U.S. Economic and Credit Trends in Q4 and Beyond
In November 2018, Equifax and Moody’s Analytics joined forces to recap the economic and credit trends of 2018 and look ahead to next year. After the webinar, Cris deRitis of Moody’s Analytics responded to participant questions. Here is an excerpt from that exchange.
Question: You indicated that the South is most impacted by tariffs. Can you discuss further which industries are impacted by tariffs, and how that shakes out regionally? Are there any signs that some threats of tariffs are more or less likely to materialize, or that any particular tariffs would be more impactful than others?
Answer: The tariffs with China will impact US businesses both directly and indirectly. The direct impact will be felt by key US exporters to China: agriculture, aircraft, petrochemicals and seafood. Regionally, the Midwest and South will be hit hardest due to the large concentration of producers of soybeans and other agricultural commodities, as well as petroleum and chemicals. The Northwest around Seattle is hit disproportionately due to aircraft exports from Boeing.
The biggest threat is simply an escalation of current tariff policies, which could see tariffs expand on additional goods at higher rates.
The indirect impact of tariffs will also be a negative, given that over half of Chinese imports into the US are either capital goods or intermediate goods used by US manufacturers in the production of final goods. US consumers will face higher prices reducing their real income.
Question: How would foreign governments or corporations or households cause a recession here in the US?
Answer: I believe this question refers to the chart comparing debt to GDP ratios for US government debt, household debt and business debt. Typically, a recession requires two conditions: an overheating of the economy in some capacity leading to increased wage or price inflation and a structural imbalance where over-investment or mal-investment leads to instability and weakness. The labor market data suggests that the economy may be starting to overheat — although there is some debate about the magnitude — and the leverage data suggests that businesses and in particular highly leveraged businesses may be unable to make their payments if interest rates should rise and the economy softens. That said, the US is integrated with the global economy so a slowdown in Europe or Asia would certainly be felt by US businesses and consumers.
At this point in the US business cycle, the global economy would need to fall dramatically to induce a recession.
Question: Do you believe that the housing market will begin to slow in regards to overall appreciation? Are we looking at a small housing bubble, without the ARMs (Adjustable Rate Mortgages)?
Answer: The Moody’s Analytics forecast does call for continued moderation in housing activity over the next couple of years. Rising interest rates will continue to pressure affordability. The lack of homes available for sale has put upward pressure on home prices over the past few years, but more recent data suggests that buyers, as well as sellers, are turning cautious. Until the uncertainty surrounding trade, interest rates and future economic growth subsides, price growth is likely to slow.
Question: Are Fintech lenders over leveraging the balance sheets of small business? How big of a risk to the economy is small business?
Answer: This is a great question that is difficult to answer, given inconsistency in the reporting of small business debt across the industry. In aggregate, Fintech lending remains a small share of total outstanding credit, suggesting the likelihood that it could cause a systemic problem is low. However, it may be more prevalent in certain industries or geographies, which could create higher risk. It’s clearly an important issue. Both Moody’s and Equifax continue to explore datasets and systems that may be able to provide more insight.
Question: As the recession looms on the horizon, from a lending point, what types of loans or credits do you see being most volatile — or subject to default in the next two to five years?
Answer: Moody’s Analytics views business loans, and in particular “leveraged lending” loans to companies which are already in debt, as posing the highest risk. Contractual provisions that protect lenders in the event a business defaults have also weakened over the past few years with the rise of so-called “covenant light” lending contracts. Given our projections for rising interest rates and a slowing economy, these companies will be at a higher risk of default.
On the consumer side, we are concerned by some of the expanded subprime lending in auto and credit card — particularly private label credit card — portfolios.
However, recent tightening of lending standards and improvements in delinquency rates should prevent the risk of these portfolios from spilling over.
Question: Can the negative effect of high student loan affect younger consumers’ ability to obtain necessary credits from other sources? What would be the impact of that for economic outlook?
Answer: High student loan balances can impact the ability of consumers to access credit, whether it’s to buy a home, buy a car or start a business. This barrier to credit is likely a larger drag on economic growth than the potential for many borrowers to default on their student loans. Delayed car and home buying can slow economic activity. New business formations are at a multi-decade low — a troubling sign for potential future growth. Unfortunately, there are no easy solutions to the current trends. Income-based repayment plans are helpful for cushioning and spreading out the impact over time, but they fail to address the fundamental problem of the debt balance itself.
Question: With the lower demand for refinance due to existing low first mortgage rates, do you see that pushing equity line/loan borrowing up?
Answer: Yes, we do expect to see slow and steady growth in home equity lending (both lines and loans) as homeowners’ equity continues to grow. The pace of growth is likely to remain moderate given memories of the previous downturn and change in rules and standards that may make these lending products more costly. To the extent that existing homeowners are unable to find houses to “move up” to, they may prefer to stay where they are and remodel their existing properties. This will add additional demand for home equity products.
Question: Can you speak more about wealth inequality and how it decreases demand for credit?
Answer: Consumers who have experienced large increases in their real estate and/or financial wealth may wish to extract some of the gains through the use of credit. Borrowing against housing wealth with a HELOC is one example.
To the extent that the growth in wealth is concentrated in a small segment of the population, the number of opportunities for lending may be more limited than if the gains in wealth were more wide spread.
A counterargument is that those without wealth gains may have even higher demand for credit in order to bridge the gap. Whether or not lenders will provide this unsecured lending will depend on their view of borrowers’ future income prospects. The type of credit provided to these two groups will vary significantly.
To replay the entire webinar, visit US Economic and Credit Trends.
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