U.K. Litigation Cases On Defaulted Consumer Debts Soar Beyond 2008 Levels

Last month, S&P warned that UK lenders could incur £30 billion of losses on their consumer lending portfolios consisting of credit cards, personal and auto loans if interest rates and unemployment rose sharply.  Much like in the U.S., S&P warned that "loose monetary policy, cheap central bank term funding schemes and benign economic conditions" had fueled an "unsustainable" yet massive expansion of consumer credit that will inevitably end badly.  Per The Guardian:

The rapid rise in UK consumer debt to £200bn from car finance, personal loans and credit cards is unsustainable at current growth rates and should raise “red flags” for the major lenders, ratings agency Standard & Poor’s has warned.

 

In detailed analysis of the sector, S&P warned that losses from this form of lending suffered by banks and other financial institutions could be “sharp and very sudden” in an economic downturn and may be exacerbated if the Bank of England increased interest rates.

 

It also warned that it could downgrade banks’ credit ratings if the high growth rate persisted or banks took on too much risk in this sector. But it did not fear any system-wide impact from consumer credit.

 

“Loose monetary policy, cheap central bank term funding schemes and benign economic conditions have supported consumer credit supply and demand,” S&P said.

 

Annual growth rates in UK consumer credit of 10% a year have outpaced household income growth, which is closer to 2%, and become a focus for the Bank which is scrutinising lenders’ approach to the sector.

 

“We believe the double-digit annual growth rate in UK consumer credit would be unsustainable if it continued at the same pace,” S&P said.

Now, new data surrounding the growing number of court filings related to the recovery of consumer debts highlights just how serious the personal leverage problem has become in the UK.  As the FT points out this morning, there have been over 900,000 court judgements on consumer debts in just the first 9 months of 2017, up 34% compared to the same period in 2016, compared to only 827,000 at  the height of the great recession in 2008.

Consumers who refuse to repay their debts are increasingly being taken to court, with litigation at levels last seen in the run-up to the 2007-08 financial crisis.

 

New figures show there were 910,345 county court judgments in the nine months to the end of September. This is an increase of 34 per cent per on the same period in 2016, and compares with 827,000 in the whole of 2008, at the onset of the financial crisis.

 

The rise in court judgments is another indication of the high levels of unsecured debt weighing on British consumers, with Bank of England data showing that borrowing through credit cards, overdrafts and car loans has topped £200bn for the first time since the global crisis.

 

Although UK unemployment is at all-time lows, growth in real incomes and the savings rate have both deteriorated in recent months, suggesting household finances are worsening. Many economists are predicting a slowdown in what has been robust consumer spending.

This should come as little surprise to our readers as we pointed out earlier this summer that the U.K. auto market had seemingly taken a page from U.S. subprime lenders by offering a brand new car, with no money down, to anyone who walks into a dealership with a pulse (see: Undercover Investigation Exposes Deteriorating Auto Lending Standards In Europe; No Job, No Problem) . As the Daily Mail pointed out, their undercover reporters visited a total of 22 dealerships and were repeatedly offered cars of various values with no money down and despite reporters admitting that they had no job and no source of income.

Reporters visited 22 dealerships in England and Scotland, saying they were in their early twenties and either unemployed, on low incomes or trying to buy a car despite having poor credit ratings. Half of the dealerships – including ones selling Audis, Mazdas, Suzukis, Fords, Vauxhalls and Seats – told them they could have a brand new car without paying a penny up front.

 

In each case they were offered Personal Contract Purchase (PCP) deals – a type of car loan that now makes up nine out of ten car sales bought on finance in Britain.

 

These deals offer smaller monthly payments than traditional car loans.

 

A reporter who said he was working part-time on the minimum wage was offered a £15,000 Seat Ibiza without a deposit at a Seat dealership in Manchester.  Another reporter suggested that he had bad credit, but he was offered an £8,600 Vauxhall Corsa in Birmingham.

