The Debt BuKbble Is Beginning To Leak Air

by Dave Kranzler, Investment Research Dynamics:

“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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