Consumers are cutting back on discretionary purchases and HELOCs are a mess, according to the company formerly known as “Bank of Italy”
You might be asking yourself what the heck is that “Bank of Italy” stuff about. Well, I’ll get to that in a second. First, it appears as though Bank of America (BAC) is finally starting to figure out that consumers are feeling “significant economic pressure.” This is the phrase that the company’s president of global consumer and small business banking used while speaking at an investor conference in New York today. Credit and debit-card purchases for “necessary” items aka food, gas, electricity rose by 13% during the first quarter of 2008 while spending on consumer discretionary items such as entertainment, travel, and retail rose by only 0.5%. While they may receive a temporary reprieve if consumers waste their government stimulus checks like they probably will instead of saving them for a rainy day like they should, I am remain extremely bearish on specialty retailers, restaurants, airlines, airports...basically any consumer discretionary play that I can think of.
I have a sneaking suspicion that many of the consumers who are racking up this credit card debt are going to have a difficult time paying it back as their wages continue to decline when compared to inflation. In the past when one’s credit card debt got out of control, they could always fall back on Old Faithful, their rapidly inflating home’s value, to bail them out by rolling their high interest rate debt into a new mortgage or HELOC. Most consumers won’t have this safety net this time around. Credit is becoming increasingly tight. Banks are much more risk averse today than they had been, causing them to be much more selective about who they provide loans to. Plus, the number of people who have little to no equity in their homes at all is growing by the day.
I am becoming increasingly pessimistic about what the near future holds for credit card companies. I am particularly down on companies that are more pure credit card plays than Bank of America, like Capital One (COF) and Discover Financial Services (DFS). After writing about my concerns in the earlier blog post titled “Swish, Swish, Swish, Swish...What's that sound?” I made room in my CAPS portfolio to short both of them.
In the aforementioned speech, the Bank of America representative went on to state that the company’s losses on home-equity loans will likely be worse that it predicted they will be just three weeks ago. B of A’s losses in its $118 billion in loans that are linked to home values are now expected to be over 2.5%. Yuck. I don't know which ones they are, but any banks with significant exposure to HELOCs are likely headed for a world of pain. HELOCs are subordinate to primary home loans, so they're basically at the bottom of the totem pole when it comes to getting repaid from the proceeds of a home that goes into foreclosure. Many banks can't even get back what they are owed on primary mortgages. How much do you think is really going to be left at the bottom of the barrel for HELOCs? Not much. Sure, they usually are almost all recourse loans so banks can go after former homeowners for repayment, but good luck at getting it.
That’s all the trash that I’ll talk about credit card companies and Bank of America for now. You know that you’re an investing nerd when you have had people come up to you on more than one occasion and ask you if you are reading a text book. I’m currently working my way through a tome called Basic Economics – A Common Sense Guide to the Economy by Thomas Sowell. It’s extremely interesting and coincidentally I just read a short story about B of A in it this afternoon at lunch.
In the early 20th century an Italian immigrant in San Francisco who was well aware of the fact that Italians, even those with low incomes, generally did a pretty good job at saving their money and paying back loans opened a small bank in San Francisco that he called the Bank of Italy. He used this name to make sure that he attracted his target customer base. After starting in a small office that had three chairs, an adding machine, a safe, and one teller’s window the company became so successful that it began to expand across the state of California and it started to attract many non-Italian customers. This is how the company that we now call “Bank of America” got its start. I never knew that. Interesting, huh?
No position in any company mentioned