 

Kevin Barker, 71, found himself £3,500 in debt when he suffered a heart attack six months into a PCP deal. He said a ‘pushy’ Toyota salesman ‘pressured’ him into taking out a 36-month agreement in November 2014 and he was not told of the repercussions if he fell ill or lost his job.

Of course, excessively levered household balance sheets work wonders for gaming GDP growth...that is, right up until the point that interest rates start to rise and those households realize their ability to "afford" their spending binge was nothing more than a temporary blip courtesy of accomodative interest rate policies...the reversal of which will now render many of them bankrupt.

Millennials Have Never Been More In Debt, And It Is Creating A Major Risk For The Economy

There is a seemingly unlimited number of disconnects in financial markets these days, not the least of which is the shocking divergence in recent years between the ever plunging unemployment rate in the United States and stubbornly rising delinquencies on consumer debt. In fact, according to a note published earlier today by UBS strategist Matthew Mish, that divergence continues to soar to all time highs with each passing month...but why?

As it turns out, the answer to the enigma above may just have something to do with the fact that, despite declining unemployment levels, wage growth remains completely non-existent at a time when consumer leverage, particularly in the form of student loans and auto debt extended to the most financially vulnerable cross sections of the American public, is soaring.  Let"s explore the data from UBS...

Per the charts below, when you break out rising consumer delinquencies into their individual buckets the catalyst for the trend above suddenly becomes more clear.  While delinquency rates on mortgages, HELOCs and credit cards are improving, or at least not deteriorating rapidly, delinquency rates on student loans and auto loans are a completely different story.

90-day delinquency rates on consumer loans are up 20bp to 7.61% Y/Y, led by deterioration in auto loans. Trends in recent loan vintages suggest a negative outlook on balance, but incremental deterioration is shifting from autos to credit cards and student loans. This is worrying as it indicates broader weakness in non-prime consumers.

For one, auto and credit card loan default rates bifurcated by credit quality (e.g., prime, subprime) continue to show sequential deterioration on average. This worsening performance in part can be explained by weaker underwriting standards and risk layering: i.e., higher loan-to-value ratios and longer loan terms. For example, negative equity was a contributing factor explaining home mortgage defaults, and is now one factor influencing rising auto loan delinquencies. Further, multiple interest rate hikes by the Federal Reserve have increased average interest rates in particular on new car loans from finance companies (from a low of 4.4% to 5.6% on 60m loans)) and for rates on credit card balances (from a low of 12.7% to 14.9%, Figure 5).

And who took on all those $40,000, 0%, 80-month loans all so they could drive around in a brand new BMW they couldn"t afford?  Well, if you guessed millennials in the lowest quintile of wages earners in the country then you"re absolutely right!  As Mish points out in Figure 7 below, the median debt-to-asset ratio for Americans under the age of 35 has surged over the past couple of decades from ~40% to a staggering 100%.

Second, aggregate consumer credit metrics mask substantial inequality across consumers. Leverage metrics, e.g., debt to assets, are at or near record levels for lower income and millennials, and the literature draws a clear linkage between lower savings and higher defaults. While interest coverage has improved, it is overstating consumer health. We do not believe these metrics are adjusting for inequality in individual income/ wealth, a decline in the US homeownership rate, and student loans in deferral status.

First we calculated median leverage levels based on debt to assets across income and age cohorts; for lower incomes (0-20, 20 – 40th percentile by income) and younger ages (less than 35, 35-44) the results suggest ratios are at or near record levels (Figures 6, 7). Median leverage measured by debt to incomes (DTI) are also at record levels for lower income households (0 – 40th %ile), while millennial (under 35) debt-to-income ratios are in-line with 2007 levels. Strikingly, DTI ratios for 3544yr olds are materially lower even though prior leverage metrics are near record levels, likely reflecting the reality that middle age households have deleveraged via mortgage debt defaults but now currently have low asset bases (Figures 8, 9).

So what does this all mean for future credit growth?  Apparently, absolutely nothing as UBS figures that banks will just continue with their reckless lending practices until something breaks.

