Money Centers Push Into Consumer Lending

 | Feb 12, 2014 | 6:00 PM EST
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About six months ago, I reviewed the performance of the large publicly traded consumer lenders that have a concentration in the credit card segment: Capital One Financial (COF), American Express (AXP) and Discover Financial Services (DFS).

One of the issues I noted in that column was how much greater the net interest margin (NIM) was at those companies than at the money centers: Bank of America (BAC), Wells Fargo (WFC), JPMorgan Chase (JPM) and Citigroup (C).

Since then, the money centers have been searching for lending opportunities as mortgage rates and other consumer loan rates have popped up and depressed activity, and they have moved aggressively into the credit card space. I'll review those numbers momentarily.

Additionally, the use of revolving credit by consumers has surged since then, and the issuance of securitized debt collateralized by credit card balances has as well.

The securitization has also been made possible again, not just because the consumers are using debt but because the buyers of that debt are there, because much of the longer-term lower-risk consumer debt, mortgages, have been and are being purchased by the Federal Reserve.

This is a part of the purpose of the Large Scale Asset Purchase (LSAP) program by the Fed. It is forcing bond buyers who are looking for yield to go further out on the risk curve and in the process forcing a liquid market for riskier debt.  

The tapering of those purchases has not yet cooled bond buyers' aggressiveness in the riskier securities, but I am watchful.  

So far, the renewed interest in the sector by the money centers, and the resulting increase in competition for consumers, hasn't yet had a negative impact on the net interest margins of the credit card companies, or on the current growth trajectory of consumer debt, which is faster than the economy. But it is probable that margins will start to come under pressure soon.

In the past six months, all four of the money centers have increased their lending in the revolving space. At Citigroup, credit card debt, at 23.2% of the company's loan assets, is the largest single sector of its loan holdings, having surpassed commercial and industrial loans last quarter.

At JPMorgan, credit cards moved from about 15.5% to 16% of the company's loan holdings in the last six months. At Bank of America, the increase has been from about 11% to 11.5%, and even Wells Fargo increased its credit card holdings from about 3% to 3.3% of its assets.

All economic expansions start with an increase in consumption, and in the U.S. that requires an increase in consumers' willingness to take on debt. 

If we are watching for a consumer-led resurgence in economic activity that leads to a potential virtuous cycle of economic activity, the next step is a willingness of consumers to take on installment debt in the form of auto loans and mortgages.

Auto loans have increased every quarter for the past 12, and at an increasing rate. A lot of this still due to the pent-up demand created by subprime auto loans that were withdrawn from the market after the 2008 financial crisis and which re-emerged about three years ago.

The big indicator is residential mortgages, and the evidence here is not as good. The increase in mortgage rates cooled the housing sector quite dramatically last year and so far this year.

That is another reason for the Fed to maintain its current purchases of mortgages.

Thirty-year fixed mortgage rates fell to a low of 3% early last year, then ran up to 5%, and have now pulled back to about 4% in the past quarter. But the new, more restrictive underwriting rules that went into effect this January, along with the substantial increase in fees for government guaranteed loans through the Federal Housing Administration, could cause the housing market this spring to be weaker than expected.

Right now, that is that is the sector to watch for indications of economic activity and Fed policy. If the increase in credit card use and auto loan originations leads to a stronger housing market this spring, markets will begin to anticipate a faster Fed tapering, higher Treasury yields and a shift back into mortgage originations, rather than competing with the credit card companies.

I'm of the opinion that as long as the U.S. economy can get through the spring and summer months without the pop up in mortgage rates that occurred last year, then this year's housing market, as measured by transactions, will be the strongest since before the subprime crisis began in 2007.

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