The Green Sheet Online Edition
March 10, 2008 • Issue 08:03:01
Economic hang-ups: Will payments wilt?
When the housing market plummeted and the subprime mortgage meltdown began in early 2007, politicians and economists alike avoided uttering "recession" at all costs. But even politicians can hardly avoid the word now; economists are all but admitting that the United States is sliding into its first recession in nearly seven years.
Whether or not the current economic downturn is labeled a recession (defined as a decline in the Gross Domestic Product for two or more consecutive quarters), the effects of a downturn are seen and felt across the United States.
In December 2007, the U.S. service sector, which accounts for 90% of the U.S. economy, hit an abrupt slump - the lowest since the aftermath of Sept. 11, which was labeled a recession. The median price on a single-family home fell 6.5% in December 2007, according to the National Association of Realtors.
The Bureau of Labor Statistics of the U.S. Department of Labor reported that the unemployment rate in January 2008 reached 4.9%, amounting to roughly 17,000 workers. Jobs in construction and manufacturing declined; health care positions increased.
The Conference Boards' U.S. Business Cycle Indicators for January 2008 showed the leading index fell 2% from July 2007 to January 2008, the largest six-month decline in the index since early 2001.
The index also showed that financial sector profits decreased dramatically over the second half of 2007, collapsing from about $10 per share in the second quarter of 2007 to almost $2 in the fourth quarter. Top global financial institutions have disclosed roughly $125 to $150 billion in asset write downs associated with the recent financial turmoil.
In the 2001 recession, investors took the biggest hit as the technology bubble burst. This time around, middle class consumers might be the new punching bags as inflation and rocketing energy prices rise. In a domino effect, day-to-day living costs now demand a larger portion of consumers' paychecks.
In fact, the one-two punch of recession and inflation is what most economists fear the most. That combination - also known as stagflation - is much worse because fixing inflation worsens the recession. What does this mean for the payments industry? The answer isn't obvious.
"When we can be hurt is with higher merchant attrition [or] cancellation. The start-up/younger merchants will have a harder time succeeding in a weaker economy," said Jared Isaacman, Chief Executive Officer of United Bankcard Inc.
Is anyone untouchable?
In the short term, at least, some businesses - processing included - may weather both inflation and recession better than others.
In 2007, Exxon Mobile Corp. posted the most profitable year of any corporation in U.S. history. The total at the pump may be more painful on consumers' wallets than ever before, but this hasn't motivated them to cut back on their purchases.
Most consumers aren't paying at the pumps with cash. Instead, they are relying on plastic. MasterCard Worldwide, the second biggest payment card network, said fourth quarter 2007 profits climbed sevenfold as U.S. consumers spent more on gas and food.
"Revenue will grow slower this year than 2007, while the rate will still be in double digits," said Robert Selander, Chief Executive Officer of MasterCard, during a conference call to analysts.
"You can't grow at certain rates forever, but for the next several years, given the secular trends from paper-based payments to electronic payments, MasterCard can continue to show very good growth."
"I'm no economist, but if money gets tight, the U.S. population will lean more toward credit," said Douglas Mack, of Card Payment Systems, and a member of The Green Sheet Inc.'s Advisory Board.
(For more Advisory Board opinions, read "Unsettled economic times - boon or bust? Part I," The Green Sheet, Sept. 24, 2007, issue 07:09:02 and "Unsettled economic times - boon or bust? Part II," The Green Sheet, Oct. 8, 2007, issue 07:10:01)
The appeal of credit cards has others scratching their heads. "It seems counterintuitive," said Scott Hoyt, Director of Consumer Spending Economics at Moody's Analytics Inc. "But the high gas prices can cause an increase in credit card spending, in spite of concerns about the economy."
Some industries are simply more resilient to downturns than others.
Experts say hardware stores and auto parts retailers tend to see sales rise when more cash-conscious people make their own home improvements and keep their vehicles longer, although the home equity crunch and weakened housing market may offset any increased volume at do-it-yourself stores.
American Express Co. and Discover Financial Services profits declined during MasterCard's growth period. This occurred because AmEx and Discover handle consumer loans, and the slowing economy caused more customers to miss payments.