Second, the supply side of credit to consumers is supported materially by federal credit support, primarily mortgage and student loans. We estimate roughly $825bn in net loan creation this cycle in mortgage and consumer-backed loans (2010 – 2017); however, the share of non-government backed loans has actually been negative to the tune of $677bn (vs. government backed loans at $1.5tn, Figure 21). The implication is consumer lending to a large extent is essentially on autopilot, with changes in loan standards likely to be inelastic and lagging severely any rise in delinquency rates.

Third, the supply of credit in consumer loans less impacted by government credit support (e.g., auto, credit card and personal loans) remains relatively accommodative. The rise in delinquency rates has triggered some tightening in underwriting standards (e.g., autos, credit cards), primarily from more conservative lenders including banks. But the magnitude of tightening has been modest (Figure 22) and competition has attracted new lenders to largely fill the void – e.g., in autos finance companies and credit unions13. And any stabilization in delinquency trends should support stable credit supply trends.

Conclusion, lenders will continue to bury their heads in the sand and ride the ponzi wave in student and auto loans until it once again blows up in their faces.

Seven Charts For Bullish Investors To Ignore

Wall Street still exudes widespread optimism that 2017 will provide another year of solid gains for stocks amid stable albeit unspectacular economic growth and only gentle interest rate rises. However, as The FT details, all is not well in reality, and the following seven charts will hearten investors of a more bearish persuasion...

After climbing to its highest in 3 years earlier in 2017, Citi’s Economic Surprise index — which gauges how well data come in better than expected — has sagged badly lately. In fact, this week saw the biggest drop in US Macro data in 6 years (after poor readings on job creation, inflation, housing starts and car sales)...

US corporate lending has also been unexpectedly weak, raising eyebrows among economists. Here is a chart from Goldman Sachs showing the growth of commercial and industrial loans has fallen sharply recently, while corporate debt servicing costs have been climbing to more normal levels reflecting rising indebtedness and the Federal Reserve’s interest rate increases. Goldman Sachs’s economists point out that debt servicing costs are likely to continue to rise, given the central bank’s plans to tighten monetary policy further.

Source: The FT

The consumer lending side is also looking less than ideal, with many households and individuals struggling with big student loans, credit card debt and car loans, after a period of anaemic wage growth. Signs of some stresses can be seen in the uptick in S&P/Experian’s bank card default rate.

Source: The FT

Even the default rate on high-quality “prime” loans edged up in the last quarter of 2016, according to the Mortgage Bankers Association.

Source: The FT

Meanwhile, one of the most accurate measures of looming recession risk is the bond market “yield curve” shaped by bonds of various maturities flattening or even inverting. The US yield curve is far from inverting, but it has flattened sharply again this year, after steepening following the US election in November. The difference between two and 10-year US Treasuries this week compressed below 100 basis points for the first time since November, and many analysts expect it to flatten further as the Fed keeps raising interest rates. As is clear from the chart below, bonds are tracking "real" economic data and stocks are tracking "soft" survey hope...

 

And focusing on equities, fading analyst optimism over US “small-caps” - smaller listed companies beyond blue-chip gauges like the S&P 500 - is another warning sign. Small-caps are the bedrock of corporate America, and were at the epicentre of the post-election “Trump trade”, because of their mainly domestic businesses that would be shielded from a stronger dollar, and high tax rates that the new president promised to slash. But the Russell 2000 small-caps index has been treading for most of 2017, and analysts have taken a chainsaw to their small-caps earnings forecasts.

Source: The FT

Lastly, the rancorous US political climate shows no signs of abating. Here is a chart of the Philadelphia Fed’s “partisan conflict” index, which tracks the degree of political disagreement among federal-level politicians by measuring the frequency of newspaper articles that report disagreements in any given month.

With the market priced for Trump policy perfection, one might want to look away from this chart before faith is entirely erased.

Just some things to ignore before you BTFD after today"s French Election.

