Board of Governors of the Federal Reserve System

2. Borrowing by Businesses and Households

Vulnerabilities from business and household debt remained moderate

The balance sheet conditions of households and businesses continued to improve on net. Growth in nominal GDP has outpaced the modest growth in total private nonfinancial-sector debt in recent years. As a result, the debt-to-GDP ratio has declined to the lowest level in two decades (figure 2.1). Trends in both the household and business sectors contributed to the decline in the overall debt-to-GDP ratio.

Business debt-to-GDP (figure 2.2, blue line) and gross leverage of publicly traded corporations remained at levels near the top of their respective historical ranges. Interest coverage ratios (ICRs)—defined as the ratio of earnings before interest and tax to interest expense—remained flat at moderate levels, partly reflecting resilient earnings.

The household debt-to-GDP ratio continued to edge down to near 20-year lows (figure 2.2, black line). Homeowners have solid equity cushions, and many households have been benefiting from lower interest rate payments associated with refinancing or home purchases several years ago. That said, delinquency rates for credit cards and auto loans to nonprime borrowers were above their pre-pandemic levels.

While balance sheets in the nonfinancial business and household sectors remained sound, a sharp downturn in economic activity would depress business earnings and household incomes and reduce the debt-servicing capacity of smaller, riskier businesses with already low ICRs as well as particularly financially stretched households.

For additional context, Table 2.1 shows the amounts outstanding and recent historical growth rates of different forms of debt owed by nonfinancial businesses and households as of the second quarter of 2024.

Table 2.1. Outstanding amounts of nonfinancial business and household credit

Business debt vulnerabilities remained moderate

Nonfinancial business debt adjusted for inflation grew modestly in the first half of this year after declining in 2023 (figure 2.3). Traditional sources of business debt, such as corporate bonds and bank-intermediated loans, have grown slowly in recent quarters. Net issuance of risky debt—defined as issuance of speculative-grade bonds, unrated bonds, and leveraged loans minus retirements and repayments—edged up in the second and third quarters of 2024, partially reversing declines in previous quarters (figure 2.4). The net issuance of institutional leveraged loans, which has been particularly weak since late 2022, was moderately positive in the third quarter. In contrast to traditional forms of business credit, private credit has grown quickly recently and constitutes about 7 percent of total outstanding nonfinancial corporate debt.

Gross leverage—the ratio of debt to assets—of all publicly traded nonfinancial firms remained high by historical standards in the second quarter of 2024 (figure 2.5), though significantly lower than record highs seen at the onset of the pandemic. Net leverage—the ratio of debt less cash to total assets—also stayed elevated among large publicly traded businesses. Overall, corporate profits remained robust, and firms continued to be well placed to service their debt, despite some emerging signs of weakness among riskier firms. The median ICR for all publicly traded firms and for publicly traded firms rated below-investment-grade was flat in the first half of 2024, around levels that were well below post-pandemic peaks and somewhat below the level that prevailed from 2011 to 2020 (figure 2.6). The pass-through of higher interest rates to firms' borrowing costs remained moderate, reflecting record fixed-rate debt issuance by firms during the pandemic when interest rates were low.⁵ The 12-month trailing corporate bond default rate was little changed, on net, around the median of its historical distribution. Expectations of year-ahead defaults remained somewhat elevated relative to their history.

Credit quality of leveraged loans remained below historical norms. The share of newly issued loans to large corporations with debt multiples—defined as the ratio of debt to earnings before interest, taxes, depreciation, and amortization—greater than 4 fell in 2023 to its lowest level in the past decade and it hovered around that level through the third quarter of 2024 (figure 2.7). ICRs on outstanding leveraged loans remained in the low end of their historical distribution for the past decade, and ICRs on newly issued leveraged loans were also near their historical lows since 2006. The volume-weighted default rate on leveraged loans stayed well below previous peaks. However, the number of defaults and distressed loans that have been worked out (that is, renegotiated between the borrower and the lender) has been elevated relative to history (figure 2.8).

Small and middle-market firms that are privately held—which have less access to capital markets and primarily borrow from banks, private credit funds, and other sophisticated investors (such as insurance companies)—account for roughly 60 percent of the total outstanding debt of U.S. nonfinancial firms. While data for these firms are not as comprehensive as those for larger firms, vulnerabilities for these firms continued to edge up throughout the second quarter of 2024. Median gross and net leverage of private firms continued to inch up in the second quarter of 2024 but remained a bit below their historical medians. The ICR for the median firm in this category kept its downward trend from its peak in 2022 and currently stands only slightly above pre-pandemic levels, as higher interest rates started to reduce earnings and raise the cost of debt servicing. The average ICR at issuance for private credit is below 2, indicating debt-servicing capacity in the range of below-investment-grade public firms.

