the form of home equity loans, the consumer, particularly the subprime borrower, is being weakened by the current economy. "The consumer is likely to remain under pressure even as the economy starts to strengthen because of the lag effect of unemployment," said Ron Cathcart, chief risk officer for retail at Bank One, Chicago.
He said pressure is increasing on consumers because:
- Consumer debt is at a record high of about $20 billion.
- Mortgage debt is increasing as consumers turn to home equity loans to pay down consumer debt. But if the debt is built up again, homes will be leveraged more.
- Bankruptcy filings are projected to increase 17 to 20 percent.
- Unemployment is expected to peak in the 6 to 7 percent range in 2002.
Credit card chargeoffs are running at approximately 6 percent on average, which is 70 basis points higher than a year ago. Last year, favorable margin spreads provided an earnings cushion for losses, but 2002 is unlikely to provide the same level of interest-rate cushion, said Cathcart.
The home equity market remains a good one for bankers. "Although prepayment rates have eased, utilization rates are remaining stable," said Cathcart. "And valuations continue to hold firm." He noted, however, that delinquency rates are starting to rise significantly in the subprime and near subprime portfolios.
Commercial Real Estate
Fourth quarter data is not encouraging for commercial real estate, said PNC's Hannon. "The overriding factor remains the strength of the economy. Until job growth returns, the demand for real estate won't improve. Our economics outlook calls the economy to start picking up in the second half of 2002, so, in view of the lag effect, it will be late in 2002 or into 2003 before we see much improvement in the real estate markets.
"Regionally, many former fast growing markets are now showing year on year declines in employment. This group includes places like Atlanta, Phoenix, Portland, San Francisco, San Jose, and New York. For the most part, the gains made during the bull market of 1999 and 2000, which many people thought were too good to be true, turned out to be exactly that, and those gains have now been lost.
"The good news is that deal structure has remained fairly sound. As a result, distressed properties are very few compared to what we had in the early 1990s. Developers and owners, faced with declining markets and falling values are not being forced to sell at discounted prices because low interest rates and refinancings have helped stabilize prices.
"Also it's interesting to note that the domestic commercial mortgage backed securitizations were nearly $75 billion in 2001 compared with just about $50 billion the previous year. Opportunity funds have continued to be able to raise money to invest in real estate although finding a place to put those dollars may be a little bit difficult.
"REIT performance was mixed, but the sector as a whole had a fairly good year in 2001 compared to negative returns for the S&P. The REIT index returned 14% versus a negative 12% for the S&P 500. When you look around on an asset class basis, you find that no asset class has remained unscathed the last six months. Even apartments which had previously been thought to be somewhat immune to downturns are experiencing some difficulties, particularly in the high end where there's been some overbuilding.
In sum, however, we're clearly better positioned than we were a decade ago because we have less leverage both at a project and a borrower level."
Industries Outlook
The RMA panelists offered their views on the outlook for these industries:
- Hospitality. The industry is suffering as a result of the recession and the events of September 11. The average hotel is experiencing a 25 to 30 percent reduction in cash flow. Fly-to locations and high-end resorts are more affected than drive-to, limited service locations such as Hampton Inns or Marriott Courtyards. So far, operators have been able to manage their expenses through layoffs an