"Who Hit The Brakes?" - Bank Loan Creation Suddenly Tumbles To Five Year Low

While the overall economy appears to be humming along, at least according to the Fed which on Wednesday is expected (with 100% certainty according to the market) to hike rates by 25bps for the second time in three months on concerns it has fallen behind the inflationary curve, with last week"s payrolls report providing some validation despite prevailing weakness within "hard data" in recent months offset by soaring "soft" sentiment reports, one area of material concern has emerged: a sudden collapse in loan growth in general, and the all important Commercial and Industrial Loan segment in particular, a drop which the WSJ recently dubbed an "ominous economic signal" and blamed policy uncertainty under Trump for the collapse in growth.

While the jury is out on whether Trump is at fault - after all the same Trump has managed to reportedly spark a historic "animal spirits" rally in the S&P, while prompting a record number of people to re-enter the labor force in the past two months -  here are facts: total loans and leases by U.S. commercial banks are currently rising at an annual pace of about 4.6%, based on weekly Fed data. That is down from a 6.4% pace for all of last year and peak rates of around 8% in mid-2016. This is the slowest pace of debt creation since the spring of 2014.

While the deceleration has been broad-based across business, real estate and consumer lending and, as the WSJ notes, "is at odds with the idea of a stronger economy and rising sentiment."

But the slowdown has been especially acute in the all important for growth Commercial and Industrial loan category, which after growing at a pace of 10% in the first half of 2016, has suddenly and unexpectedly tumbled to just 4.0% as of the latest week, nearly 50% lower than the 7% growth notched at the start of the year.  This was the lowest pace of loan growth since July of 2011.

There has been no definitive explanation for this sudden phenomenon, prompting the WSJ to inquire "who hit the brakes?" which is ironic because just as troubling as the big drop in C&I loans is the relentless grind lower in auto loans, which are likewise growing at a pace that is half what it was as recently as last September.

Two potential ideas have been put forth to explain the sharp slowdown: according to Barclays analyst Jason Goldberg it is possible that companies have shifted from the loan to the bond market, and are selling more bonds to lock in cheap financing before rates rise, while not encumbering assets with issuing unsecured debt. To be sure, corporate debt issuance in January soared by 43% from a year earlier, however the number may be misleading as it comes from a low base in the year-earlier period, when global markets were in turmoil.

The other, more troubling explanation is that either political uncertainty is causing companies and banks to put off big decisions until the outlook for trade and tax policy is clearer, or that consumer demand for loans has plunged, forcing a sharp slowing in loan demand, as the underlying economy suffering a steep slowdown perhaps on the back of surging interest rates. The lending slowdown began showing up clearly just before the election last year, which also coincided with the sharp jump in interest rates.

If it is uncertainty, and should it persist, caution on the part of lenders and borrowers could become a growing drag on the economy. Alternatively, if the slowdown is rate-dependent, any future Fed rate hikes will only further pressure loan growth: 3M Libor has continued its relentless rise higher, and with every passing day makes new 8 year highs.

At this pace, C&I loan growth may turn negative Y/Y within a few months, and since historically US economic growth has been a function of easy bank credit, should the recent drop not be arrested, it is likely that the Fed will have no choice but to reverse its tightening course in the very near future.

Goldman Had 600 Cash Equity Traders In 2000; It Now Has 2

For the dramatic impact of technology, and specifically trade automation from algo, quant and robotic trading  on today"s capital markets, look no further than Goldman"s cash equities trading floor at the firm"s headquarters which, according to the MIT Tech Review, employed 600 traders its height back in 2000, buying and selling stocks for Goldman"s institutional client clients. Today there are just two equity traders left.

Complex trading algorithms, some with machine-learning capabilities, first replaced trades where the price of what’s being sold was easy to determine on the market, including the stocks traded by Goldman’s old 600.

Call it the rise of the machines which we warned about over 8 years ago back in 2009, just after the peak of the financial crisis, which have led to the extinction of the cash equity trader job.

