“Recent economic data including June’s payroll report and retail sales appear to suggest the positive momentum in consumer spending which emerged in Q2 is carrying over to start Q3. This picture, however, seems at odds with the rise in consumer delinquencies we documented last month. What then explains this conundrum? Should investors conclude that recent consumer strength will lead to lower consumer delinquencies in coming quarters?” – UBS Evidence Lab

Last month Matthew Mish and Stephen Caprio at UBS put out a research report about why US consumer defaults are rising, a concerning developing trend that could do further damage down the road.

US Consumer – The $13 trillion Gorilla In The Room

The report concluded that looser lending standards by nonbank lenders and too much liquidity chasing fewer investment opportunities are two of the main driving factors in the broad-based increase in delinquency across consumer loan segments. Another significant contributing factor appears to be inequality, which is masking a growing fundamental divide between more and less stressed consumers.

This week Matthew Mish and Stephen Caprio took another look at the subject of stressed US consumers. The research is part of UBS’s Evidence Lab series, which draws upon survey data from 2,100 US adults along with data from other innovative sources.

US consumer defaults are on the rise

The proprietary Evidence Lab survey finds that the share of lower and middle-income consumers that have ‘strained’ finances (consumers are ‘strained’ if their monthly income barely covers or is below monthly expenses) remains near peak levels, comprising roughly 36% of all US consumers.

Why is Spending Not Keeping Up with Income? It Is Not Because Of Cautious Consumers

Further, the study finds that income-stressed households have average income and debt 22% below and 20% to 30% above non-stressed peers respectively. Middle-income consumers have similar average income but debt levels 10% to 40% higher.

US consumer
The US consumer is struggling

It also appears that the stressed US consumer has not benefited from rising asset prices. According to the answers given in UBS’s survey, only three in ten consumers seem to have benefited significantly from rising home prices while financial asset holdings are insignificant excluding retirement accounts.

Trouble ahead? 

Matthew Mish and Stephen Caprio’s research report presents a worrying overall picture of the US consumer as their findings indicate that a significant percentage of US consumers are in fact stressed.

Should Investors Be Worried About Consumer Borrowing?

UBS’s survey shows that 69% of households with an annual income below $40,000 a year can be classified as stressed. 41% of households with an income of $40,000 a year to $99,000 are considered stressed and 26% of households with an income of over $100,000 a year also meet the stressed criteria. In total, these cohorts comprise about 44% of the US consumer population.

us consumer 1
US consumers are struggling with higher levels of debt and lower incomes

As noted above, one of the findings of the survey is that stressed middle-income consumers have an average income 22% below non-stressed peers but debt levels 10% to 40% higher. Findings show that these higher debt levels are a result of higher credit card, auto and student loan debt. UBS:

“For lower income households, those stressed report considerably higher reliance on credit card, medical and student loan debt versus their peers, while the trends in usage have remained relatively stable since 2014. 37%, 28% and 22% of this cohort report utilizing such debt, respectively. Conversely, for middle-income households, those stressed report significantly higher usage of debt across loan types versus peers, with 44%, 42% and 28% carrying credit card (balances), auto and student loan debt, respectively. And the largest relative increases in debt have occurred in auto and student loans”.

Unfortunately, things only seem to be getting worse for the stressed US consumer. Since late 2014 about 30% of stressed consumers in the low-income bracket have characterised their finances as getting worse sequentially, while about 50% to 55% have noticed little change.

Household-wealth-debt-defaults45 Household-wealth-debt-defaults2

What’s Behind The Rise In Consumer Nonperforming Loans?

In the middle-income cohort of stressed consumers, since 2014 25% have consistently reported deteriorating finances, while the proportion citing stable finances has fallen from near 55% to just below 50%. The proportion noting improving finances has risen from 15%-20% to 25%.

What does all of this mean for the US economy? UBS explains:

“Our analysis of the consumer lending environment and stressed US consumer fundamentals seem to support the thesis that lending is extending to riskier consumers, while the finances of those consumers are not materially improving. The combination is likely to result in consumer delinquencies that will not fall in coming quarters, consistent with our broader thesis that the credit cycle will remain in the later innings as ebbing fears about a corporate earnings recession are offset by rising concerns over higher delinquencies and tighter credit availability and delinquencies. We expect higher defaults not only in the consumer (non – residential), but also in the C&I (ex-energy) sectors in coming quarters16 17. As such our credit-based recession gauge will likely continue to signal a 12-month forward recession probability of a US recession at or around its current level at 31%.”