Household Debt: Myth vs Reality

Consumer Credit Card default rates have “surged” to 4 year highs. Capital One reported its largest write off since 2011 due to credit card delinquencies. Discover Card loan loss provisions in the 1st quarter 2017 rose a whopping 38% to $586 Million. Sounds like the alarm bells have rung! Myth or Reality?

Alarming headlines are not always tethered to reality, seeking to grab your attention and “go viral”. The next chart is identical to the chart above with a broader time perspective. Wake us up when default rates rise into the 4 to 5% neighborhood!  If the economy improves we would expect default rates to rise as consumers take on more risk and banks tighten credit ahead of excess speculation and potential inflation. In spite of the sensationalist “the sky is falling” stories, Credit Card delinquencies are still historically low with considerable room to rise before banks tighten credit enough to choke off this slow growth economy.

Auto loans have risen back to the scary levels of 2007 and 2008 when the economy was overheating and the real estate bubble was bursting. Car inventories by US brands have risen back to 2009 levels requiring manufacturers to slow production to 17.3 Million autos from 17.5 Million average the previous 2 years.

Increased loan defaults should be expected during a “strong” growth surge in auto loans in an economic recovery. Car and light truck purchases in 2016 returned to their average peak levels of the record pace in the early 2000’s although well below their population adjusted peak. Auto loan demand correlates with delinquencies. Yet, Experian’s Auto loan default rate is very tame, which again relegates the alarming headlines as trumped up news.

However, Real Estate is the big fish in the sea of debt, as we learned during the global sub-prime meltdown of 2008. Mortgages make up 67% of all household debt and will be the area of focus if interest rates finally have the rise that has been prematurely expected for years (currently rates are “falling”). Typically home purchases rise enough during an economic recovery to cause mortgage rate overheating with debt service costs exceeding 12% of a households disposable income before credit trouble arrives. Thus far the recent historically low rates and a paucity of millennial home buying have created record low debt service burdens. This excess leverage available to consumers is normally witnessed in the “early” innings of an economic recovery, not the late innings as many economists assume.

Mortgage delinquencies will rise if interest rates rise significantly. Currently homeowner defaults continue to improve and show no signs of stress.

With overall home ownership hovering at its historic 1960’s low near 63%, Millennials are just 35%, choosing to rent rather than own. This has eased debt burdens and created boom times for apartment building. With so many delaying home purchases we are growing pent up borrowing capacity and enhancing average consumer credit scores basis FICO (Fair Isaac Corporation). 

Strong rental demand as evidenced by very low vacancy rates and rapidly inflating rents will soon be met with a wave of new supply over the next few years. As millennials age out of single life, it’s likely family formation will increase with a slow shift to home ownership. 

 While the surge in apartments and multi-family construction is booming along with pricier rents, the slow pace of home building may keep the millennial migration to homes at a modest pace due to a lack of home building capacity. However, longer term the Millennial migration will be an area to watch as they increase their home ownership from 35% to 65% as they matriculate from their 20’s and 30’s into their 40’s. With home inventories low, a shortage of skilled construction workers and Millennial family formation starting to increase, it becomes clear why home prices are high and home builder stocks are performing so well since 2011 and again this year. When the inventory of unsold homes begins to surge along with higher interest rates, then we should begin to worry about consumer debt burdens.

In May average credit scores as measured by FICO hit record highs with extremely low levels of consumer bankruptcies and defaults. This doesn’t sound like a consumer that is in trouble as in 1980, 1990 and 2006-2008. The alarm in recent months about consumer debt is a myth according to the evidence. Banks and consumers have a better buffer to handle a weak economy, now we just need a catalyst triggering consumer animal spirits to start spending and investing this excess liquidity. 



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