Is the Credit Crunch Biting or Feeding?
| Created: 17/02/2008 |
There has been a lot of talk in the press over the last few months about the "Credit Crunch" and how it is making life difficult for borrowers. In this article we discuss whether the crunch is biting or feeding the stoozing community - is it making life harder or easier?
The Credit Crunch arose out of the US sub-prime housing market where higher than expected numbers of borrowers defaulted on their mortgages, thus causing very significant losses to many of the world's banks. Even though UK banks hadn't lent directly to US home owners, they had financed large amounts of US debt indirectly, by buying into investment vehicles like CDOs (collaterised debt obligations). CDOs are a way of packaging up debt and selling it on as an investment. For a detailed explanation of CDOs, see this Wikipedia description.
As US borrowers defaulted on their mortgages, these CDOs declined in value and the banks had to write off much of the value that they had attributed to them. In other words, the banks had less money than they thought they had. Consequently, they started taking a very close look at all their lending risk and were also much more wary of investing in CDOs from other banks. This brought the money supply to something akin to a standstill.
So what effect does this have on the UK consumer? It undoubtedly means that there is less money for lending in the financial system, so credit is going to be harder to come by. It also means that lenders are going to take a long, hard look at who they lend to and how risky that lending is going to be. That all sounds like doom and gloom, but we believe that this is precisely why some stoozers may benefit!
In the world of money and investment there is a widely used term called "flight to quality". In brief a flight to quality occurs when there is a high degree of uncertainty in a market which causes investors to flee from higher risk investments in favour of the more stable lower-risk ones. What has this got to do with credit cards? Well, as the banks get more concerned about the risk of having customers default on their debts (e.g. Not paying their credit card debts), they are likely to drop the more risky customers and head towards the less risky ones. In other words, the banks themselves may have a flight to quality: a flight to quality customers.
Earlier this month, Egg made a huge splash in the papers about the fact it was removing credit facilities from 161,000 customers, whose credit profiles "had deteriorated" since they were bought by US financial giant Citi. While they were undoubtedly removing unprofitable customers as well, there is little doubt they were also removing some higher risk lending too.
Having established what is happening in the credit card market and why, let's take a look at how stoozers will appear on the spectrum from low risk to high risk. If I were a lender, the presence of missed or late payments would be right at the top of my list of warning signs that a customer may be having financial difficulty and, consequently, be at risk of defaulting on their payments. How would a stoozer fare using that criteria? A good stoozer has an absolutely perfect card payment history, probably over many years, so would not feature on such a list of customers at all.
My next assessment criteria would be a mix of 'available credit' and 'used credit' versus income. If it was very high and the customer was making minimum payments, I might begin to get a bit nervous. Clearly some stoozers could come into this category: high credit limits, highly used and only making minimum payments, so some stoozers could suffer.
However, let's not forget three things here. First of all, lenders still need to make money to satisfy their shareholders and their financial targets. Secondly, they get higher returns from their riskier lending, so if they are moving away from riskier customers then they will need to find even more low risk customers to replace them. Thirdly, while looking for low risk customers, they still need to find profitable ones. Now what category of customers are generally the ones the banks earn the most from? You've guessed it - customers who only make the minimum payments each month! So, I think that stoozers could very well benefit from a lenders flight to quality. What has your experience been? Why not vote in our Credit Crunch Poll.
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