Consumer Credit Contraction to Impact ARM Industry Over Time

While consumer credit fell for the ninth straight month in October, according to a government report, the decline was less than many economists had forecast.

Consumer credit decreased at an annual rate of 1.7 percent, or $3.51 billion, in October, according to the Federal Reserve’s Consumer Credit — or G.19 — report, released late Monday.

Revolving credit, mostly comprised of credit card accounts, decreased at an annual rate of 7.25 percent, or by $6.95 billion, in the month. Total credit card debt outstanding in the U.S. was $888.1 billion at the end of October, down from a record reading of $975.1 billion in September 2008. Total credit card debt has contracted every month since then.

Non-revolving debt, like that found in auto or student loans, increased at an annual rate of 1 percent or by $3.44 billion.  It is the first gain for non-revolving debt since August. The Fed’s G.19 report does not cover debt backed by real property.

A Bloomberg News survey of economists had predicted that consumer credit would drop by a total of $9.4 billion during the month.

The reduced credit is being effectuated by a combination of bankers lending less and consumers tightening their own belts, said Dan North, chief economist at Euler Hermes, a trade credit insurance firm. Another factor is that charged off debt is no longer considered part of the credit equation. So as more debt is charged off, the amount of consumer credit in the G.19 report drops as well.

The declining credit will have long term implications for the credit and collection industry, said Paul Legrady, director for Kaulkin Ginsberg, a strategic advisor to the accounts receivable management industry and a sister company of insideARM.

“I’ve been saying for some time that the declining credit represents a sea change for the industry,” Legrady explained. “It’s just common sense. As the credit declines, the supply of credit to be charged off continues to decline. So there will be fewer opportunities for collections afterwards.”

The collection firms that will be the most successful in this environment, according to Legrady, will be those that have the best analytics, execution, management and controls.

The shrinking credit environment is likely to persist for some time, according to North. The better than expected unemployment report that came out Friday could mean that the economy will bounce back more quickly than some have predicted. If that happens, the Fed could raise rates more quickly than expected.

However, Federal Reserve Board chairman Ben Bernanke recently told the Economic Club of Washington that he foresees an extended period of low rates.

While interest rates are at their current levels, banks can make significant margins on credit because they are getting funds for virtually nothing, then lending at 4.75 percent (the current average for 30-year mortgages) or better. But for the most part, lenders are still risk averse, North said. So they’re investing most of their funds in low-yield Treasuries rather than in consumer or business credit.

North expects banks to maintain that posture until rates start rising. When the Fed starts boosting rates, it will show the government’s confidence in the economy, he explained. “As soon as [the Fed] starts pulling the punch bowl away, [lenders] will look harder at putting the money to work.”