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FINANCIAL INDUSTRY
Has Consumer
Credit Growth
Jeopardized
Bank Profits?
Closer examination of
consumer credit trends
suggests that while the
growth in bank lending
to the consumer may
indeed slow, consumer
lending poses little risk to
the banking industry.
•
Banks continued to earn strong profits in
1995, posting a return on assets of 1.2 percent for the year, both in the Eleventh District
and in the rest of the United States. One
factor that contributed to banks' profitability
was rapid growth in bank lending to the
consumer; the U.S. banking industry's consumer loans increased 37 percent from early
1990 through 1995.
Emerging signs of deteriorating quality
in consumer credit have, however, raised
questions about whether the rapid growth in
bank lending to the consumer will continue
and whether banks' future profitability is in
jeopardy. Yet closer examination of consumer credit trends suggests that while the
growth in bank lending to the consumer may
indeed slow, consumer lending poses little
risk to the banking industry.
FEDERAL RESERVE BANK OF DALLAS
FIRST OUARTER 1996
portfolios is the share of interest income
various types of loans contribute. Chart 2
shows the percentages of interest income
from C&I and credit card loans during
1990-95. The share of banks' interest income from credit cards is on an upward
trend but remains a small fraction (11 percent) of total interest income. A second
trend is the decrease in interest income
from C&I loans between 1990 and 1995,
despite a rise in 1994. These trends provide
additional evidence of the rebalancing of
bank portfolios away from C&I loans toward
consumer loans.
Credit card debt has been growing for
several reasons. Consumers are not only
using their credit cards as a traditional borrowing source; consumers are also using
credit cards for so-called "convenience
Rebalancing of Bank Portfolios
Bank credit to the consumer, particularly
credit extended to the consumer through
credit cards, has been growing rapidly. As
shown in Chart 1, banks' credit card lending
to the consumer has increased by 77 percent
since the beginning of 1990, with much of
that growth occurring during 1994 and 1995.
Other consumer credit increased as well,
growing by 19 percent during 1990-95. The
growth in consumer loans significantly outpaced growth in commercial and industrial
(C&I) loans over this period, with C&I loans
growing only 6 percent during 1990-95. As
these growth rates show, the banking industry has rebalanced its portfolio away from
traditional business loans toward consumer
loans, especially loans through credit cards.
Another measure of the shift in bank
Chart 1
Loan Growth
{U.S. Insured Commercial Banks)
Cumulative growth, percent
D A T A S O U R C E : Report of Condition a n d Income.
This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)
Chart 4
Chart 2
Interest Income
{U.S. Insured Commercial Banks*)
Income Growth
{U.S. Insured Commercial Banks)
Total interest income, percent
Cumulative growth, percent
* Data include only banks with $300 million or more in assets.
DATA S O U R C E : Report of Condition and Income.
The implications
of debt growth for
credit quality depend
on debt growth in
DATA SOURCE: Report of Condition and Income.
relation to borrowers'
ability to pay.
credit." Convenience credit refers to the use
of credit cards as a substitute for cash or
checks, both for convenience and for incentives such as frequent flyer miles. Convenience credit users pay their current charges
at the end of each billing cycle, so they pay
no interest on credit card purchases.
To the extent that the growth in credit
card debt reflects convenience credit, banks'
exposure to consumers may have been
overstated in recent financial data. The
trends in interest income, however, reveal
Chart 3
Interest Income Spread and Consumer Loan Growth
{U.S. Insured Commercial Banks*)
Interest spread,
" Data include only banks with $300 million or more in assets.
DATA SOURCES: Report of Condition and Income, Citibase.
Loan growth,
significant growth in interest paid on credit
card debt. The growth of interest income
suggests that the new credit card debt does
not belong solely to convenience users.
Income and Growth in Consumer Loans
While some signs of deteriorating consumer credit quality have emerged, consumer credit has remained a profitable line
of business for the banking industry. Chart 3
reflects the extent to which the growth in
consumer lending can be attributed to the
profitability of consumer lending. The chart
shows the interest income spread that
banks have earned on their consumer loan
portfolio and the year-over-year growth rate
of consumer loans. The interest income
spread is the difference between the interest
yield on the consumer loan portfolio and
the interest rate on three-month Treasury
bills; the interest yield on the consumer loan
portfolio is the interest income earned from
the consumer loan portfolio, less net chargeoffs, divided by the size of the consumer
loan portfolio. As the chart indicates, banks
began to accelerate their growth in consumer loans in early 1993 and continued
the increase in 1994 and 1995. The growth
in consumer lending began after the spread
on consumer loans widened. The spread
then narrowed as banks accelerated their
loan growth. Such a result is consistent with
the premise that banks took advantage of
the profit opportunity offered by the large
spread on consumer loans, and the resulting
competition narrowed the spread.
