Consumer Credit Usage Spikes In June: A Sign Of Consumer Spending Strength?

In an earlier article on Bank of America (BAC), I noted that if the trend of increased consumer credit usage continued, it could be a sign that debt losses at the retail banks will continue to accelerate.

Well, the Fed numbers are in and it appears that we have a 6.5% YoY increase in consumer debt during the month of June; this is on top of the 7.9% increase in consumer debt during the month of May. Looking at the specific categories of consumer debt, there was an 8.4% increase in credit card debt [compared to a 12.2% increase in May] and a 5.3% [remaining steady from May] increase in auto loan debt.

I’m sure there are analysts out there who will declare this to be a sign that consumer spending is still strong, or that this is a good sign for the retail banks. However, there are a couple of things influencing this increase in consumer debt usage, revolving debt in particular:

1. The housing ATM is closed, so consumers can no longer use home equity loans to fuel spending and pay down credit card debt. As a result, consumers who were effectively abusing one type of credit have now shifted that abuse onto another type. The potential risk in this “credit shift”, is that the problems within many banks’ HELOC portfolios could be shifted onto credit card portfolios that are already suffering from a decline in credit quality.

2. Considering the spike in revolving debt usage, June should have been a strong month for retail; instead, June’s results were mixed with some retailers only beating previously lowered expectations. Mixed retail results coupled with a spike in credit usage, seems to indicate that consumers are using their credit cards to finance day to day expenses, not discretionary spending. Long-term this seems to indicate that consumer spending will continue to weaken as the year goes on, and that banks should continue to experience an increase in losses within their credit card portfolios until the consumer spending trend reverses.

As a potential lagging indicator, I think credit quality within the bank’s revolving debt portfolios will improve ahead of the consumer spending recovery. My theory is that once people get their revolving debt under control and no longer have to use their credit cards for necessities, they’ll be able to allocate more funds towards discretionary spending.

Whilst increases in consumer credit usage are often good for the banking and retail sectors, I think they constitute an area of risk at the moment. Considering that the current credit problem was caused by unsustainable lending and debt investment activities, the banking and retail sectors need consumer credit usage to decrease to a level that can be sustained long-term.

Source: Federal Reserve Statistical Release, Consumer Credit August 7, 2007

Disclosure: The Author doesn’t own a position in Bank of America.

Comments

[mrottersman:]

You are on the money. Worse, credit card debt is probaby covering more than incidental daily living expenses; it's the last-ditch effort to pay the mortgage. Obviously if that's the case, there is nothing but trouble ahead.

2007 Aug 09 12:24 PM

[Markham Lee_:]

You're probably right as nearly every week I get "convenience checks" from my Credit Card companies, which offer lower rates than I get on the respective card and can be used for anything. I also get regular notices touting their bill pay service, which can be used to pay anything as well. It's no wonder credit card losses are increasing, when banks are encouraging customers to use them to pay for all of their bills.

2007 Aug 09 03:18 PM