UBS AG's Investment Research Analyst Eric E. Wasserstrom, in step with UBS' prediction of a recession in the first half of the year, cut his rating on AmEx from buy to sell. He also changed Capital One Financial Corp. and Discover from neutral to sell. AmEx posted a 10% lower quarterly profit in 2007, as the company wrote off loans in the United States at a rate of 4.3%, up from 3.7% in the third quarter. AmEx forecasted a much slower profit growth in 2008.
What is consumers' impact?
In a survey conducted by Discover in January 2008, 49% of consumers said they planned on reducing discretionary spending by February. That was an increase of 5 percentage points from its December survey and a 10-point jump since September.
Card Associations may find their portfolios squeezed. Recessions cause good card customers to try to pay on their debt, while others fall behind on their payments. Card promotions to encourage recession spending may backfire if the recession deepens and cardholders lose their jobs.
Bank of America Corp. is trying to keep delinquent accounts to a minimum. As part of its review of credit card risk, BofA started notifying thousands of customers in January 2008 that they face a 9% to 28% fee hike if they don't pay off their credit card balances and stop using their cards. This notification was also extended to consumers with good credit history.
Increasingly, consumers' credit is starting to crumble. According to an analysis conducted by RiskMetrics Group Inc., 7.6% of credit card loans in 2007 were either at least 60 days delinquent or had gone into default, up from 6.4% a year earlier.
"We see a particularly challenging environment for credit card lenders heading into 2008 as the risk of continued deterioration in consumer credit quality, caused by the disruption in residential lending, combines with rising uncertainty regarding the direction of the macroeconomy," said Kevin Mixon, certified Public Accountant, Financial Sector Analysis at RiskMetrics.
Mixon noted that a recession would cause higher delinquency and charge-off rates as more consumers struggle to make credit card payments. "In the face of a looming recession, however, credit card issuers will naturally seek to restrict lending to limit their potential credit losses," he said.
According to Mixon, this equates to higher rates on card products, lower credit lines and increased difficulty for consumers with less than prime credit in obtaining or increasing credit card lines.
In early February, the Federal Reserve Bank reported a slowdown in consumers' credit card borrowings. In December 2007, Americans had $944 billion in total revolving debt, most of it on credit cards. That was a significant dip from the seasonally adjusted growth rates of 13.7% in November and 11.1% in October.
But Hoyt said the Fed's figures fluctuate monthly and, in spite of recent reports, Moody's Investors Service sees a trend toward using credit cards.
"Overall, we see a slight deceleration in consumer debt, but that figure reflects auto loans," Hoyt said. "With that removed from the picture, the credit card debt alone should show a slight acceleration, nowhere near the height of credit card debt load of the '90s, but nonetheless, not a deceleration."
The economy features many competing influences, Hoyt said. "Consumers will have less access to home equity, and they'll be forced back to their second choice: credit cards," he said.
"Additionally, those who lose jobs may fall back on credit cards for living expenses until they find new jobs." Hoyt added that credit card lending standards will tighten, and consumers will become more cautious with their spending because of the economic conditions.
The Fed reported in 2007 that the median U.S. household income is $43,200 and the average family's credit card balance is almost 5% of annual income. Consumer credit increased at an annual rate of 4.5% in the fourth quarter of 2007 and rose 5.5% over the year as a whole. In December, consumer credit increased at an annual rate of 2%.
Why is spending constant?
In tight economic times, consumers tend to cut back not only on large purchases such as houses and cars, but also luxury items and eating out. Basic necessities continue, and goods and services that repair rather than replace - such as automotive supply stores - tend to do well in recessions.
According to Isaacman, the state of the economy can be summed up by consumers' spending habits. When the economy is strong, consumers use credit and debit cards for more disposable income purchases such as electronics, furniture, deposits on cars and so forth. During this time period, the ticket sizes for credit card purchases are above average.
But when the economy is weak, consumers use credit cards more for everyday purchases such as fast food, convenience stores and dry cleaning. During this time period, ticket sizes for credit card purchases are below average.
For the last 25 years, Americans have kept up shopping habits, even during recessions. When adjusted for inflation, consumer spending rose every single quarter over previous years except one: There was a minor drop (0.4%) in the first quarter of 1991.
But this time around, American consumers' overspending may have caught up with them.
