A lingering consumer credit problem

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Years ago while furthering my debt-funded education I found myself studying abroad in Swansea, Wales. I came across many cultural norms which were different to those to which I was accustomed back in the U.S. 

Right from the beginning I was struck by the U.S. government’s obsession (shared by American people) with acronyms. The US Federal Reserve is no exception to this norm and provides a dizzying amount of data and publications updated with various frequencies and cryptic naming conventions such as the Z.1, H.8, G.19 and my personal favourite, FRED.

One of the more closely followed and scrutinized, with its own memorable acronym, is the SLOOS report or more accurately, The Senior Loan Officer Opinion Survey on Bank Lending Practices. This report is published every quarter and tracks changes in the standards and terms of the banks’ lending, state of business and household demand for loans.

Much attention is given to the causal relationship between current and expected delinquencies and the future availability of credit.

Commercial loan delinquency rates bottomed nationally in the fourth quarter of 2014 following the financial crisis and have steadily increased every quarter since. Much of this has to do with the Energy sector as it adjusts to a lower oil price. In fact the percentage of delinquent commercial loans has increased from 0.49% in the fourth quarter 2014 to 1.25% in the first quarter 2016. While the outright number may not sound like much of a worry, the pace at which non-performing loans are increasing coupled with the expectation for them to continue higher as more companies struggle to adjust, has provided enough justification for bank managers to tighten current lending standards.

In the most recent SLOOS report we learned that for the first time since the end of the financial crisis banks are no longer easing credit conditions across certain segments and have continued to increase tightening standards as seen in exhibit 1 below:

Exhibit 1: Changes in bank lending practices with regard to applications for commercial and industrial (C&I) loans by large and middle-market firms, all respondents (based on data from the SLOOS report for the period from December 2015 through January 2016)

C&I loans

Source: Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS), as at June 2016.

Some market participants are pointing to the decline in this series as a harbinger for a recession. While we agree that the transmission mechanism from increased delinquencies to tighter lending standards will likely reduce future potential growth, it is too early to suggest any broad based spillover to areas in the economy to suggest a looming recession.

Turning to consumer credit it’s hard not to notice that nearly all financial metrics have improved since the global financial crisis some eight years ago. Consumer segments such as credit cards and autos are all experiencing lower delinquency rates from an improving jobs markets, consumer confidence and refinance ability. However one area of consumer credit which has yet to see a drop in serious delinquencies is student loan debt.

Much like the U.S. government did to encourage household formation it also did for the student loan market. It did this as a way to prepare for a demographically changing workforce and to improve productivity all through the goals of higher education.

Using data from the Federal Reserve’s Z.1 and G.19 it shows that since the beginning of 2006 student loan debt, largely through the US government, has increased from USD 481bn to USD 1.35tr at end of March 2016 or roughly a 180% increase. In exhibit 2 below we see that student loan debt as a percentage of total consumer credit has increased from 20% in 2006 to roughly 38% ten years later. Offsetting this increase has been a decline in credit cards as presumingly (current author included) students took on additional debt to finance spending habits which previously might have been financed by credit cards. Rather unfortunately serious delinquencies rising from student loan debt at the end of the financial crisis in 2009 have risen at a national level of 8.3% to 11% today. Making the problem more difficult than other areas of consumer credit is that in most cases student loan debt is non-dischargeable in bankruptcy making it more difficult for consumers to restructure their debt.

Exhibit 2: Student loan debt, as a proportion of outstanding US consumer credit, has risen from 20% to around 38% in the ten years through March 2016 (the chart shows changes in the different types of consumer credit for the pierod between March 2006 and March 2016)

US consumer credit

Source: Board of Governors of the Federal Reserve System (US), as at June 2016.

Rising commercial delinquencies and tightening credit standards both potentially suggest a lower path for US investment and consumption. Investors would be well served to respect these market signals and to closely monitor future data releases from the Federal Reserve in the coming months and quarters to identify any further deteriorating credit conditions.

As for student loans the message is clear, either borrowers find employment at a wage level commensurate enough to service their debt burden or a change to the bankruptcy laws needs to be considered. Anything short of this could suggest that future economic growth may face headwinds from a cohort potentially unable to finance buying a home or saving for retirement.

Article written in New York on 10 June 2016.

Dan Singleman

Senior Portfolio Manager, Sector Rotation

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