"Automated trading programs have taken over the rest of the work, supported by 200 computer engineers. Marty Chavez, the company’s deputy chief financial officer and former chief information officer, explained all this to attendees at a symposium on computing’s impact on economic activity held by Harvard’s Institute for Applied Computational Science last month."

It"s not just cash trading: according to Goldman"s next CFO, Marty Chavez, areas of trading like currencies and even parts of business lines like investment banking are moving in the same automated direction that equities have already traveled. As Tech Review adds, today, nearly 45 percent of trading is done electronically, according to Coalition, a U.K. firm that tracks the industry. In addition to back-office clerical workers, on Wall Street machines are replacing a lot of highly paid people, too.

Ironically, the age of trading automation, means that the big banks, like the rest of the economy, are increasingly seeing the same income spreads that mirror the broader economy.

Average compensation for staff in sales, trading, and research at the 12 largest global investment banks, of which Goldman is one, is $500,000 in salary and bonus, according to Coalition. Seventy-five percent of Wall Street compensation goes to these highly paid “front end” employees, says Amrit Shahani, head of research at Coalition.

According to Goldman"s most recent quarterly report, after sliding for the past few years, average banker comp rebounded to the highest in one year, reaching $338,576, still well below the levels attained in recent years.

As the MIT publication adds, for the highly paid who remain, there is a growing income spread that mirrors the broader economy, says Babson College professor Tom Davenport. “The pay of the average managing director at Goldman will probably get even bigger, as there are fewer lower-level people to share the profits with,” he says.

With time, even more highly paid jobs will be lost to automation:

Complex trading algorithms, some with machine-learning capabilities, first replaced trades where the price of what’s being sold was easy to determine on the market, including the stocks traded by Goldman’s old 600.

Now areas of trading like currencies and futures, which are not traded on a stock exchange like the New York Stock Exchange but rather have prices that fluctuate, are coming in for more automation as well. To execute these trades, algorithms are being designed to emulate as closely as possible what a human trader would do, explains Coalition’s Shahani.

After equities, the next distressed group appear to be FX traders, which is hardly surprising after the recent scandals rocking the cash and spot trading FX community, resulting in billions of settlements payments over rigged fixes and markets. Here, Goldman has already begun to automate currency trading, and has found consistently that four traders can be replaced by one computer engineer, Chavez said at the Harvard conference.

Stunningly, some 9,000 people, about one-third of Goldman’s staff, are computer engineers, Chavez said at the symposium.

And, after equity and FX traders, it will be the backbone of Wall Street: investment bankers themselves: "Next, Chavez said, will be the automation of investment banking tasks, work that traditionally has been focused on human skills like salesmanship and building relationships. Though those “rainmakers” won’t be replaced entirely, Goldman has already mapped 146 distinct steps taken in any initial public offering of stock, and many are “begging to be automated,” he said."

Needless to say, this is great news for Goldman, which says that reducing the number of investment bankers would be a great cost savings for the firm. Investment bankers working on corporate mergers and acquisitions at large banks like Goldman make on average $700,000 a year, according to Coalition, with most MDs and partners earning orders of magnitude more.

Chavez himself is an example of the rising role of technology at Goldman Sachs. It’s his expertise in risk that makes him suited to the task of CFO, a role more typically held by accountants, Chavez told analysts on a recent Goldman Sachs earnings call. “Everything we do is underpinned by math and a lot of software,” he told the Harvard audience in January.

Finally, for the most glaring example of how technology impact new Goldman product lines, consider that Goldman’s new consumer lending platform, Marcus, aimed at consolidation of credit card balances, is entirely run by software, with no human intervention, according to the CFO. It was nurtured like a small startup within the firm and launched in just 12 months, he said. It’s a model Goldman is continuing, housing groups in “bubbles,” some on the now-empty trading spaces in Goldman’s New York headquarters:

“Those 600 traders, there is a lot of space where they used to sit,” he said.

Of course, regular readers are well aware of the extinction of the carbon-based trader, seen nowhere better than on the trading floor of the legendary UBS trading floor, once upon a time the world"s biggest.

