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A Bumpy Landing

US credit levels need to fall. It may not be good news when they do...

THE US may have had five straight quarters of loosening lending standards, as well as strong US credit growth data. But actual loan growth in the US economy is dangerously anemic, writes Shah Gilani for Money Morning.

What isn't apparent to investors is that the reason first-quarter gross-domestic-product (GDP) growth fell to 1.8% from the fourth quarter's more robust 3.1% rate is that loans and leases – which accounted for as much as 51.2% of US GDP as recently as 2008 – fell to 45% of GDP in March.

Behind the headlines about positive credit trends, the truth is that weak loan demand will continue pressuring GDP growth and put a lid on some rising US stock prices.

This underscores yet again how important so-called "capital waves" can be, why we need to watch them.

In its just-released "National Credit Trends Report" for March 2011, credit-reporting company Equifax showed strong US credit growth across several important sectors. 

On a year-over-year basis, for instance, auto credit growth increased 23%; bankcards credit growth increased 14%; home equity credit growth was 9%; and consumer finance saw a 5% growth in available credit.

In addition to expanding US credit growth, Equifax revealed that credit scores are improving as American consumers are paying down debt in general and are making more timely payments.

On top of that good news, the US Federal Reserve's first quarter "Senior Loan Officer Survey" revealed that bank-lending officers are more willing to lend now than at any point since 1994. 

In fact, none of the banks that responded to the Fed's survey reported any tightening of credit terms and conditions for borrowers. Conversely, 16% of respondents reported they were easing standards.

That sounds great. But, as usual, the headlines don't tell the real story.

Actual available credit, while slowly rising, is still only half that of its peak year in 2006.

Installment loans – one measure of credit availability – have been rising steadily and now account for 33.9% of total consumer loans, a five-year high. Notably, however, the bulk of those loans are originations for bankcards, and for new and used cars.

And those auto loans are sending lenders careening straight into brick walls.

Bank profits on auto loans are disappearing. With loan demand elsewhere weak, banks' only consistent expansion valve has been new and used auto loan origination. But the competition to finance pent-up demand for automobiles and light trucks is all but eliminating lenders' profits on their loan portfolios.

Ally Financial Inc., the country's top car lender, which just reported that new-and-used car loans originated in its most-recent quarter almost doubled, also reported a 15.8% drop in earnings.

Intense competition for auto-loan business is also hurting profit margins at all the big banks that went after Ally's business. In order to offer deals to consumers, who Autodata Corp. said bought 1.2 million vehicles in March, lenders eased loan standards by 30%. 

No wonder there's been a boom in auto sales while bank profit margins on auto loans have collapsed. 

According to Fifth Third Bancorp, one of the nation's top auto lenders, "unusually attractive" spread profits are narrowing. BB&T Corp., another big auto-loan provider, recently reported that its year-over-year loan spread on auto originations fell from 6.31% to 5.21%. That means that the bank's profit spread declined by more than 17%.

It's unlikely that banks and specialty lenders can continue – or even would be willing – to extend favorable credit terms to auto buyers if the economy were to erode in the face of these thinning profit margins.

And just because banks are making terms and conditions easier on other types of loans doesn't mean that consumers are lining up to take advantage of growing credit availability.

When it comes to credit, consumer sentiment plays a major role in determining:

  • Whether consumers are willing to add to their existing debt burdens.
  • And just how confident they are that they'll be able to pay any borrowed money back.

And right now, consumers just aren't feeling the love.

According to a recent behavior index survey by First Command Financial Services Inc., a Fort Worth, TX, advisory firm, six out of ten respondents were stressing about meeting current financial obligations and were not even capable of saving for retirement. 

That survey's conclusions were very similar to those of a March confidence survey conducted by the Employee Benefits Research Institute (EBRI). EBRI found that more than half of its survey respondents were "not too confident" or "not at all confident they can enjoy a decent retirement."

At a time when folks aren't confident they'll be able to meet their current obligations – let alone financing their own retirements – it's hard to imagine that we'll see robust US credit growth going forward.

And what about commercial and industrial loans? Fed data shows that these grew only 1% in 2010. 

The most recent data indicates that emerging-market-loan growth was 64.1, while the same measure for the US market was at a near-flatline level of 50.1 (a level of above 50 shows expansion, while below 50 shows contraction).

From 1976 to 2010, loans and leases averaged 36% of GDP. Low interest rates and easy (make that "sleazy") credit standards in the 2000s saw loans peak at 51.2% of GDP in 2008. 

As of March 2010, loans were 45% of GDP.

Any downdraft to the historical average of 36% of GDP – which itself is skewed higher because of inordinate US credit growth in the 2000s – would require a 20% drop in loans as a percentage of GDP from today's levels.

Is it any wonder that US GDP decelerated precipitously, falling from a 3.1% rate of growth in the 2010 fourth quarter to 1.8% in the first quarter of the New Year?

If US credit growth (in the form of loan demand) sputters and stalls altogether, it won't be long before discussion of the US economic recovery is replaced by whispers of a double-dip recession.

Investors: You have been warned.

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