Delinquencies at small businesses were above pre-pandemic levels, and credit availability tightened

Interest rates on small business loans have been largely stable in recent months and remained near the top of the range observed since 2008. According to the National Federation of Independent Business's Small Business Economic Trends Survey, the share of firms that borrow regularly has fallen in recent months and sits in the lower range of its historical distribution in September 2024.⁶ Credit availability appeared to tighten for small firms in recent months. Data from the Small Business Lending Survey showed that banks continued to tighten standards on loans to small businesses.⁷ Further, measures of small business loan originations declined through September 2024. Small business credit quality has deteriorated in recent quarters, as both short-term (up to 90 days) and long-term (more than 90 days) delinquency rates rose from the historically low levels reached in spring 2022 to above their pre-pandemic levels.

Vulnerabilities from household debt remained moderate

Outstanding household debt adjusted for inflation has been little changed since the April report (figure 2.9). The ratio of total required household debt payments to total disposable income (the household debt-service ratio) was little changed at modest levels. As most household debt carries fixed interest rates, the increase in interest rates over 2022 and 2023 has only partially passed through to household interest expenses.

Mortgage credit risk remained low

Mortgage debt accounts for roughly three-fourths of total household debt. Since the April report, estimates of housing leverage, which measure outstanding mortgage loan balances relative to home values, stayed significantly below their previous peaks (figure 2.10). The model-based measure (black line), which measures home values as a function of rents and other market fundamentals, indicated higher leverage than the market-based measure (blue line), suggesting that homeowners' current large equity cushions are vulnerable to a future price correction. However, the model-based measure was only modestly elevated relative to its history. The overall mortgage delinquency rate and the share of mortgage balances in loss-mitigation programs in the third quarter remained close to the lower end of their historical distribution (figure 2.11). Delinquency rates have been held in check by large home equity cushions (figure 2.12) and strong underwriting standards.

New mortgage extensions, which have been skewed heavily toward prime borrowers over the past decade, continued to decline in the second quarter of 2024 amid elevated mortgage rates and high house prices (figure 2.13). In the fourth quarter of 2023, the early payment delinquency rate—the share of balances becoming delinquent within one year of mortgage origination—remained somewhat above the median of its historical distribution, possibly reflecting higher house prices and interest rates and the corresponding financial strains on newly originated mortgages.

Credit risk of consumer debt edged up, with some signs of stress among borrowers with lower credit scores

Consumer debt—which accounts for the remaining one-fourth of household debt and consists primarily of student, auto, and credit card loans—was about flat in inflation-adjusted terms since the last report (figure 2.14). However, delinquency rates for auto loans and credit cards remained above average, particularly among borrowers with lower credit scores. These borrowers hold a relatively small share of aggregate debt, and their high delinquency rates reportedly reflect, in part, increased borrowing by some households during and after the pandemic, rather than an abrupt broad-based weakening in households' ability to repay. Partly in response, lenders have tightened credit standards on those types of loans.

Inflation-adjusted auto loan balances were about flat since the last report at levels below their recent highs. Continued growth for subprime borrowers offset small declines for near-prime borrowers. The average maturity of auto loans at origination remained elevated in recent quarters, particularly for lower-credit score borrowers (figure 2.15). On balance, long-maturity loans tend to have higher default risks, partly because such loans have higher risk of falling deep into a negative equity position, which can be a factor that influences consumer defaults. The share of auto loans in delinquent status stayed at a level somewhat above its historical median (figure 2.16) after having increased moderately in recent years, largely owing to a more significant rise in auto loan delinquencies for subprime borrowers throughout 2023. The rise in delinquencies for subprime borrowers likely owes to a combination of factors, such as high car prices, loosened underwriting, higher interest rates, and elevated loan maturities.

Aggregate inflation-adjusted credit card balances were little changed for prime and near-prime borrowers through the third quarter of 2024 but continued to inch up for subprime borrowers (figure 2.17). Credit card delinquency rates moved up further in the third quarter and have reached their highest level since 2010 (figure 2.18), which largely owes to elevated delinquencies among nonprime borrowers.

 

References

 

 5. Only about 8 percent of outstanding bonds rated triple-B and 4 percent of outstanding high-yield bonds are due within a year. That said, about 16 percent of outstanding bonds rated triple-B and 20 percent of outstanding high-yield bonds are due within one to three years, indicating that pass-through may be higher if borrowing costs stay elevated for longer. Return to text

 6. This survey's data are available on the National Federation of Independent Business's website at https://www.nfib.com/surveys/small-business-economic-trends. Return to text

 7. This survey's data are available on the Federal Reserve Bank of Kansas City's website at https://www.kansascityfed.org/surveys/small-business-lending-survey/. Return to text