Before:

 And 8 year after, when all that"s left of the UBS trading floor, and the legacy of that version of Wall Street, is this.

Time To Panic In Australia

Submitted by Mike Shedlock via MishTalk.com,

Australians’ private debt has soared to 187 per cent of their income. Debt is up from about 70 per cent in the early 1990s.

The jobless rate rose for the second straight month in December to 5.8 per cent, and underemployment, the number of workers wanting more hours, is near an all-time high. Wage growth is the lowest on record.

Australia has one of the world’s biggest property bubbles. In some sections of the country, prices are already under severe price pressure. The entire country will soon face that problem, at least in my opinion.

The Financial Review reports There’s $1 trillion of Australian Mortgages and Some Now Worry of What’s Next

The Reserve Bank of Australia frequently seeks feedback on the health of the economy. It might want to call the debt counsellors soon.

Homeowners, consumers and property investors around Australia are making more calls to financial helplines as three warning signs back up the spike in demand: mortgage arrears are creeping up, lenders’ bad debt provisions have increased and personal insolvencies are near an all-time high.

“It’s steadily out of control — I don’t know of too many financial counselling services where demand doesn’t exceed supply,” said Fiona Guthrie, chief executive officer of Financial Counselling Australia, who says the biggest increase in calls is from people suffering mortgage stress. “There are more people who have got mortgages that they can’t afford to pay.”

Australia’s households are among the world’s most-indebted after bingeing on more than $1 trillion of mortgages amid a housing boom that’s fizzled out in parts of the country, but still roaring in Sydney and Melbourne.

RBA governor Philip Lowe places financial stability at the forefront of monetary policy.

The concerns are understandable. Australians’ private debt has soared to 187 per cent of their income, from about 70 per cent in the early 1990s, encouraged by low interest rates. In a November speech, Lowe said that while most households are managing these levels of debt, many feel they are closer to their borrowing capacity than they once were.

Knocking out the wind

“There’s so much household debt that a couple of rate hikes here would completely knock the wind out of the housing market, and a lot of people would be impacted by it,” said Gareth Aird, economist at Commonwealth Bank of Australia, the nation’s largest lender. That’s partly why he doesn’t think the RBA will lift rates until 2018 at the earliest.

Lenders are watching these indicators as closely as the RBA. After a seven year bull-run, annual cash earnings at Australia’s big four banks fell last year for the first time since the financial crisis, said PricewaterhouseCoopers. At the same time, their bad debt expenses – which encompass both business and consumer lending – jumped 39 per cent to $5.1 billion, the highest since 2012.

But the hardest indicator to track may be borrowers worried about making their next repayment. Counsellors at the National Debt Helpline deal with such problems and are now even getting calls from property investors, said Guthrie. In the last quarter of 2016, phone calls to the service jumped 12 per cent on the previous year to an average 11,079 per month, she said. That’s double the rate of increase of the same period a year earlier.

Time to panic?

It’s not time to panic. Banks’ losses still remain small by historical standards and are largely confined to mining areas, according to PwC. Some 77 per cent of customers at Commonwealth Bank were ahead on their mortgage payments as at June; the lender is likely to update those figures next week. The RBA also noted in November that borrowers have set aside funds tied to their mortgages equivalent to 17 per cent of outstanding balances.

Key Phrase: “Not Time To Panic”

When credit stress starts, and central banks and media analysts say "it"s not time to panic", it"s likely a fine time to panic.

— Mike Mish Shedlock (@MishGEA) February 8, 2017

The #1 rule of panic is simple: Panic before everyone else does.

Those thinking of buying a house in Australia now are out of their freaking minds. Yes, I have been saying this for quite some time. And many can point to profits. But those profits are all on paper. Try selling. It’s impossible for everyone to cash out.

Those who place their homes on the market now, with aggressive below-market pricing, will likely be able to find suckers. Those who think it’s too early to panic will likely to be trapped down the road.

Home are illiquid. It’s seldom too early to panic.

When selling real estate, it’s a catastrophe to panic after the panic has already started.