Board of Governors of the Federal Reserve System

2. Borrowing by businesses and households

Business-sector debt relative to GDP is historically high amid weak credit standards, whereas debt owed by households remains at a modest level relative to incomes

On balance, vulnerabilities arising from total private-sector credit are at moderate levels. Business debt levels are high compared with either business assets or GDP, with the riskiest firms accounting for most of the increase in debt in recent years. By contrast, household borrowing has advanced more slowly than economic activity and has been heavily concentrated among borrowers with high credit scores.

Table 2 shows the current volume and recent historical growth rates of forms of debt owed by nonfinancial businesses and households. Total outstanding private credit is split equally among businesses and households, with each owing close to $16 trillion.

Table 2. Outstanding Amounts of Business and Household Credit

Total private credit has advanced roughly in line with economic activity...

Over the past several years, total debt owed by businesses and households expanded at a pace similar to that of nominal GDP. As a result, the nonfinancial-sector credit-to-GDP ratio has been broadly stable, similar to its level in mid-2005, the period preceding the most rapid credit growth from 2006 to 2007 (figure 2-1).

Figure 2-2 shows the credit-to-GDP ratio separately for the household and nonfinancial business sectors (leverage of financial firms is discussed in the next section). Before the crisis, household debt relative to GDP rose steadily to levels far above historical trends. After the crisis, the household debt-to-GDP ratio fell sharply and has leveled off since then. Business borrowing tends to track the economic cycle more closely. After the crisis, the business debt-to-GDP ratio also fell but has expanded significantly over the past several years and is now near its historical high.

. . . but debt owed by businesses is historically high, and risky debt issuance has remained robust

Having grown faster than GDP through most of the current expansion, total business-sector debt relative to GDP is historically high. Furthermore, growth of this debt remained strong and was above the growth rate of economic output in the first half of 2019 (figure 2-3). The net issuance of riskier forms of business debt—high-yield bonds and institutional leveraged loans—shows some variation in recent quarters but has remained robust, overall, in 2019 (figure 2.4).

In addition, about half of investment-grade debt outstanding is currently rated in the lowest category of the investment-grade range (triple-B)—near an all-time high. The volume of debt downgraded from investment grade to speculative grade in 2019 has been close to the average over the past five years. However, in an economic downturn, widespread downgrades of bonds to speculative-grade ratings could lead investors to sell the downgraded bonds rapidly, increasing market illiquidity and downward price pressures in a segment of the corporate bond market known already to exhibit relatively low liquidity.⁸

Moreover, credit standards for some business loans remain weak...

In line with the discussion of price terms and risk appetite in section 1, demand for institutional leveraged loans has remained strong and credit standards have remained weak. The share of newly issued loans to large corporations with high leverage—defined as those with ratios of debt to earnings before interest, taxes, depreciation, and amortization greater than 6—exceeds previous peak levels observed in 2007 and 2014 when underwriting quality was poor (figure 2-5). Incoming data point to continued strong issuance of leveraged loans in the third quarter of 2019. However, the credit performance of leveraged loans has been solid so far, with low default rates (figure 2-6).

. . . and balance sheet leverage of businesses is near its highest level over the past two decades

A broad indicator of the leverage of businesses—the ratio of debt to assets for all publicly traded nonfinancial firms—is at its highest level in 20 years (figure 2-7).⁹ Moreover, the leverage ratio among highly leveraged firms—defined as firms above the 75th percentile of the leverage distribution—is close to a historical high. Despite high balance sheet leverage, historically low interest rates have contributed to keeping the ratio of corporate earnings to interest expenses high for the median firm and near the historical median for riskier firms, which are those in the bottom 25th percentile of the distribution of this ratio (figure 2-8).

Borrowing by households, however, has risen in line with incomes and is concentrated among borrowers with low credit risk

Household debt continues to expand in line with income, but debt owed by households with prime ratings accounts for most of the growth. Loan balances owed by borrowers with a prime credit score, who account for about one-half of all borrowers and about two-thirds of all balances, continued to grow in the first half of 2019, surpassing pre-crisis levels (after an adjustment for general price inflation). By contrast, inflation-adjusted loan balances for the remaining one-half of borrowers with near-prime and subprime credit scores have changed little since 2014 (figure 2-9).

Credit risk of outstanding mortgages remains generally low...

Mortgage debt accounts for roughly two-thirds of total household credit. New mortgage extensions remain skewed toward prime borrowers, consistent with the general shift in the composition of household debt toward less-risky borrowers and in line with stronger underwriting standards relative to the mid-2000s (figure 2-10). Mortgage loan performance has been solid, resulting in low credit losses for lenders. An early indicator of payment difficulties is the rate at which existing mortgages transition into delinquency, and this rate has been low for several years among borrowers with prime and nonprime credit scores and for loans in programs offered by the Federal Housing Administration and the U.S. Department of Veterans Affairs (figure 2-11). Delinquency rates for newly originated mortgages, a gauge of recent underwriting standards, have been low as well. In addition, the ratio of outstanding mortgage debt to home values is now at the level seen in the relatively calm housing market of the late 1990s, suggesting that home mortgages are currently backed by sufficient collateral, thus providing lenders with protection against credit losses (figure 2-12). Also, the share of outstanding mortgages with negative equity—mortgages where the amount owed on a property exceeds its underlying value—has continued to edge down (figure 2-13).

. . . although some households are struggling to manage their debt

The remaining one-third of total debt owed by households, commonly referred to as consumer credit, consists mainly of student loans, auto loans, and credit card debt (figure 2-14). Table 2 shows that consumer credit rose 5 percent over the year ending in the first quarter of 2019 and currently stands at about $4 trillion.

Household balances on student loans continued their upward trajectory in the first half of 2019. Delinquency rates on those loans remain high relative to historical standards, although they have been, on balance, moving sideways in recent years. Although the risks posed to the broader financial system appear limited, as the majority of student loans were issued through government programs, the elevated student loan balances and delinquency rates highlight the challenges associated with debt payments some households continue to face.

Auto loan balances continued to expand moderately (in real terms) through the first half of 2019, but all of that growth accrued to households with prime credit scores (figure 2-15). Despite the economic expansion and low interest rates, delinquency rates for auto loans to subprime borrowers were on the rise for the past several years but have recently stabilized, albeit at a relatively high level (figure 2-16).

Household credit card accounts have also increased at a moderate pace this year and stand at about $1 trillion. Adjusted for inflation, credit card balances owed by borrowers with prime credit scores continue to rise modestly relative to balances owed by near-prime and subprime borrowers (figure 2-17). Moreover, the delinquency rate for subprime credit card debt appears to have flattened out recently at a level that is considerably lower than its average over the past 20 years (figure 2-18).

References

 8. The box "Vulnerabilities Associated with Elevated Business Debt" in the May 2019 report gives a fuller description of risks associated with downgrades of credit ratings. Return to text

 9. The dashed line in the series beginning in the first quarter of 2019 reflects a structural break due to a new accounting standard that requires operating leases, previously considered off-balance-sheet activities, to be included in measures of debt and assets. Return to text