Board of Governors of the Federal Reserve System

2. Borrowing by Businesses and Households

Vulnerabilities from business and household debt remained moderate

Households and businesses continued to improve their financial condition, on net, reducing outstanding debts relative to GDP. Business debt-to-GDP and gross leverage of public corporations remained at levels near the top of their respective historical ranges but significantly lower than record highs seen at the onset of the pandemic. Interest coverage ratios (ICRs)—defined as the ratio of earnings before interest and tax to interest expense—remained flat at a level that pointed to robust debt-servicing capacity, reflecting resilient earnings. In addition, the prevalence of fixed-rate borrowing among many businesses has attenuated the effect of higher interest rates on debt-servicing costs.

The household debt-to-GDP ratio continued to decline, while the aggregate household debt service ratio remained flat. Homeowners have solid equity cushions, and many households continued to benefit from lower interest rate payments associated with refinancing or home purchases several years ago. That said, some borrowers continued to be financially stretched, and auto loan and credit card delinquencies for nonprime borrowers increased. While balance sheets in the nonfinancial business and household sectors remained sound, a sharp downturn in economic activity would depress business earnings and household incomes and could reduce the debt-servicing capacity of smaller, riskier businesses with already low ICRs as well as particularly financially stretched households.

Table 2.1 shows the amounts outstanding and recent historical growth rates of different forms of debt owed by nonfinancial businesses and households as of the fourth quarter of 2023. The overall debt-to-GDP ratio declined further and now stands somewhat below the level prevailing over the past decade (figure 2.1). This gradual decline of the debt-to-GDP ratio is due to slower growth in combined total nonfinancial debt relative to the growth rate of nominal GDP over the past three years. Taken separately, both the household and business debt-to-GDP ratios decreased, in line with the decline in the overall debt-to-GDP ratio (figure 2.2).

Table 2.1. Outstanding amounts of nonfinancial business and household credit

Business debt vulnerabilities remain moderate relative to historical levels

Nonfinancial business debt adjusted for inflation declined over the past year (figure 2.3), and net issuance of risky debt—defined as the difference between issuance of speculative-grade bonds, unrated bonds, and leveraged loans minus retirements and repayments—was negative in the fourth quarter of 2023 and subdued in the first quarter of 2024 (figure 2.4). Similarly, the net issuance of institutional leveraged loans has been tepid for much of the past year.

Gross leverage—the ratio of debt to assets—of all publicly traded nonfinancial firms edged down slightly in the third quarter of 2023 but stayed high by historical standards (figure 2.5). Net leverage—the ratio of debt less cash to total assets—also inched down among all large publicly traded businesses, although it remained at an elevated level. Overall, firms remained well placed to service their debt, despite some emerging signs of weakness among riskier firms. After declining from its peak reached post-pandemic, the median ICR stayed largely flat through the first three quarters of 2023 owing to resilient earnings (figure 2.6). In addition, the pass-through of higher interest rates to firms' borrowing costs remained moderate, reflecting record fixed-rate debt issuance by firms during the pandemic when interest rates were low.³ Corporate earnings remained strong through the first three quarters of 2023.

However, signs of stress in debt servicing and deterioration in credit quality continued to emerge. For example, the 12-month trailing corporate bond default rate moved up further, on net, since the October report and stood near the median of its historical distribution. Expectations of year-ahead defaults remained somewhat elevated relative to their history.

Small and middle-market firms that are privately held—which have less access to capital markets and primarily borrow from banks, private credit and equity funds, and sophisticated investors (such as insurance companies and brokers, for example)—account for roughly 60 percent of outstanding U.S. debt. While data for these firms are not as comprehensive as those for larger firms, vulnerabilities for these firms appeared to inch up throughout the second half of 2023 as higher interest rates started to reduce earnings and raise the cost of debt servicing. Although subdued by historical standards, median gross and net leverage of small firms and businesses continued to increase into the fourth quarter of 2023. The ICR for the median firm in this category continued to decline from its peak in 2022, falling notably in the fourth quarter of 2023, but remained above pre-pandemic levels.

The credit quality of outstanding and newly issued leveraged loans has shown continued signs of deterioration over the past several quarters. ICRs on outstanding leveraged loans declined in the third quarter of 2023 and more recent high-frequency data suggest that rating downgrades continued to outpace upgrades. Meanwhile, the default rate remained around its historical median (figure 2.7). The share of newly issued loans to large corporations with debt multiples—defined as the ratio of debt to earnings before interest, taxes, depreciation, and amortization—greater than 4 fell in 2023 to its lowest level in the past decade, reflecting a waning willingness of investors to tolerate additional leverage, and only modestly rebounded in the first quarter of 2024 (figure 2.8).

