The tale of US “de-leveraging”

Market Realist

Sam Madden, CFA, founder, and CEO of Interactive Buyside, sheds light on whether consumer de-leveraging is a myth, and points out the fact that systemic leverage isn’t reducing, but is merely shifting and is actually growing

What I keep hearing from Wall Street and media pundits is this great “de-leveraging” environment we are in today (in Europe and in the U.S.). Analysts continue to stress how U.S. citizens are paying down credit card debt and paying off their mortgages, and all components of the U.S. economy are reducing leverage. This should be a bad thing in the short term, as more U.S. dollars go to debt reduction and less to buying consumer goods. In the long term, however, this should be beneficial to the U.S. economy, as we are tackling this bubble sooner rather than later.

As most anyone who follows the economy and the markets can observe, retail sales are going up (+1.1% in September, +1.2% in August) and so are most retail corporate sales and profits. So, is this consumer de-leveraging a myth or is there something I’m missing here? Going through the numbers, I find a mixed bag of good and bad vis-à-vis debt levels in the U.S.

1. Household debt growth trends: From the financial peak at the start of 2008, total U.S. household debt has been consistently coming down each quarter. From 2008 to mid-2010, this was driven by both home mortgage reduction and consumer credit reduction. However, in 4Q 2010, households experienced a pivot. Home mortgage credit continued to decline, but consumer credit started growing again. In fact, in the most recent quarter, the seasonally adjusted annual rate (“SAAR”) growth was at its highest rate since 2008, and actually drove total household debt SAAR growth.

Home Mtg SAAR Growth

Consumer Credit SAAR Growth

Total Household Debt SAAR Growth

2010Q1

-4.9%

-3.1%

-3.3%

2010Q2

-2.3%

-3.5%

-1.9%

2010Q3

-2.7%

-0.6%

-2.4%

2010Q4

-2.1%

2.2%

-1.3%

2011Q1

-2.6%

2.7%

-2.0%

2011Q2

-2.4%

3.0%

-2.7%

2011Q3

-1.8%

1.9%

-1.7%

2011Q4

-2.5%

5.9%

0.1%

2012Q1

-3.3%

5.7%

-0.9%

2012Q2

-2.1%

6.2%

1.2%

2012Q3

-3.0%

4.3%

-2.0%

2012Q4

-0.8%

6.4%

2.4%

2013Q1

-2.1%

5.7%

-0.5%

2013Q2

-1.7%

5.6%

0.2%

Source:  Federalreserve.gov

2. Relative household debt: The above chart doesn’t mean much if you don’t have a reference point or something to compare these growth levels to. So let’s break household debt down:

  • Consumer credit: Peaked in 2008Q2 at $2,579 billion. This amount trended down for the next couple years (as discussed above in our SAAR analysis) but then picked back up at a brisk pace and now stands at $2,709 billion. Yes, GDP has been growing as well, but as a percent of GDP this is back up to 20% (the same percent of GDP as back in 2008). So consumer credit is now 5% above where it was at the peak of the market, but unemployment is what versus market peak?
  • Home mortgages: U.S. households have done a solid job in consistently paying down mortgage amounts over the past few years. Mortgage credit peaked at $10,640 billion in 2008Q1, and is now at $9,590 billion (a 10% drop from peak). So clearly one could argue that households are able to transfer some of their mortgage debt to more consumer-oriented debt (credit cards, installment credit, etc.).
  • Total household debt: Peak was in 2008Q1 with $13,822 billion of total household debt. This dropped to $12,906 billion in 2012Q1 (a 6.6% drop), yet ticked back up in the recent quarter (as shown in SAAR growth table above).

So yes, households have reduced their debt loads from the peak, but the numbers tell you that families are simply paying down mortgages with extra cash/savings, and then levering up to continue buying more and more consumer goods… Using more consumer credit than they did at the peak of the market to buy goods. Can households handle this new (as of 2Q) trend of total debt increases?

