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Afraid of Commitments

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Citigroup's decision is just the beginning of a massive reduction in credit availability for both consumers and the commercial world.

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As Prof. Depew highlighted earlier, over the weekend The Wall Street Journal reported that Citigroup's (C) U.K. credit card operation was canceling the credit available to 161,000 "high risk" cardholders.

While on the surface it would be easy to say that Citigroup's action does not affect me, I highlight the news because I firmly believe that Citigroup's decision is just the beginning of a massive reduction in credit availability that is going to flow through the consumer and commercial credit worlds – starting (as always) with the weakest of credits, but ultimately affecting even the best borrowers.

As I wrote earlier today, banks have seriously misjudged the difference between "net" and "gross" exposures in a number of key risk management areas. However, at least to me, no place is that more apparent than in the granting of lines of credit.

Until recently, lines of credit were truly "money for nothing." Whether you were a consumer borrower or a corporate treasurer banks were granting unprecedented levels of available credit, either for free or at historically tight spreads – all with the expectation that the lines would never be used.

And through the beginning part of 2007, that was true. While off-balance sheet lines of credit ballooned, on-balance sheet system-wide bank assets grew at a modest 6-7% annual rate. Since, July, however, with the capital markets in stress, bank balance sheets have grown at a more than 15% annual rate – adding more than $1.0 trillion to assets.

While things like the TAF program, arranged by the Fed, have helped the banks fund the balance sheet growth, capital levels are not keeping pace. In fact, since July, bank capital levels have been essentially flat, (so every additional balance sheet loan asset represents additional leverage to the system). Further, as weak credits tend to draw down available lines first, a significant amount of the $1.0 trillion in new bank assets likely represents lower tier borrowers unable to find credit elsewhere rather than top quality credits.

It should come as no surprise, then, that banks like Citigroup are reducing lines wherever possible. And as I said above, they will start with the weakest credits first.

Unfortunately, I don't believe just hitting the weak will be enough, particularly as spreads in the debt capital markets continue to ratchet higher and more and more borrowers find it cheaper to turn to their "back-up" bank lines. Between capital and liquidity constraints, however, banks will have to choose to whom and at what price credit will be available. And my guess is that coming out of this cycle we will see far smaller lines and significantly higher pricing.


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