Besides producing interest income, consumer loans also yield noninterest income.
Credit cards, in particular, yield income from
2
FEDERAL RESERVE BANK OF DALLAS
annual fees and fees on individual transactions. While data are not available to separate how much comes from consumer loans,
Chart 4 shows the growth in banks' noninterest income and net interest income.
Both sources of income have grown rapidly
since the beginning of 1990, which is consistent with the strong recent profitability of
the banking industry. While both noninterest
income and net interest income have grown,
noninterest income has grown more rapidly,
reflecting the rising importance of fee income for banks.
Chart 5
Net Charge-Offs
{U.S. Insured Commercial Banks*)
|
Real estate
|
Business
|
Other consumer
|
Credit card
Asset Quality
The banking industry's recent expansion
in consumer lending has been a successful
effort to earn profits by providing valuable
credit services to consumers. Some concerns
exist, however, regarding the decline in the
quality of consumer loans in 1994 and 1995.
Chart 5 shows net charge-offs for four categories of loans. The sum of charge-offs among
the categories was lower at the end of 1995
than at the peak in 1991. On the other hand,
the combined charge-offs were 13 percent
higher in 1995 than in 1994; charge-offs on
credit cards and other consumer loans were
39 percent higher in 1995 than in 1994.
Aside from the rise in the dollar amount
of charge-offs on credit cards and other
consumer loans in 1995, the charge-off rate
on those loans also increased. In 1995, 3.4
percent of credit card loans were charged
off, up from 3 percent in 1994. The chargeoff rate also rose on other consumer loans,
with 0.7 percent of other consumer loans
charged off in 1995, up from 0.5 percent in
1994. Also, the percentage of credit card
and other consumer loans that were noncurrent increased in 1995, rising from 3.4 to 4.1
for credit cards and from 2.5 to 3.1 for other
consumer loans during 1995. So, trends in
the percent of consumer loans that were
noncurrent and in the charge-off rate are
consistent with the deterioration of consumer credit quality suggested by the rise in
charge-offs on consumer loans.
Outlook for Consumer Loan Growth
How are banks likely to respond to
the signs of deteriorating consumer credit
quality? One indication comes from the Federal Reserve's Senior Loan Officer Opinion
Survey, which tracks bankers' response to
the statement, "Please indicate your bank's
willingness to make consumer installment
loans now as opposed to three months ago."
The solid line in Chart 6 summarizes banks'
response to this query. The line shows the
FINANCIAL INDUSTRY ISSUES
3
1990
1991
1995
* Data include only banks with $300 million or more in assets.
DATA SOURCE: Report of Condition and Income.
Chart 6
Bankers' Willingness to Make Consumer Loans
(Net Percentage More Willing to Make Consumer Installment Loans*)
• Net percentage equals the percentage of loan officers who said they were more willing to make consumer loans, minus the
percentage of loan officers reporting that they were less willing to make consumer loans.
DATA S O U R C E : Federal Reserve Senior Loan Officer Opinion Survey.
Chart 7
Debt Growth
Cumulative growth, percent
NOTE: Data are adjusted for inflation.
DATA S O U R C E S : Board of Governors of the Federal Reserve System, Flow of Funds Accounts; Citibase.
net percentage of survey respondents who
reported being more willing to lend. To the
extent that these survey results reflect general banking industry trends, Chart 6 indicates that banks have lost enthusiasm for
making consumer loans. This loss of enthusiasm for consumer loans could slow
growth in bank lending to consumers.
Consumers' Financial Strength
To put banks' consumer lending in perspective, it is helpful to examine consumers'
overall financial well-being. Broad credit
market trends affecting consumers' financial
Chart 8
Debt Relative to Income
Total debt to GDP,
Percent
Household debt to income,
Percent
DATA S O U R C E S : Board of Governors of the Federal Reserve System, Flow of Funds Accounts; Citibase.
strength will affect consumers' ability to repay debts, including bank debts.
One credit market trend affecting both
the consumer and the overall economy is
the growth in the inflation-adjusted amount
of debt, as shown in Chart 7. Of the three
sectors shown on the chart, the largest percentage increase in inflation-adjusted debt
occurred in government, followed by households and nonfinancial businesses. Much of
the increase in debt in the economy, then, is
not the result of businesses borrowing to
finance productive investment projects but
comes instead from an increase in government and household borrowing. And
household debt has roughly doubled in
inflation-adjusted terms since 1980.