3. Total non-financial debt: When we add in total business debt, state and local government debt, and federal government debt statistics, the U.S. leverage situation looks a lot sketchier. Granted, federal government debt has been driving a lot of this increase in leverage, but total non-financial business debt is actually a larger piece of the pie (in dollar terms) and is growing. Plus the most recent quarter started to see an increase in leverage across the board for the first time in years. Let’s take a look at recent SAAR growth rates for credit components:

Total Household Debt SAAR Growth

Total Business Debt SAAR Growth

Total State & Local Gov’t SAAR Growth

Total Federal Gov’t SAAR Growth

2010Q1

-3.3%

-0.5%

2.8%

21.9%

2010Q2

-1.9%

-1.8%

0.4%

22.2%

2010Q3

-2.4%

2.9%

1.8%

15.4%

2010Q4

-1.3%

2.5%

3.7%

16.0%

2011Q1

-2.0%

3.7%

-2.8%

9.1%

2011Q2

-2.7%

5.2%

-2.6%

8.2%

2011Q3

-1.7%

4.2%

-0.2%

13.7%

2011Q4

0.1%

5.3%

-2.1%

12.7%

2012Q1

-1.1%

4.4%

0.4%

13.5%

2012Q2

1.4%

4.9%

2.9%

11.0%

2012Q3

-1.6%

5.1%

-0.2%

7.1%

2012Q4

2.1%

9.1%

-3.8%

10.4%

2013Q1

-0.5%

4.9%

2.4%

10.1%

2013Q2

0.2%

6.9%

1.1%

2.5%

Source:  Federalreserve.gov

And when summing everything up to get to total non-financial debt? That never declined once (even in 2009), and has been growing at an average 4.0% SAAR clip since 2010 (+5.0% in 2012Q2).

The goal of this analysis is not to provide all the answers to our domestic debt issues, however. Its purpose is to point out the fact that systemic leverage is not being reduced—it is merely being shifted and is actually growing. Household consumer credit is 5% above the peak of the market, and relative to GDP it is actually slightly higher than peak. This is being offset by less mortgage debt, but with unemployment stagnant at ~8% and real incomes not growing for most Americans, can this trend continue? I published an IB report on Conn’s a few weeks back, and one of the most interesting metrics for this retailer is the amount of credit its customers have been taking on to buy consumer goods and electronics (Conn’s has a sizeable internal credit sub-prime lending program). Conn’s credit per customer has now surpassed what it was in the 2008 timeframe. This is simply a microcosm of U.S. households in general, it seems.

The Market Realist Take

The Federal Reserve’s Q2 2013 Z.1 “flow of funds” report stated federal borrowings increased at a 2.5% rate in the second quarter of 2013, down from Q1 2013′s 10.1%. Consumer credit rose at a 5.6% pace, slightly down from Q1 2013′s 6.2%. Home mortgage debt contracted at a 1.7% pace, a bit less than Q1′s 2.1% rate of decline. Total non-financial debt (or NFD) expanded at a seasonally adjusted and annualized rate (SAAR) of $1.251 trillion, down from Q1′s SAAR of $1.974 trillion, to a record $40.938 trillion. NFD expanded $1.678 trillion, or 4.3%, in the past year. Consumers increased their borrowing by $10.4 billion in July—less than what was forecast. Credit card debt or revolving credit declined by $1.84 billion from June. On the other hand, non-revolving credit, which is driven mostly by student and auto loans, increased 7.4% in July.

With unemployment rates at 7.3%, and low wage increases, households seem to be feeling the pressure of borrowing to make ends meet. Consumer spending was slightly high, at 0.3% in August, fueling speculation that economic growth could slow down in the July–September quarter to ~2%. Retail sales in August grew modestly, at 0.2%, with consumers spending more on automobiles, furniture, and electronic appliances and less on clothing, building materials, and sporting goods. The move seems to be affecting retailers like Walmart (WMT), which recently cut its annual profit outlook, on the back of disappointing sales in the second quarter. Costco Wholesale Corporation (COST), Target Corporation (TGT), Family Dollar Stores, Inc. (FDO), and Dollar General (DG) are some of the retail stocks that might be impacted by changes in consumer spending.

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