PMC Weekly Review - April 21, 2017

A Macro View: Is the American Consumer Maxed Out?

Over the past couple of weeks, reports of consumer credit have started to pique investors’ interest, and not necessarily in a positive way. The Federal Reserve (Fed) reported in early April that consumers now hold over $1 trillion of debt in each of three key areas: auto loans, student debt, and credit-card debt. Typically, the market takes a positive view of increased consumer borrowing, as it reflects heightened consumer confidence. However, what is notable about this rising debt is that all three of these areas have now surpassed their 2008 financial crisis levels. Also, as consumer debt balances continue to expand, the likelihood of delinquencies and defaults expands as well. Current evidence shows that delinquencies are on the rise in some areas of the market, and investors are starting to pay more attention. But should they? Are the current and increasing levels of consumer debt harming the market and economy enough to cause another crisis?

Let’s first take a look at the current state of auto loans. In the last several months, reports show that auto loans, particularly subprime auto loans and deep subprime (loans to consumers with credit scores below 550), had begun to show weakness and an increased number of delinquencies. In fact, out of the $1.16 trillion in outstanding auto loan debt (roughly 15% of which is subprime and below), 3.8% of that was reported to be 90-days delinquent as of the end of 2016. Although this figure is still below the level of delinquencies witnessed during the Financial Crisis, the percentage has consistently trended higher every quarter over the last year.

Another area of consumer debt that keeps growing is student loans, which, as of the end of 2016, sits at $1.31 trillion – twice the amount reported during the 2008 financial crisis. This isn’t exactly surprising, considering the increased importance of a college degree and the rising number of individuals going back to school to retool their skills in the wake of the recession. In addition, despite the increased total amount of student loans, delinquency rates for student loans haven’t materially picked up over the last several years. A further mitigating factor is that most student loans are backed by the government, so defaults aren’t necessarily a significant concern from an investor’s perspective.

Credit card debt is the area that has garnered the most headlines recently and has just crossed the $1 trillion mark and breached the previous high watermark seen in 2009. But concern over this current level of credit card debt should be moderated, as the percentage of delinquencies has continued to decline and remains below pre-Financial Crisis levels. What could be cause for concern in the not-so-distant future is the threat of rising rates and the effect they will have on the variable rates assigned to credit cards. If rates do rise as expected, those consumers who don’t pay off their cards every month will likely see their monthly payments increase, which could lead to a rise in delinquencies and defaults.

Taking all of this into consideration, these heightened levels of consumer debt seem to be manageable for now. Auto loan delinquencies are trending up, but the market for bonds backed by these types of loans is relatively small, compared to the assetbacked securities market, and thus has a less likely risk of widespread contagion. Government-backed student loans are also unlikely to trigger another crisis, though they may have the more likely effect of being a small drag on long-term consumer spending. Credit card debt, which has been attracting the most attention, appears to be showing little signs of instability, despite rising levels. Furthermore, modest wage growth and currently low unemployment bolster the case for overall continued stability in these areas.

The bottom line is that it may take a noticeable shift in other macro factors, like unemployment and interest rates, to raise investors’ anxiety about consumer loans.

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