Some experts say the housing market has kept spending habits artificially fueled. Increasing home equity made it possible for a person's net wealth to increase on paper, even when cash flow did not; home equity loans made it possible to spend more than was earned. In this downturn, that option may not be available much longer.
"U.S. retailers, who are a bellwether for our nation's changing economic climate, are greatly concerned about the softening of the U.S. economy," said Tracy Mullin, National Retail Federation President and CEO.
According to Mullin, holiday sales in 2007 were the weakest since 2002. And consumer spending in the new year remains sluggish. "Consumer spending represents 70% of the U.S. economy and has fueled our economy for the past decade," she said.
The NRF expects the nation's economy will be under continued financial stress in 2008 due to high energy costs, fallout from the housing slump, and declining employment opportunities and income growth.
In its 2008 economic forecast, the NRF predicted retail industry sales - which exclude automobiles, gas stations and restaurants - will increase 3.5% from last year. Reduced discretionary spending is already being felt by luxury retailers.
American luxury consumers cut their spending on luxury goods and services more than 20% from the first half of 2007 to the second, according to the latest survey of affluent consumer spending by Unity Marketing Inc.
Will there be empty tables?
Restaurateurs are also worried. If consumers start to pinch pennies, does this mean less dining trips? Some experts think not.
"Spending in restaurants is closely tied to the economy and particularly to consumers' disposable income," said Hudson Riehle, Senior Vice President, Research & Information Services, National Restaurant Association.
"However, dining out is an essential part of Americans' lifestyle, and people are not likely to change that no matter what the economic conditions."
But restaurants aren't completely in the clear. "While the impact will vary across markets, what typically happens is that consumers spend less but don't necessarily cut back on frequency," Riehle said. "They become more value-conscious and tend to choose restaurants at lower price points than they typically would."
Riehle also noted that high energy, gas and wholesale food prices, in addition to consumers' pinched disposable income, are economic challenges. "With the average restaurant profit margin at only 4%, operators often feel even small fluctuations," he said.
According to Riehle, the restaurant industry as a whole is still expected to grow this year for the 17th consecutive year, with sales reaching $558 billion in 945,000 outlets. "While growth is moderate compared to past years, there are no signs the industry is contracting or that growth is anemic," he said.
"On a broader level, it is important to recognize that the slowdown in consumer spending is part of the rebalancing of the U.S. economy," said Gail Fosler, Chief Economist at the Conference Board. "Americans have enjoyed over two decades of continuous consumer spending growth, which is one of the causes for the large trade deficits over the past decade."
These gains go beyond the normal term of an economic cycle and diminish as consumer needs are met, Fosler said.
Who benefits from tax rebates?
On Feb. 13, 2008, President George W. Bush signed the Economic Stimulus Act of 2008, designed to boost the U.S. economy by providing tax incentives for businesses and tax rebates to individuals within a certain income bracket. It was hailed by retailers and restaurateurs.
"The recently passed economic stimulus package is positive for the industry, putting more money in consumers' pockets, offering tax rebates and beneficial depreciation," Riehle said. "Small businesses, which make up more than 70% of the industry, will especially benefit from these measures."
"Tax rebate checks should have the desired effect of both bolstering the economy in the short-term and putting consumers in a better position to spend for the future," Mullin said.
"This stimulus package is a crucial component to economic recovery and will provide much needed relief to American shoppers."
According to a recent NRF survey, consumers plan to spend 40.6% of tax rebate checks when they are distributed between May and July, which will provide an immediate $42.9 billion boost to the economy.
The survey also found that part of the $105.7 billion distributed in tax rebate checks will be used to pay debt ($30 billion) and medical bills ($4.6 billion).
When will relief come?
According to the most recent NRF Retail Sales Outlook report, the slow pace in retail sales growth is expected to continue before picking up in the second half of 2008. Many economists project weak consumer spending throughout the entire year.
But some are not sold on the "sky is falling" theory. Fosler pointed out that there is a credit crunch, not a credit collapse. "While the correction in the financial sector is just beginning, the correction in the housing sector is nearly over," she said.
"While there is continuing uncertainty about the economic outlook, economic shocks from the contracting financial sector are not enough to tip the U.S. economy into recession."
Even if experts can't agree on whether to call the current slump a recession, one thing is certain: Numbers are declining. And where that leaves the payments industry remains to be seen.
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