Tuesday, March 10, 2009

Supplying Credit Where Credit is Due

The liquidity, or rather illiquidity, crisis manifests in various forms: notably, corporations (large and small) struggle to raise capital and consumers struggle to finance their purchases.

With home prices sharply down -- as opposed to consistently up -- homeowners can no longer resort to the mortgages for speedy cash-out refinancing (mortgage equity withdrawal, or "MEW"). As the downturn continues, and with banks freezing their consumer lending practices, our consumer base moves toward student loans and credit cards as an ultimate, non-recourse, source of funds.

The availability of funding in these two markets, often the final source for troubled consumers, may help certain borrowers avoid bankruptcy (see The Bankruptcy Burden). But these markets, too, are troubled.

Credit Cards
Meredith Whitney writes in "Credit Cards Are the Next Credit Crunch" that credit card lines are being reduced with increasing velocity, with an overall contraction likely in the order of 57%, in her estimation. Indeed, "overly optimistic underwriting standards made more borrowers appear creditworthy. As we return to more realistic underwriting standards, certain borrowers will no longer appear worth the risk, and therefore lines will continue to be pulled from those borrowers."

On the flip-side, with credit card write-offs steadily increasing, credit card companies' profitably will likely suffer, as the charge-offs outpace the increase in yield they're able to generate on performing cards. The three largest programs Chase(CHAIT), Citi(CCCIT) and Bank of America (BACCT) already have below average excess-spread generation, according to a Moody's report I'm looking at from mid-January.

What will happen to Discover (DFS), currently on the brink of sub-investment grade status at BBB-/Baa3, is a worthwile consideration. Absent further government intervention, will they be able to finance their securitized portfolio if it hits an early amortization event?

Student Loans
The student loan situation is no less compelling: students cut off from student loans may be forced to drop out of school, which in turn decreases their earning capacity and ability to settle their loans.

With the FFELP Stafford Loan program having a four-year limit of $27K, any reduced student loan availability may particularly impinge upon students attending schools with low graduation and/or poor job placement percentages.

In a market notorious for its absence of job growth, studying -- expensive as it already is -- is increasingly in demand. This demand may prove good for certain coffee shops, but if we don't approach this situation from the bottom up, we're going to find ourselves with a large population of frustrated, defaulting "student-borrowers" devoid of the access to funding required to set their record straight.


Chris said...

Are you not counting on TALF to address these two markets well enough?

GP said...

@ Chris

TALF will take a while to make its merry way through the system. Importantly, it's a level removed from credit card lending itself.

TALF will help encourage investors in securitized form, but the direct lending (and willingness to lend) remains worrying. But yes, the ability to securitize portfolios is, as you say, advantageous. But not the Holy Grail on the fundamental level.

Kass said...

also TALF will only be able to buy solid AAAs. won't necessarily create new issue market on its own.

Anonymous said...

Saving securitization for now only helps the financial institutions who hold securitized notes. If we can help the underlying market, be it corporate or consumer lending we help everybody, including the securitized "toxic assets" as their performance improves. Need to spend money at base of problem as this decreases costs of cleaning it up