Falling Delinquency Rates Point To Additional Economic Stability


We believe that the current downtrend in US loan delinqu ency rates will remain in place, which is positive for both the stability of the banking sector and the economic recovery over the coming quarters. W hile the aggregate figure for commercial delinquencies rates remains high compared to previous economic recoveries, the data is slightly skewed by the residential and commercial real estate sectors, disguising the sharp improvement in the consumer and business loan segments. Moreover, we believe that we are past the worst in terms of the real estate sector, and this, combined with other positive dynamics, should help push the aggregate delinquency rate lower. This implies a more stable banking sector going forward, and potential fo r an uptick in loan growth , which would bode well for the economic recovery.

Right Direction, But Still High
US - Delinquency Rates On Loans From All Commercial Banks (%)

Real Estate Remains A Troubled Area

The overall delinquency rate on all loans from commercial banks currently stands at 5 % - around levels seen in the early 1990s - and marginally down from a peak of 7.5% in 2010 . However, the overall number is being skewed to the upside by the real estate sector, which still has a high delinquency rate. T he delinquency rate on single-family residential mortgages has remained stubbornly high around the 10-11% level, while the rate on commercial real estate loans remains at a still- high, but less troublesome 5%. A t US$3.5trn, loans to the real estate sector are still the largest single component of commercial bank loans - commercial and i ndustrial lending accounts for about US$1.5trn, while consumer loans account for about another US$1.1trn - but we believe that the worst is behind us for the real estate sector , as a combination of positive dynamics come together , which should help delinquency rates fall further .

Residential Delinquencies Remain Stubbornly High
US - Delinquency Rates (%)

First, the growth outlook will continue to improve and we forecast an acceleration in GDP growth to 2.3% in 2013 from 2.0% in 2012. Second, interest rates and mortgage rates will continue to be held down at record lows by the Fed, and this will allow for the take up of new loans as well as the refinancing of older ones. Third, the housing market is slowly improving with house prices rising in recent months according to the Case-Schiller house price index, which should help household, corporate and banks' balance sheets. Moreover, residential construction expanded in 2012, the first time in five years, and our Infrastructure team forecast this trend to remain in place in 2013. Finally, real disposable income and employment continue to slowly improve, which should improve households' cash flow s and their ability to repay loans.

Business, Consumer & Credit Card Delinquencies At Low Levels
US - Delinquency Rates (%)

Other Areas Remain Benign

In contrast to the real estate sector, delinquencies on business and consumer loans have fallen to record lows , and we do not believe that they will move much higher in the very near future. This in turn, should help the stability of the banking sector as the low level of default rates and smaller loan loss provisions , could help banks improve profitability. Indeed, delinquency rates on business loans of all commercial banks have fallen to 1.2%, levels not seen since 2007. Moreover, the delinquency rate on consumer loans ha s also fallen to the level of 2.8%, while those on credit card loans have fallen to a record low of 2.7% from over 6 .0 % at the peak of the crisis.

While delinquency rates could tick up slightly in the coming months, we do not envisage a larg e deterioration in the near term . First , with interest rates at extremely low levels, debt servicing costs remain extremely low for households as illustrated by the chart below, a trend we expect to remain in place. Second, as previously mentioned, record profits at the corporate level and rising incomes should ensure that the ability to service loans should remain high for companies and should continue to improve for households. Third, g overnment policy remains accommodative in terms of facilitatin g refinancing, which could offe r borrowers an alternative to outright default as a solution, should they find it difficult to repay their loans.

Household Debt Servicing Costs Remain Low Thanks To The Fed
US - Debt Servicing Costs

Key Risks To Outlook

Although we have painted a positive outlook for the delinquency rates, there are significant risks . First, given the large aggregate amount of, and delinquency rates on residential loans, any deterioration in the sector , or a rapid deceleration in economic growth could have a significant negative impact on the banking sector. Indeed, to some degree, the quality of real estate assets sitting on banks ' balance sheets is still very much un known , while the value of future write-downs and losses owing to ongoing settlements also remain s unclear. Finally, although one would assume that banks would have been conservative in their lending practices , some of the data does not fully support this argument. Indeed, the w eighted- a verage r isk r ating by s ize of l oan (above U S $10,000 ) stands at 2.8 , which is the same level seen in the run up to the crisis. Furthermore, the total value of loans by size of loans (above US$10,000) for all commercial banks remains around lev els seen just before the crisis ( but much lower than levels registered in the 1990s ) . As such, we will continue to monitor these factors for any signs of deterioration.

This article is tagged to:
Sector: Country Risk
Geography: United States