The implications of debt growth for
credit quality depend on debt growth in
relation to borrowers' ability to pay. One way
to gauge debt relative to ability to pay is to
look at debt-to-income ratios, as in Chart 8.
The economy's debt-to-income ratio, measured as the ratio of nonfinancial debt to
gross domestic product (GDP), rose during
the 1980s but has stabilized in the 1990s. In
other words, debt in the overall economy
grew faster than income in the 1980s, but in
the 1990s debt growth and GDP growth
have been nearly equal. For households, the
debt-to-income ratio (measured as the ratio
of household debt to disposable personal
income) increased during the 1980s, like
the overall economy's debt-to-income ratio,
but the debt-to-income ratio continued to
increase in the 1990s, reaching a new high
in late 1995. Viewed as an isolated event,
this recent peak in households' debt-to2
FEDERAL RESERVE BANK OF DALLAS
income ratio could suggest that households may have difficulty servicing their
debt and that the quality of banks' consumer
loans could suffer.
Additional evidence, however, indicates
that households' ability to service debt is
greater than the debt-to-income ratio alone
implies. Chart 9 shows one type of additional
evidence, the fraction of disposable income
devoted to debt service. This ratio, unlike
the debt-to-income ratio, was not unusually
high in late 1995, implying that households'
debt is not unusually burdensome.
Several factors help explain why debt
service payments are not unusually high
relative to income, despite unusually high
debt relative to income. One factor that
has held down debt service payments is
low market interest rates. Another factor
that has held down debt service payments is
the lengthening of maturities on consumer
loans, especially auto loans; this lengthening of maturities has reduced principal
payments. Finally, the rapid growth in
credit card lending itself has helped hold
down debt service payments for some consumers; to attract new customers, offers for
new credit cards often come with low
"teaser" rates that allow consumers to roll
over their existing credit card balances
into the new card and its low rate for a
few months.
Another measure of consumer debt burden is debt relative to financial assets because, in addition to income, consumers
can also use their financial assets to repay
their debt. Chart 10, a graph of consumers'
debt relative to their financial assets, shows
that this ratio was not unusually high by
recent historical standards. The implication
from this ratio is that consumers' debt is
not unusually burdensome. Also, the ratio
was falling during 1995, reflecting the rapid
growth in stock prices during that period
that increased consumers' wealth.
Some doubt remains, however, about
the extent to which households' financial
assets are available for the repayment of
debt. For instance, the households that
owe the debt may not be the same households that hold the assets. Second, some
of the households' financial assets are inaccessible, such as assets held in pension
funds. Finally, the value of the financial
assets can fluctuate, although consumers
must still repay debt.
To summarize the evidence on consumers' financial strength, current consumer
debt does not appear to be unusually burdensome; neither the proportion of disposable income devoted to debt service nor
the amount of debt relative to financial assets
is unusually high. High debt relative to income, however, implies that the consumer's
position is somewhat vulnerable; a decline
in income could push the proportion of
income devoted to debt service to an uncomfortably high level, and a decline in the
value of financial assets would increase debt
relative to financial assets.
Banks' Ability to Weather Oeterioration
In Consumer Credit Quality
These indications that consumers' financial position may be somewhat vulnerable
raise the question of how well banks could
weather deterioration in consumer credit
quality. Several factors suggest that banks'
ability to weather deterioration in consumer
credit quality is great. The recent high
Chart 9
Chart 10
Debt Service Payments as a
Percentage of Disposable Income
Debt Relative to Financial Assets
(Household Sector)
Percent
DATA SOURCE: Board of Governors of the Federal
Reserve System.
FINANCIAL INDUSTRY ISSUES
DATA SOURCES: Board of Governors of the Federal
Reserve System, Flow of Funds Accounts.
3
Several factors
suggest that banks'
ability to weather
deterioration in
consumer credit
quality is great.
level of bank profits implies that if difficulties in consumer lending caused profits
to fall by 15 percent, banks' return on assets
would remain above 1 percent. Also, consumer loans remain a relatively small part
of bank lending, accounting for only 20.6
percent of total bank loans. Finally, if the
fraction of consumer loans that are noncurrent and the fraction of noncurrent consumer loans that are charged off both rose to
the peaks reached after the 1990-91 recession, banks' return on assets would fall by
only 11 basis points.
Financial Industry Issues
Federal Reserve Bank of Dallas
Robert D. McTeer, Jr.
