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Consumer Debt Challenge Looms Before Servicers

While consumers typically prioritize home loan payments over other types of consumer debt, lenders and industry observers are becoming increasingly concerned about the growing debt burden faced by many households.

U.S. consumer debt, mostly mortgage, credit card and auto loans, grew by 10% in 2001 and 2002, according to researchers at UBS Warburg who label that growth rate "unsustainable." Personal income only grew at about half that pace, they said in a recent report. And the analysts do not expect the mortgage industry to be immune from problems associated with a "credit bubble" if debt burdens rise too high.

To some extent, the payment burden for consumers has been offset by lower interest rates.

"The best-case scenario is that consumer credit slows quickly toward a sustainable 5%-7% growth rate. The worst- case scenario is that it continues at or near its current growth rate through 2003 and into 2004. We would then assume consumer credit quality would deteriorate materially," analyst Gary Gordon and his colleagues said in their report.

For the consumer debt burden to remain flat, consumer loan growth would have to be cut in half, to 5%, according to the report.

Most of the risk associated with growing consumer debt falls outside of the home loan sector, but the analysts do see risks for the mortgage sector.

"Our consumer credit outlook is not positive for mortgage finance fundamentals. We expect a slowdown in mortgage debt growth to "as low as 5%" in 2004-2006 from 12% in 2002," UBS Warburg said. In addition, the analysts expect mortgage credit quality will "worsen either moderately or materially during the next few years."

One sector that has helped push up mortgage debt growth, which has averaged about 10% annually in recent years, is home equity lending. Banks have heavily marketed home equity loans for debt consolidation and home equity lines of credit as an alternative to credit cards. UBS Warburg estimates that home equity loans and lines account for about $1 trillion of the $6 trillion in total mortgage debt outstanding. HELOC lending grew at an estimated 22% clip in 2002.

UBS Warburg advises clients interested in investing in the consumer credit sector to "focus on lower risk names." Those recommended banks include Fifth Third Bancorp, Wells Fargo, Compass Bancshares and National Commerce, along with mortgage banking specialists Fannie Mae, Freddie Mac and Countrywide.

While cautioning about the growth of consumer credit, UBS Warburg said it is "too early to state that structural credit problems are imminent for the consumer lending industry."

Despite concerns about debt growth, UBS Warburg points out that there could be some negative implications to slowing down the rate of consumer borrowing. 80% of new consumer debt is used for spending, and a slowdown in debt growth would likely have implications for the economy.

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