One of the outcomes of the Great Recession has been the extent of household and corporate deleveraging. However, the stock of outright debt remains at record highs; debt reduction on an outright basis has not occurred in any meaningful way. Rather, it is the recovery in asset prices that has fueled the improvement in debt ratios.
Data from the Federal Reserve’s Flow of Funds report for Q1 2014 highlight the extent to which the balance sheets of household and companies alike are susceptible to any re-pricing in assets—particularly equities and real estate—two categories that have rallied meaningfully from recession troughs. Such concern may be increasingly warranted as the timing of the Federal Reserve’s first rate hike comes into view.
Despite the rebound in property values and the growth in overall debt, mortgage financing has continued to retreat. While the stock of home mortgage liabilities has been on the decline, the total level of commercial mortgage debt has risen (albeit modestly) for the last five quarters.
Chart 1 illustrates credit market borrowing by major issuer type, showing that the domestic non-financial sector—which includes non-financial corporate businesses, households and government entities—represented more than 70% of the almost $60 trillion in total borrowing at the end of Q1 2014. While the total level of debt fell for five consecutive quarters following Q1 2009’s $53.9 trillion peak, the level of debt has steadily risen since Q2 2010, growing at an annualized rate of 3.4% in the most recent quarter.
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Chart 1. Total Credit Market Debt Owed in the U.S. by Major Issuer, Not Seasonally Adjusted
Consumer credit has been responsible for the growth of debt in the household sector (Chart 2). Household consumer credit contracted in 2009 and 2010, but in the subsequent three years, grew at annual rates of 4.1% (2011), 6.2% (2012) and 5.9% (2013), and rose by an annualized 6.6% in Q1 2014 to $3.1 trillion.
Chart 2. Households: Composition of Liabilities, Not Seasonally-Adjusted
Similarly, debt stocks have risen for the non-financial corporate sector as well as the financial sector (Chart 3 and Chart 4). Not surprisingly, companies have taken advantage of the low level of interest rates that have resulted from the Federal Reserve’s quantitative easing policy to add long-term debt on a precautionary basis.
Chart 3. Non-Financial Corporate Business: Total Liabilities, Not Seasonally Adjusted
Chart 4. Financial Business: Total Liabilities, Not Seasonally Adjusted
Despite the rise in overall debt stocks, debt ratios have been improving, however. While borrowing has increased, asset values have increased even more, with the resulting effect that the level of indebtedness relative to net worth has fallen (Chart 5).
Chart 5. Debt to Net Worth by Sector, Not Seasonally Adjusted
The increase in net worth has come, not surprisingly, from the rebound in real estate and equity values (Chart 6 and Charts 7a and 7b).
Chart 6: Market Value of Real Estate Assets by Sector, Not Seasonally Adjusted
Charts 7a and 7b. Holding Gains on Select Assets at Market Value, Not Seasonally Adjusted
Even with the repair in household and corporate balance sheets, however, mortgage debt outstanding has yet to reach pre-recession levels. Home mortgage debt has steadily declined (Chart 8), even as charge-offs, which totaled $239 billion in 2009 and another $580 billion in 2010-2013, fell to a relatively small annualized rate of $4.3 billion in Q1 2014.
Chart 8. Households: Home Mortgage Debt, Level and Percentage of Total Liabilities
In contrast, commercial mortgage debt has begun to increase slowly, having risen since Q1 2013 (Chart 9). While the composition of holders by sector is largely unchanged from late 2008—when commercial mortgage debt was at its peak—the 3.4% increase in the stock of commercial mortgage debt over the last year stands in contrast to the -0.9% decline in home mortgage debt over the same period.
Chart 9: Commercial Mortgage Debt by Owner, Not Seasonally Adjusted
While sustained upward pressure on real estate values and downward pressure on interest rates remains somewhat of a wildcard over the next 12-24 months, we expect that the growth rate of commercial mortgages will continue to exceed that of residential mortgages. Even with the rebound in property prices, delinquency rates for residential properties are still very elevated, while the same rates on commercial properties are almost back to pre-recession levels (Chart 10).
Chart 10: Delinquency Rates of the Top 100 Commercial Banks, by Property Type, Seasonally Adjusted