Delinquencies at small businesses edged up

Interest rates on small business loans ticked down in the most recent data but remained at high levels overall—near the top of the range observed since 2008. According to the National Federation of Independent Business Small Business Economic Trends Survey, the share of firms that borrow regularly dropped somewhat and stayed in the lower range of its historical distribution in February 2024.⁴ Credit availability appeared to tighten for small firms in recent months. Data from the Small Business Lending Survey showed that banks continued to tighten standards on small businesses.⁵ However, measures of small business loan originations were stable and the share of firms with unmet financing needs remained unchanged at a low level as of February 2024. Small business credit quality has deteriorated in recent quarters, as longer-term delinquency rates rose from their historic lows to above their pre-pandemic levels.

Vulnerabilities from household debt remained moderate

Outstanding household debt adjusted for inflation increased marginally in the fourth quarter of 2023, due to slight increases in the prime and subprime categories (figure 2.9). Since the October report, the ratio of total required household debt payments to total disposable income (the household debt service ratio) decreased a touch and remained at modest levels. As most household debt carries fixed interest rates, the increase in interest rates starting in early 2022 has only partially passed through to household interest expenses.

Mortgage credit risk remained generally low

Mortgage debt, which accounts for roughly two-thirds of total household debt, grew more slowly than GDP over the past two quarters. An estimate of housing leverage, which measures home values as a function of rents and other market fundamentals, increased modestly but remained significantly lower than its peak levels before 2008 (figure 2.10, black line). The overall mortgage delinquency rate increased only marginally in the fourth quarter of 2023, continuing to tick up from the historically low levels reached in 2021, while the share of mortgage balances in loss-mitigation programs ticked down from already low levels (figure 2.11). Delinquency rates have been held in check by large home equity cushions and strong underwriting standards (figure 2.12).

New mortgage extensions, which have been skewed heavily toward prime borrowers over the past decade, continued to decline sharply in 2023 amid elevated mortgage rates and high housing prices (figure 2.13). In the second quarter of 2023, the early payment delinquency rate—the share of balances becoming delinquent within one year of mortgage origination—continued to rise from its 2020 low, possibly reflecting higher interest expenses and the corresponding financial strains on newly originated mortgages.

Credit risk of consumer debt edged up with some signs of stress among borrowers with low credit scores

Consumer debt—which accounts for the remaining one-third of household debt and consists primarily of student, auto, and credit card loans—edged down in real terms since the last report (figure 2.14) and, in nominal terms, increased at a slower pace than nominal GDP. However, delinquency rates for auto loans and credit cards increased, particularly among borrowers with lower credit scores.

Real auto loan balances ticked up for prime and subprime borrowers but declined modestly for near-prime borrowers (figure 2.15). Overall, total real auto loan balances remained below pandemic highs. The share of auto loans in mitigation—that is, when the lender offers relief or repayment options to a borrower struggling to keep up their loan payments—ticked down in the fourth quarter of 2023. That said, this share increased modestly over the past several quarters and currently stands roughly in line with its historical median. The share of auto loans in delinquent status increased somewhat—although the upward trend has moderated recently—and stayed at a level above its historical median (figure 2.16). Behind this moderate increase in the overall delinquency rate was a much sharper rise in auto loan delinquencies for subprime borrowers throughout 2023.

Aggregate real credit card balances continued to increase over the second half of the year, with broad-based increases across the credit score distribution (figure 2.17). As interest rates on credit card balances are flexible, they increased in line with short-term rates over the past year. Credit card delinquency rates have continued to rise over the same period (figure 2.18).

After rising rapidly for more than a decade, inflation-adjusted student loan debt began to decline with the onset of the pandemic and has continued to do so through the end of 2023.

 

References

 3. Only about 6 percent of outstanding bonds rated triple-B and 2 percent of outstanding high-yield bonds are due within a year—that is, up to the first quarter of 2025. Return to text

 4. This survey's data are available on the National Federation of Independent Business's website at https://www.nfib.com/surveys/small-business-economic-trends. Return to text

 5. This survey's data are available on the Federal Reserve Bank of Kansas City's website at https://www.kansascityfed.org/surveys/small-business-lending-survey. Return to text