President and Chief Executive Officer
Helen E. Holcomb
First Vice President and Chief Operating Officer
Robert D. Hankins
Senior Vice President
Genie D. Short
Conclusion
Vice President
Over the past several years, banks have
significantly increased their lending to the
consumer in response to the profit opportunities offered by consumer loans. During
1995, signs of deteriorating credit quality
emerged, raising questions of whether
troubles with consumer lending could present difficulties for the banking industry.
The broader trends in consumer credit
markets suggest that consumers' ability to
service their debt is currently adequate.
Going forward, however, consumers' financial position may be somewhat vulnerable.
If consumers' vulnerable financial position
does cause consumer loan quality to continue to slip, the banking industry's recent
vigorous profits, high capital ratios, and modest exposure to the consumer puts the industry in a strong position for handling consumer
loan problems.
—Robert R. Moore
Economists
Sujit Chakravorti
Jeffery W. Gunther
Kenneth J. Robinson
Robert R. Moore
Thomas F. Siems
Financial Analysts
Robert V. Bubel
Howard C. "Skip" Edmonds
Karen M. Couch
Kelly Klemme
Susan P. Tetley
Research Programmer Analyst
Olga N. Zograf
Graphic Designer
Lydia L. Smith
Editors
Rhonda Harris
Monica Reeves
Financial Industry Issues
Graphic Design
Gene Autry
Laura J. Bell
Financial Industry Issues is p u b l i s h e d by t h e
Federal Reserve Bank of Dallas. The views expressed
are those of the authors and should not be attributed
to the Federal Reserve Bank of Dallas or the Federal
Reserve System.
Articles may be reprinted o n the condition that
the source is credited and a copy of the publication
containing the reprinted article is provided t o t h e
Financial Industry Studies Department of the Federal
Reserve Bank of Dallas.
Financial Industry Issues i s available free of
charge b y w r i t i n g t h e P u b l i c Affairs Department,
Federal Reserve Bank of Dallas, P.O. Box 655906,
D a l l a s , Texas 7 5 2 6 5 - 5 9 0 6 , o r b y t e l e p h o n i n g
(214) 922-5254 or (800) 333-4460, ext. 5254.
2
FEDERAL RESERVE BANK OF DALLAS
11K Bank Notes
District Lending Outpaces U.S. Total
A stable net interest margin and double-digit growth rates in their loan portfolios helped
make 1995 another profitable year for Eleventh District banks. Total loans increased by
$14.3 billion, or 13.8 percent, during 1995. The biggest gains came in real estate loans, which
were up $10 billion, or 22 percent. Commercial and industrial loans recorded the second
highest gains—$4 billion, or 14 percent. Consumer loans were up $1 billion, a 6 percent
increase for the year. (Other loans declined $500 million.) The rise in lending activity in the
Eleventh District outpaced the rest of the United States, which had loan growth of 10.3
percent during 1995.
The District's asset quality ratios remained good, as noncurrent loans and other real estate
owned constituted only 0.55 percent of total assets at year-end, the lowest troubled asset ratio
reported by the 12 Federal Reserve Districts. Net loan losses rose but remained at a relatively
low level of 0.23 percent of average loans for 1995, compared with 0.16 percent for 1994.
Outside the District, net loan losses equalled 0.51 percent of average loans in 1995.
Loan Growth at Insured
Commercial Banks
Loans Outstanding at Eleventh
District Insured Commercial Banks
Year-over-year growth, percent
Billions of dollars
16
120 -,
12 -
1992
1993
1994
1992
1995
•
Other
1993
•
1994
1995
Commercial and industrial
Consumer
Real estate
Net Loan Losses at Insured
Commercial Banks
Troubled Asset Ratio for Insured
Commercial Banks
Percent of average loans
1.5
1992
1993
Eleventh District
Eleventh District
Rest of the United States
Rest of the United States
1994
1992
1995
1993
1994
1995
NOTE: The Eleventh District of the Federal Reserve System encompasses Texas, northern Louisiana and southern New Mexico.
DATA S O U R C E : Report of Condition and Income.
FINANCIAL INDUSTRY ISSUES
3
A New Look,
A New Location
This issue of Financial Industry Issues
introduces a new, expanded format. Now
Has Consumer
-T—
Credit Growth
Jeopardized Z Z J E
Bank Profits?
the newsletter's lead articles present more
graphics, and a new feature, "1 IK Bank
Notes," offers quarterly updates on
banking data for the Southwest.
The publication also has a new home on FedDallas, the Dallas Fed's
new World Wide Web home page. Text and PDF versions of all
1995 issues are available online, and 1996 issues will be added
as they are published. The Internet address is http://www.dallasfed.org
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