Monday, November 10, 2008

Another Bubble Will Burst

Consumer credit will be the next asset class to deplete the capital of financial institutions. In this post, consumer credit will be considered credit card loans (and similar revolving credit lines) and automobile loans (car leases are not included). The use of loan securitization and the deterioration of underwriting standards that affected the mortgage industry were also present in the consumer credit market.

The market has grown considerably over the last 30 years. Technological advances (increased bandwidth, Internet, etc.) have contributed to the expansion. In addition, the growth of the loan securitization markets has aided as well.

The asset backed securities market is currently the second largest holder of these loans. It trails only the commercial banks in this regard. The importance of this market is clear from the graph on the right.

However, it is also clear from both graphs that the demand for these assets as collateral for structured bonds peaked in 2003. Obviously, consumer credit continued to grow since then, meaning that originators were probably holding a larger proportion of their loans. The key is then what can be said about the quality of this collateral?

Well, the data to the left and below describe both loan maturity and loan to value characteristics of automobile loans. Longer dated and more levered loans prevailed until the last few months.

On another note, it becomes easy to see why the automobile manufacturers are having such a difficult time. They relied on easy credit terms to "forward sell" inventory.

Recent earning reports have also clued us in to the issues facing consumer credit. Citigroup's North American credit card division (3rd quarter, 2008) experienced a 35% annual increase in managed loans 90 or more days past due. Managed net credit losses increased by 63%.

American Express increased loss provisions by almost $1 billion in the 3rd quarter and reported a net-loan write off rate of 5.9% for their managed loans. The rate stood at 3% the year before.

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