"The current state of credit card delinquency flows can be an early indicator of future
trends and we will closely monitor the degree to which this uptick is predictive of
further consumer distress.” – New York Fed official in reference to rising delinquency rate of credit cards.
The
recent sell-off in junk bonds likely reflects a growing uneasiness in
the market with credit risk, where “credit risk” is defined as the
probability that a borrower will be able to make debt payments. This
past week SocGen’s macro strategist, Albert Edwards, issued a warning
that the falling prices of junk bonds might be “the key area of
vulnerability that could bring down the inflated pyramid scheme that the
Central Banks have created.”
The New York Fed released its quarterly report on household debt and credit for Q3 last week. The report showed a troubling rise in the delinquency rates for auto debt and mortgages. The graph to the right shows 90-day auto loan delinquencies by credit score. As you can see, the rate of delinquency for subprime borrowers (620 and below) is just under 10%.
This rate is nearly as high the peak delinquency rate for subprime auto debt at the peak of the great financial crisis. In fact, you can see in the chart that the rate of delinquency is rising for every credit profile. I find this fact quite troubling considering that we’re being told by the Fed and the White House that economic conditions continue to improve
While the Fed reports that 20% of the $1.2 trillion in
auto loans outstanding has been issued to subprime borrowers, there
tends to be a significant time-lag between when an individual’s credit
condition deteriorates and when the FICO score reflects that
deteriorated financial condition. I would argue that the true percentage
of subprime auto debt outstanding is likely over 30%. Bloomberg
reported last week that “delinquent subprime loans are nearing crisis
levels at auto finance companies.”Before the 2008 crisis, the
outstanding level of auto loans peaked in late 2005 at $825 billion. The
current level based on the most recent data is over $1.2 trillion, or
nearly 50% higher than the previous peak. More troubling, the average
loan balance, at close to $30,000, is substantially higher now.
Revolving
credit is now over $1 trillion. At $1.005 trillion, it’s slightly below
the previous peak of $1.020 trillion in April 2008. Most of the
revolving debt category as tracked by the Fed is credit card debt. The
Fed reports that 4.6% of credit card debt is 90-days delinquent, up from
4.2% in Q3. I would note that the Fed relies on reporting from banks
and consumer finance for the delinquency data. Accounting regulations
give banks a fairly wide window of discretion before a loan is
officially declared to be delinquent. Banks and consumer finance
companies tend to drag their feet before declaring a loan to be
delinquent because it directly affects quarterly earnings. I would bet
money that the true delinquency rate is higher than is being reported.
Mortgage delinquencies are now following the trend higher in auto, student and revolving loans:
The
data in the graph above is sourced from the Mortgage Bankers
Association (MBA). MBA data is lagged. again because of reporting
methodology and because banks under-report delinquencies. As such, the
true current rate of delinquency is likely higher. I drew the red line
to illustrate that, outside of the period from 2009 to 2014, the current
rate of delinquency is at the high end of the historical range going
back to 1979.
Let’s drill down a little deeper. The delinquency
rate for FHA mortgages soared to 9.4% in Q3 2017 from 7.94% in Q2. That
jump in the rate of delinquency is the highest quarterly increase in the
history of the MBA’s survey. Recall that the FHA began offering 3.5%
down-payment mortgages in 2008. Because of the minimal down payment
requirement, the FHA’s share of single-family home purchase mortgage
underwriting went from 3.9% 2007 to it current 17% share. In effect,
FHA replaced the underwriting void left by the bankrupt private-issuer
subprime lenders like Countrywide and Wash Mutual. It’s no surprise
that FHA paper is starting to collapse. Fannie and Freddie started
issuing 3% down-payment mortgages in early 2015. All three agencies
(FHA, FNM, FRE) reduced the amount of mortgage insurance required for
low down payment loans. Just in time for the FHA complex to start
cratering.
The reduction in mortgage qualification
standards was implemented by the Government in order to keep the homes
sales activity artificially stimulated. Do not overlook the fact that
the National Association of Realtors drops more magic money dust on
Congress than the Too Big To Fail Wall Street banks combined.
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Dave Kranzler spent many years working in various Wall Street jobs. After business school, he traded junk bonds for a large bank. He has an MBA from the University of Chicago, with a concentration in accounting and finance, and graduated Oberlin College with majors in Economics and English. Dave has nearly thirty years of experience in studying, researching, analyzing and investing in the financial markets. Currently he co-manages a precious metals and mining stock investment fund in Denver and publishes the Mining Stock and Short Seller Journals. Contact Dave at dkranzler62@gmail.com.
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The author is not affiliated with, endorsed or sponsored by Sprott Money Ltd. The views and opinions expressed in this material are those of the author or guest speaker, are subject to change and may not necessarily reflect the opinions of Sprott Money Ltd. Sprott Money does not guarantee the accuracy, completeness, timeliness and reliability of the information or any results from its use.
