Resilience on household and business balance sheets
admin | November 9, 2018
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Despite the length and almost surely with help from the current long economic expansion, the average US household remains in a fantastic position. Business balance sheets, meanwhile, are also in solid shape in the aggregate, despite well-documented instances of potential overleverage among certain heavily indebted firms to trying to hold on their investment-grade status. Both aggregate balance sheets should bring important resilience along for the foreseeable future.
After the run-up in debt in the 2000s, mostly associated with mortgage-related borrowing, households have spent more than a decade repairing their balance sheets. The ratio of overall household debt to GDP has been trending lower since peaking in 2008 at exactly 100%. In fact, in the last nine years, there have only been four quarters when this ratio ticked up and three of those were by a tenth of a percentage point or less (Exhibit 1).
Exhibit 1: Household debt-to-GDP ratio
The fall in household debt relative to GDP has brought the ratio down to 77% as of mid-2018, the lowest reading since 2002 and almost entirely unwinding the steep run-up in the ratio during the mortgage boom years of the early-to-mid 2000s. This series exhibited a significant uptrend trend, even before the unsustainable borrowing seen in the 2000s, as households have come to use credit for more and more of their spending, including many types of routine day-to-day transactions that would never have been purchased on credit decades ago. As a result, the drop in the debt-to-GDP ratio over the last decade has brought the latest levels modestly below a trend line fitted to the uptrend seen in the 1970s, 1980s, and 1990s.
In short, household balance sheets are remarkably healthy, a verdict further underscored by the benchmark revisions to GDP published in July, which included a massive upward adjustment to the household savings rate over the past few years. While borrowing costs are rising as the Fed normalizes monetary policy, households in the aggregate are far from being overburdened with debt and should have the wherewithal, especially given the vigor of labor demand and an uptick in wage gains, to continue spending at a solid clip for the foreseeable future.
Corporate balance sheets
It has been well-documented, including by our team (Rising risk from BBBs) that there appear to be pockets of overleverage in the corporate universe. The proportion of ‘BBB’ credit in the investment grade corporate bond universe is unusually high, and in a number of high-profile cases, leverage ratios for some of these ‘BBB’ firms seem to be too high to justify their current ratings based on historical ratings metrics.
Even so, the Federal Reserve data show that in the aggregate, corporate balance sheets do not point to signs of extreme stress (Exhibit 2). Indeed, the data show that nonfinancial corporations’ debt-to-net-worth has been remarkably steady throughout the decade and certainly do not illustrate the sort of run-up that occurred, for example, in the 1980s.
Exhibit 2: Nonfinancial corporate debt to net worth ratio
For unincorporated businesses, the debt situation is arguably even better. It is well-documented that small businesses suffered through a fierce credit squeeze during and in the years after the 2008 financial crisis. Many small businesses traditionally used credit cards or home equity lines to fund their operations, a tactic that became far more difficult with the sharp tightening in credit standards seen in the aftermath of the crisis Thus, debt-to-net-worth for unincorporated nonfinancial businesses spiked during the downturn (probably due mostly to plunging net worth) but has been falling ever since, and in recent quarters is approaching the readings seen in the 1980s and 1990s (Exhibit 3).
Exhibit 3: Nonfinancial noncorporate business debt to net worth ratio
As with the household sector, there appears to be a long-term uptrend in this series, as small businesses have greater access to various forms of credit than they may have had decades ago, when a bank loan was probably their main or only avenue for borrowing. In that context, the slide in the debt ratio since 2010 has taken the measure to or potentially even below the trend line going back to 1970.
These data are also consistent with the NFIB monthly small business survey responses, which suggest that small businesses are doing extraordinarily well and that very few of them are having difficulty accessing credit.
Any time that an expansion reaches the age that the current one has, it is a good idea to be on heightened alert for the appearance of the sort of imbalances that have led to downturns in the past. One candidate would be overleveraged households or businesses. The aggregate data suggest that households are in unusually good shape for such an extended expansion, likely reflecting a more cautious approach to borrowing in the wake of the 2008 crisis. The situation for businesses is not quite as unambiguously favorable, but there are also no obvious signs of widespread stress, which suggests that the prevalence of BBB debt and high leverage that has followed in the case of several high-profile acquisitions may not be broadly indicative of the overall business debt picture.