Mortgage woes spreading to other credit markets
NEW YORK – The malaise in the mortgage market is starting to spread to credit-card and auto loans in what one analyst has dubbed consumer credit “contagion.” It’s an ominous warning signal for the economy.
Many of the nation’s big banks and credit-card companies have begun acknowledging that they are seeing a shift in consumer behavior, including more people unable pay off their debts.
Things are unraveling faster than expected for some like Capital One Financial Corp., which on Tuesday boosted its estimates for credit losses next year to potentially above $5 billion in part because of elevated delinquencies on its cards.
No one is calling this problem the next debt-related land mine yet, but it is still important to watch what happens, especially as the holiday shopping season gets under way.
Much attention has been paid in recent months to the collapse in housing prices and the upheaval in the mortgage market. The initial trigger was people with shaky credit – known as subprime borrowers – increasingly defaulting on their home loans.
An added complication was that many Americans used their homes as piggy banks in recent years. When debt was cheap and easy to get and the value of their homes was surging, they borrowed against them. People used part of that cash to pay off other debts, but mostly to fuel a spending surge on everything from flat-screen TVs to new cars to vacation homes.
That party seems to be over. Morgan Stanley analyst Betsey Graseck warns that an oncoming consumer credit “contagion” could be ahead, and uses that as the basis to downgrade her ratings on large banks to “cautious” – the lowest rating Morgan Stanley has on industries. Among those on her watch list: Citigroup, Bank of America and Wells Fargo.
She says there is already evidence that subprime mortgage implosion is affecting other areas, given that banks have tightened their lending to consumers. She expects more stringent lending standards to put the squeeze on consumers at the same time unemployment rates are rising and housing values are falling.
In recent weeks, many banks and card issuers have boosted what is known as loan-loss reserves. Under accounting rules, they are required to estimate the amount of loans that won’t be collected, and should that increase, they must set aside more money to cover those loans. Higher loan-loss reserves equal lower earnings.
“Firms that are now adding to the portfolio might have had a few whiffs of trouble brewing earlier this year, and dragged their feet in adding to reserves because they were hoping that interest rate cuts might bail them out and give borrowers breathing room,” said Jack Ciesielski, who writes the industry newsletter, The Analyst’s Accounting Observer.
“Now the odor is getting stronger, and it looks like adding reserves is the only course of action they can follow without presenting misleading financials,” he said.